United States v. Textron Inc. & Subsidiaries , 577 F.3d 21 ( 2009 )

United States Court of Appeals
For the First Circuit
No. 07-2631
UNITED STATES OF AMERICA,
Petitioner, Appellant,
v.
TEXTRON INC. AND SUBSIDIARIES,
Respondent, Appellant.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF RHODE ISLAND
[Hon. Ernest C. Torres, Senior U.S. District Judge]
Before
Lynch, Chief Judge,
Torruella, Boudin, Lipez and Howard,
Circuit Judges.
Judith A. Hagley, Tax Division, Department of Justice, with
whom David I. Pincus, Robert W. Metzler, Attorneys, Tax Division,
Department of Justice, John A. DiCicco, Acting Assistant Attorney
General, Gilbert S. Rothenberg, Acting Deputy Assistant Attorney
General, and Robert Clark Corrente, United States Attorney, were on
supplemental brief for appellant.
John A. Tarantino with whom Patricia K. Rocha, Adler Pollock
& Sheehan P.C., Arthur L. Bailey, J. Walker Johnson and Steptoe &
Johnson LLP were on supplemental brief for appellee.
Professor Claudine V. Pease-Wingenter, Phoenix School of Law,
on brief in support of appellee Textron Inc., Amicus Curiae.
David M. Brodsky, Robert J. Malionek, Adam J. Goldberg, Latham
& Watkins LLP, Robin S. Conrad, Amar D. Sarwal, National Chamber
Litigation Center, Inc., Susan Hackett, Senior Vice President and
General Counsel, Association of Corporate Counsel, on brief in
support of Textron Inc., Amici Curiae.
______________________
OPINION EN BANC
August 13, 2009
BOUDIN, Circuit Judge. The question for the en banc
court is whether the attorney work product doctrine shields from an
IRS summons "tax accrual work papers" prepared by lawyers and
others in Textron's Tax Department to support Textron's calculation
of tax reserves for its audited corporate financial statements.
Textron is a major aerospace and defense conglomerate, with well
over a hundred subsidiaries, whose consolidated tax return is
audited by the IRS on a regular basis. To understand the dispute,
some background is required concerning financial statements,
contingent tax reserves and tax audit work papers.
As a publicly traded corporation, Textron is required by
federal securities law to have public financial statements
certified by an independent auditor. See 15 U.S.C. §§ 78l, 78m
(2006); 17 C.F.R. § 210 et seq. (2009). To prepare such financial
statements, Textron must calculate reserves to be entered on the
company books to account for contingent tax liabilities. Such
liabilities, which affect the portrayal of assets and earnings,
include estimates of potential liability if the IRS decides to
challenge debatable positions taken by the taxpayer in its return.
The calculation of such reserves entails preparing work
papers describing Textron's potential liabilities for further
taxes; these underpin the tax reserve entries in its financial
statement and explain the figures chosen to the independent auditor
who certifies that statement as correct. By examining the work
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papers the accountant discharges its own duty to determine "the
adequacy and reasonableness of the corporation's reserve account
for contingent tax liabilities." United States v. Arthur Young &
Co., 465 U.S. 805, 812 (1983) (rejecting claim of accountant work
product privilege protecting such work papers).1 The work papers
are thus one step in a process whose outcome is a certified
financial statement for the company.
In Textron's case, its Tax Department lists items in the
tax return that, if identified and challenged by the IRS, could
result in additional taxes being assessed. The final spreadsheets
list each debatable item, including in each instance the dollar
amount subject to possible dispute and a percentage estimate of the
IRS' chances of success. Multiplying the amount by the percentage
fixes the reserve entered on the books for that item. The
spreadsheets reflecting these calculations may be supported by
backup emails or notes.
A company's published financial statements do not
normally identify the specific tax items on the return that may be
debatable but incorporate or reflect only the total reserve figure.
As the Supreme Court explained in Arthur Young, tax accrual work
1
The procedural requirement that auditors examine tax accrual
work papers is based on a combination of Statement on Auditing
Standards No. 96, Audit Documentation (2002), superseded by
Auditing Standards No. 3, Audit Documentation (2004); Statement on
Auditing Standards No. 326, Evidential Matter (1980); and Auditing
Interpretation No. 9326, Evidential Matter: Auditing
Interpretations of Section 326 (2003).
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papers provide a resource for the IRS, if the IRS can get access to
them, by "pinpoint[ing] the 'soft spots' on a corporation's tax
return by highlighting those areas in which the corporate taxpayer
has taken a position that may, at some later date, require the
payment of additional taxes" and providing "an item-by-item
analysis of the corporation's potential exposure to additional
liability." 465 U.S. at 813.
The IRS does not automatically request tax accrual work
papers from taxpayers; rather, in the wake of Enron and other
corporate scandals, the IRS began to seek companies' tax accrual
work papers only where it concluded that the taxpayer had engaged
in certain listed transactions "that [are] the same as or
substantially similar to one of the types of transactions that the
[IRS] has determined to be a tax avoidance transaction." 26 C.F.R.
§ 1.6011-4(b)(2) (2009). Only a limited number of transactions are
so designated.2
The present case began with a 2003 IRS audit of Textron's
corporate income tax liability for the years 1998-2001. In
reviewing Textron's 2001 return, the IRS determined that a Textron
subsidiary--Textron Financial Corp. ("Textron Financial")--had
engaged in nine listed transactions. In each of the nine
2
A current list of such transaction types, amounting to less
than three dozen, appears at Internal Revenue Service, Recognized
Abusive and Listed Transactions - LMSB Tier I Issues,
http://www.irs.gov/businesses/corporations/article/0,,id=120633,0
0.html (visited July 7, 2009).
-5-
instances, Textron Financial had purchased equipment from a foreign
utility or transit operator and leased it back to the seller on the
same day. Although such transactions can be legitimate, the IRS
determined that they were sale-in, lease-out ("SILO") transactions,
which are listed as a potential tax shelter subject to abuse by
taxpayers.
SILOs allow tax-exempt or tax-indifferent organizations--
for example, a tax-exempt charity or a city-owned transit
authority--to transfer depreciation and interest deductions, from
which they cannot benefit, to other taxpayers who use them to
shelter income from tax. Where the only motive of a sale and lease
back is tax avoidance, it can be disregarded by the IRS and taxes
assessed on the wrongly sheltered income.3
Textron had shown the spreadsheets to its outside
accountant, Ernst & Young, but refused to show them to the IRS.
The IRS issued an administrative summons pursuant to 26 U.S.C. §
7602 (2006), which allows the IRS, in determining the accuracy of
any return, to "examine any books, papers, records, or other data
which may be relevant or material to such inquiry." Id. §
7602(a)(1). According to IRS policy, where the taxpayer claims
3
See AWG Leasing Trust v. United States, 592 F. Supp. 2d 953,
958 (N.D. Ohio 2008) (upholding denial of depreciation and interest
deductions for SILO transaction); I.R.S. Notice 2005-13, 2005-9
I.R.B. 630 (Feb. 11, 2005); Shvedov, Tax Implications of SILOs,
QTEs, and Other Leasing Transactions with Tax-Exempt Entities 10-
12, CRS Report for Congress (Nov. 30, 2004).
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benefits from only a single listed transaction, the IRS seeks only
the workpapers for that transaction; but where (as in Textron's
case) the taxpayer claims benefits from multiple listed
transactions, the IRS seeks all of the workpapers for the tax year
in question. I.R.S. Announcement 2002-63, 2002-27 I.R.B. 72 (July
8, 2002). The summons also sought related work papers created by
Ernst & Young in determining the adequacy of Textron's reserves
that Textron might possess or could obtain. Textron again refused.
The IRS brought an enforcement action in federal district
court in Rhode Island. See 26 U.S.C. § 7604(a) (2006). Textron
challenged the summons as lacking legitimate purpose and also
asserted, as bars to the demand, the attorney-client and tax
practitioner privileges and the qualified privilege available for
litigation materials under the work product doctrine. The IRS
contested all of the privilege claims. Both the IRS and Textron
filed affidavits and, in addition, the district court heard
witnesses from both sides.4
4
Textron's evidence came from Norman Richter, chief tax
counsel and manager of Textron's Tax Department; Roxanne Cassidy,
director of tax reporting; Edward Andrews, director of tax audits;
Debra Raymond, vice president, taxes, of Textron Financial; and
Mark Weston, a partner in Ernst & Young. IRS evidence was
provided by Internal Revenue Agent Edward Vasconcellos; Professor
Douglas Carmichael, former chief auditor of the regulatory body for
auditors of public companies (the Public Company Accounting
Oversight Board); and Gary Kane, an IRS expert on tax accrual work
papers.
