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Taxpayer Partially Waived Work-Product Immunity by Disclosing Valuation Report to IRS
(Parker Tax Publishing September 2020)
The Ninth Circuit affirmed in part and reversed in part a district court's determination that a taxpayer had waived attorney-client privilege and work-product protection for certain legal memoranda prepared by the taxpayer's in-house counsel in support of a worthless stock deduction that were referenced in a valuation report prepared by an outside law firm. The court held that the taxpayer expressly waived the attorney-client privilege when it disclosed the memos to the law firm; the court also held that the taxpayer did not expressly waive work-product immunity merely by providing the memos to the law firm, but it impliedly waived the privilege as to the factual content of the memos when it subsequently used the report prepared by the law firm to support its tax deduction in an IRS audit. U.S. v. Sanmina Corp., 2020 PTC 241 (9th Cir. 2020).
Background
In 2008, Sanmina Corporation claimed a worthless stock deduction arising from its ownership of shares of stock in a Swiss subsidiary, Sanmina International AG. The deduction totaled $503 million and offset all of Sanmina's taxable income for the 2008 tax year and resulted in carryforward losses. The IRS subsequently initiated an examination of Sanmina's federal income tax liabilities for the 2008, 2009, and 2010 tax years.
To support the worthless stock deduction, Sanmina provided the IRS with a valuation report prepared by the law firm DLA Piper. In a footnote, the DLA Piper report referred to two memoranda authored by Sanmina's in-house counsel. The IRS issued a summons for the two attorney memos but Sanmina declined to produce them, invoking attorney-client privilege and attorney work-product protection. However, Sanmina did agree to disclose to the IRS the "non-privileged documents on which the analyses contained in the memos were based."
In January 2015, the IRS filed a petition in a district court to enforce the summons for the attorney memos. The district court denied enforcement of the summons, finding that the memoranda were privileged and that the privileges were not waived. The IRS appealed. In December 2017, a panel of the Ninth Circuit remanded, but retained jurisdiction over the appeal, for the district court to review the memos in camera to determine (1) whether the memos were privileged, and (2) whether such privilege was waived.
On remand, the district court held that the memos were protected by the attorney-client privilege and attorney work-product doctrine but that the privileges were waived when Sanmina disclosed the memos to DLA Piper for the non-legal purpose of obtaining an opinion on value. The district court alternately held that Sanmina's disclosure of the DLA Piper valuation report to the IRS waived any applicable privilege as to materials used to reach the valuation. The district court reasoned that, because the report relied on the contents of the memos, and based its conclusions at least in part on them, the analyses that informed the report's conclusions should in fairness be considered together. The district court rejected Sanmina's argument that merely disclosing the existence of the memos did not waive privilege as to their entire contents, reiterating that it would be fundamentally unfair for Sanmina to disclose the valuation report while withholding its foundation.
Ninth Circuit's Analysis
The Ninth Circuit affirmed in part and reversed in part the district court. The court held that Sanmina waived the attorney-client privilege by disclosing the attorney memos to DLA Piper. The court also held that Sanmina impliedly waived work-product protection over the memos, but only with respect to the factual portions of the attorney memos, while the opinion information in the memos continued to be protected by work-product immunity.
First, the court addressed the attorney-client privilege issue. In the court's view, there was evidence that Sanmina may have shared the attorney memos with DLA Piper for the purpose of seeking both legal and nonlegal advice. The court noted that while such "dual purpose" communications are not unusual in the tax law context, the Ninth Circuit had not yet addressed how to assess when such a communication remains within privilege. However, the court sidestepped that issue because it found that the district court's conclusion that Sanmina's purpose was to obtain a nonlegal valuation analysis from DLA Piper, rather than legal advice, was not clearly erroneous.
The court then turned to the issue of whether Sanmina also waived work-product protection. The court explained that work-product is a qualified privilege that protects from discovery documents prepared in anticipation of litigation. According to the court, work-product protection is not as easily waived as the attorney-client privilege because, while attorney-client privilege protects confidentiality, work-product protection is provided against adversaries. As the court explained, work-product protection is expressly waived only when disclosure is made to an adversary, and is impliedly waived when a disclosure is inconsistent with the purpose of protecting the adversarial process.
Applying that framework, the court held that Sanmina's disclosure of the memos to DLA Piper did not alone qualify as a disclosure to an adversary. The court rejected the government's contention that DLA Piper was a "conduit to an adversary" because the report was intended for disclosure to interested tax authorities. According to the court, the relevant question was whether Sanmina had a reasonable basis for believing that DLA Piper would keep the memos confidential in the process of preparing its valuation analysis. The court found that Sanmina's sharing of the memos with DLA Piper did not necessarily mean that it knew or should have known that the resulting report would disclose or make reference to its attorney work product. In the court's view, the circumstances suggested that Sanmina had a reasonable expectation of confidentiality over the memos at the time of their disclosure to DLA Piper.
