The Second Circuit Reaffirms the Work-Product Doctrine’s Scope

When tax controversy or litigation is anticipated, retaining confidentiality of documents is of the utmost importance. Fortunately, a recent decision brings good news for taxpayers. In Schaeffler v. United States, the United States Court of Appeals for the Second Circuit issued a taxpayer‑friendly decision on the scope of the attorney‑client privilege and the work‑product doctrine, holding that (1) the taxpayer did not waive attorney‑client privilege when it shared a document created by an accounting firm with a consortium of banks because the taxpayer and banks shared a common legal interest; and (2) the work‑product doctrine also protected the documents. Significantly, the court’s work‑product doctrine holding departs from the analysis used by the First Circuit Court of Appeals in United States v. Textron to hold that the work‑product doctrine did not protect tax accrual workpapers. Further, the Schaeffler decision should prove useful for taxpayers pursuing issues on a mutual basis with other parties who have a common interest.

Georg Schaeffler was the 80 percent owner of the Schaeffler Group (collectively, “Schaeffler”), an automotive and industrial parts supplier incorporated in Germany. In 2008, Schaeffler sought to acquire a minority interest in the German company Continental AG by means of a tender offer financed with an €11 billion loan from a consortium of banks. German law prohibits a tender offer seeking less than all of a company’s shares, so Schaeffler made the offer at a price that was estimated to result in the acquisition of the desired number of shares. During the offer period, the financial crisis of 2008 significantly worsened, the price of Continental AG shares fell sharply, and because German law prohibited the offer’s withdrawal, far more shareholders than anticipated accepted the offer. Schaeffler emerged as the 90 percent owner of Continental AG, a result that threatened Schaeffler’s solvency and ability to repay the bank consortium’s loan.

Schaeffler and the consortium sought to refinance the debt and restructure the group. Due to the complexity of the refinancing and restructuring, and anticipating IRS scrutiny of the U.S. tax consequences, Schaeffler retained Ernst & Young (EY) and Dentons US LLP, and it executed an agreement with the consortium to share legal analyses. When the IRS did, indeed, commence an audit, Schaeffler sought to quash the IRS’s demand for tax opinions, arguing both that they were privileged and entitled to protection as attorney work‑product. A district court denied the petition to quash, holding that Schaeffler had waived attorney‑client privilege by sharing the documents with the bank consortium and also rejecting the work‑product claim. On appeal, the Second Circuit vacated and remanded the district court’s decision.

Attorney‑client privilege protects communications between a lawyer and his or her client that are intended to be (and in fact are) kept confidential for the purpose of obtaining or providing legal advice. It is intended to encourage clients to communicate freely and openly with their lawyer. Generally, the privilege is deemed waived if the client voluntarily discloses otherwise‑privileged information to a third party. However, privilege is not destroyed where the client has a common legal interest with that third party, and the communication is in furtherance of that ongoing common enterprise.

Against this background, the Second Circuit examined whether the bank consortium’s common interest with Schaeffler was “of a sufficient legal character” to avoid waiver of the privilege upon the sharing of documents prepared by EY with the banks. In holding that it was, the court noted several facts. According to the court, both parties stood to avoid a “mutual financial disaster” (that is, Schaeffler’s insolvency and resulting default on the consortium’s loan) by securing a particular tax treatment for the refinancing and restructuring. Securing this treatment, they expected, would involve a legal encounter with the IRS, and thus, both Schaeffler and the banks had a common interest in that legal encounter’s outcome. The court further explained that the EY documents at issue were “directed to the tax issues, a legal problem albeit with commercial consequences,” and that “[a] financial interest of a party, no matter how large, does not preclude a court from finding a legal interest shared with another party where the legal aspects materially affect the financial interests.”