Significant Second Circuit Ruling on Common-Interest Doctrine

In a ruling that will elate companies and financial institutions that consult on legal issues—including tax issues—that have financial consequences, the Second Circuit has ruled that the common-interest doctrine precluded the IRS from compelling disclosure of otherwise privileged documents that a borrower shared with its lender. Schaeffler v. United States, 2015 WL 6874979 (CTA2 Second CircuitNov. 10, 2015).  You may read this decision here.

It’s a Doctrine, not an Independent Privilege

Many courts and attorneys often label the concept of sharing privileged information as the “common-interest privilege” or the “joint-defense privilege.”  These labels are misnomers.  The concept, rather, is one of non-waiver of an existing privilege.

So, the common-interest doctrine is not an independent privilege, but rather a non-waiver doctrine by which parties sharing a common legal interest in pending or anticipated litigation may share otherwise privileged information without fear that such disclosure waives that privilege.

Background—Sharing Privileged Information

The Schaeffler Group, an automotive and industrial-parts supplier, made a tender offer to purchase shares of a Continental AG and obtained financing for the transaction through a consortium of banks.  Two days before the offer was to expire, however, Lehman Brothers declared bankruptcy, the stock market collapsed, and Continental’s share value plummeted.  Continental’s shareholders, therefore, sold their shares at a previously agreed-upon yet now inflated value, resulting in serious financial consequences to Schaeffler.

Facing potential insolvency and default on the consortium’s loan, Schaeffler and the consortium collaborated on a refinancing and restructuring strategy that they feared would receive IRS scrutiny.  Schaeffler retained Ernst & Young and Dentons to advise on federal tax implications and possible litigation with the IRS, and E&Y provided Schaeffler a tax-related memorandum that Schaeffler shared with the consortium.

The IRS issued a subpoena to Schaeffler seeking documents, including legal analyses and opinions, which it provided outside parties.  The subpoena covered the E&Y tax memo because Schaeffler shared it with the consortium, but Schaeffler petitioned to quash the subpoena stating that the common-interest doctrine protected the memo and related documents from disclosure.

Ruling

The USDC SDNY denied the petition and ruled that Schaeffler waived any privilege when it shared the documents with the consortium.  The common-interest doctrine did not apply, the court reasoned, because any IRS litigation would not involve the consortium as a party and the consortium’s interest was purely economic rather than legal.

The 2d Circuit reversed.  The dispositive question for the appellate court was whether the consortium’s common interest with Schaeffler was of sufficient legal character to prevent waiver.  Answering this question with a “yes,” the court found that securing favorable tax treatment of the refinancing and restructuring would “likely involve” a legal encounter with the IRS, and that both Schaeffler and the consortium had a “strong common interest in the outcome of that legal encounter.”  The common interest arose because, without the refinancing and restructuring, Schaeffler faced insolvency and the consortium faced a loan default—a “mutual financial disaster.”

Common-Interest Agreement

Schaeffler and the consortium smartly entered into a common-interest agreement that they titled an “Attorney–Client Privilege Agreement.”  While the court stated that the agreement’s title “was not binding” on the court’s privilege determination, it was helpful to prove that the shared documents were confidential, would remain confidential, and that the parties were pursuing a “common legal interest.”

So, while not dispositive, the court’s reliance upon this agreement reminds us that securing the proper documentation before sharing privileged information will increase the chances that a reviewing court will find that the common-interest doctrine precludes compelled disclosure of privileged documents.

Legal vs. Commercial Interest

The common-interest doctrine protects privileged information shared for a common legal interest, but not a common commercial interest, and this distinction was at the heart of the Second Circuit’s ruling.  While the district court found the common interest was financial related, the appellate court focused on the parties’ mutual need for a particular tax—or legal—strategy to withstand regulatory scrutiny.

The court recognized that Schaeffler’s refinancing and restructuring contained a “commercial component,” but held that the presence of financial benefits of a legal strategy “does not render those issues ‘commercial.’”  In other words, “a legal problem albeit with commercial consequences” will not destroy a properly documented, deliberate intention to share privileged information pertaining to a legal issue that involves both parties.

Actual Litigation Required?

When common-interest disclosures receive judicial review, a recurring question is whether the sharing parties are the subject of actual or anticipated litigation.  States that follow the Uniform Rules of Evidence, for example, require an actual “pending action” before applying the common-interest doctrine.  Unif. R. Evid. 502(b)(3).

The Schaeffler court, however, held that actual litigation involving both sharing parties was not a prerequisite for the common-interest doctrine, and applied the doctrine simply where Schaeffler and the consortium’s preferred tax treatment would “likely involve” a legal encounter with the IRS.

Privilege Covers In-House Lawyer’s Communications with “Indirect Subsidiary”

The USDC for the Western District of Texas (Austin) recently held that the attorney–client privilege protects from discovery communications between a parent company’s in-house counsel and management personnel of an “indirect subsidiary.”  The court ruled that the joint-client doctrine applied as the in-house lawyer supplied a well-crafted affidavit establishing the client relationship and all elements of the privilege.  Nester v. Textron, Inc., 2015 WL 1020673 (W.D. Tex. Mar. Org Chart9, 2015).  You may read the decision here.

Background

In this products-liability case, the plaintiff claimed that Textron negligently designed the “kick off brake system” on its E-Z-GO Workhorse cart.  In 2005, a fatal accident occurred in the United Kingdom involving a similar model distributed by Ransomes Jacobsen, Ltd (RJL), an indirect subsidiary of Textron.  The British Health & Safety Executive (HSE) investigated the incident, and Textron’s in-house counsel provided legal advice to RJL during the investigation.

