The ongoing Textron Inc. (“Textron”) litigation recently provided a significant ruling pertaining to work product doctrine in the context of documents created by in-house accountants and counsel. On August 13, 2009, the First Circuit issued a 3-2 en banc decision that rejected Textron Inc.’s position that its internal tax accrual workpapers were protected by the work product doctrine. The decision is a victory for the Internal Revenue Service (“IRS”) in its longstanding effort to gain access to these workpapers and a major blow to companies that utilize the privilege. Despite their creation by in-house accountants under the direction of counsel and by counsel themselves; the First Circuit deemed these workpaper documents that were created in the ordinary course of business and not for litigation purposes.
History
The procedural history can be summarized rather briefly. As stated above, the workpapers central to this matter were originally created by Textron in-house counsel or by Textron in-house accountants under the guidance of their in-house counsel. These workpapers listed certain positions on Textron’s 2001 tax returns and were coupled with an analysis of litigation risks associated with each position. Specifically, the litigation risk analyses entailed the probability of litigation and reserves associated with each position. As part of an audit, the IRS requested these papers in 2005 and Textron refused to supply these documents on the grounds that the documents were protected under the attorney-client privilege.
The IRS and Textron initially squared off in district court and, in 2007, the district court held that these documents were created to gauge the adequacy of reserves in case of litigation and therefore, were protected work product. The crucial factor for the district court was that the workpapers were created in contemplation of litigation. The court did not subscribe to the IRS’s position that these documents were created in the ordinary course of business. Furthermore, the district court did not agree that the attorney-client privilege was effectively waived because Textron disclosed the documents to a third-party, their outside auditors, Ernst & Young, LLP.
The matter journeyed through the courts and encountered appeals and remands and ultimately led to the First Circuit’s recent decision. The First Circuit’s decision is based on the premise that the workpapers were not created in anticipation of litigation. According to the majority, these workpapers would likely have been created absent any potential of litigation and were created for both litigation and non-litigation purposes. The Court focused on evidence that indicated that these workpapers were created to meet GAAP requirements and appeared to place less emphasis on evidence indicating that the workpapers were created for potential litigation.
The Work Product Doctrine
The Federal Rules of Civil Procedure apply to documents “prepared in anticipation of litigation or for trial.” While documents clearly prepared for litigation receive the protection, those documents that are not clearly trial materials have divided the courts. The majority of courts hold that the documents must be created because of prospective litigation and the minority holds that the primary motivating purpose of document creation must be to assist in pending or impending litigation. In essence, the majority view casts a wider net of protection over documents. While not exact, the Textron court resembles the minority view by only protecting documents prepared for pending or impending litigation. The Textron majority focused on the fact that the documents were not prepared for pending or impending litigation. To support its position, the Textron majority appeared to rely on the assumption that trial lawyers would not view these workpapers as case preparation materials.
Eisner Analysis
The decision by the First Circuit sets a difficult precedent for many companies such as Textron. While the government and the IRS must collect revenue, it should not be at the expense of the work product doctrine. The implication of the First Circuit’s ruling is certainly problematic and predictably far-reaching. One exception to the work product doctrine may lay the groundwork for more exceptions. The First Circuit’s exception coupled with any future exceptions may significantly damage the protection currently afforded by the doctrine and may ultimately render it useless for certain taxpayers. At minimum, companies that now create dual-purpose tax/accounting documents should be cognizant that the attorney-client privilege may not automatically exist. More importantly, companies should note that tax and accounting documents that were partially created in anticipation of potential litigation may ultimately result in handing over their strategies to the IRS.