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Textron agreed that it usually settled disputes with the
IRS through negotiation or concession or at worst through the
formal IRS administrative process; but it testified that sometimes
it had litigated disputed tax issues in federal court. Its
evidence also showed that the estimates for tax reserves and the
supporting work papers were generated within its Tax Department but
that tax lawyers in that department were centrally involved in
their preparation and that Textron Financial also used an outside
counsel to advise it on tax reserve requirements.
Textron described generically the contents of the work
papers in question: these included (1) summary spreadsheets showing
for each disputable item the amount in controversy, estimated
probability of a successful challenge by the IRS, and resulting
reserve amounts; and (2) back up e-mail and notes. In some
instances the spreadsheet entries estimated the probability of IRS
success at 100 percent. Textron said that the spreadsheets had
been shown to and discussed with its independent auditor but
physically retained by Textron.
Neither side disputed that the immediate purpose of the
work papers was to establish and support the tax reserve figures
for the audited financial statements. Textron's evidence was to
the effect that litigation over specific items was always a
possibility; the IRS did not deny that in certain cases litigation
could result although it said that this was often unlikely.
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Whether Textron's evidence is materially different than that of the
IRS remains to be considered.
Ultimately, the district court denied the petition for
enforcement. United States v. Textron Inc., 507 F. Supp. 2d 138,
150, 155 (D.R.I. 2007). The court agreed with the IRS that the
agency had a legitimate purpose for seeking the work papers. Id.
at 145. It also ruled that insofar as the Textron-prepared work
papers might otherwise be protected by attorney-client privilege,
or the counterpart tax practitioner privilege for non-lawyers
engaged in tax practice, see 26 U.S.C. § 7525 (2006), those
privileges had been waived when Textron disclosed the work papers'
content to Ernst & Young. Id. at 152.
However, the district court concluded that the papers
were protected by the work product privilege, which derived from
Hickman v. Taylor, 329 U.S. 495 (1947), and is now embodied in Rule
26(b)(3) of the Federal Rules of Civil Procedure. This privilege,
the district court held, had not been waived by disclosure of the
work papers to the accountant. Textron, 507 F. Supp. 2d at 152-53.
The district court's decision that the work papers were protected
work product involved both a description of factual premises and a
legal interpretation of applicable doctrine.
The district court first said (paraphrasing a Textron
witness) the work papers were prepared to assure that Textron was
"adequately reserved with respect to any potential disputes or
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litigation" over its returns; the court also said that, by fair
inference, the work papers served "to satisfy an independent
auditor that Textron's reserve for contingent liabilities satisfied
the requirements of generally accepted accounting principles (GAAP)
so that a 'clean' opinion would be given" for Textron financial
statements. Textron, 507 F. Supp. 2d at 143.
Then, in its discussion of legal doctrine, the district
court stated:
As the IRS correctly observes, the work
product privilege does not apply to
"'documents that are prepared in the ordinary
course of business or that would have been
created in essentially similar form
irrespective of the litigation.'" Maine, 298
F.3d at 70 (quoting [United States v. Adlman,
134 F.3d 1194, 1202 (2d Cir. 1998)]). However,
it is clear that the opinions of Textron's
counsel and accountants regarding items that
might be challenged by the IRS, their
estimated hazards of litigation percentages
and their calculation of tax reserve amounts
would not have been prepared at all "but for"
the fact that Textron anticipated the
possibility of litigation with the IRS. . . .
Thus, while it may be accurate to say that the
workpapers helped Textron determine what
amount should be reserved to cover any
potential tax liabilities and that the
workpapers were useful in obtaining a "clean"
opinion from E & Y regarding the adequacy of
the reserve amount, there would have been no
need to create a reserve in the first place,
if Textron had not anticipated a dispute with
the IRS that was likely to result in
litigation or some other adversarial
proceeding.
Textron, 507 F. Supp. 2d at 150.
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The court concluded that the work papers were therefore
prepared "because of" the prospect of litigation, Textron, 507 F.
Supp. 2d at 150, a phrase used in Maine v. United States Dep't of
Interior, 298 F.3d 60, 68 (1st Cir. 2002). The court rejected the
IRS' reliance on a Fifth Circuit decision rejecting work product
protection for tax accrual work papers on the ground that the Fifth
Circuit followed a different "primary purpose" test for work
protect. Textron, 507 F. Supp. 2d at 150 (discussing United States
v. El Paso Co., 682 F.2d 530, 543 (5th Cir. 1982), cert. denied,
466 U.S. 944 (1984)).
On appeal, a divided panel upheld the district court's
decision. The en banc court then granted the government's petition
for rehearing en banc, vacated the panel decision, and obtained
additional briefs from the parties and interested amici. We now
conclude that under our own prior Maine precedent--which we
reaffirm en banc--the Textron work papers were independently
required by statutory and audit requirements and that the work
product privilege does not apply.
The case presents two difficulties. One, which can
readily be dispelled, stems from the mutability of language used in
the governing rules and a confusion between issues of fact and
issues of legal characterization. The other problem is more basic:
how far work product protection extends turns on a balancing of
policy concerns rather than application of abstract logic; here,
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two circuits have addressed tax accrual work papers in the work
product context, but, apart from whatever light is cast by Arthur
Young, the Supreme Court has not ruled on the issue before us,
namely, one in which a document is not in any way prepared "for"
litigation but relates to a subject that might or might not
occasion litigation.
In origin, the work product privilege derives from the
Supreme Court's decision in Hickman v. Taylor, 329 U.S. at 510-11,
and focused at the outset on the materials that lawyers typically
prepare for the purpose of litigating cases. Hickman v. Taylor
concerned ongoing litigation in which one side filed
interrogatories seeking from opposing counsel memoranda recording
witness interviews that the latter had conducted after receiving
notice of possible claims. Often such material and other items
designed for use at trial (e.g., draft briefs, outlines of cross
examination) are not obtained from or shared with clients and are
unprotected by the traditional attorney-client privilege.
Hickman v. Taylor addressed "the extent to which a party
may inquire into oral and written statements of witnesses, or other
information, secured by an adverse party's counsel in the course of
preparation for possible litigation after a claim has arisen." 329
U.S. at 497. The Court cited a privilege in English courts
protecting
[a]ll documents which are called into existence
for the purpose--but not necessarily the sole
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purpose--of assisting the deponent or his legal
advisers in any actual or anticipated
litigation . . . . Reports . . . if made in
the ordinary course of routine, are not
privileged . . . .
Id. at 510 n. 9.
This history led the Court to practical considerations:
Proper preparation of a client's case demands
that he assemble information, sift what he
considers to be the relevant from the
irrelevant facts, prepare his legal theories
and plan his strategy without undue and
needless interference. . . . This work is
reflected, of course, in interviews,
statements, memoranda, correspondence, briefs,
mental impressions, personal beliefs, and
countless other tangible and intangible ways--
aptly though roughly termed . . . as the "work
product of the lawyer."
Id. at 511.
On this basis the Court declared that the interrogatories,
which sought witness interviews conducted by opponent counsel in
preparation for litigation, were protected by a qualified privilege.
See id. at 511-12. When in 1970 the Supreme Court through the rule-
making process codified the work product privilege in Rule 26(b)(3),
it described the privilege as extending to documents and other
tangible things that "are prepared in anticipation of litigation or
for trial." This phrase, as illuminated by Hickman v. Taylor's
reasoning, is the one to be applied in this case.
Turning back to the present case, the IRS is
unquestionably right that the immediate motive of Textron in
preparing the tax accrual work papers was to fix the amount of the
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tax reserve on Textron's books and to obtain a clean financial
opinion from its auditor. And Textron may be correct that unless
the IRS might dispute an item in the return, no reserve for that
item might be necessary, so perhaps some of the items might be
litigated. But in saying that Textron wanted to be "adequately
reserved," the district judge did not say that the work papers were
prepared for use in possible litigation--only that the reserves
would cover liabilities that might be determined in litigation. If
the judge had made a "for use" finding--which he did not--that
finding would have been clearly erroneous.
