United States District Court, D. Delaware
Kathryn Keneally, Nathan L. Strup, UNITED STATES DEPARTMENT OF JUSTICE, Washington, DC, Attorneys for Petitioner.
Philip A. Rovner, Jonathan A. Choa, POTTER ANDERSON & COOPER LLP, Wilmington, DE, Breon S. Peace, Yaron Z. Reich, Jonathan Gifford, CLEARY GOTTLIEB STEEN & HAMILTON LLP, New York, NY, Attorneys for Respondent.
LEONARD P. STARK, District Judge.
Pending before the Court is Petitioner United States of America's Motion to Enforce Internal Revenue Service ("IRS") Summonses against Veolia Environnement North America Operations, Inc. ("Taxpayer"). (D.I. 1) Taxpayer has refused to produce materials sought by the IRS based on Taxpayer's assertion of work-product protection, attorney-client privilege, and tax practitioner privilege.
I. The IRS Audit
This dispute arises out of an IRS audit of Taxpayer's 2006 U.S. federal income tax return, in which Taxpayer claimed a $4.5 billion worthless stock deduction. (D.I. 5 at 2; D.I. 11 at 1) Taxpayer is a U.S. holding company owned by Veolia Environnement S.A. ("VE"), which is itself a subsidiary of Vivendi S.A., a multi-billion dollar French conglomerate. (D.I. 11 Ex. 1 ¶¶ 7-8)
In April 1999, Taxpayer purchased Water Application & Solutions Corporation ("WASCO") for $8.2 billion. (D.I. 8 ¶ 6) By 2006, Taxpayer had come to the conclusion that WASCO's stock was worthless. It then retained legal advisors and tax experts to identify a means by which it could claim WASCO's stock as a deduction under Section 165(g) of the Internal Revenue Code, 26 U.S.C. § 165(g). (D.I. 7 ¶¶ 7-11) Specifically, Taxpayer intended to reduce ordinary income by taking a deduction for worthless securities in affiliated corporations. See 26 U.S.C. § 165(g)(3); see also D.I. 11 at 3-4.
In 2006, Taxpayer determined that converting WASCO to a Delaware Limited Liability Corporation ("LLC") could be a viable "trigger" for claiming the deduction on its tax return. (D.I. 8 ¶ 10) Before finalizing the decision to convert WASCO to an LLC and claim the deduction, Taxpayer and VE retained counsel at Cleary Gottlieb Steen & Hamilton LLP ("Cleary Gottlieb") for legal advice, and additionally hired two valuation firms, Aon Accuracy ("Aon") and XRoads Solutions Group LLP ("XRoads"), to evaluate and produce written reports on WASCO's insolvency. (D.I. 7 ¶¶ 7-8; D.I. 8 ¶¶ 18, 20-21) On December 18, 2006, the Boards of Directors of WASCO and Taxpayer met and authorized the companies to pursue the claim. (D.I. 7 ¶ 12) Several days later, on December 22, 2006, WASCO was converted to an LLC. (D.1. 7 ¶ 15)
In February 2007, Taxpayer - already under audit by the IRS for its 2004 and 2005 returns - applied for and subsequently enrolled in the IRS's newly established Pre-Filing Agreement ("PFA") program, which was created "to resolve, before returns are filed, issues that are likely to be disputed in post-filing audits." (D.I. 8 ¶ 28; D.I. 11 at 4-5; see also D.I. 5 at 4) In April 2007, VE and Taxpayer hired a third valuation firm, Duff & Phelps LLC ("Duff & Phelps"), to produce an independent valuation of WASCO's stock. (D.I. 8 ¶ 30; D.I. 5 at 5) Taxpayer provided the IRS with XRoads' final versions of the reports on WASCO's stock, which both XRoads and Duff & Phelps prepared, as an effort to bolster Taxpayer's claim that WASCO's stock was worthless. (D.I. 8 ¶ 31; D.I. 5 at 5)
On December 5, 2008, the IRS issued summonses for a variety of documents in Taxpayer's possession. (D.I. 1 at ¶ 8) While Taxpayer produced "hundreds of thousands of pages in response to hundreds of requests from the IRS" (D.I. 4 at ¶ 10), it initially withheld 361 documents and portions of 45 documents. (D.I. 5 at 1; see also D.I. 8 ¶ 43) (stating that Taxpayer produced 641, 415 bates-stamped pages to IRS between January 2009 and April 2013) Taxpayer refused to produce these materials based on its assertion of several privileges: (1) work-product protection under Federal Rule of Civil Procedure 26(b)(3); (2) attorney-client privilege; and (3) tax practitioner privilege under 26 U.S.C. § 7525(a)(1). (D.I. 5; D.I. 12)
II. Procedural History
On January 4, 2013, the government filed this action to enforce the summonses and compel the production of the documents withheld by Taxpayer. (D.I. 1) On April 30, 2013, following briefing, the Court held a hearing regarding the government's motion. ( See Transcript of Apr. 30, 2013 hrg. (D.I. 21)) ("Tr.") Among the matters discussed were whether the Court should review a portion of the withheld documents in camera and, if so, which ones. ( See Tr. at 14) After the parties further met and conferred, the government agreed to withdraw its request for 178 documents and requested that the Court conduct a review of a sample of 55 documents representative of the remaining 228 contested documents. (D.I. 16 at 2) The Court then ordered Taxpayer to submit the requested 55 documents for in camera review (D.I. 18), and on May 24, 2013 Taxpayer did so.
