In the wake of the First Circuit's decision in United States v. Textron Inc., 577 F.3d 21 (1st Cir. 2009) - holding that the work-product doctrine does not protect "tax accrual workpapers" from disclosure - corporations and their attorneys may find themselves wondering how this surprising shift in work-product jurisprudence will shape the way in which they do business.

Textron Background

In preparing its audited financial statements, Textron calculates reserves to account for contingent tax liabilities, i.e., estimates of potential liability if the IRS decides to challenge questionable positions taken by Textron in its returns. In doing so, Textron prepares tax accrual workpapers listing each debatable item, including the dollar amount at issue and a percentage estimate of the IRS's chances of success. Only the reserve amount is included in Textron's published financial statements.

In 2003, after reviewing Textron's 2001 tax returns in connection with an audit of the company, the IRS issued an administrative summons seeking production of Textron's underlying tax accrual workpapers. Textron declined to turn over the workpapers - primarily prepared by lawyers and others in the company's tax department - on the grounds that, among other things, they constituted protected work product.

The IRS filed a petition in federal district court in Rhode Island to enforce the summons. Denying the petition, the court held that the workpapers were prepared "because of" litigation and therefore constituted work product. On appeal, a divided panel affirmed the lower court's decision. On August 13, 2009, on rehearing, the en banc court (in a 3-2 decision) held that the work-product doctrine did not protect the tax accrual workpapers from disclosure.

The Majority Decision

Framing the issue as whether the work-product doctrine applies to "a document [that] is not in any way prepared 'for' litigation but relates to a subject that might or might not occasion litigation," the court concluded that the workpapers were not protected from disclosure. Although the court stated that its conclusion was consistent with the "because of" test - i.e., whether the documents were prepared "because of" litigation - adopted by the First Circuit in Maine v. United States Department of the Interior, 298 F.3d 60 (1st Cir. 2002), the decision does not appear to apply the "because of' test but instead relies upon a new, unannounced test based on whether the materials were "prepared for use in litigation [and] whether the litigation was underway or merely anticipated." According to the court, Textron's workpapers were not work product, because they were prepared "to fix the amount of the tax reserve on Textron's books and to obtain a clean financial opinion from its auditor" and would not "serve any useful purpose for Textron in conducting litigation if it arose."

The Dissent

In a strongly worded dissent, Judge Juan Torruella stated that under the "because of" test, Textron's workpapers constituted work product, since they were created in connection with the calculation of a reserve fund needed in case litigation subsequently arose. Although the creation of the workpapers may have stemmed in part from other business needs, "without the anticipation of litigation, there would be no need to estimate a reserve to fund payment of tax disputes." Attacking the majority for "ignor[ing] a tome of precedents from the circuit courts" and "contraven[ing] much of the principles underlying the work-product doctrine," Judge Torruella harshly criticized the majority for essentially rejecting the established "because of" test and adopting a new test for determining whether the work-product doctrine applies. He expressed deep concern that the majority decision would have broad, negative consequences reaching beyond the discoverability of tax accrual workpapers. For example, he pointed out, under the court's new rule, documents analyzing the prospects and business risks of litigation, traditionally protected by the work-product doctrine, would be discoverable. Judge Torruella warned: "Corporate attorneys preparing such analyses should now be aware that their work product is not protected in this circuit."

Further Appellate Activity

On December 24, 2009, Textron filed a Petition For A Writ Of Certiorari with the United States Supreme Court. The First Circuit stayed issuance of the Court's mandate pending resolution of the petition. On May 24, 2010, the Supreme Court denied the petition. Companies must thus now be mindful of Judge Torruella's warning and consider Textron's implications when consulting with their attorneys to prepare analyses of the risks associated with litigation, both in the tax context and beyond.

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