That the purpose of the work papers was to make book
entries, prepare financial statements and obtain a clean audit
cannot be disputed. This was the testimony of IRS expert and former
Chief Auditor of the Public Company Accounting Oversight Board
Douglas Carmichael:
Q. . . . Would you please explain what tax
accrual workpapers are?
A. . . . Tax accrual workpapers really
include all the support for the tax assets and
liabilities shown in the financial statements
. . . .
A. Well, from the company's perspective,
they're created because, for example, for a
public company, the key officers of the company
sign a certification saying that those
financial statements are fairly presented, and
they need support for that.
From the auditor's perspective, it's the
same thing, the auditor needs to record in the
workpapers what the auditor did to comply with
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generally accepted auditing standards. So the
workpapers are the principal support for the
auditor's opinion.
Q. And why do public companies prepare
financial statements?
A. Usually, to meet requirements for
raising capital. If they're a public company,
they need to file annual financial statements
on a form 10K with the SEC and quarterly
information on a 10Q.
The Textron witnesses, while using the word "litigation"
as often as possible in their testimony, said the same thing.
Textron's testimony differed from that of the IRS expert only in its
further assertion that, without the possibility of litigation, no
tax reserves or audit papers would have been necessary. For
example, Roxanne Cassidy, Textron's director of tax reporting,
testified as follows:
Q. . . . [W]hat was Textron's purpose in
preparing those tax reserve papers?
A. The purpose primarily was to determine
whether Textron was adequately reserved with
respect to any potential disputes or
litigations that would happen in the future.
We would need to ensure that we were adequately
reserved in the current year on Textron's
financial statements.
. . .
Q. And as a publicly traded company, is
Textron required to file its financial
statements with the Securities and Exchange
Commission?
A. Yes.
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Q. And do those financial statements
include tax reserves?
A. Yes. . . .
. . .
Q. And in having its tax reserves audited
by an independent auditor, must Textron be able
to support the determinations it has made
regarding the adequacy of its tax reserves with
some type of evidence?
A. Yes, the support needs to be to the
satisfaction of the auditors.
As the IRS expert stated, even if litigation were
"remote," the company would still have to prepare work papers to
support its judgment. Textron's own witness acknowledged that it
would "have to include in its . . . tax accrual work papers any new
transactions that the company entered into that year that there
might be some tax exposure on" regardless of whether it anticipated
likely litigation. Judged by Textron's own experience, most--
certainly those with high percentage estimates of IRS success--would
never be litigated.
To complete the story, we note one suggestion by one
Textron witness that, if litigation did occur, the work papers could
be useful to Textron in that litigation.5 This assertion was not
5
Textron Vice President of Taxes Norman Richter said that
Textron would still prepare tax accrual workpapers absent GAAP
requirements "[b]ecause it guides us--it's--the analysis is still--
it would guide us in making litigation and settlement decisions
later in the process." This assertion was not contained in
Richter's affidavit, which instead said that Textron prepared the
work papers "to comply with GAAP" as required for reporting taxes
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supported by any detailed explanation, was not adopted by the
district judge and is more than dubious: the main aim of audit work
papers is to estimate the amount potentially in dispute and the
percentage chance of winning or losing. Even an academic supporter
of Textron's legal position conceded that "it is doubtful that tax
accrual workpapers, which typically just identify and quantify
vulnerable return positions, would be useful in the litigation
anticipated with respect to those positions." Pease-Wingenter, The
Application of the Attorney-Client Privilege to Tax Accrual
Workpapers: The Real Legacy of United States v. Textron, 8 Houston
Bus. & Tax L.J. 337, 346 (2008).
Any experienced litigator would describe the tax accrual
work papers as tax documents and not as case preparation materials.
Whether work product protection should apply to such documents is
a legal question informed by the language of rules and Supreme Court
doctrine, direct precedent, and policy judgments. The first of
these sources--Supreme Court doctrine and the wording of the rules--
is helpful to the IRS; direct circuit precedent and the underlying
policy of the doctrine and other prudential considerations are more
helpful still. Legal commentators can be found on each side; the
most persuasive of them favors the IRS.6
to the SEC, and was not supported by detail or explanation in the
record.
6
See Ventry, Protecting Abusive Tax Avoidance, 120 Tax Notes
857, 870-83 (2008); Johnson, The Work Product Doctrine and Tax
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From the outset, the focus of work product protection has
been on materials prepared for use in litigation, whether the
litigation was underway or merely anticipated. Thus, Hickman v.
Taylor addressed "the extent to which a party may inquire into oral
and written statements of witnesses, or other information, secured
by an adverse party's counsel in the course of preparation for
possible litigation after a claim has arisen." 329 U.S. at 497(emphasis added). Similarly, the English privilege, invoked by
Hickman v. Taylor, privileged "documents which are called into
existence for the purpose--but not necessarily the sole purpose--of
assisting the deponent or his legal advisers in any actual or
anticipated litigation." Id. at 510 n. 9 (emphasis added) (internal
quotation marks omitted).
The phrase used in the codified rule--"prepared in
anticipation of litigation or for trial" did not, in the reference
to anticipation, mean prepared for some purpose other than
litigation: it meant only that the work might be done for litigation
but in advance of its institution. The English precedent, doubtless
the source of the language in Rule 26, specified the purpose "of
assisting the deponent or his legal advisers in any actual or
anticipated litigation . . . ." The Advisory Committee's Note cited
Accrual Workpapers, 124 Tax Notes 155, 160-68 (2009). The Pease-
Wingenter article, supra, identifies many weaknesses in the Textron
argument, id. at 343-48, although Pease now says her own ultimate
view favors Textron.
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with approval a decision denying work product protection to a
driver's accident report, made pursuant to Interstate Commerce
Commission rules, even though it might well have become the subject
of litigation. Fed. R. Civ. P. 26 advisory committee's note
(1970).7
It is not enough to trigger work product protection that
the subject matter of a document relates to a subject that might
conceivably be litigated. Rather, as the Supreme Court explained,
"the literal language of [Rule 26(b)(3)] protects materials prepared
for any litigation or trial as long as they were prepared by or for
a party to the subsequent litigation." Federal Trade Commission v.
Grolier Inc., 462 U.S. 19, 25 (1983) (emphasis added). This
distinction is well established in the case law. See, e.g., NLRB
v. Sears, Roebuck & Co., 421 U.S. 132, 138 (1975).8
7
Goosman v. A. Duie Pyle, Inc., 320 F.2d 45 (4th Cir. 1963).
In Goosman, the Fourth Circuit denied work product protection to
reports a truck driver made to the lessee and owner of the truck
following an accident. The court explained that the reports "were
made in the ordinary course of business under ICC regulations and
do not represent the lawyer's work product within the holding in
Hickman v. Taylor." Id. at 52. See also, e.g., Calabro v. Stone,
225 F.R.D. 96, 99 (E.D.N.Y. 2004); In re Raytheon Securities
Litigation, 218 F.R.D. 354, 359 (D. Mass. 2003).
8
Accord United States v. Roxworthy, 457 F.3d 590, 595 (6th
Cir. 2006) ("Nevertheless, the key issue in determining whether a
document should be withheld is the function that the document
serves."); Coastal States Gas Corp. v. Dep't of Energy, 617 F.2d
854, 858 (D.C. Cir. 1980) (same); Church of Scientology Int'l v.
IRS, 845 F. Supp. 714, 723 (C.D. Cal. 1993) ("The Ninth Circuit
test focuses on the function of a document as part of the
deliberative process rather than on the contents of the
document.").
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Nor is it enough that the materials were prepared by
lawyers or represent legal thinking. Much corporate material
prepared in law offices or reviewed by lawyers falls in that vast
category. It is only work done in anticipation of or for trial that
is protected. Even if prepared by lawyers and reflecting legal
thinking, "[m]aterials assembled in the ordinary course of business,
or pursuant to public requirements unrelated to litigation, or for
other nonlitigation purposes are not under the qualified immunity
provided by this subdivision." Fed. R. Civ. P. 26 advisory
committee's note (1970). Accord Hickman v. Taylor, 329 U.S. at 510
n. 9 (quoting English precedent that "[r]eports . . . if made in the
ordinary course of routine, are not privileged").
Every lawyer who tries cases knows the touch and feel of
materials prepared for a current or possible (i.e., "in anticipation
of") law suit. They are the very materials catalogued in Hickman
v. Taylor and the English precedent with which the decision began.
