The Second Circuit Clarifies the “Common Legal Enterprise” Doctrine
November 2015In a recent decision, the Court of Appeals for the Second Circuit found that certain documents sought by the IRS pursuant to a summons were protected from disclosure under the tax practitioner privilege and the work product doctrine. In particular, the Second Circuit found that there had been no waiver of the tax practitioner privilege when documents sought by the IRS were shared with another party because the taxpayer and that party were engaged in a “common legal enterprise.” As the IRS and taxpayers grow increasingly litigious, taxpayers may wish to consider whether tax opinions and tax memoranda may be shared with third parties in a manner that preserves the privilege under the common legal enterprise doctrine.
Facts of the case
The Schaeffler Group (the “Group”) is an automotive and industrial parts supplier incorporated in Germany. Georg Shaeffler (“Schaeffler”), a U.S. resident, owns an 80 percent interest in the Group. During 2008, the Group made a tender offer to acquire a minority interest in another German company. The tender offer was financed by a consortium of banks (the “Consortium”). Under German corporate law, a tender offer for a minority interest may be effected only by setting an offer price estimated to result in the tender of the desired number of shares (i.e., an offer may not be made to purchase a fixed number of shares).
Two days before the end of the tender period, global stock markets crashed, and 90 percent of the shares of the German target were tendered to the Group. Under German law, the Group could not revoke the offer. As a result, the Group’s solvency was threatened.
These circumstances were the impetus for an agreement between Schaeffler, the Group and the Consortium to enter into various transactions to refinance the debt owing to the Consortium and avoid insolvency for the Group. Due to the “novel and complex” nature of the refinancing, Schaeffler and the Group expected scrutiny from the IRS. A law firm and an accounting firm were retained by the group to advise on the federal income tax consequences of the refinancing and possible future litigation with the IRS concerning the same.
During a subsequent IRS audit of the transactions, the IRS requested documents prepared by the accounting firm that had been shared with the Consortium. The District Court for the Southern District of New York ruled that by sharing the documents prepared by the accounting firm with the Consortium, Schaeffler and the Group had waived the tax practitioner privilege. The District Court also found that certain documents prepared by the accounting firm were not protected under the work-product doctrine.
The Second Circuit’s analysis of “common legal enterprise”
On appeal to the Second Circuit, Schaeffer and the Group argued that there had been no waiver of the tax practitioner privilege because Schaeffer, the Group and the Consortium were engaged in a “common legal enterprise.” The Second Circuit stated the question as “whether the Consortium’s common interest with appellants was of a sufficient legal character to prevent a waiver by the sharing of these communications.”
The Second Circuit concluded that the common legal enterprise doctrine applied to the facts. The court acknowledged that the refinancing and the restructuring had both a commercial component and a tax component.
“Appellants interest was in securing a refinancing. The Consortium’s interest was in funding a refinancing that would protect its earlier investment and would be repaid, goals dependent on the resolution of legal tax issues. The fact that 11 billion Euros of sunken investment and any additional sums advanced in the refinancing were at stake does not render those legal issues ‘commercial,’ and sharing communications relating to those legal issues is not a waiver of the privilege”
The Second Circuit also observed that the parties had agreed that the Group would request a private letter ruling from the IRS on certain tax matters, and, that with regard to tax matters not resolved by the ruling, they would share “certain core tax advice” prepared by the U.S. tax advisors. This provided further evidence of a common legal enterprise in the eyes of the court.
Although the facts of this case are relatively uncommon and the precise boundaries of the common legal enterprise doctrine remain undefined, the reasoning of the Second Circuit may be applicable to other fact patterns. For example, when one party acquires an interest in a company, there may be tax issues of one of the parties to the transaction (or the company itself) that materially affect, either directly or indirectly, the other party or the target company. Accordingly, communications between the parties of otherwise privieged tax opinions and memoranda may not result in a waiver of the privilege in appropriate circumstances. To the extent that the parties wish to share privileged tax sensitive documents, it would appear prudent to enter into a written agreement to share the documents and recite any relevant facts supporting a future claim of the common legal enterprise doctrine.
KEYWORD: Tax Contoversy
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