Wednesday, December 12, 2012

Third Circuit on Crime-Fraud Exception to Attorney-Client and Work-Product Privileges (12/12/12)

The Third Circuit yesterday issue a major opinion involving assertions of the attorney-client and work-product privileges and the application of the crime-fraud exception to those privileges.  In Re: Grand Jury John Doe 1; John Doe 2; ABC Corporation, 705 F.3d 133 (3d Cir. 12/11/12), here.  The introduction of the majority opinion is (footnotes omitted):
ABC Corp., John Doe 1, and John Doe 2 are subjects of an ongoing grand jury investigation into an alleged criminal tax scheme.1 As part of that scheme, ABC Corp., under the direction of John Doe 1 and John Doe 2, purchased and subsequently sold numerous companies. These consolidated appeals concern whether documents and testimony relating to legal advice obtained by ABC Corp. in connection with these transactions are shielded by the attorney-client and work product privileges. 
When ABC Corp. objected that the Government had improperly served a subpoena for documents on ABC Corp., the Government issued grand jury subpoenas for those documents to ABC Corp.'s current outside counsel—LaCheen, Wittels & Greenberg, LLP, and Blank Rome, LLP. Later, it also served subpoenas for documents and testimony on three attorneys formerly employed by ABC Corp. as in-house counsel. In each instance, the firms and counsel asserted attorney-client and work product privileges on ABC Corp.'s behalf, the Government moved to enforce the subpoenas, and ABC Corp. opposed the motion as the purported privilege holder. 
The District Court granted the Government's motions to enforce based in part on the crime-fraud exception, which permits the Government to obtain access to otherwise privileged communications and work product when they are used in furtherance of an ongoing or future crime. Finding that the requested communications and work product either did not qualify as privileged or that any protection afforded was vitiated by this exception, the Court largely rejected ABC Corp.'s privilege claims and issued corresponding disclosure orders—the first directed to ABC Corp., LaCheen Wittels, and Blank Rome in March 2012 (the "March Order"), and the second directed to the three in-house counsel in June 2012 (the "June Order").
ABC Corp. seeks to appeal these Orders.2 Disclosure orders are not normally immediately appealable final decisions. To obtain immediate appellate review, a privilege holder must disobey the court's order, be held in contempt, and then appeal the contempt order. That has not happened here. ABC Corp. argues nonetheless that it can appeal under an exception to the contempt rule established in Perlman v. United States, 247 U.S. 7 (1918). Under Perlman, a privilege holder may immediately appeal an adverse disclosure order when the traditional contempt route is unavailable to it because the privileged information is controlled by a disinterested third party who is likely to disclose that information rather than be held in contempt for the sake of an immediate appeal. 
We disagree that we have jurisdiction to hear ABC Corp.'s appeal from the March Order.3 It directs both ABC Corp. and the law firms to produce the withheld documents. While Blank Rome is in physical possession of them, it is holding them at the behest of ABC Corp. If ABC Corp. wants immediate appellate review, it can take possession of the documents, defy the disclosure Order, and appeal any resulting contempt sanctions.4 Because it has not yet taken these steps, we dismiss its appeal from the March Order for lack of appellate jurisdiction.
We agree, however, that we have jurisdiction to hear ABC Corp.'s appeal from the June Order, which is directed solely to its former in-house counsel. ABC Corp. cannot be held in contempt of this Order because it does not direct ABC Corp. to take or refrain from any action. And there is no indication that ABC Corp.'s former employees are anything but disinterested third parties unwilling to be held in contempt to vindicate its purported privilege. We therefore reach the merits of ABC Corp.'s appeal from the June Order. 
ABC Corp. alleges a series of problems with that Order: (1) the Court applied the wrong standard of proof in determining whether the Government made a sufficient showing to support application of the crime-fraud exception; (2) no matter the proof required, the Court wrongly found that the Government satisfied its burden; (3) the Court erred in applying the crime-fraud exception to work product generated by the in-house counsel because there is no suggestion these attorneys were involved in the alleged criminal scheme; and (4) with respect to five particular documents, the Court ruled incorrectly that they either did not qualify as privileged or were subject to the crime-fraud exception. 
We sympathize with the difficult position of ABC Corp.'s attorneys. They are arguing against the applicability of the crime-fraud exception without knowledge of the underlying evidence for that exception. Because this evidence would reveal aspects of the grand jury's investigation and thus cannot be made public, the District Court filed its March and June Orders under seal and provided only redacted copies to the parties. See Fed. R. Crim. P. 6(e)(2). Though we limit our discussion to background facts already disclosed to both parties in order to maintain this secrecy, we have received and closely reviewed unredacted versions of the Orders, as well as secret grand jury information submitted ex parte by the Government.5 On the basis of that review, we affirm the District Court's June Order.
And, here is the conclusion succinctly summarizing the holdings (footnote omitted):
We summarize our holdings. 
1. ABC Corp. has standing to contest the grand jury subpoenas because it claims privilege in the sought-after documents and testimony. John Doe 1 and John Doe 2, in contrast, lack standing because they are not privilege holders, and do not have any other legally cognizable interest in the documents or testimony. 
2. Even though ABC Corp. has standing, we lack jurisdiction to hear its appeal from the March Order because ABC Corp. may travel the well-worn contempt path to jurisdiction. If ABC Corp. wishes to appeal this Order immediately, it must take possession of its documents from Blank Rome, refuse to produce them to the Government, and appeal any resulting contempt sanctions. Because the parties have been unable to agree on a mechanism for transferring the documents, we lift the stay to allow the District Court to effect an appropriate transfer. In doing so, the Court, if it wishes, may designate a representative of ABC Corp. to receive delivery of the documents or direct ABC Corp. to do so. 
3. We have jurisdiction to hear the appeal by ABC Corp. from the June Order because that Order is not directed to it and its former employees are unlikely to risk contempt sanctions on its behalf. Contrary to the Government's suggestion, we decline to hold that the Supreme Court's decision in Mohawk Industries, Inc. v. Carpenter, 558 U.S. 100, 130 S. Ct. 599 (2009), precludes Perlman appeals by grand jury subjects. 
4. Finally, in reaching the merits of ABC Corp.'s appeal from the June Order, we hold that the Court correctly (a) applied the crime-fraud exception to deny ABC Corp. a privilege protection over testimony and two documents sought from its former in-house counsel and (b) determined that three documents sought from those counsel do not qualify as privileged. 
In this context, we dismiss the appeals by John Doe 1 and John Doe 2 for lack of standing, dismiss the appeal by ABC Corp. from the March Order for lack of jurisdiction, and affirm the June Order.
JAT Analysis.