No one with experience of law suits would talk about tax accrual
work papers in those terms. A set of tax reserve figures,
calculated for purposes of accurately stating a company's financial
figures, has in ordinary parlance only that purpose: to support a
financial statement and the independent audit of it.
Focusing next on direct precedent, work product protection
for tax audit work papers has been squarely addressed only in two
circuits: this one and the Fifth. In Maine, we said that work
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product protection does not extend to "documents that are prepared
in the ordinary course of business or that would have been created
in essentially similar form irrespective of the litigation." Maine,
298 F.3d at 70 (quoting United States v. Adlman, 134 F.3d 1194, 1202
(2d Cir. 1998)) (internal quotation marks omitted). Maine applies
straightforwardly to Textron's tax audit work papers--which were
prepared in the ordinary course of business--and it supports the IRS
position.
Similarly, the Fifth Circuit in El Paso denied protection
for the work papers because the court recognized that the company
in question was conducting the relevant analysis because of a need
to "bring its financial books into conformity with generally
accepted auditing principles." 682 F.2d at 543. The Fifth Circuit,
which employs a "primary purpose" test, found that the work papers'
"sole function" was to back up financial statements. Id. at 543-44.
Here, too, the only purpose of Textron's papers was to prepare
financial statements.
Other circuits have not passed on tax audit work papers
and some might take a different view. But many of the debatable
cases affording work product protection involve documents
unquestionably prepared for potential use in litigation if and when
it should arise.9 There is no evidence in this case that the work
9
See, e.g., Delaney, Migdail & Young, Chartered v. IRS, 826
F.2d 124, 127 (D.C. Cir. 1987) (protection for "attorneys'
assessment of . . . legal vulnerabilities in order to make sure it
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papers were prepared for such a use or would in fact serve any
useful purpose for Textron in conducting litigation if it arose.
Finally, the underlying prudential considerations squarely
support the IRS' position in this case, and such considerations have
special force because Hickman v. Taylor was the child of such
considerations, as the quotations above make clear. The privilege
aimed centrally at protecting the litigation process, Coastal States
Gas Corp. v. Department of Energy, 617 F.2d 854, 864 (D.C. Cir.
1980), specifically, work done by counsel to help him or her in
litigating a case. It is not a privilege designed to help the
lawyer prepare corporate documents or other materials prepared in
the ordinary course of business. Where the rationale for a rule
stops, so ordinarily does the rule.
Nor is there present here the concern that Hickman v.
Taylor stressed about discouraging sound preparation for a law suit.
That danger may exist in other kinds of cases, but it cannot be
present where, as here, there is in substance a legal obligation to
prepare such papers: the tax audit work papers not only have a
different purpose but have to be prepared by exchange-listed
companies to comply with the securities laws and accounting
principles for certified financial statements. Arthur Young made
does not miss anything in crafting its legal case"); see also In re
Sealed Case, 146 F.3d 881, 885 (D.C. Cir. 1998) (protection for
documents to "protect the client from future litigation about a
particular transaction").
-22-
this point in refusing to create an accountant's work product
privilege for tax audit papers:
[T]he auditor is ethically and professionally
obligated to ascertain for himself as far as
possible whether the corporation's contingent
tax liabilities have been accurately stated. .
. . Responsible corporate management would not
risk a qualified evaluation of a corporate
taxpayer's financial posture to afford cover
for questionable positions reflected in a prior
tax return.
465 U.S. at 818-19; see also Johnson, supra, at 160-61.
Textron apparently thinks it is "unfair" for the
government to have access to its spreadsheets, but tax collection
is not a game. Underpaying taxes threatens the essential public
interest in revenue collection. If a blueprint to Textron's
possible improper deductions can be found in Textron's files, it is
properly available to the government unless privileged. Virtually
all discovery against a party aims at securing information that may
assist an opponent in uncovering the truth. Unprivileged IRS
information is equally subject to discovery.10
The practical problems confronting the IRS in discovering
under-reporting of corporate taxes, which is likely endemic, are
serious. Textron's return is massive--constituting more than 4,000
pages--and the IRS requested the work papers only after finding a
10
See Abel Inv. Co. v. United States, 53 F.R.D. 485, 488 (D.
Neb. 1971) (holding that IRS documents created during an audit were
not protected work product, despite containing attorneys' mental
impression and legal theories, because an IRS audit is not
litigation).
-23-
specific type of transaction that had been shown to be abused by
taxpayers. It is because the collection of revenues is essential
to government that administrative discovery, along with many other
comparatively unusual tools, are furnished to the IRS.
As Bentham explained, all privileges limit access to the
truth in aid of other objectives, 8 Wigmore, Evidence § 2291
(McNaughton Rev. 1961), but virtually all privileges are restricted-
-either (as here) by definition or (in many cases) through explicit
exceptions--by countervailing limitations. The Fifth Amendment
privilege against self-incrimination is qualified, among other
doctrines, by the required records exception, see Grosso v. United
States, 390 U.S. 62, 67-68 (1968), and the attorney client
privilege, along with other limitations, by the crime-fraud
exception, see Clark v. United States, 289 U.S. 1, 15 (1933).
To sum up, the work product privilege is aimed at
protecting work done for litigation, not in preparing financial
statements. Textron's work papers were prepared to support
financial filings and gain auditor approval; the compulsion of the
securities laws and auditing requirements assure that they will be
carefully prepared, in their present form, even though not
protected; and IRS access serves the legitimate, and important,
function of detecting and disallowing abusive tax shelters.
-24-
The judgment of the district court is vacated and the case
is remanded for further proceedings consistent with this decision.
It is so ordered.
Dissent follows.
-25-
TORRUELLA, Circuit Judge, with whom LIPEZ, Circuit Judge,
joins, Dissenting. To assist the IRS in its quest to compel
taxpayers to reveal their own assessments of their tax returns, the
majority abandons our "because of" test, which asks whether "'in
light of the nature of the document and the factual situation in the
particular case, the document can be fairly said to have been
prepared or obtained because of the prospect of litigation.'" Maine
v. United States Dep't of the Interior, 298 F.3d 60, 68 (1st Cir.
2002) (emphasis in original) (quoting United States v. Adlman, 134
F.3d 1194, 1202 (2d Cir. 1998)). The majority purports to follow
this test, but never even cites it. Rather, in its place, the
majority imposes a "prepared for" test, asking if the documents were
"prepared for use in possible litigation." Maj. Op. at 13. This
test is an even narrower variant of the widely rejected "primary
motivating purpose" test used in the Fifth Circuit and specifically
repudiated by this court. In adopting its test, the majority
ignores a tome of precedents from the circuit courts and contravenes
much of the principles underlying the work-product doctrine. It
also brushes aside the actual text of Rule 26(b)(3), which
"[n]owhere . . . state[s] that a document must have been prepared
to aid in the conduct of litigation in order to constitute work
product." Adlman, 134 F.3d at 1198. Further, the majority
misrepresents and ignores the findings of the district court. All
while purporting to do just the opposite of what it actually does.
-26-
I. The Majority Quietly Rejects Circuit Precedent
The majority claims allegiance to our prior decision in
Maine, 298 F.3d at 70. Specifically, the majority seizes upon a
single line from that decision: "the 'because of' standard does not
protect from disclosure 'documents that are prepared in the ordinary
course of business or that would have been created in essentially
similar form irrespective of the litigation.'" Id. (quoting Adlman,
134 F.3d at 1202). This qualification is important to be sure, and
I will address it infra, Section III.B.2. But I must start by
addressing the rest of the Maine decision, which the majority is
careful to ignore.
In that decision, Maine sought documents prepared by the
Department of the Interior regarding its decision, made during
pending related litigation, to classify salmon as a protected
species. Id. at 64. The district court found some of these
administrative documents unprotected as the Department had not shown
that litigation preparation was "'the primary motivating factor for
the preparation of the documents.'" Id. at 66-67. This formulation
of the test for "anticipation of litigation" was based on the Fifth
Circuit rule that the work-product doctrine did not protect
documents that were "not primarily motivated to assist in future
litigation." United States v. El Paso, 682 F.2d 530, 542-43 (5th
Cir. 1982) (emphasis added) (citing United States v. Davis, 636 F.2d
1028, 1040 (5th Cir. 1981)). On appeal in Maine, we specifically
-27-
repudiated this test and adopted the broader "because of" test,
which had been thoughtfully and carefully explained by Judge Leval
in the Second Circuit decision in Adlman, 134 F.3d at 1202-03. See
Maine, 298 F.3d at 68 ("In light of the decisions of the Supreme
Court, we therefore agree with the formulation of the work-product
rule adopted in Adlman and by five other courts of appeals.").
