In US v. Veolia Environmental North American Operations, the District Court for Delaware had an interesting holding at the end of last month regarding document privilege in a minor $4.5 billion worthless stock deduction case. I do not believe any new law was forged, but the holding had a good discussion of work product, attorney client privilege, attorney expert privilege, and waiver. The case highlights the importance of the various privileges and ensuring actions fall within the privilege if you hope to not share something in discovery.
A quick review of the underlying law. Pursuant to FRCP 26(b)(3)(A), a party may not discover documents “that are prepared in anticipation of litigation or for trial by or for another party or its representative.” This is the work product doctrine and allows parties to prepare for litigation without being worried that it will be used against them. The party’s state of mind is key in determining whether the document was prepared in anticipation of litigation or in the normal course of business. FRCP 26(a)(2)(B)(ii) provides a testifying expert witness must disclose all facts, data, and assumptions considered in forming opinions to be testified on. Communications between experts and the party’s attorney are protected under FRCP26(b)(4)(C), but the expert still must disclose 1) the experts compensation, 2) identifying facts or data the attorney provided and the expert considered in forming the opinions, and 3) assumptions provided by the attorney that the expert relied upon in forming opinions.
On to the facts, where in April of 1999, Veolia purchased Water Application & Solutions Corporation (“WASCO”) for $8.2 billion, which turned out to be a crap investment. In ’06, Veolia retained attorneys and experts to find a way to write off and deduct the WASCO stock as worthless. During ’06, a plan was outlined to convert WASCO into an LLC as a triggering event to deduct the value. The taxpayer obtained additional counsel, sought a PLR, and hired two valuation firms to produce reports on WASCO’s insolvency. The plan was implemented, and, in 2007, Veolia entered into the pre-filing agreement program to attempt to determine the deductibility prior to filing its return. A third valuation firm was hired, and the report provided to the Service. The Service then requested a few (hundred thousand) documents. Veolia complied with most of the documents, but withheld all or portions of slightly under 361 documents. The IRS knew that those were probably the ones they wanted, and issued a summons. Keith had recent post on the new IDR rules in large cases, which can be found here, which may result in more summons cases.
Veolia refused to hand over the documents, stating various privileges, including work product and attorney- expert. The Court first addressed Veolia’s work product argument. Veolia had provided evidence to the Service and the Court that it had anticipated IRS scrutiny, disagreement and possible litigation as early as 2006 when it started considering the deduction and how to obtain it under the Code. The Service argued that part of Veolia’s business model was purchasing companies in distress, and dismantling them for tax benefits. As such, the research and opinion was simply normal business practices and not generated in anticipation of litigation. The Court found that the Service position was correct in that Veolia’s actions were part of its ordinary business practices, but held that did not preclude those actions from also being taken in anticipation of litigation. The hiring of valuation experts and counsel, and the reports regarding IRS scrutiny and the chances of success all indicated that Veolia was taking steps to properly handle the transaction, but also to properly position itself for a contentious debate with the Service. The Court further held that it was objectively reasonable for Veolia in 2006 to think litigation was possible, as the size of the deduction–$4.5 billion– would cause IRS review and Veolia was already under audit for various other years.
Another aspect of the holding that I found interesting was the portion pertaining to the information relied upon by the expert. The Service and the taxpayer disagreed as to the extent of the documents and information that had to be supplied to the Service that the experts reviewed. Veolia felt it met its obligation by disclosing all the information and documents it provided to the expert, whereas the Service wanted the information and facts that anyone had provided to the expert. The Court held that Rule 26(b)(4)(C) only protects communications between the party’s attorney and the party’s testifying expert, and communications by anyone other than the party’s attorney are not protected and must be disclosed. The Court extended this to communications by one expert to the other expert. The Court also noted that the attorney-expert privilege is also limited, in that the expert must disclose all facts, data and assumptions it relied on that were provided by the attorney, and it would not make sense to protect that information if supplied by the other expert. See Fialkowski v. Perry, 2012 WL 2527020, at *4 (E.D. Pa. June 29, 2012) (stating that disclosure requirements for testifying experts “were meant to trump all claims of privilege, mandating production of all information furnished to the testifying expert for consideration in the formulation of [the expert’s] opinions, regardless of privilege”).
The Court did leave open the possibility that Veolia could assert some other privilege for these documents, but was not specifically ruling on any documents at that time. The question this raised in my mind was the extent to which the lawyers provided the first set of experts with the documents and information that were subsequently provided to the second expert. Did this expert to expert communication taint otherwise protected attorney work product or attorney expert privilege, or was it all discoverable as facts, data and assumptions? Perhaps the Court’s statements indicating other privileges could still be raised was a guide to Veolia that it would treat the expert as an agent of the attorney for otherwise protected materials if those materials were outside of the discoverable facts, data and assumptions. As stated above, the Court was providing general holdings, and it hoped the parties could then come to an agreement as to what had to be disclosed. The Court was not holding on any particular document, so the holding did not show how exactly this would be applied.
One last point worth noting was the Court’s statement on the waiver doctrine. A waiver of otherwise privileged documents can occur if the taxpayer shares those documents with third parties. The Service argued that communications between Veolia’s employees and employees of other related entities resulted in a waiver. The Court held that Veolia had similar interests as its parent company and other related entities, and the participation of various entities was required for obtaining and enacting legal or tax advice, so waiver was inapplicable.