However, the court said the more difficult question was whether Sanmina waived work-product protection when it provided the DLA Piper report to the IRS. In the court's view, Sanmina could have chosen to substantiate the deduction with documents that did not refer to the attorney memos, but chose not to. Such conduct seemed to the court to be inconsistent with Sanmina's purported goal of keeping the memos secret from the IRS. The court found that by disclosing a valuation report to the IRS that explicitly cited the memos as a basis for its conclusions, Sanmina increased the possibility that the IRS might obtain its protected work product, and thereby engaged in conduct inconsistent with the purposes of the privilege.
However, the court found that the scope of the implied waiver had to be narrowly tailored and limited to what was necessary to rectify any unfair advantage Sanmina gained from its conduct. In the court's view, it was unclear what unfair advantage Sanmina had gained or how the IRS had been unfairly disadvantaged. The court disagreed with the district court's conclusion that the IRS would be forced to simply accept the DLA Piper report without access to the foundational material. The court pointed out that, at the audit stage, the IRS was not required to accept the conclusions in the report at all - even without the attorney memos, the IRS could still proceed with its examination, conclude that Sanmina had failed to adequately support its claimed deduction with the DLA Piper report and other documents provided, and disallow the deduction.
The court noted that the attorney memos contained both factual discussions and legal analyses of the facts in light of various legal authorities. In other words, the memos contained both factual work product and opinion work product. The court held that Sanmina had implicitly waived protection over any factual or non-opinion work product in the memos that served as the foundational material for the DLA Piper report. However, the court found no reason why the scope of the implied waiver should encompass the opinion work product contained in the memos. The court therefore ordered Sanmina to disclose the factual work product contained in the memos. The court concluded that this information, along with the report itself and the underlying transactional documents which Sanmina had already produced, would allow the IRS to analyze the relevant facts in light of the applicable tax authorities to determine the legal validity of Sanmina's deduction.
For a discussion of attorney-client and work-product privileges in an IRS examination, see Parker Tax ¶263,130.
Taxpayer Partially Waived Work-Product Immunity by Disclosing Valuation Report to IRS
The Ninth Circuit affirmed in part and reversed in part a district court's determination that a taxpayer had waived attorney-client privilege and work-product protection for certain legal memoranda prepared by the taxpayer's in-house counsel in support of a worthless stock deduction that were referenced in a valuation report prepared by an outside law firm. The court held that the taxpayer expressly waived the attorney-client privilege when it disclosed the memos to the law firm; the court also held that the taxpayer did not expressly waive work-product immunity merely by providing the memos to the law firm, but it impliedly waived the privilege as to the factual content of the memos when it subsequently used the report prepared by the law firm to support its tax deduction in an IRS audit. U.S. v. Sanmina Corp., 2020 PTC 241 (9th Cir. 2020).
Background
In 2008, Sanmina Corporation claimed a worthless stock deduction arising from its ownership of shares of stock in a Swiss subsidiary, Sanmina International AG. The deduction totaled $503 million and offset all of Sanmina's taxable income for the 2008 tax year and resulted in carryforward losses. The IRS subsequently initiated an examination of Sanmina's federal income tax liabilities for the 2008, 2009, and 2010 tax years.
To support the worthless stock deduction, Sanmina provided the IRS with a valuation report prepared by the law firm DLA Piper. In a footnote, the DLA Piper report referred to two memoranda authored by Sanmina's in-house counsel. The IRS issued a summons for the two attorney memos but Sanmina declined to produce them, invoking attorney-client privilege and attorney work-product protection. However, Sanmina did agree to disclose to the IRS the "non-privileged documents on which the analyses contained in the memos were based."
In January 2015, the IRS filed a petition in a district court to enforce the summons for the attorney memos. The district court denied enforcement of the summons, finding that the memoranda were privileged and that the privileges were not waived. The IRS appealed. In December 2017, a panel of the Ninth Circuit remanded, but retained jurisdiction over the appeal, for the district court to review the memos in camera to determine (1) whether the memos were privileged, and (2) whether such privilege was waived.