In the present case, the majority purports to follow
Maine, but really conducts a new analysis of the history of the
work-product doctrine and concludes that documents must be
"'prepared for any litigation or trial.'" Maj. Op. at 18 (emphasis
in original) (quoting FTC v. Grolier Inc., 462 U.S. 19, 25 (1983)).
Similarly, at another point, the majority suggests that documents
must be "for use" in litigation in order to be protected. Id. at
13. Grolier did not establish such a test and the majority can
point to no court that has so ruled.11 Rather, the majority of
11
To support its conclusion, the majority commits a plain
logical error. The majority states that work-product protection
must not be judged solely on its subject matter, but rather whether
the documents's purpose is for use in litigation. In support of
this proposition, the majority cites a number of cases that
propound the uncontroversial proposition that a document must be
judged according to its purpose, not solely its content. Maj. Op.
at 18 n.8. But those cases do not establish the majority's rule
that the documents' purpose must be limited to use in litigation.
Rather, one of the cases the majority cites adopts the test that
the document must have been created "because of" litigation, which,
as Adlman describes, is antithetical to the majority's new
requirement. United States v. Roxworthy, 457 F.3d 590, 593-94 (6th
Cir. 2006) (adopting Adlman's "because of" test). Another of the
majority's citations is from the D.C. Circuit, which has also since
adopted the "because of" test. Senate of Puerto Rico v. United
States Dep't of Justice, 823 F.2d 574, 587 n.42 (D.C. Cir. 1987).
-28-
circuit courts, led by the Second Circuit's decision in Adlman, have
rejected such a rule.
Adlman's articulation of the "because of" test is fatal
to the majority's position. In that case, Judge Leval discussed the
application of the work-product doctrine "to a litigation analysis
prepared by a party or its representative in order to inform a
business decision which turns on the party's assessment of the
likely outcome of litigation expected to result from the
transaction." Adlman, 134 F.3d at 1197. In other words, Adlman
asked whether the work-product doctrine applies where a dual purpose
exists for preparing the legal analysis, that is, where the dual
purpose of anticipating litigation and a business purpose co-exist.
To answer that question, the Adlman court examined and rejected the
"primary purpose" test adopted by the Fifth Circuit in El Paso, 682
F.2d at 542-43, which only grants work-product immunity to
workpapers prepared "primarily motivated to assist in future
litigation over the return," id. at 543:
[Protection] is less clear, however, as to
documents which, although prepared because of
expected litigation, are intended to inform a
business decision influenced by the prospects
of the litigation. The formulation applied by
The final decision cited by the majority, from the Northern
District of California, deals with the deliberative process
privilege, not the work-product doctrine. Church of Scientology
Int'l v. IRS, 845 F. Supp. 714, 723 (C.D. Cal. 1993). In any
event, the Ninth Circuit also applies the "because of" test. In re
Grand Jury Subpoena, 357 F.3d 900, 907-08 (9th Cir. 2004) (praising
and following Adlman).
-29-
some courts in determining whether documents
are protected by work-product privilege is
whether they are prepared "primarily or
exclusively to assist in litigation" -- a
formulation that would potentially exclude
documents containing analysis of expected
litigation, if their primary, ultimate, or
exclusive purpose is to assist in making the
business decision. Others ask whether the
documents were prepared "because of" existing
or expected litigation -- a formulation that
would include such documents, despite the fact
that their purpose is not to "assist in"
litigation. Because we believe that protection
of documents of this type is more consistent
with both the literal terms and the purposes of
the Rule, we adopt the latter formulation.
Adlman, 134 F.3d at 1197-98, quoted in part in Maine, 298 F.3d at
68. And if it needs to be spelled out any more clearly, Adlman
makes it explicitly clear that the broader "because of" formulation
is not limited to documents prepared for use in litigation:
We believe that a requirement that documents be
produced primarily or exclusively to assist in
litigation in order to be protected is at odds
with the text and the policies of the Rule.
Nowhere does Rule 26(b)(3) state that a
document must have been prepared to aid in the
conduct of litigation in order to constitute
work product, much less primarily or
exclusively to aid in litigation. Preparing a
document "in anticipation of litigation" is
sufficient.
The text of Rule 26(b)(3) does not limit its
protection to materials prepared to assist at
trial. To the contrary, the text of the Rule
clearly sweeps more broadly. It expressly
states that work-product privilege applies not
only to documents "prepared . . . for trial"
but also to those prepared "in anticipation of
litigation." If the drafters of the Rule
intended to limit its protection to documents
made to assist in preparation for litigation,
-30-
this would have been adequately conveyed by the
phrase "prepared . . . for trial." The fact
that documents prepared "in anticipation of
litigation" were also included confirms that
the drafters considered this to be a different,
and broader category. Nothing in the Rule
states or suggests that documents prepared "in
anticipation of litigation" with the purpose of
assisting in the making of a business decision
do not fall within its scope.
Id. at 1198-99 (emphasis and alterations in original). Rather than
confront this language, the majority resorts to simplistic
generalizations. Using its novel "prepared for" test, the majority
unhelpfully explains that "[e]very lawyer who tries cases knows the
touch and feel of materials prepared for a current or possible . . .
law suit." Maj. Op. at 19. Once the majority ignores decades of
controlling precedent, the matter becomes so clear that "[n]o one
with experience of law suits" could disagree. Id.
I need say little else; the majority's new "prepared for"
rule is blatantly contrary to Adlman, a leading case interpreting
the work-product doctrine that we specifically adopted in Maine.
The majority's opinion is simply stunning in its failure to even
acknowledge this language and its suggestion that it is respecting
rather than overruling Maine.
II. The Majority's Announces a Bad Rule
The majority acts as if it is left to this court to draw
a line from Hickman to the present case. In so doing, the majority
ignores a host of cases which grapple with tough work product
questions that go beyond the stuff that "[e]very lawyer who tries
-31-
cases" would know is work product. Lower courts deserve more
guidance than a simple reassurance that a bare majority of the en
banc court knows work product when it sees it.12 Of course, since
this is an en banc proceeding, the majority is free to create a new
rule for the circuit -- though it would be better if it admitted
that it was doing so. But our new circuit rule is not even a good
rule.
First, as Judge Leval observed in Adlman, a "prepared for"
requirement is not consistent with the plain language of Federal
Rule of Civil Procedure 26, which provides protection for documents
"prepared in anticipation of litigation or for trial." Fed. R. Civ.
P. 26(b)(3)(A) (emphasis added); see also Adlman, 134 F.3d at 1198-
99. There is no reason to believe that "anticipation of litigation"
was meant as a synonym for "for trial." Claudine Pease-Wingenter,
Prophetic or Misguided? The Fifth Circuit's (Increasingly) Unpopular
Approach to the Work Product Doctrine, 29 Rev. Litig. (forthcoming
12
This test is reminiscent of Justice Stewart's famously
unhelpful test for identifying obscenity:
[C]riminal laws in this area are
constitutionally limited to hard-core
pornography. I shall not today attempt
further to define the kinds of material I
understand to be embraced within that
shorthand description; and perhaps I could
never succeed in intelligibly doing so. But I
know it when I see it, and the motion picture
involved in this case is not that.
Jacobellis v. Ohio, 378 U.S. 184, 197 (1964) (Stewart, J.,
concurring).
-32-
2009) (analyzing and rejecting many of the arguments advanced by the
majority in favor of a narrow construction of the phrase
"anticipation of litigation"). Since the terms are not synonymous,
the term "anticipation of litigation" should not be read out of the
rule by requiring a showing that documents be prepared for trial.
See Carcieri v. Salazar, 129 S. Ct. 1058, 1066 (2009) (discussing
the basic principle that statutes should be construed to give effect
to each word).