The corporate chain for this “indirect subsidiary,” illustrated in the accompanying chart, is: RJL, a British company, is a subsidiary of British company Ransomes Limited (RL).  RL is a subsidiary of British company Textron Acquisition Limited, which is a subsidiary of Textron Atlantic, LLC, a Delaware company.  And Textron Atlantic is a subsidiary of the defendant in this case, Textron, Inc.

The plaintiff sought in discovery communications between Textron, Inc.’s in-house lawyer and RJL personnel created during the HSE investigation.  Textron asserted that RJL was a joint client of Textron’s in-house counsel and, therefore, the attorney–client privilege protected these communications from discovery.

In-House Counsel Affidavit

I commend for your review the Textron in-house counsel affidavit, available here, because it adequately covered all of the elements to establish the joint-client doctrine and the corporate attorney–client privilege.  The lawyer explained the Textron–RJL relationship and that RJL “engage[d] [him] to provide legal advice and counsel” related to the UK accident and the HSE investigation.

Regarding the communications, the in-house lawyer covered all of the necessary elements to establish the attorney–client privilege, stating that he was Assistant General Counsel at the time and provided “professional legal services to and represented the legal interests of” RJL and Textron.  And as to the specific emails at issue, the lawyer persuasively stated that they “were confidential, and intended to remain confidential, and were made for the primary purpose of securing professional legal services” to RJL.

Ruling

In this diversity case, the court correctly held that state privilege law supplies the rule of decision, and then applied Texas’s attorney–client privilege set forth in Tex. R. Evid. 503(b).   On a side note, it appears that neither the parties nor the court addressed whether Texas’s conflict-of-laws rules mandated application of UK privilege law.

Based primarily on Textron’s in-house counsel’s affidavit, the court ruled that he was “engaged to represent both RJL and Textron as joint clients during the 2005 HSE investigation.”  And because of this joint-client situation, the court ruled that “it is black letter Texas law” that the attorney–client privilege covers the emails between Textron’s in-house lawyer and RJL personnel.

What about the Allied-Litigant Doctrine?

Citing a 2012 Texas Supreme Court case, In re XL Specialty, 373 S.W.3d 46 (Tex. 2012), the plaintiff argued that Texas’s allied–litigant doctrine precluded the privilege finding.  In XL Specialty, a case that PoP profiled in this post, the Texas Supreme Court held that the common-interest privilege applies only to communications made by two parties during ongoing litigation.

Arguably, the allied–client doctrine would not apply to the communications sought from Textron/RJL because they pre-dated the litigation.  The Nester court, however, found this argument moot because XL Specialty “expressly does not change the long-standing Texas law that one attorney may simultaneously represent two or more clients on the same matter.”

PoP Analysis

Textron’s handling of this privilege issue provides guidance for in-house lawyers supplying legal advice to direct or indirect subsidiaries.  In-house counsel should document the subsidiary’s engagement of her services and request for legal advice. And after the attorney–client relationship exists, the lawyer must establish that the privilege covers the client communications by ensuring they were confidential when made, remained confidential thereafter, and were made for the purposes of securing legal advice.

Joint Clients and the Privilege—A New Wrinkle

The joint-client doctrine, which applies when one lawyer represents two or more clients, holds that the attorney–client privilege protects lawyer–client communications against all others but not when the clients become adverse to each other.  Separately, the at-issue waiver doctrine provides that a client waives the attorney–client privilege when he claims that the attorney breached a Joint Clientduty arising from the attorney–client relationship.

But what happens to the privilege when one, but not the other, of the lawyer’s joint clients sues the lawyer for malpractice—can the nonsuing client assert the privilege to prevent disclosure of attorney–client communications made in the course of joint representation?

In what appears to be a matter of first impression, a California appellate court answered in the negative, ruling that one joint client waives the privilege for all joint clients when he charges the attorney with malpractice.  Anten v. Superior Court, 183 Cal. Rptr. 3d 422 (Ct. App. 2015).  You may read the decision here.

In Anten, Lewis Anten and Arnold and Lillian Rubin retained a law firm to represent them on a matter of common interest.  Anten later sued the law firm for malpractice, but the Rubins did not.  Anten sought discovery of communications between the Rubins and the law firm, but the law firm asserted that the attorney–client privilege protected those communications and the Rubins had not waived it.

The court rejected the privilege and identified two bases for its ruling.  First, the court determined that, because the Anten and the Rubins were joint clients of the law firm, their communications were confidential and privileged as to strangers, but not between themselves.  In other words, the Rubins had no expectation of confidentiality with respect to Anten.  No confidentiality equals no privilege.

Second, the court held that considerations of “fundamental fairness” weighed in favor of vitiating the privilege.  It found unfair the situation where one joint client could prevent a lawyer from introducing communications in a suit to collect his fee.  And conversely, it found unfair the situation where a nonsuing client could prevent disclosure of communications in the other client’s suit against the lawyer.  The court also found “substantial” the risk of collusion between the joint clients in the former situation and the lawyer-nonsuing client in the latter situation.

PoP Analysis.  Given the joint-client doctrine, the court’s ruling on the first-impression issue is not surprising.  Joint clients must know and understand that communications with their lawyer, whether in separate or joint meetings, are not confidential between themselves.  And they must know that it is unlikely that they can raise the privilege to preclude disclosure of their communications in any subsequent suit involving the clients and lawyer as adversaries.

The Anten case provides lawyers with a take-away as well.  Lawyers representing multiple clients should ensure that their clients understand the lack of confidentiality between themselves of lawyer communications—in any situation. A best practice is to include these statements in the engagement agreement or otherwise having the client sign an acknowledgement.