The Second Circuit held last week that a borrower did not waive the attorney-client privilege by providing documents to a consortium of lender banks that shared a common legal interest with the borrower in the tax treatment of a refinancing and corporate restructuring resulting from an acquisition originally financed by the consortium. The November 10, 2015 decision in Schaeffler v. United States also held that the work-product doctrine protected documents analyzing the tax treatment of the refinancing and restructuring because those documents had been prepared in anticipation of potential litigation with the Internal Revenue Service.

The Schaeffler case arose from a tender offer made by the borrower and financed by the consortium in 2008. The offer expired in the midst of the worsening economic crisis, but the buyer/borrower could not withdraw from the offer and ended up paying far more than it had expected to pay. The borrower and the lenders therefore needed to refinance the acquisition debt and restructure the borrower group. To effect the refinancing and restructuring, the borrower retained lawyers and accountants to advise on federal tax implications and possible litigation with the IRS. The borrower shared some of the advice with the lender consortium.

The IRS audited the borrower and sought documents that had been created by the accountants and provided to the lenders, including a tax memorandum identifying tax issues, possible IRS challenges to the desired tax treatment, and relevant legal authority. The District Court held that the borrower had waived the attorney-client privilege by sharing those documents with the lenders and that the documents were not entitled to work-product protection because they would have been prepared even without regard to potential litigation. But the Second Circuit vacated the District Court’s rulings and held that both the attorney-client privilege and the attorney work-product doctrine applied.

Attorney-Client Privilege. The Second Circuit first discussed the so-called common-interest privilege and observed that the attorney-client “privilege is not waived by disclosure of communications to a party that is engaged in a ‘common legal enterprise’ with the holder of the privilege” – even if the parties sharing the common legal interest are not parties in ongoing litigation. The court ruled that the borrower and the lender consortium shared a common legal interest in avoiding the borrower’s potential insolvency by cooperating in obtaining a particular tax treatment of a refinancing and restructuring. “Securing that treatment would likely involve a legal encounter with the IRS. Both [the borrower] and the Consortium, therefore, had a strong common interest in the outcome of that legal encounter.”

Work Product. The Second Circuit also held that the tax advice in the accountant’s memorandum deserved work-product protection because “[i]t was specifically aimed at addressing the urgent circumstances arising from the need for a refinancing and restructuring and was necessarily geared to an anticipated audit and subsequent litigation, which was on this record highly likely.” The court disagreed with the District Court’s conclusion that the accountant would have given the same advice even without any anticipated litigation, because the borrower here “would not have sought the same level of detail if merely preparing an annual routine tax return with no particular prospect of litigation.” The Second Circuit also noted that “[t]he size of a transaction and the complexity and ambiguity of the appropriate tax treatment are important variables that govern the probability of the IRS’s heightened scrutiny and, therefore, the likelihood of litigation.”

The Schaeffler decision should provide some comfort to clients that need to provide privileged information to lenders in situations where the clients and the lenders share a common legal interest in the issues underlying corporate financings or restructurings. (A purely business interest, without legal ramifications, might raise different issues, depending on the circumstances.) Such information should ideally be shared pursuant to agreements that attempt to preserve privilege and confidentiality – as was done in the Schaeffler case. Although the Second Circuit noted that the agreement’s designation as an “Attorney Client Privilege Agreement” does not bind a reviewing court, it “is relevant, however, to the issues of whether [the parties] maintained confidentiality with regard to third parties and were pursuing a common legal interest.”