On remand, the district court held that the memos were protected by the attorney-client privilege and attorney work-product doctrine but that the privileges were waived when Sanmina disclosed the memos to DLA Piper for the non-legal purpose of obtaining an opinion on value. The district court alternately held that Sanmina's disclosure of the DLA Piper valuation report to the IRS waived any applicable privilege as to materials used to reach the valuation. The district court reasoned that, because the report relied on the contents of the memos, and based its conclusions at least in part on them, the analyses that informed the report's conclusions should in fairness be considered together. The district court rejected Sanmina's argument that merely disclosing the existence of the memos did not waive privilege as to their entire contents, reiterating that it would be fundamentally unfair for Sanmina to disclose the valuation report while withholding its foundation.
Ninth Circuit's Analysis
The Ninth Circuit affirmed in part and reversed in part the district court. The court held that Sanmina waived the attorney-client privilege by disclosing the attorney memos to DLA Piper. The court also held that Sanmina impliedly waived work-product protection over the memos, but only with respect to the factual portions of the attorney memos, while the opinion information in the memos continued to be protected by work-product immunity.
First, the court addressed the attorney-client privilege issue. In the court's view, there was evidence that Sanmina may have shared the attorney memos with DLA Piper for the purpose of seeking both legal and nonlegal advice. The court noted that while such "dual purpose" communications are not unusual in the tax law context, the Ninth Circuit had not yet addressed how to assess when such a communication remains within privilege. However, the court sidestepped that issue because it found that the district court's conclusion that Sanmina's purpose was to obtain a nonlegal valuation analysis from DLA Piper, rather than legal advice, was not clearly erroneous.
The court then turned to the issue of whether Sanmina also waived work-product protection. The court explained that work-product is a qualified privilege that protects from discovery documents prepared in anticipation of litigation. According to the court, work-product protection is not as easily waived as the attorney-client privilege because, while attorney-client privilege protects confidentiality, work-product protection is provided against adversaries. As the court explained, work-product protection is expressly waived only when disclosure is made to an adversary, and is impliedly waived when a disclosure is inconsistent with the purpose of protecting the adversarial process.
Applying that framework, the court held that Sanmina's disclosure of the memos to DLA Piper did not alone qualify as a disclosure to an adversary. The court rejected the government's contention that DLA Piper was a "conduit to an adversary" because the report was intended for disclosure to interested tax authorities. According to the court, the relevant question was whether Sanmina had a reasonable basis for believing that DLA Piper would keep the memos confidential in the process of preparing its valuation analysis. The court found that Sanmina's sharing of the memos with DLA Piper did not necessarily mean that it knew or should have known that the resulting report would disclose or make reference to its attorney work product. In the court's view, the circumstances suggested that Sanmina had a reasonable expectation of confidentiality over the memos at the time of their disclosure to DLA Piper.
However, the court said the more difficult question was whether Sanmina waived work-product protection when it provided the DLA Piper report to the IRS. In the court's view, Sanmina could have chosen to substantiate the deduction with documents that did not refer to the attorney memos, but chose not to. Such conduct seemed to the court to be inconsistent with Sanmina's purported goal of keeping the memos secret from the IRS. The court found that by disclosing a valuation report to the IRS that explicitly cited the memos as a basis for its conclusions, Sanmina increased the possibility that the IRS might obtain its protected work product, and thereby engaged in conduct inconsistent with the purposes of the privilege.
However, the court found that the scope of the implied waiver had to be narrowly tailored and limited to what was necessary to rectify any unfair advantage Sanmina gained from its conduct. In the court's view, it was unclear what unfair advantage Sanmina had gained or how the IRS had been unfairly disadvantaged. The court disagreed with the district court's conclusion that the IRS would be forced to simply accept the DLA Piper report without access to the foundational material. The court pointed out that, at the audit stage, the IRS was not required to accept the conclusions in the report at all - even without the attorney memos, the IRS could still proceed with its examination, conclude that Sanmina had failed to adequately support its claimed deduction with the DLA Piper report and other documents provided, and disallow the deduction.
The court noted that the attorney memos contained both factual discussions and legal analyses of the facts in light of various legal authorities. In other words, the memos contained both factual work product and opinion work product. The court held that Sanmina had implicitly waived protection over any factual or non-opinion work product in the memos that served as the foundational material for the DLA Piper report. However, the court found no reason why the scope of the implied waiver should encompass the opinion work product contained in the memos. The court therefore ordered Sanmina to disclose the factual work product contained in the memos. The court concluded that this information, along with the report itself and the underlying transactional documents which Sanmina had already produced, would allow the IRS to analyze the relevant facts in light of the applicable tax authorities to determine the legal validity of Sanmina's deduction.
For a discussion of attorney-client and work-product privileges in an IRS examination, see Parker Tax ¶263,130.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
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