Opinion
Civ. No. H-99-106.
September 1999
MEMORANDUM AND ORDER
Two more motions relating to discovery in this case are pending before the Court. Defendant Ecolab, Inc. ("Ecolab") has filed a motion to compel compliance with subpoena. William Atkinson and his wife Mary Atkinson are the sole stockholders and officers of plaintiff Atkinson Warehousing and Distribution, Inc. ("AWD"). The Atkinsons have filed an emergency motion for protective order or to quash subpoenas. Both motions relate to Ecolab's attempt to compel Mary Atkinson to produce tax returns and certain other documents.
Memoranda and exhibits in support of the two pending motions have been filed by the parties and reviewed by the Court. No hearing is necessary. See Local Rule 105.6. For the reasons to be stated herein, defendant's motion to compel will be denied, and the Atkinsons' motion to quash subpoenas will be granted.
I Background Facts
For approximately the past twenty years, defendant Ecolab has used the services of BEP Inc., t/a Metropolitan Warehouse ("BEP") or its predecessor for warehousing and distribution of its products. Sometime on or before April 1998, Jack Schafers, an authorized agent of Ecolab, contacted William Atkinson ("Mr. Atkinson"), then an employee of BEP, in an effort to determine whether BEP had additional warehouse space available to meet Ecolab's expanding warehousing and distribution needs. Mr. Atkinson inquired of BEP whether it could meet Ecolab's increased needs and was informed that BEP could not do so. Thereafter, Ecolab and Mr. Atkinson engaged in negotiations whereby a corporation to be formed and controlled by Mr. Atkinson would perform all of Ecolab's warehousing and distribution services.
On October 27, 1998, AWD was incorporated for the purpose of performing a contract entered into on that same date whereby AWD would provide Ecolab with the aforementioned services. Plaintiff AWD claims that such provision of services was to commence on Friday, December 4, 1998, and would run for two (2) years. AWD also alleges that a written document entitled "Warehousing and Service Agreement" was entered into on November 3, 1998, pursuant to the October 27, 1998 contract formed between the parties. AWD contends that on November 5, 1998, Ecolab, through its authorized agent, Dave Macrae, repudiated the contract between AWD and Ecolab. Ecolab has denied that it breached any contract between the parties.
As a part of its discovery undertaken in this case, defendant Ecolab served on plaintiff AWD a request for the production of documents. Request No. 14 sought "Documents sufficient to show your current employment and/or business, including income." Ecolab objected to AWD's response that there were no documents responsive to Request No. 14. Ecolab then served a motion to compel on AWD and at various times thereafter counsel discussed this discovery dispute. Subsequently, Ecolab served on Mrs. Atkinson a subpoena duces tecum requesting the production of all personal income tax returns filed jointly by the Atkinsons from January 1, 1994 through the present. In response to this subpoena, Mrs. Atkinson produced a 1997 corporate tax return for Equity Services, Inc. ("Equity Services") (a related corporation of which Mrs. Atkinson is the President) and brokerage account statements from October and November of 1998 for the Atkinsons' joint Merrill Lynch account.
On July 28, 1999, defendant Ecolab filed the pending motion to compel compliance with subpoena. Ecolab has asked this Court to order Mary Atkinson to produce personal income tax returns filed by the Atkinsons from January 1, 1994 through the present, and various other documents relating to the assets, liabilities and net worth of the Atkinsons and Equity Services.
Ecolab later served subpoenas on Neil Demchick, AWD's expert witness, and on Robert Hunt, the personal accountant for the Atkinsons. These subpoenas sought production of the Atkinsons' tax returns and other documents relating to their finances. On August 20, 1999, the Atkinsons filed the pending emergency motion for protective order or to quash subpoenas. By that motion, the Atkinsons requested that the Court quash Ecolab's subpoenas issued to Demchick and Hunt to the extent that those subpoenas required production of the Atkinsons' personal tax returns prior to calendar year 1998.
