Assume that your company is faced with an important business decision. It decides to study whether to merge two of its wholly-owned subsidiaries. The contemplated merger will result in losses of hundreds of millions of dollars, which will, in turn, generate a tax refund of tens of millions of dollars. Because of the tax consequences of this merger, it is almost a foregone conclusion that the Internal Revenue Service will challenge the tax treatment of the merger and the company will end up in litigation. To help determine whether to proceed with the merger given the likelihood of litigation, your company wants to hire an outside consultant, an individual who is a lawyer and an accountant, to evaluate the risks of the litigation. You ask yourself, however, will the company have to disclose the report issued by the consultant in any resulting litigation, thereby giving your adversary an enormous advantage?
These are the facts of U.S. v. Aldman, 134 F.3d 1194 (2d Cir. 1998), and in the Second Circuit at least, the answer is now that the work-product doctrine may shield the report from disclosure under Federal Rule of Civil Procedure 26(b)(3) Â— notwithstanding the fact that the report was created primarily to assist in a business decision. Aldman represents a departure from contrary decisions by the Fifth Circuit that held that if a document was created primarily to assist in a business decision Â— rather than having been created primarily because of expected litigation Â— the work-product doctrine did not apply. See, e.g., U.S. v. El Paso Co., 682 F.2d 530 (5th Cir. 1982), cert. denied, 466 U.S. 944 (1984). The effect of Aldman, therefore, is to enlarge the universe of documents that may qualify for work-product protection to include documents that are created to inform a business decision, assuming that they otherwise qualify under Rule 26(b)(3).
Rule 26(b)(3) protects from disclosure materials prepared by or at the direction of a lawyer "in anticipation of litigation," subject to a showing of substantial need. Under the rule, courts most particularly guard against the disclosure of an attorney's "mental impressions, conclusions, opinions or legal theories." FRCP 26(b)(3). The reason for this heightened protection is to encourage thoughtful legal analysis of potential actions without the fear that the conclusions reached will later have to be handed over to one's adversary.
The report at issue in Aldman contained legal theories, conclusions and opinions of the type that the work-product doctrine most particularly seeks to protect. The report was a 58-page legal analysis prepared by Arthur Andersen & Co. that contained a discussion of applicable statutes, regulations and precedents. It evaluated numerous challenges to the merger available to the IRS, and it set forth proposed responses and methods of structuring the transaction. Finally, the report made predictions regarding the likely outcome of an anticipated suit by the IRS. The recommendations set forth in the report were used to decide whether to proceed with the transaction, and the suggestions were incorporated into the process of designing the structure of the transaction. When the company then claimed a tax loss of $289 million, and a resulting tax refund of $35 million, the IRS sued as expected. In discovery, the IRS sought to obtain the report.
This year's appellate opinion in Aldman is the latest round in an ongoing battle by the IRS to obtain a copy of the report. In 1994, the United States District Court for the Southern District of New York rejected an attempt by the company to withhold the report on the basis of the work-product doctrine and attorney-client privilege. That Court found that the report could not qualify as work product because the event giving rise to the anticipated litigation, i.e., the transaction, had not yet occurred when the report was prepared. The Court also held that the attorney-client privilege was not applicable because the circumstances indicated that Arthur Andersen & Co. was not hired to provide legal advice. Rather, Arthur Andersen & Co. performed its analysis along with other accounting services.
On appeal, the Second Circuit, in 1995, reversed only the District Court's ruling on the application of the work-product doctrine. The Second Circuit held that the non-occurrence of the merger at the time of the report, while a factor to be considered, was not dispositive. It then remanded the case. On remand, however, the District Court again held that the work-product protection did not apply, this time because the report was not created in anticipation of litigation. In February of this year, the Second Circuit again reversed the lower court and again remanded for further consideration based upon the analysis outlined below.
The Fact That a Document is Created to Assist in a Business Decision is "Irrelevant" to Whether it is Eligible for Work-Product Protection
The Second Circuit held that "a document created because of anticipated litigation, which tends to reveal mental impressions, conclusions, opinions or theories concerning the litigation, does not lose work-product protection merely because it is intended to assist in the making of a business decision influenced by the likely outcome of the anticipated litigation."
To support this holding, the Court first reviewed the purpose of the work-product doctrine. The work-product protection, the Court noted, "is intended to preserve a zone of privacy in which a lawyer can prepare and develop legal theories and strategy Â‘with an eye toward litigation,' free from unnecessary intrusion by his adversaries." If this zone of privacy were intruded upon and if a party was forced to hand over its attorney's litigation strategies to its adversary, the opposing party would receive an unjust benefit, and the interests of justice would ultimately suffer because attorneys would not create needed analytical documents.