Second, though the majority goes into some depth
describing the foundational case of Hickman v. Taylor, 329 U.S. 495(1947), it misses the fundamental concern of that decision with
protecting an attorney's "privacy, free from unnecessary intrusion
by opposing parties and their counsel." Id. at 510. Without such
privacy, litigants would seek unfair advantage by free-riding off
another's work, thus reducing lawyers' ability to write down their
thoughts:
Were the attorney's work accessible to an
adversary, the Hickman court cautioned, "much
of what is now put down in writing would remain
unwritten" for fear that the attorney's work
would redound to the benefit of the opposing
party. Legal advice might be marred by
"inefficiency, unfairness and sharp practices,"
and the "effect on the legal profession would
be demoralizing." Neither the interests of
clients nor the cause of justice would be
served, the court observed, if work product
were freely discoverable.
Adlman, 134 F.3d at 1197 (quoting Hickman, 329 U.S. at 511)
(citations omitted). The majority posits that these rationales do
-33-
not apply to documents containing a lawyer's legal analysis of a
potential litigation, if that analysis was prepared for a business
purpose. Maj. Op. at 21. This is both unpersuasive and directly
contrary to the policy analysis in Adlman, which we adopted in
Maine. Adlman identified an example of a protected document:
A business entity prepares financial statements
to assist its executives, stockholders,
prospective investors, business partners, and
others in evaluating future courses of action.
Financial statements include reserves for
projected litigation. The company's
independent auditor requests a memorandum
prepared by the company's attorneys estimating
the likelihood of success in litigation and an
accompanying analysis of the company's legal
strategies and options to assist it in
estimating what should be reserved for
litigation losses.
Id. at 1200. Discussing this example, the court concluded that in
this scenario "the company involved would require legal analysis
that falls squarely within Hickman's area of primary concern --
analysis that candidly discusses the attorney's litigation
strategies, appraisal of likelihood of success, and perhaps the
feasibility of reasonable settlement." Id. Further, there is "no
basis for adopting a test under which an attorney's assessment of
the likely outcome of litigation is freely available to his
litigation adversary merely because the document was created for a
business purpose rather than for litigation assistance." Id. In
other words,
[i]n addition to the plain language of the
Rule, the policies underlying the work-product
-34-
doctrine suggest strongly that work-product
protection should not be denied to a document
that analyzes expected litigation merely
because it is prepared to assist in a business
decision. Framing the inquiry as whether the
primary or exclusive purpose of the document
was to assist in litigation threatens to deny
protection to documents that implicate key
concerns underlying the work-product doctrine.
Id. at 1199; see also Roxworthy, 457 F.3d at 595 (stating "the IRS
would appear to obtain an unfair advantage by gaining access to
KPMG's detailed legal analysis of the strengths and weaknesses of
[the taxpayer's] position. This factor weighs in favor of
recognizing the documents as privileged.").
The majority offers no response to this sound policy
analysis and no reason to doubt that inefficiency and "sharp
practices" will result from its new rule allowing discovery of such
dual purpose documents, which contain confidential assessments of
litigation strategies and chances. Instead of addressing these
concerns, the majority's policy analysis relies instead on case-
specific rationales -- namely the need to assist the IRS in its
difficult task of reviewing Textron's complex return. See Maj. Op.
at 22-23. Such outcome determinative reasoning is plainly
unacceptable. Thus, properly framed, it is clear that the
rationales underlying the work-product doctrine apply to documents
-35-
prepared in anticipation of litigation, even if they are not also
for use at trial.13
And these policy rationales are squarely implicated in
this case. First, Textron's litigation hazard percentages contain
exactly the sort of mental impressions about the case that
Hickman sought to protect. In fact, these percentages contain
counsel's ultimate impression of the value of the case. Revealing
such impressions would have clear free-riding consequences. With
this information, the IRS will be able to immediately identify weak
spots and know exactly how much Textron should be willing to spend
to settle each item. Indeed, the IRS explicitly admits that this
is its purpose in seeking the documents.
Second, as argued to us by amici, the Chamber of Commerce
of the United States and the Association of Corporate Counsel, if
attorneys who identify good faith questions and uncertainties in
their clients' tax returns know that putting such information in
writing will result in discovery by the IRS, they will be more
likely to avoid putting it in writing, thus diminishing the quality
of representation. The majority dismisses such concerns, concluding
13
Perhaps because of these very same concerns about privacy and
fairness, the IRS itself argued for the protection of its documents
prepared for the dual purposes of helping the IRS understand the
litigation risks that might result if the IRS made the
administrative decision to adopt a new program. Delaney, Migdail
& Young, Chartered v. IRS, 826 F.2d 124 (D.C. Cir. 1987). This
point was also noted by the Adlman court when it observed that "the
IRS successfully argued against the very position it here
advocates." Adlman, 134 F.3d at 1201.
-36-
that tax accrual workpapers are required by law. Maj. Op. at 21.
But the majority fails to cite the record for this conclusion,
likely because the majority is simply wrong. As the majority
opinion earlier admits, Maj Op. at 2-3, the law only requires that
Textron prepare audited financial statements reporting total
reserves based on contingent tax liabilities. Accounting standards
require some evidential support before such statements can be
certified, but do not explicitly require the form and detail of the
documents prepared here by Textron's attorneys with respect to each
potentially challenged tax item. See also Michelle M. Henkel,
Textron: The Debate Continues as to Whether Auditor Transparency
Waives the Work Product Privilege, 50 Tax Management Memorandum 251,
260 (2009) (distinguishing auditor's workpapers and corporate
workpapers and explaining that the latter are not mandatory but
serve to evaluate a company's litigation risks). Rather, all that
must be actually reported is the final tax reserve liability amount.
Thus, as amicii worry, the majority's new rule will have
ramifications that will affect the form and detail of documents
attorneys prepare when working to convince auditors of the soundness
of a corporation's reserves.
These concerns are even more clearly implicated in this
case because the majority's decision will remove protection for
Textron's "backup materials" as well as its actual workpapers. The
district court found that these materials included "notes and
-37-
memoranda written by Textron's in-house tax attorneys reflecting
their opinions as to which items should be included on the
spreadsheet and the hazard of litigation percentage that should
apply to each item." United States v. Textron Inc., 507 F. Supp.
2d 138, 143 (D.R.I. 2007). Thus, these documents thus go beyond the
numbers used to compute a total reserve. Rather, they explain the
legal rationale underpinning Textron's views of its litigation
chances. The majority fails to acknowledge this subtlety, explain
why it views such documents as required by regulatory rules, or
explain why such mental impressions should go unprotected. Exposing
such documentation to discovery is a significant expansion of the
IRS's power and will likely reveal information far beyond the basic
numbers that the IRS could discover through production of Textron's
auditor's workpapers.
But more important are the ramifications beyond this case
and beyond even the case of tax accrual workpapers in general. The
scope of the work-product doctrine should not depend on what party
is asserting it. Rather, the rule announced in this case will, if
applied fairly, have wide ramifications that the majority fails to
address.
For example, as the IRS explicitly conceded at oral
argument, under the majority's rule one party in a litigation will
be able to discover an opposing party's analysis of the business
risks of the instant litigation, including the amount of money set
-38-
aside in a litigation reserve fund, created in accordance with
similar requirements as Textron's tax reserve fund. Though this
consequence was a major concern of the argument in this case, the
majority does not even consider this "sharp practice," which its new
rule will surely permit.
And there are plenty more examples. Under the majority's
rule, there is no protection for the kind of documents at issue in
Adlman, namely "documents analyzing anticipated litigation, but
prepared to assist in a business decision rather than to assist in
the conduct of the litigation." 134 F.3d at 1201-02. Nearly every
major business decision by a public company has a legal dimension
that will require such analysis. Corporate attorneys preparing such
analyses should now be aware that their work product is not
protected in this circuit.
III. The Workpapers Are Protected Under the Right Test
Applying the "because of" test thoughtfully adopted in
Adlman and Maine, the majority should have concluded that Textron's
workpapers are protected by the work-product doctrine. The proper
starting point in reaching this legal conclusion should be the
factual findings of the district court, which held an evidentiary
hearing to understand the nature of the documents sought here by the
IRS.
-39-
A. Factual findings
After considering affidavits and testimony, the district
court found that the tax accrual workpapers are:
1. A spreadsheet that contains:
(a) lists of items on Textron's tax returns,
which, in the opinion of Textron's counsel,
involve issues on which the tax laws are
unclear, and, therefore, may be challenged by
the IRS;
(b) estimates by Textron's counsel expressing,
in percentage terms, their judgments regarding
Textron's chances of prevailing in any
litigation over those issues (the "hazards of
litigation percentages"); and
(c) the dollar amounts reserved to reflect the
possibility that Textron might not prevail in
such litigation (the "tax reserve amounts").