II Applicable Principles of Law
The Federal Rules of Civil Procedure provide for the discovery of relevant material. Rule 26(b)(1), F.R.Civ.P. The scope and limits of discovery are set forth in Rule 26(b)(1), which allows for "discovery regarding any matter, not privileged, which is relevant to the subject matter involved in the pending action." Id . The information sought need not be admissible at trial, so long as it is "reasonably calculated to lead to the discovery of admissible evidence." Id . ; see also Degen v. U.S . , 517 U.S. 820, 825 (1996).
Rule 34(a) provides for discovery of documents in the "possession, custody or control" of a party to an action, provided that the documents "constitute or contain matters within the proper scope of discovery as defined in Rule 26(b)." See also 8A Charles Alan Wright, Arthur R. Miller Richard L. Marcus, Federal Practice and Procedure § 2206 at 379 2d 1994). Although Rule 34 may be applied only to a party to an action, Rule 45 subjects the non-party witness to the same scope of discovery as a party to an action.
It is well established that tax returns in the hands of a taxpayer are not privileged from civil discovery. Terwilliger v. York International Corp . , 176 F.R.D. 214, 216 (W.D.Va. 1997) (citations omitted). However, as a matter of policy, courts have concluded that great caution should be exercised in ordering the disclosure of tax returns. See Natural Gas Pipeline Co. v. Energy Gathering, Inc . , 2 F.3d 1397, 1411 (5 th Cir. 1993), cert. denied , 510 U.S. 1073 (1994); TeleRadio Sys. Ltd. v. DeForest Electronics, Inc . , 92 F.R.D. 371, 375 (D.N.J. 1981). Unnecessary disclosure of tax returns is to be avoided. Premium Serv. Corp. v. Sperry Hutchinson Co . , 511 F.2d 225, 229 (9 th Cir. 1975).
Examination of the case law reveals the emergence of a judicially developed "qualified privilege . . . that disfavors the disclosure of income tax returns as a matter of general federal policy." Eastern Auto Distribs., Inc. v. Peugot Motors of Am., Inc . , 96 F.R.D. 147, 148-149 (E.D.Va. 1982). Many courts have employed a two-prong test to assess whether the qualified privilege should be overcome and a party's income tax returns should be disclosed. Id . at 149. Courts must determine (1) whether the tax return was relevant to the subject matter in dispute; and (2) whether a compelling need existed for the return because the information sought was not obtainable from other sources. Id . at 148; Hawkins v. South Plains Int'l Trucks, Inc . , 139 F.R.D. 679, 681-82 (D.Colo. 1991); United States v. Bonanno Organized Crime Family , 119 F.R.D. 625, 627 (E.D.N.Y. 1988); S.E.C. v. Cymaticolor Corp . , 106 F.R.D. 545, 547 (S.D.N.Y. 1985). The party seeking discovery of the tax returns bears the burden of establishing its relevance and the resisting party has the task of identifying an alternative source of information. See Terwilliger , 176 F.R.D. at 217; Eastern Auto Distribs., Inc . , 96 F.R.D. at 149; Kelling v. Bridgestone-Firestone, Inc ., 157 F.R.D. 496, 497 (D.Kan. 1994).
It has been held that where a subpoena duces tecum has been served on someone who has custody of records that belong to another person or entity, formal notice should be served on the owner of the records before production of the documents will be required, thus providing the owner the opportunity to be heard to protect his rights and interests. Alma-Schuhfabrik Ag. v Rosenthal , 25 F.R.D. 100, 101 (E.D.N.Y. 1960); see also 8A Charles Alan Wright, Arthur R. Miller Richard L. Marcus, Federal Practice and Procedure § 2456 at 31-32 2d 1994).
As with all discovery matters, motions to compel discovery are addressed to the sound discretion of the district court. LaRouche v. National Broadcasting Co., Inc . , 780 F.2d 1134, 1139 (4 th Cir. 1986).
III
Discussion
After due consideration of the parties' arguments, this Court has concluded that defendant's motion to compel compliance with subpoena must be denied and that plaintiff's emergency motion to quash subpoenas must be granted.
