Textron - First Circuit Throws a Curve - Decision Creates More Questions Than Answers

Tax Controversy Alert

Taxpayers had hoped that the Textron case in the First Circuit would bring clarity to the application of the work-product protection to tax accrual workpapers. A divided en banc panel of First Circuit, however, delivered an opinion that, according to the dissenting judges, may have “thrown the law of work-product protection into disarray.” The majority vacated the taxpayer-favorable trial court judgment and remanded the case for further proceedings “consistent with this decision.” On remand, the trial court will have to follow a new standard set out in the majority opinion that virtually guarantees that the work-product protection will not apply to Textron’s (or perhaps anyone else’s) tax accrual workpapers.


The trial court ruled that the IRS could not compel the production of tax accrual workpapers prepared by Textron’s attorneys. Those workpapers identified issues that the company’s attorneys believed could be challenged by the IRS and reflected their estimate of the prospects for prevailing before the IRS or in court. The trial court had rejected Textron’s claims of attorney-client and § 7525 privileges based on waiver. This left the issue of work-product protection -- specifically, whether Textron's tax accrual workpapers were prepared in anticipation of litigation or for trial. See Fed. R. Civ. P. 26(b)(3).

Textron argued that the workpapers were prepared in anticipation of litigation notwithstanding that they also served to ensure that the company recorded the appropriate tax reserves for financial accounting purposes. The trial court found that Textron would not have created the workpapers but for the fact that the taxpayer reasonably anticipated litigation over one or more matters reflected in the workpapers. Consequently, the court ruled, those documents come within the protection provided by the work product doctrine.

The First Circuit in January 2009 affirmed the trial court's ruling that Textron's workpapers qualified for work-product protection. The decision was 2-1, over a strong dissent by former Chief Judge Boudin, in which he argued that the panel’s decision conflicted with existing First Circuit precedent. On March 25, 2009, the First Circuit granted the government’s petition for rehearing en banc. On August 13, 2009, in a majority opinion written by former Chief Judge Boudin, the en banc panel reversed course and adopted Judge Boudin’s views.

The En Banc Majority Opinion

The central question addressed by the panel was the proper legal standard and its application to assess whether the workpapers deserved work-product protection. The majority opinion reaffirmed the standard in the First Circuit, based on the decision in Maine v. Department of Interior, 298 F.3d 60 (1st Cir. 2002), that documents prepared “because of” the prospect of litigation would be protected under the work-product doctrine. Ordinarily, this would have been an important decision for taxpayers due to the First Circuit’s rejection of the more restrictive “primary purpose” standard applied in the Fifth Circuit, which allows work-product protection only for documents when the “primary purpose” for the creation of those documents was the prospect for litigation. See United States v. El Paso Co., 682 F.2d 530 (5th Cir. 1982). However, as discussed below, the majority's application of the “because of” test left Textron’s workpapers unprotected by the work-product doctrine.

In applying the “because of” test, the majority took a practical approach that focused almost exclusively on whether the materials were of the type that a litigator would use in preparing for actual or anticipated litigation. If the materials would have been prepared in the same way notwithstanding the litigation, due to independent legal or regulatory requirements, then the majority held the materials to be unprotected. The majority supported its conclusions by examining the origins of the work-product doctrine in the seminal case of Hickman v. Taylor, 329 U.S. 495 (1947). The majority noted that “[f]rom the outset, the focus of the work product protection has been on materials prepared for use in litigation, whether the litigation was underway or merely anticipated.” The majority then reviewed the trial court record, including the testimony of the witnesses, and concluded that the workpapers were prepared for financial reporting purposes and were not intended to be used in the course of preparing for litigation. Although the subject matter of the document relates to an issue that might be the subject of litigation, according to the majority, that was “not enough to trigger work product protection.” Similarly, according to the majority, work product protection does not extend to documents merely because they were prepared by lawyers or represent legal thinking. The majority noted that “[a]ny experienced litigator would describe the tax accrual workpapers as tax documents and not as case preparation materials.” Later, the majority similarly commented that “[e]very lawyer who tries cases knows the touch and feel of materials prepared for a current or possible (i.e., ‘in anticipation of’) lawsuit.” The majority further found that any conclusion that the workpapers were prepared “for use in possible litigation . . . would have been clearly erroneous.” Accordingly, it is difficult to imagine the result on remand being anything other than that Textron's workpapers are not afforded work-product protection.