Textron, 507 F. Supp. 2d at 142-143 (emphasis added). These
workpapers do not contain any facts about the transactions that
concerned the IRS. Id. at 143.
The district court also found, "[a]s stated by Norman
Richter, Vice President of Taxes at Textron and Roxanne Cassidy,
Director, Tax Reporting at Textron, Textron's ultimate purpose in
preparing the tax accrual workpapers was to ensure that Textron was
'adequately reserved with respect to any potential disputes or
litigation that would happen in the future.'" Id. at 143. Further,
"there would have been no need to create a reserve in the first
place, if Textron had not anticipated a dispute with the IRS that
was likely to result in litigation or some other adversarial
proceeding." Id. at 150.
-40-
In addition to recognizing these litigation purposes, the
district court also recognized the dual purposes driving the
creation of these documents and found that the workpapers' creation
"also was prompted, in part" by the need to satisfy Textron's
auditors and get a "clean" opinion letter. Id. at 143. The
district court later clarified:
Thus, while it may be accurate to say that the
workpapers helped Textron determine what amount
should be reserved to cover any potential tax
liabilities and that the workpapers were
useful in obtaining a "clean" opinion from [the
auditor] regarding the adequacy of the reserve
amount, there would have been no need to create
a reserve in the first place, if Textron had
not anticipated a dispute with the IRS that was
likely to result in litigation or some other
adversarial proceeding.
Id. at 150. Relatedly, the district court found that anticipation
of litigation was the "but for" cause of the documents' creation.
Id. Thus, the district court clearly found two purposes leading to
the creation of the workpapers.
The majority makes no effort to reject these factual
findings, but simply recharacterizes the facts as suits its
purposes. For example, the majority declares, without reference to
the district court's more nuanced findings, that the "the IRS is
unquestionably right that the immediate motive of Textron in
preparing the tax accrual work papers was to fix the amount of the
tax reserve on Textron's books and to obtain a clean financial
opinion from its auditor." Maj. Op. at 12-13. At another point,
-41-
the majority boldly pronounces, "the only purpose of Textron's
papers was to prepare financial statements." Id. at 20. Of course,
as explained above, the district court's factual findings about
Textron's "ultimate purpose" were directly contrary to these
pronouncements. Discarding a district court's factual finding on
causation without any demonstration of clear error is not within
this court's proper appellate function. See Fed. R. Civ. P. 52(a)
("Findings of fact, whether based on oral or other evidence, must
not be set aside unless clearly erroneous, and the reviewing court
must give due regard to the trial court's opportunity to judge the
witnesses' credibility."); see also Constructora Maza, Inc. v. Banco
de Ponce, 616 F.2d 573, 576 (1st Cir. 1980) (noting that clear error
review applies even when "much of the evidence is documentary and
the challenged findings are factual inferences drawn from undisputed
facts").
Instead, the majority exalts in the fact that the district
court made no finding that the documents were "for use in possible
litigation." Maj. Op. at 13. That proposition is true. But, as
described above, "for use" (i.e. "prepared for") is not and has
never been the law of this circuit.
The majority does suggest that the documents business
purpose "cannot be disputed." Id. This is also uncontroversial.
The district court found both a litigation and a business purpose.
But, in straining to ignore the documents' litigation purposes, the
-42-
majority proceeds to rely heavily on the IRS's expert. In so doing,
the majority makes no effort to explain why the district court
should have been required to adopt the view that the workpapers
existed only for a non-litigation purpose. The majority claims that
Textron's witnesses agreed with the IRS expert, but the majority
fails to reconcile this proclamation with the competing view of
Textron's witnesses, which the district court explicitly relied upon
in its factual findings regarding Textron's "ultimate purpose."
Textron, 507 F. Supp. 2d at 143. This is another corruption of the
proper role of an appellate court. See Anderson v. Bessemer City,
470 U.S. 564, 574 (1985) ("Where there are two permissible views of
the evidence, the factfinder's choice between them cannot be clearly
erroneous.").
The majority does suggest that the district court's
findings regarding the cause of the workpapers' creation was only
stated in its legal analysis section. Maj. Op. at 9. But the
actual purpose of the documents' creators, or, in the words of the
district court, "but-for" causation, is a factual issue, and the
majority makes no effort to explain why such issue should be
reviewed as a legal conclusion.
The majority also proclaims, without record support, that
"[a]ny experienced litigator would describe the tax accrual work
papers as tax documents and not as case preparation materials."
Maj. Op. at 16. As described above, this conclusion reverses,
-43-
without any finding of clear error, the district court's factual
findings. Further, this language dangerously suggests that this
court can, from its general knowledge, offer an expert opinion as
to how such documents are always seen by "experienced litigators."
Another of the many errors of this approach is revealed by reference
to undisputed record testimony. Namely, the majority's assumption
that tax accrual workpapers are a uniform class from corporation to
corporation is simply wrong. When the district court carefully and
specifically defined what documents were actually at issue in this
case, it explained that "there is no immutable definition of the
term 'tax accrual papers,'" and that their content varies from case
to case, Textron, 507 F. Supp. 2d at 142, a conclusion that is
consonant with the testimony of the government's expert. Id. at 142
n.2. Thus, even were it not our rule that we defer to the district
court's factfinding, such a rule would make good sense in handling
the wide range of workpapers likely to confront district courts in
the future as the IRS increasingly seeks their discovery.
Even if we looked at the purpose of tax accrual workpapers
as a general matter, the district court's conclusion that Textron's
anticipation of litigation drove its reporting obligations is not
so outrageous as to leave us with a firm conviction of error.
Rather, other courts reviewing similar kinds of documents have
reached similar conclusions. Regions Fin. Corp. & Subsidiaries v.
United States, No. 2:06-CV-00895-RDP, 2008 WL 2139008, at *6 (N.D.
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Ala. May 8, 2008) (concluding, in examining another company's
workpapers that "[w]ere it not for anticipated litigation, Regions
would not have to worry about contingent liabilities and would have
no need to elicit opinions regarding the likely results of
litigation"); Comm'r of Revenue v. Comcast Corp., 901 N.E.2d 1185,
1191, 1205 (Mass. 2009) (affirming a finding of work-product
protection for a business memorandum analyzing the "pros and cons
of the various planning opportunities and the attendant litigation
risks" since the author "had 'the prospect of litigation in mind
when it directed the preparation of the memorandum'" and would not
have been prepared irrespective of that litigation (quoting Adlman,
134 F.3d at 1204)).
B. Analysis
This court should accept the district court's factual
conclusion that Textron created these documents for the purpose of
assessing its chances of prevailing in potential litigation over its
tax return in order to assess risks and reserve funds. Under these
facts, work-product protection should apply.
1. The "because of" test
First, the majority does not develop any analysis
contesting the proposition that disputes with the IRS in an audit
can constitute litigation, within the meaning of Fed. R. Civ. P.
26(b)(3)(A). Indeed, such a conclusion is clear. For these
purposes, the touchstone of "litigation" is that it is adversarial.
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See Restatement (Third) of the Law Governing Lawyers § 87 cmt. h
(2000). Though the initial stages of a tax audit may not be
adversarial, the disputes themselves are essentially adversarial;
the subject of these disputes will become the subject of litigation
unless the dispute is resolved.
Applying the "because of" test as articulated in Adlman
and Maine, the workpapers are protected. Under these precedents,
a document is protected if, "'in light of the nature of the document
and the factual situation in the particular case, the document can
be fairly said to have been prepared or obtained because of the
prospect of litigation.'" Maine, 298 F.3d at 68 (emphasis in
original) (quoting Adlman, 134 F.3d at 1202). The "because of" test
"really turns on whether [the document] would have been prepared
irrespective of the expected litigation with the IRS." Adlman, 134
F.3d at 1204. As the district court found, the driving force behind
the preparation of the documents was the need to reserve money in
anticipation of disputes with the IRS. Textron, 507 F. Supp. 2d at
143. Though other business needs also contributed to Textron's need
to create the documents, those needs depended on Textron's
anticipating litigation with the IRS. In other words, without the
anticipation of litigation, there would be no need to estimate a
reserve to fund payment of tax disputes. Id. at 150. In this way,
the dual purposes leading to the documents' creation were
intertwined, and work-product protection should apply. See In re
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Grand Jury Subpoena, 357 F.3d at 910 ("The documents are entitled
to work product protection because, taking into account the facts
surrounding their creation, their litigation purpose so permeates
any non-litigation purpose that the two purposes cannot be
discretely separated from the factual nexus as a whole."); see also
Andrew Golodny, Note: Lawyers versus Auditors: Disclosure to
Auditors and Potential Waiver of Work-Product Privilege in United
States v. Textron, 61 Tax Law. 621, 629 (2008) ("As a commentator
noted, 'in the case of tax contingency reserves, the prospect of
future litigation and the business need for the documents are so
intertwined that the prospect of future litigation itself creates
the business need for the document.'" (quoting Terrence G. Perris,
Court Applies Work Product Privilege to Tax Accrual Workpapers, 80
Prac. Tax. Strategies 4 (2008))).