The defendant has already received various documents in response to its Request No. 14. The Court is satisfied that the Atkinsons' personal income tax returns for 1994 through 1997 and the other personal financial information sought by defendant are not relevant to the issues in this case, nor is the information sought reasonably calculated to lead to the discovery of admissible evidence. Arguments presented by defendant Ecolab are insufficient to overcome the qualified privilege disfavoring the disclosure of federal income tax returns. See Terwilliger , 176 F.R.D. at 216 ( citing Eastern Auto , 96 F.R.D. at 148-49). On the record here, the Court concludes that defendant is unable to satisfy the relevance prong of the test endorsed in Terwilliger .
Defendant's motion to compel is based almost entirely upon defendant's contention that the Atkinsons' personal income tax returns for 1994 through 1997 and certain other financial information are relevant to the issue of plaintiff's claimed damages. Defendant's arguments center around its purported need to thoroughly assess whether AWD would have been able to perform on the alleged contract, the nature of any outstanding obligations possessed by the Atkinsons, and whether AWD could have operated at a profit. None of these arguments demonstrate how the Atkinsons' tax returns or the other financial information now requested could be relevant to the dispute in this case.
In response to defendant's subpoena, Mrs. Atkinson voluntarily provided defendant with a copy of the 1997 corporate tax return of Equity Services and two brokerage statements covering October and November 1998. Mrs. Atkinson has indicated that these documents reveal sources from which the start-up costs associated with AWD would have been derived. In addition, Mrs. Atkinson testified in her deposition that some portion of the start-up costs would have been obtained from a loan or gift from her father. Furthermore, after defendant filed its motion to compel, Mrs. Atkinson voluntarily provided defendant with the personal 1998 joint income tax return of the Atkinsons. There is no indication in the record here that the financing of AWD came from any sources other than those mentioned hereinabove. No claim has been made here that the debts and obligations of the Atkinsons would be assumed by AWD. Moreover, defendant has received a copy of Demchick's extensive report on the damages claimed and the manner in which those damages have been calculated.
The relevant time frame in this dispute is late October 1998 through early November 1998. This was the period when AWD was incorporated and was to allegedly begin providing defendant with warehousing and distribution services. As such, defendant possesses all documentation necessary to assess AWD's financial ability to perform at the inception of the contract and also all documentation relevant to the nature and substance of the damages alleged by plaintiff.
Defendant's contention that the 1994 through 1997 tax returns and other requested documents would in some way demonstrate AWD's ability to meet its alleged contractual obligations is untenable. Information relating to those years involves periods and financial resources which do not reasonably relate to the Atkinsons' capacity to meet AWD's start-up costs in late 1998, nor to AWD's ability to operate profitably, nor to the business acumen of either of the Atkinsons. Therefore, defendant's request fails to satisfy the relevance prong of the Eastern Auto test and defendant has accordingly not overcome the qualified privilege possessed by the Atkinsons concerning their personal income tax returns.
For similar reasons, defendant is not entitled to have Demchick and Hunt produce the personal income tax returns of the Atkinsons for the years 1994 through 1997. Moreover, applying the principles articulated in Alma-Schuhfabrik Ag . , 25 F.R.D. at 101, this Court concludes that defendant should have provided the Atkinsons with formal notice of the subpoena duces tecum which it served upon Demchick and Hunt, who possessed copies of the tax returns at issue. Since there is no indication in this record that defendant in fact complied with this requirement, such failure is another ground for the granting of plaintiff's motion to quash the subpoenas served on Demchick and Hunt.
In its opposition to defendant's motion to compel compliance with subpoena, plaintiff has requested that it be awarded reasonable attorneys' fees incurred in defending the motion. On the record here, the Court concludes that plaintiff is not entitled to recover the attorneys' fees incurred by it.
V Conclusion
For all the reasons stated, it is this _____ day of September, 1999 by the United States District Court for the District of Maryland,
ORDERED:
1. That the motion of defendant Ecolab, Inc. to compel compliance with subpoena is hereby denied;
2. That the emergency motion to quash subpoenas of William Atkinson and Mary Atkinson is hereby granted; and
3. That the request of plaintiff Atkinson Warehousing and Distribution, Inc. for an award of attorneys' fees is hereby denied.