The Dissenting Opinion

In a scathing dissent, two members of the en banc panel characterized the majority opinion as “purporting to do just the opposite of what it actually does.” The dissent points out that while the majority opinion claims to reaffirm the “because of” test from Maine, the majority’s application of the test to Textron’s workpapers was so strained that it actually creates yet another test -- that the “documents ‘were prepared for use in possible litigation.’” The dissent reviews the Second Circuit decision in United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998), which articulated in detail the standard the First Circuit relied upon in Maine. The dissent points out that Adlman afforded work product protection to documents created for some business purpose other than litigation but nonetheless reflected the business’ or its lawyer’s assessment of the prospects in litigation. Therefore, the majority’s adoption of the “new ‘prepared for’ rule is blatantly contrary to Adlman” and thus also contrary to Maine.

The dissent expressed concern about the potential ramifications of this decision beyond merely the application to tax accrual workpapers. As the dissent points out, “[n]early every major business decision by a public company has a legal dimension that will require [an analysis of anticipated litigation]. Corporate attorneys preparing such analyses should now be aware that their work product is not protected in this [the First] circuit.”

Result-Oriented Decision

The analysis in the majority opinion may reflect that the majority was caught between its desire to remain true to existing circuit precedent but also to allow the IRS access to the tax accrual workpapers. In response to Textron arguing that it would be unfair to provide the IRS, its adversary, with a roadmap of the soft spots in its return (a classic rationale for the application of the work-product protection), the majority commented that “tax collection is not a game.” The majority described the under-reporting of corporate taxes as “likely endemic” and sympathized with the IRS in its task of auditing Textron’s “massive” return. After noting that the IRS had already discovered that Textron had engaged in tax shelter transactions, the “unfairness” was apparently outweighed because the “collection of revenues is essential to government.” These statements by the majority reflect strongly-held concerns that the government be given the tools that it needs to effectively combat “abusive” tax shelters. If sustained, the Textron court’s decision to deny work-product protection may become another example of how the recent tax-shelter phenomenon has altered the legal landscape for taxpayers.

What's Next

As the dissent noted, “[t]he time is ripe for the Supreme Court to intervene and set the circuits straight on this issue.” We fully expect Textron to seek Supreme Court review, which would have to be requested by November 11, 2009. There has already been a split in the circuits with respect to the “primary purpose” test in the Fifth Circuit and the “because of” test is many others. The en banc decision in Textron may have exacerbated that split if one reads the majority opinion, as the dissent does, as creating yet another “for use” test. Whether the Supreme Court will agree to review the decision is impossible to predict. One factor that may influence the Court to grant a review is the extent to which the Court believes the dissent is correct that the majority's decision will have far-reaching consequences for work-product protection outside the arena of tax accrual workpapers.

Taxpayers would still have to address some significant questions even if the Supreme Court were to reverse and afford work- product protection to tax accrual workpapers. The original First Circuit opinion in Textron had remanded to the trial court to determine if the disclosure of Textron’s workpapers to Ernst & Young waived the work-product protection. That question remains unanswered. Furthermore, the original IRS request asked for the workpapers of both Textron and E&Y, but the trial court addressed only the request for Textron’s workpapers. The original First Circuit opinion ruled that this was an error and the remand was expected to address the IRS ability to obtain the E&Y workpapers, which could be just as damaging to Textron as its own workpapers.

Please consult any of the following individuals for assistance with the issues discussed in the Alert:

David Blair

Kevin Kenworthy, kkenworthy@milchev.com, 202-626-5848

Alan Horowitz, ahorowitz@milchev.com, 202-626-5839

George Hani, ghani@milchev.com, 202-626-5953

Justin Miller

Related Files
Related Links

The information contained in this newsletter is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information about these issues, please contact the author(s) of this newsletter or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

This newsletter is protected by copyright laws and treaties. You may make a single copy for personal use. You may make copies for others, but not for commercial purposes. If you give a copy to anyone else, it must be in its original, unmodified form, and must include all attributions of authorship, copyright notices and republication notices. Except as described above, it is unlawful to copy, republish, redistribute, and/or alter this newsletter without prior written consent of the copyright holder.