Following inspection of the 55 documents, this Court issued a Memorandum Order on October 25, 2013. ( See D.I. 23) The Court made several findings, including a finding that Taxpayer had met its burden to show that it anticipated litigation as early as March 2006 ( id. at 9), and that Taxpayer improperly withheld documents containing communications made to its testifying experts, XRoads and Duff & Phelps ( id. at 13). The Court ordered the production of documents disclosed to testifying experts unless otherwise protected under Rule 26(b), and further ordered the parties to meet and confer to identify which documents still remained in dispute. ( Id. at 14, 16-17)
By November 14, 2013, both parties indicated to the Court that 92 documents remained in dispute. (D.I. 25, 26) These disputed documents generally fall into two categories: (1) materials claimed as work-product from 2006 onwards, and (2) materials protected under the attorney-client and tax practitioner privileges. On November 22, 2013, the Court ordered Taxpayer to submit the remaining documents in dispute for in camera inspection and - given the variety of documents claimed protected under the attorney client and tax practitioner privileges - allowed Taxpayer to accompany each document with a brief description of the privilege purportedly protecting each document in question. (D.I. 27) On December 6, 2013, Taxpayer submitted the documents. On December 13, the parties notified the Court that no other documents remained in dispute. (D.I. 29, 30)
I. Work-Product Doctrine
Federal Rule of Civil Procedure 26(b)(1) broadly provides: "[p]arties may obtain discovery regarding any non-privileged matter that is relevant to any party's claim or defense." The work-product exception to this disclosure requirement is set forth in Rule 26(b)(3)(A), which states: "Ordinarily, a party may not discover documents... that are prepared in anticipation of litigation or for trial by or for another party or its representative." This work-product doctrine functions to "promote[ ] the adversary system" by guarding the confidentiality of documents prepared in anticipation of litigation, allowing a party to prepare for litigation without fear that its work-product will be used against it. See Westinghouse Elec. Corp. v. Republic of Philippines, 951 F.2d 1414, 1428 (3d Cir. 1991); see Hickman v. Taylor, 329 U.S. 495, 510-11 (1947).
The "burden of demonstrating that a document is protected as work-product rests with the party asserting the doctrine." Conoco Inc. v. U.S. Dept. of Justice, 687 F.2d 724, 730 (3d Cir. 1982). Hence, "[o]nly by looking to the state of the mind of the party preparing the document, or... the party ordering the preparation of the document[, ]" Martin v. Bally's Park Place Casino & Hotel, 983 F.2d 1252, 1260 (3d Cir. 1993), can a court determine if a document comes within the scope of Rule 26(b)(3) protection. "[D]isclosure to a third party does not necessarily waive the protection of the work-product doctrine;" thus, in order to determine whether there has been a waiver of the work-product doctrine, courts must "distinguish between disclosures to adversaries and disclosures to non-adversaries." Westinghouse Elec. Corp., 951 F.2d at 1428. "Under this standard, the voluntary disclosure of attorney work-product to an adversary or a conduit to an adversary waives work-product protection for that material." United States v. Deloitte LLP, 610 F.3d 129, 140 (D.C. Cir. 2010); see also In re Chevron Corp., 633 F.3d 153, 165 (3d Cir. 2011) ("[I]t is only in cases in which the material is disclosed in a manner inconsistent with keeping it from an adversary that the work-product doctrine is waived.").
II. Attorney-Expert Communications
Federal Rule of Civil Procedure 26(a)(2)(B)(ii) mandates the disclosure of all "facts or data considered by" an expert witness who is retained or employed to provide expert testimony, when the facts or data were considered by the expert "in forming" "opinions the witness will express." See also Fed.R.Civ.P. 26(a)(2)(B)(i). In 2010, Rule 26 was amended to "address concerns about expert discovery, " including by adding Rule 26(b)(4)(B) protecting drafts of export reports required under Rule 26(a)(2)(C). See adv. comm. notes (2010). Also added was Rule 26(b)(4)(C), which "protect[s] communications between the party's attorney and any [expert] witness required to provide a report under Rule 26(a)(2)(B), " with three exceptions into which discovery is permitted: "communications [that] (i) relate to compensation for the expert's study or testimony; (ii) identify facts or data that the party's attorney provided and that the expert considered in forming the opinions to be expressed; or (iii) identify assumptions that the party's attorney provided and that the expert relied on in forming the opinions to be expressed." The advisory committee notes accompanying the 2010 amendments state: "The addition of Rule 26(b)(4)(C) is designed to protect counsel's work-product and ensure that lawyers may interact with retained experts without fear of exposing these communications."
III. Attorney-Client and Tax Practitioner Privileges
The attorney-client privilege protects client and attorney communications related to securing legal advice. See Rhone-Poulenc Rorer Inc. v. Home Indem. Co., 32 F.3d 851, 856 (3d Cir. 1994). The privilege applies to communications from an attorney to a client as well as from a client to its attorney. See Upjohn v. United States, 449 U.S. 383, 390 (1981). The attorney-client privilege must be "strictly confined within the narrowest possible limits consistent with the logic of its principle" because the "privilege obstructs the search for the truth and... its ...