1.  The Perlman Doctrine.  The issue reached the court of appeals by intermediate appeal prior to the court holding anyone in contempt.  The fulcrum for such an intermediate appeal is the Perlman doctrine, based on the Supreme Court case of that name (Perlman v. United States, 247 U.S. 7 (1918)).  The Court of Appeals described the Perlman doctrine as follows:  "Under Perlman, a privilege holder may immediately appeal an adverse disclosure order when the traditional contempt route is unavailable to it because the privileged information is controlled by a disinterested third party who is likely to disclose that information rather than be held in contempt for the sake of an immediate appeal."  Elsewhere the Court says (case citations omitted):
Though the Perlman doctrine's reach has not been set precisely by the Supreme Court, it generally permits an interlocutory appeal of a disclosure order if it is directed at a disinterested third party lacking a sufficient stake in the proceeding to risk contempt by refusing compliance. In that circumstance, the privilege holder is allowed to appeal immediately without suffering contempt sanctions because the privilege holder cannot itself disobey the disclosure order and the third party to whom the disclosure order is directed is unlikely to do so on its behalf.
I have previously blogged on the application of the Perlman doctrine in a Ninth Circuit case, United States v. Krane, 625 F.3d 568 (9th Cir. 2010), cited by the Third Circuit in its opinion.  That blog is Ninth Circuit Applies Perlman Rule for Collateral Appeal of Order Rejecting Attorney-Client Privilege for Former Attorneys of NonIndicted Party (Federal Tax Crimes Blog 10/31/10), here.  As in Krane, the Third Circuit offers considerable nuance as to the effect of the Supreme Court's subsequent opinion in Mohawk Industries, Inc. v. Carpenter, 558 U.S. 100 (2009).  I don't intend to delve into the weeds on that one, since I don't think I can add anything meaningful to the Third Circuit's opinion and my prior blog on Krane.  The Third Circuit declines to read Mohawk as limiting Perlman in the context of a grand jury investigation.