These concerns, the Court held, apply equally to documents created to assist in a business decision that will likely lead to litigation where those documents set forth a lawyer's legal conclusions and strategies. The Court thus rejected the "primary purpose" test used by the Fifth Circuit, which does not allow work-product protection for documents not primarily created to assist in litigation, as one "at odds with the text and policies" of the work-product rule.
The Second Circuit noted that the text of Rule 26(b)(3) does not state that the materials at issue must have been produced "primarily or exclusively" because of litigation. Indeed, the court pointed out that "[n]othing in the Rule states or suggests that documents prepared Â‘in anticipation of litigation' with the purpose of assisting in the making of a business decision do not fall within its scope." Moreover, the Rule provides heightened protection for documents containing legal analysis and the Advisory Committee notes to the Rule support the notion that detailed preparatory analysis of an attorney should not have to be given to one's adversary. Having to reveal such detailed analysis Â— just because the document was prepared to help make a business decision Â— "would oddly undermine" the protection of the Rule.
To demonstrate how such a result would contravene the purpose of the work-product protection, the Second Circuit provided a number of hypothetical factual situations. These hypotheticals provide further guidance on when the Second Circuit might find that work-product protection exists; interestingly, the majority of the hypotheticals involve disclosure of attorney work product to entities outside the company. For example, the Court hypothesized that a company's bank may request a report from the company's attorneys evaluating the likelihood of success in pending litigation to assist in the formation of lending policies for the company. Similarly, underwriters might request such a report from a company contemplating a public offering of securities, or independent auditors evaluating litigation loss reserves might request such an analysis. Framing the issue as whether these reports were prepared primarily for litigation or primarily to assist the making of a business decision, the Court stated, improperly focuses the analysis. Regardless of the document's primary purpose, the Court asserted that each example "falls squarely within [the work product doctrine's] area of primary concern."
A contrary rule would leave a company analyzing a business decision with a Hobson's choice: Does it commission a study of the contemplated action thereby receiving detailed and helpful analysis Â— but realizing that it will be severely prejudiced when it is forced to turn the study over it its opponents? Or does the company forego the analysis to achieve a litigation advantage Â— thereby sacrificing the possibility of making a more informed judgment? Because there is nothing in Rule 26(b)(3) that suggests that a company must be subjected to this quandary, the Court concluded that "[t]he fact that a document's purpose is business-related appears irrelevant to the question whether it should be protected under Rule 26(b)(3)."
The Proper Inquiry is Whether the Document Was Prepared "Because of" Litigation
Adopting a formulation set forth by noted legal scholars Charles Wright and Arthur Miller, the Aldman Court next held that a document should be considered prepared "in anticipation of litigation" where "Â‘in light of the nature of the document and the factual situation in the particular case, the document can fairly be said to have been prepared or obtained because of the prospect of litigation.'" This test adequately limits the circumstances in which a document will be protected, the Court noted. Documents created in the ordinary course of business, for example, will not be protected.
The Court also cautioned that a finding that a document was created "because of" litigation does not mean that it is absolutely protected from disclosure. Rather, the result of such a finding is that the document is eligible for work-product protection. Then, a court must analyze whether the adverse party has made a showing of substantial need for the information and an inability to obtain the information through other means without undue hardship.
In remanding Aldman back to the District Court, the Second Circuit identified the ultimate issue to be decided as whether the document "would have been prepared irrespective of the expected litigation with the IRS." If the document would have been created in any event, no protection applies. If, however, the document would not have been prepared "but for" the company's expectation of litigation with the IRS, it should not be disclosed.
Aldman's expansion of the work-product protection to documents created because of litigation but primarily to assist a business decision is a positive development for businesses. As the Aldman Court noted, corporations need these types of documents to make informed business decisions. Because such documents may set forth the very type of analytical and strategic thoughts that no company wants to hand over to its adversary in a subsequent dispute, the work-product doctrine should be available as a protection.
While this decision represents a major step toward that result, corporations must realize that, as of now, Aldman is not universally the law. Instead, other jurisdictions, such as the Fifth Circuit, still impose a contrary rule. Accordingly, the company faced with an important decision still may want to pause and consider the ramifications before it hires the consultant to render a report.