Question

5. You prepared the income tax return for Brian’s sister, Diana. She is now being accused of tax evasion by the IRS. Her attorney wants to retain you to evaluate the evidence the IRS is compiling and give him recommendations on what to do in her case. You’ve accepted the retainer and write a report for the attorney.

a. Is this entire report covered by the attorney-client privilege? Why or why not?

b. Is this report covered by the accountant’s privilege in I.R.C. § 7525? Why or why not?

Answer 1

We begin our analysis of the privilege with the obvious: before the privilege exists, there must be an attorney-client relationship. As elementary as this concept seems, many clients assume the relationship exists and mistakenly rely upon the protection of the privilege, but the privilege does not exist until the relationship is firmly established. Generally speaking, the attorney-client privilege does not take hold until the parties have agreed on the representation of the client.

In the majority of cases, the determination that the attorney-client relationship exists is not a laborious undertaking, for more often than not, the attorney has expressly acknowledged representation of the client. Such an express acknowledgment may be demonstrated by an engagement letter, a fee contract, or even an oral agreement as to the scope of the representation. An attorney-client relationship may also be expressly acknowledged by the “appearance” of the attorney on behalf of the client, including filing pleadings in court for the client, drafting documents on behalf of the client, or appearing in court as the representative of a litigant.¹¹

Unfortunately, it is not always so clear when an attorney-client relationship exists. Suppose Sally Smith contacted David Jones, an attorney, by telephone. During the course of the conversation, Smith explained to Jones that she is involved in a dispute with the Internal Revenue Service concerning a tax savings arrangement devised for certain business objectives. She discloses important facts and highly sensitive information during the conversation, then asks Jones for his legal opinion. Is the content of this conversation privileged? It depends.

An express contract is not necessary to form an attorney-client relationship; the relationship may be implied from the conduct of the parties. However, the relationship cannot exist unilaterally in the mind of the potential client absent a “reasonable belief” that the attorney-client relationship exists. The implied relationship may be evidenced by several factors, including, but not limited to, the circumstances of the conversation, the payment of fees to an attorney, the degree of sophistication of the would-be client, the request for and receipt of legal advice, and the history of legal representation between the alleged client and the practitioner. While this list of factors is illustrative, none of these factors, standing alone, will affirmatively establish the existence of an attorney-client relationship.¹²

In our example above, without more, a confidential relationship likely does not exist unless there is some history of former representation. Of course, if the conversation continued, and Jones proceeded to dispense legal advice, then Smith might have a reasonable belief that the relationship exists. This reasonable belief would be strengthened by evidence that Smith and Jones discussed payment, potential courses of action, and other details regarding the future handling of the matter.

The waters become more murky when the potential client is a business entity. In the corporate context, the attorney-client privilege exists between outside counsel and the corporation. Necessarily, however, the invocation of this right by a corporation is more complex than when an individual is involved, as a corporation is an artificial “person” created by law and is only able to act through a representative, including officers, directors and employees.

The courts have faced the daunting task of determining when the attorney-client privilege applies when a corporation is the client. For years, courts employed one of two “tests” to make this determination: the subject matter test¹³ and the control group test.¹⁴ The current trend, however, focuses on whether the matters discussed are encompassed by the corporate duties and responsibilities of the employee.

Take, for example, our hypothetical from before. Suppose that Sally Smith called not on her own behalf, but on behalf of her corporation, ABC Company (ABC). Smith is the president or chief financial officer of ABC, and discusses with Jones, the attorney, the tax exposure or potential liability of ABC. Because Smith is the president of the corporation, the privilege clearly extends to these communications. If, however, the call was made by Jane Edwards, the accounting manager, the answer becomes less clear. Based upon the current trend of the courts, Edwards’ conversations with the attorney are privileged so long as the issues she discusses with the attorney are directly related to her responsibilities within the company.

What is the result, however, when an employee such as Smith seeks advice in her individual capacity, as opposed to the corporate one? The courts will extend the attorney-client privilege to corporate officers, even as an individual, as long as there is clear evidence that the corporate officer communicated with counsel in the officer’s individual capacity concerning personal matters such as potential individual liability. Not surprisingly, the showing required of the corporate employee in this regard is a more stringent one. Moreover, even if the requisite showing is made, certain information might create a conflict of interest for the corporate attorney. In that case, the corporate attorney must end the conversation and advise the corporate employee to seek separate counsel.¹⁵

One final consideration arises in the context of in-house counsel. A communication relating to corporate legal matters between a corporation’s in-house counsel and the corporation’s outside counsel is normally subject to the privilege.¹⁶ However, when the communication is between a representative of the corporation and the in-house counsel, the distinction is less clear. Because in-house counsel often wears several hats, courts have struggled with the application of the privilege.¹⁷ The privilege would extend to any legal advice rendered, but it does not protect communications that are strictly business-related.¹⁸ Problems arise when the communication contains both legal and business advice, and the courts take different approaches in determining whether or not to apply the privilege. At the very least, it appears that the court will first attempt to determine what role in-house counsel plays within the company — that of a lawyer or that of a corporate executive. From there, many courts will examine the content of the communication, and this examination will yield varying results.¹⁹ As such, the in-house lawyer should be careful to separate his legal advice from his business opinions.

For purposes of applying IRC § 7525, it will be the federal version of the privilege which will be important. The conditions to the application of the privilege generally can be summarized as follows:

(T)he privilege applies only if (1) the asserted holder of the privilege is or sought to become a client; (2) the person to whom the communication was made (a) is a member of the bar of a court, or his subordinate and (b) in connection with this communication is acting as a lawyer; (3) the communication relates to a fact of which the attorney was informed (a) by his client (b) without the presence of strangers (c) for the purpose of securing primarily either (i) an opinion on law or (ii) legal services or (iii) assistance in some legal proceeding and not (d) for the purpose of committing a crime or tort; and (4) the privilege has been (a) claimed and (b) not waived by the client. United States v. United Shoe Machine Corp., 89 F. Supp. 357 (D. Mass 1950).

The privilege belongs to the client and can be asserted or waived by the client notwithstanding the attorney's objection. Clients include persons who may not have established an attorney-client relationship but who provide confidential information to the attorney in seeking to become a client. Companies can be clients, and whoever controls the client controls the privilege. This includes bankruptcy trustees, purchasers of subsidiaries (as to the subsidiary company’s privilege), directors, LLC managers, etc.

To obtain the privilege, the communication must be with counsel or counsel’s subordinates. In-house counsel is generally protected to the same extent as outside counsel. Some courts grant protection to foreign counsel or persons serving similar functions in foreign countries.

To obtain the privilege, the communication must be with counsel or counsel’s subordinates. In-house counsel is generally protected to the same extent as outside counsel. Some courts grant protection to foreign counsel or persons serving similar functions in foreign countries.