2.  The Normal Path for the Privilege Holder is to Appeal after Suffering a Contempt Order.  The Court of Appeals denied the Corporation's appeal of an order compelling it to turn over the allegedly privileged documents.  Those documents were in the physical possession of third parties (e.g., attorneys) but subject to the Corporation's control and thus subject to the order compelling production.  If the privilege holder is the party compelled by the subpoena, then the traditional appeal after being held contempt is adequate without the need for an intermediate appeal.  The Court noted:
ABC Corp. cautions that refusing to hear this appeal would "essentially destroy[] the Perlman doctrine" because "Perlman can now be defeated if the government or another litigant simply names the privilege holder in the motion to compel and includes the privilege holder in the compulsion order, even where the privilege holder is not in possession of the subpoenaed documents." Appellants' Br. at 36. This concern is overstated. Our reasoning would only prevent an appeal where a privilege holder subject to a disclosure order retains legal control of the documents that are in the physical possession of another and the Government has agreed that the documents can be transferred to the privilege holder without the transferor risking contempt. fn16 Although the Government may be wise in the future to avoid these complications by issuing a subpoena only to the privilege holder, the contempt route remains open in this instance and there is no need for us to allow a Perlman appeal.
   fn16 Several courts of appeals permit Perlman appeals where the disclosure order is directed solely at the privilege holder's attorney. In re Grand Jury Subpoenas, 123 F.3d 695, 698-700 (1st Cir. 1997) (collecting cases). These cases are properly distinguished because their disclosure orders were not also directed at the privilege holder, making it effectively impossible for the holder to be held in contempt. These cases often concern as well  the production of subpoenaed documents (e.g., law firm records) that are legally controlled by the firm rather than the client. See, e.g., In re Klein, 776 F.2d 628 (7th Cir. 1985).
3.  Crime-Fraud Exception.  The Court explains the crime-fraud exception as follows:
Despite their importance, the protections afforded by the attorney-client privilege and the work product doctrine are not absolute. The Supreme Court has explained that the crime-fraud exception is one limit on the scope of the protection afforded by the attorney-client privilege. 
The attorney-client privilege must necessarily protect the confidences of wrongdoers, but the reason for that protection—the centrality of open client and attorney communication to the proper functioning of our adversary system of justice—ceases to operate at a certain point, namely, where the desired advice refers not to prior wrongdoing, but to future wrongdoing. 
United States v. Zolin, 491 U.S. 554, 562-63 (1989) (quotation marks, alterations, and citations omitted). We have held that this exception also applies to the work product doctrine. "The work product privilege is perverted if it is used to further illegal activities as is the attorney-client privilege, and there are no overpowering considerations in either situation that would justify the shielding of evidence that aids continuing or future criminal activity." In re Grand Jury Proceedings, 604 F.2d 798, 802 (3d Cir. 1979).
4.  Government Burden to Establish the Crime-Fraud Exception - the Reasonable Basis Standard.  The Government bears the burden of establishing its right to get otherwise privileged documents under the crime-fraud exception.  All courts agree that this burden exists, but what quantum of proof is required?  The Court speaks:
To circumvent these privileges under the crime-fraud exception, the party seeking to overcome the privilege — in this case, the Government—"must make a prima facie showing that (1) the client was committing or intending to commit a fraud or crime, and (2) the attorney-client communications were in furtherance of that alleged crime or fraud." In re Grand Jury Subpoena, 223 F.3d at 217 (citations omitted). The "prima facie" standard is drawn from the Supreme Court's decision in Clark v. United States, 289 U.S. 1 (1933). 
There are early cases apparently to the effect that a mere charge of illegality, not supported by any evidence, will set the confidences free. But this conception of the privilege is without support in later rulings. It is obvious that it would be absurd to say that the privilege could be got rid of merely by making a charge of fraud. To drive the privilege away, there must be something to give colour to the charge; there must be prima facie evidence that it has some foundation in fact. When that evidence is supplied, the seal of secrecy is broken. 
Id. at 15 (quotation marks and citations omitted). 
While there is general agreement on these precepts, courts of appeals are divided as to the appropriate quantum of proof necessary to make a prima facie showing. This is not surprising. "'Prima facie' is among the most rubbery of all legal phrases; it usually means little more than a showing of whatever is required to permit some inferential leap sufficient to reach a particular outcome." In re Grand Jury Proceedings, 417 F.3d 18, 22-23 (1st Cir. 2005) (citing Black's Law Dictionary 1228 (8th ed. 2004); McDonnell Douglas Corp. v. Green, 411 U.S. 792, 802 (1973)). 
* * * *
Courts of appeals have articulated the proper measure of proof in different ways. Some require there to be probable cause or a reasonable basis to suspect or believe that the client was committing or intending to commit a crime or fraud and that the attorney-client communications were used in furtherance of the alleged crime or fraud. See In re Grand Jury Proceedings, 417 F.3d at 23 & n.4; United States v. Jacobs, 117 F.3d 82, 87 (2d Cir. 1997); United States v. Collis, 128 F.3d 313, 321 (6th Cir. 1997); In re Grand Jury Proceedings, 87 F.3d 377, 381 (9th Cir. 1996). Other courts call for evidence sufficient to compel the party asserting the privilege to come forward with an explanation for the evidence offered against the privilege. See United States v. Boender, 649 F.3d 650, 655-56 (7th Cir. 2011); In re Grand Jury Subpoena, 419 F.3d 329, 336 (5th Cir. 2005). Still other courts demand a showing of evidence that, if believed by a trier of fact, would establish that some violation was ongoing or about to be committed and that the attorney-client communications were used in furtherance of that scheme. See In re Grand Jury, 475 F.3d 1299, 1305 (D.C. Cir. 2007); In re Grand Jury Proceedings #5 Empanelled January 28, 2004, 401 F.3d 247, 251 (4th Cir. 2005); In re Grand Jury Investigation, 842 F.2d 1223, 1226-27 (11th Cir. 1987). 
