The Southern District of New York, in Schaeffler v. United States12, recently denied a petition to quash an IRS summons for a tax memorandum prepared by the petitioner’s accounting firm in connection with a complex refinancing and corporate restructuring on the part of the Schaeffler Group, determining that (i) the tax memorandum was not protected by the work product doctrine, and (ii) attorney-client and tax practitioner privilege was waived when the tax memorandum was shared with a consortium of banks that funded the original transaction being refinanced and restructured.

The Schaeffler Group believed an IRS audit and possible dispute as to at least some of the US tax consequences of the proposed transactions was likely, and therefore engaged outside tax and legal advisors to assist with the US tax implications of the transactions. As part of its engagement, Ernst & Young LLP prepared a memorandum that identified potential US tax consequences of the proposed transactions, as well as possible IRS challenges to the Schaeffler Group’s treatment of the transactions (the “E&Y memo”).

Because the US tax consequences of the proposed refinancing and restructuring transactions could materially affect the Schaeffler Group’s ability to repay the bank consortium’s debt, the consortium and its law firm worked closely with the Schaeffler Group’s outside tax advisors in effectuating the transactions and analyzing the US tax consequences of them. In this regard, the Schaeffler Group and the bank consortium signed an agreement whereby they agreed to share privileged, protected and confidential documents and their analyses without waiving those privileges,  protections or the confidentiality of the information. After the execution of this agreement, the Schaeffler Group shared with the bank consortium, among other things, the E&Y memo.

The IRS, in conjunction with an audit of the Schaeffler Group’s tax returns for 2009 and 2010, issued a number of IDRs requesting all tax opinions and analyses that discussed the US tax consequences of the Schaeffler Group’s restructuring, and, eventually, an administrative summons to Ernst & Young requiring it to provide all legal opinions that it provided to parties outside the Schaeffler Group. The Schaeffler Group petitioned to quash this summons on the grounds that it sought legal opinions and other confidential advice protected by both the work product doctrine and the attorney-client privilege, as extended to Ernst & Young by the tax practitioner privilege.

With respect to attorney-client privilege, the petitioners argued that no waiver of the privileged tax memorandum occurred when the documents were provided to the bank consortium because the Schaeffler Group and the consortium had a common legal interest. The court disagreed, holding that the shared interest between the two parties was economic, not legal. The consortium may have shared the desire that the transactions receive favorable tax treatment from the IRS so that the Schaeffler Group could service its debt to the bank consortium, but there was no common legal stake in the Schaeffler Group’s putative litigation with the IRS. The court noted that this result would be different if the bank consortium could have been named as a co-defendant in the anticipated dispute with the IRS. Accordingly, the court held that the common interest rule did not apply and, therefore, petitioners waived any attorney-client or tax practitioner privilege that attached to the E&Y memo when they shared it with the bank consortium. The fact that the parties had previously signed an agreement that sought to preserve privilege did not affect the court’s analysis on this point.

The petitioners also argued that the E&Y memo was protected from disclosure to the IRS under the work product doctrine. The court rejected an argument by the Government that the Schaeffler Group had waived work product protection by sharing the E&Y memo with the bank consortium. The court held that, because the parties had a shared commercial incentive in keeping the details of the refinancing negotiations from the Schaeffler Group’s potential adversaries, including the IRS, and because the bank consortium was contractually required to keep the disclosed information confidential, the disclosure of the E&Y memo to the consortium did not materially increase the likelihood of disclosure to an adversary. Accordingly, to the extent the E&Y memo was entitled to work product projection, the court held that the disclosure did not waive the protection.

On the merits of the work product protection claim the court followed the requirement set out in United States v. Adlman, 134 F. 3d 1194 (2d Cir. 1998), that documentation protected by the work product doctrine would have been created in essentially similar form had litigation not been anticipated. The court determined that, as a sophisticated businessperson engaging in a complex financial transaction, the petitioner would likely have sought out the same sort of tax advice Ernst & Young provided to ensure that advantageous tax strategies were employed to their fullest potential, even in the  absence of anticipated litigation. The court noted that petitioners had presented no   facts suggesting that Ernst & Young would have acted any differently had it known no audit or litigation would ensue. Furthermore, the court focused on the requirement of Treasury Department Circular 230 that tax practitioners cannot allow the possibility that a tax return will remain unaudited to affect the advice they give, concluding that when Ernst & Young provided legal advice on the tax treatment of the transactions, it had a responsibility to consider in full the relevant legal issues regardless of whether they anticipated an audit and ensuing litigation with the IRS. The court held that the E&Y memo would have been produced in the same form irrespective of any concern about litigation, and therefore, that it was not protected from disclosure under the work product doctrine.