The majority simply refuses to accept the district court's
finding that the documents would not exist but for Textron's need
to anticipate litigation. This rejection is essential to the
majority's erroneous conclusion. Accepting the district court's
findings regarding purpose compels a finding of work-product
protection, since the precedents are clear that under the "because
of" test, dual purpose documents are protected. In fact, that is
one of the very reasons some courts have adopted the test. 8
Charles Alan Wright, Arthur R. Miller & Richard L. Marcus, Federal
Practice and Procedure, § 2024 (2d ed. 2009) ("'Dual purpose'
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documents created because of the prospect of litigation are
protected even though they were also prepared for a business
purpose."); see also Roxworthy, 457 F.3d at 598-99 ("[D]ocuments do
not lose their work product privilege 'merely because [they were]
created in order to assist with a business decision,' unless the
documents 'would have been created in essentially similar form
irrespective of the litigation.'" (quoting Adlman, 134 F.3d at
1202)); In re Grand Jury Subpoena, 357 F.3d at 907 (adopting Wright
and Miller's "because of" test in order to handle "dual purpose"
documents); Maine, 298 F.3d at 68 (adopting Adlman after recounting
the distinction between the "because of" test and the "primary
purpose" test in their handling of dual purpose documents); Adlman,
134 F.3d at 1197-98, 1202 ("Where a document is created because of
the prospect of litigation, analyzing the likely outcome of that
litigation, it does not lose protection under this formulation
merely because it is created in order to assist with a business
decision."); In re Special Sept. 1978 Grand Jury (II), 640 F.2d 49,
61 (7th Cir. 1980) ("We conclude that the materials . . . were
indeed prepared in anticipation of litigation, even though they were
prepared as well for the filing of the Board of Elections
reports.").
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2. The exception to the "because of" test
The majority reads too much into one sentence from Maine
and Adlman. Specifically, it is true that "the 'because of'
standard does not protect from disclosure 'documents that are
prepared in the ordinary course of business or that would have been
created in essentially similar form irrespective of the
litigation.'" Maine, 298 F.3d at 70 (quoting Adlman, 134 F.3d at
1202). This proviso relates to the advisory notes to the rule,
which excludes from protection "[m]aterials assembled in the
ordinary course of business, or pursuant to public requirements
unrelated to litigation, or for other nonlitigation purposes." Fed.
R. Civ. P. 26 advisory committee's note (1970). Understood in light
of the fact that the "because of" test unequivocally protects "dual
purpose" documents, this proviso does not strip protection for dual
purpose documents that have one business or regulatory purpose.
Rather, the best reading of the advisory committee's note is simply
that preparation for business or for public requirements is
preparation for a nonlitigation purpose insufficient in itself to
warrant protection. The note states that there is no protection for
documents created for business, regulatory, or "other nonlitigation
purposes." This language suggests the note is considering business
and regulatory purposes as nonlitigation purposes, but does not
suggest that the presence of such a purpose should somehow override
a litigation purpose, should one exist. Thus, correctly formulated,
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this exception should be understood as simply clarifying the rule
that dual purpose documents are protected, though "there is no
work-product immunity for documents prepared in the regular course
of business rather than for purposes of the litigation." Wright &
Miller, supra, § 2024 (emphasis added); see also Roxworthy, 457 F.3d
at 599 ("[A] document can be created for both use in the ordinary
course of business and in anticipation of litigation without losing
its work-product privilege."). Under the majority's interpretation,
the exception swallows the rule protecting dual purpose documents.
So understood, the exception does not control this case.
After citing this exception, the district court concluded that the
documents were not created irrespective of litigation because
Textron would not have prepared the documents but for the
anticipation of litigation. Textron, 507 F. Supp. 2d at 150. The
majority makes no effort to label this finding clearly erroneous.
To the contrary, the finding is correct. The tax accrual workpapers
identify specific tax line items, and then anticipate the likelihood
that litigation over those items will result in Textron having to
pay the IRS more money. That Textron will not ultimately litigate
each position does not change the fact that when it prepared the
documents, Textron was acting to anticipate and analyze the
consequences of possible litigation, just like the memorandum
example in Adlman, 134 F.3d at 1200. The documents would not be the
same at all had Textron not anticipated litigation. So, under the
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"because of" test, as applied in Adlman and the many circuit courts
that have followed it, these documents were not prepared
"irrespective" of the prospect of litigation. They should be
protected.
3. Arthur Young and El Paso do not control
Neither the Supreme Court's decision in United States v.
Arthur Young & Co., 465 U.S. 805 (1984), nor the Fifth Circuit's
decision in El Paso, 682 F.2d at 530, support a different result.
In Arthur Young, the Court declined to recognize an
accountant's work-product doctrine, thus holding that tax accrual
workpapers created by an independent auditor were not protected.
Arthur Young, 465 U.S. at 815-21. But unlike the Court in Arthur
Young, we are not now confronted with the question of whether to
recognize a new privilege. Here, the doctrinal decision we face is
how to apply existing work-product doctrine to the present facts,
in other words whether the "because of" test protects dual purpose
documents, as the Maine and Adlman courts so held. This question
was not at all presented in Arthur Young.
On the other hand, El Paso is clearly factually on point
-- there the Fifth circuit rejected work-product protection for
similar tax accrual workpapers. El Paso, 682 F.2d at 542. But, as
explained above, that court applied a different definition of the
work-product doctrine, asking whether the "primary motivating
purpose behind the creation of the document was to aid in possible
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future litigation." Id. at 542-44 (concluding that the document
should not be protected as it "carries much more the aura of daily
business than it does of courtroom combat"). Finding Textron's
workpapers protected would not create a circuit split, but be merely
an application of a widely acknowledged existing difference between
our law and the law of the Fifth Circuit. It is precisely in these
"dual purpose" situations that the "because of" test used in this
circuit is meant to distinguish itself from the "primary purpose"
test used in the Fifth Circuit. Maine, 298 F.3d at 68 (citing
Adlman for the proposition that the primary purpose test "is at odds
with the text and the policies of Rule 26 because nothing in it
suggests that documents prepared for dual purposes of litigation and
business or agency decisions do not fall within its scope"). Thus,
unlike the Fifth Circuit, we need not assess whether the tax accrual
workpapers carry more of one "aura" than another.
IV. Conclusion
The majority's decision may please the IRS and some tax
scholars who understandably see discovery of tax accrual workpapers
as an important tool in combating fraud. But this decision will be
viewed as a dangerous aberration in the law of a well-established
and important evidentiary doctrine. Whatever else one may think
about this case, the majority's assertion that it is following Maine
is plainly erroneous. Rather, the majority's "prepared for" test
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is directly contrary to Adlman, a decision we explicitly adopted in
Maine.
In straining to craft a rule favorable to the IRS as a
matter of tax law, the majority has thrown the law of work-product
protection into disarray. Circuits have already split interpreting
the meaning of "anticipation of litigation," between the "primary
purpose" and "because of" tests. Now this court has proceeded to
further the split by purporting to apply the "because of" test while
rejecting that test's protection for dual purpose documents. In
reality, the majority applied a new test that requires that
documents be actually "prepared for" use in litigation. The time
is ripe for the Supreme Court to intervene and set the circuits
straight on this issue which is essential to the daily practice of
litigators across the country.
The correct test is that spelled out in Adlman, and
adopted by most circuit courts. Applying that test to the facts
actually found by the district court, these tax accrual workpapers
should be protected. For these reasons, I respectfully dissent.
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