* * * *
Today, we clarify that our precedent is properly captured by the reasonable basis standard. The attorney-client privilege, work product doctrine, and crime-fraud exception are all compromises based on policy determinations. Although it is difficult to predict whether a particular standard of proof will strike the appropriate balance between these competing policy concerns, we believe, as do other circuit courts, that the reasonable basis standard affords sufficient predictability for attorneys and clients without providing undue protection to those that seek to abuse the privileges afforded to them. This is also the standard that we believe is closest to the Supreme Court's pronouncement that, for the crime-fraud exception to apply, "there must be something to give colour to the charge" that the attorney-client communication was used in furtherance of a crime or fraud. Clark, 289 U.S. at 15.
Where there is a reasonable basis to suspect that the privilege holder was committing or intending to commit a crime or fraud and that the attorney-client communications or attorney work product were used in furtherance of the alleged crime or fraud, this is enough to break the privilege. The reasonable basis standard "is intended to be reasonably demanding; neither speculation nor evidence that shows only a distant likelihood of corruption is enough." In re Grand Jury Proceedings, 417 F.3d at 23. At the same time, the party opposing the privilege is not required to introduce evidence sufficient to support a verdict of crime or fraud or even to show that it is more likely than not that the crime or fraud occurred. See id. at 22; In re Grand Jury Investigation, 445 F.3d at 274-75. The reasonable basis standard is one with which courts are familiar, and we are confident that they will be able to apply it consistently to achieve the policy objectives of the privileges and the crime-fraud exception. 
* * * * 
Neither our own nor Supreme Court precedent suggests that a preponderance-of-the-evidence standard is necessary to protect the policy concerns underlying the crime-fraud exception. To the contrary, we have found that these policy concerns, which differ from those attending evidentiary admissibility, are appropriately protected by a lower standard. This is particularly true in the grand jury context, where the need for speed, simplicity, and secrecy weighs against imposing a crime-fraud standard that would require adversarial hearings or the careful balancing of conflicting evidence.20 See In re Impounded, 241 F.3d at 313 ("'Any holding that would saddle a grand jury with minitrials and preliminary showings would assuredly impede its investigation and frustrate the public's interest in the fair and expeditious administration of the criminal laws.'" (quoting United States v. Dionisio, 410 U.S. 1, 17 (1973)); In re Napster, 479 F.3d at 1094-95 ("[C]ourts of appeal have noted that the need for speed and simplicity at the grand jury stage weighs against a crime-fraud standard that requires courts to hear testimony or to determine facts from conflicting evidence before making a crime-fraud determination." (quotation marks and citations omitted)). Accordingly, we do not adopt a preponderance-of-the-evidence test as the proof necessary to apply the crime-fraud exception.
5.  The district court held that the Government had made the necessary showing.  I won't get into the details of the discussion of that showing, which is a bit cryptic in order to limit the disclosure of grand jury matters subject to Rule 6(e)'s secrecy requirement, but is seems to be variant of the Midco transaction where the IRS is left holding the bag for taxes clearly due where the benefit of the unpaid taxes is economically shared among the parties to the overall transaction.  The Court of Appeals described the transactions as follows:
This scheme, which occurred between 2004 and 2006, unfolded in two phases. In the acquisition phase, ABC Corp. acquired the stock of closely held companies. The target companies generally had large cash accounts, few or no tangible assets, and considerable tax liabilities. In the disposition phase, ABC Corp. would remove significant amounts of the target companies' cash assets, transfer the stock of the target companies to two limited liability companies, and engage in various transactions that had the effect, it is alleged, of fraudulently eliminating the target companies' tax liability. Having done so, John Doe 1 and John Doe 2 would then divert the target companies' cash assets to themselves and their family members.
The court did disclose its conclusion that the transactions under review were sufficiently different, as alleged, that those involved in the civil cases involving Midco that the results of the civil cases would not be controlling.

6.  The dissenting judge, Judge Vanaskie, agrees with most of the majority opinion and disagrees only with whether the majority's holding that the Court of Appeals did not have jurisdiction over the March Order.


  1. The post discusses the crime/fraud exception in the context of a grand jury investigation. What about in civil discovery? Suppose the IRS has good reason to think that a taxpayer has been using and will continue to use a criminal tax shelter, and thinks the taxpayer's lawyer helped him design it. But the IRS doesn't want to bring a criminal case yet. Can it subpoena the lawyer's memos to the client about the tax shelter?

  2. I think the IRS could use it in a civil case, but keep in mind that it will have to prove the existence of the crime-fraud exception. If it is thinking about bringing a criminal case later, the IRS may not want to lay out its hand this early.

    Jack Townsend


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