Opinion
Case No. 02-CV-0632-H (POR)
July 26, 2002
On April 2, 2002, Petitioners Dean Gordon Potter ("Potter") and Unico Industrial Service Co. Subsidiary ("Unico") filed a Petition to Quash IRS Summonses issued to third-party Michael G. Chatzky. On April 26, 2002, Petitioners amended the petition. On June 10, 2002, Respondent filed a Motion for Summary Enforcement of Internal Revenue Summonses and Opposition to Amended Petition to Quash. On July 3, 2002, Respondent filed an amended memorandum in support of its Motion. Petitioners filed their response on July 12, 2002.
The Court held a hearing on the matter on July 26, 2002. Edward Simpson appeared on behalf of Petitioners, and Traci Patterson appeared on behalf of Respondent.
BACKGROUND
This dispute stems from the issuance of third-party summonses by the Internal Revenue Services ("IRS") to Michael G. Chatzky, President of Release Me, Inc. and President of Chatzky and Associates, a Law Corporation. The summonses were issued in association with the IRS investigation of Dean Gordon Potter ("Potter") and Unico Industrial Service Co. Subsidiary ("Unico").
I. The IRS Investigation
The IRS is investigating the individual income tax liability of Potter for the tax years ending December 31, 1998 and December 31, 1999, and the Federal tax liabilities of Unico for the taxable years ending June 30, 1998 and June 30, 1999. (Amend. Decl. of Rev. Agent Allen, ¶¶ 2, 3.) There is no criminal investigation being conducted against Potter or Unico, and neither has been referred to the Department of Justice for criminal prosecution. (Id. ¶ 12.)
During the course of the IRS investigation, Revenue Agent Barbara Marie Allen ("Revenue Agent Allen") learned that on January 1, 1998, Potter entered into an agreement with Pixley Services, Limited ("Pixley"), a Irish corporation. Under the agreement, Pixley acquired the exclusive rights to the worldwide services of Mr. Potter in exchange for $250,000 annually, plus bonuses. (Id., ¶ 14.)
Revenue Agent Allen also learned that on that same day, Pixley entered into an agreement with Release Me, Inc., a United States corporation. (Id., ¶ 15.) Michael Chatzky is the president of Release Me, Inc. Under the terms of this agreement, Release Me, Inc. obtained all rights to Mr. Potter's services from January 1, 1998 through December 31, 2004. (Id., ¶ 16.) Release Me., Inc. was given full rights to utilize and market the services of Mr. Potter, provided that such services are rendered solely within the United States. (Id.) Release Me, Inc. was to retain 5% of the gross paid to it for Mr. Potter's services and remit the remaining 95% to Pixley. (Id.) Revenue Agent Allen also learned that on January 1, 1998, Unico entered into a contract with Release Me, Inc. under which Unico acquired all rights to Mr. Potter's services from January 1, 1998 through December 31, 2004. (Id.) Under this agreement, Unico was to pay Release Me, Inc. a flat rate of $850,000 per calendar year plus an annual performance bonus. (Id.) Unico also agreed to pay Release Me, Inc. an "incentive fee" of $350,000 on or before June 1, 1998. Michael Chatzky signed the agreement on behalf of Release Me, Inc. and Mr. Potter signed the agreement on behalf of Unico. (Id.) Mr. Potter, together with Potter Omnibus Trust, controls 80% of Unico's voting stock. Mr. Chatzky is also a California attorney, practicing law as president of Chatzky and Associates, a law corporation. (Decl. of Michael Chatzky, ¶¶ 1, 2.)
As part of the examination of Potter and Unico and pursuant to 26 U.S.C. § 7602, on April 8, 2002, Revenue Agent Allen reissued an administrative third-party summons, IRS form 2039, to Michael G. Chatzky, President of Chatzky Associates, at 4250 Executive Square, #660, La Jolla, California. (Decl. of Rev. Agent Allen, ¶ 4.) The summons directed the representative of Chatzky Associates to appear before her on May 22, 2002, to give testimony and to produce for examination certain books, records, papers, and other data. (Id.) Revenue Agent Allen served an attested copy of the summons by mailing a copy via certified mail. (Id., ¶ 5.)
Also as part of the examinations of Potter and Unico, on April 8, 2002, Revenue Agent Allen reissued an administrative third-party summons, IRS Form 2039, to Release Me, Inc., Attn: Michael G. Chatzky, President, 4250 Executive Square, #660, La Jolla, California, directing its representative to appear before her on May 22, 2002 to give testimony and to produce for examination certain books, records, papers, and other data. (Id., ¶ 6.) An attested copy of the IRS summons was served by personal delivery on Release Me, Inc., at 12335 Sycamore Ridge Creek, San Diego, CA 92131. (Id., ¶ 7.)
Revenue Agent Allen also reissued an administrative third-party summons, IRS Form 2039, to Michael G. Chatzky, 12335 Sycamore Ridge Creek, San Diego, CA, directing Michael G. Chatzky to appear before her on May 22, 2002, to give testimony and produce for examination certain books, records, papers, and other data. (Id., ¶ 8.) An attested copy of the summons was served by personal delivery to the front door of Chatzky's home, his last and usual place of abode, 12335 Sycamore Ridge Creek, San Diego, California. (Id., ¶ 9.)
Excluding an inventory of documents received during the course of the investigations, at the time of issuing the summonses, the IRS did not have any of the summoned documents in its possession. (Id.) Subsequent to the issuance of the summons, however, Chatzky has provided various documents requested by these summonses, excluding a group of documents on which he claims attorney-client privilege and attorney work product privilege. (Id.) The documents already produced are in Revenue Agent Allen's possession. (Id.)
II. The Parties Associated with the Disputed Documents
Alan Eber and Peter Double represented Petitioners for estate planning purposes, which included helping Petitioners enter into contracts with other entities for the purpose of asset protection. (See Decl. of Alan Eber, ¶¶ 2, 4.) In their capacity as Petitioners' attorneys, Eber and Double retained Michael Chatzky to assist in providing legal advise on the Potter and UNICO matters. (See id., ¶ 4.) The documents Petitioners claim are covered by attorney-client privilege were prepared by, provided to, or addressed to one of these attorneys or their agents. Ron Haikin is a paralegal in Alan Eber's office. (Id., ¶ 3.) Heidi K Scholz was an attorney employed by Chatzky and Associates from 1992 to 2002 who worked under Chatzky as a tax lawyer. (Decl. of Michael Chatzky, ¶¶ 3, 4.) Haiken and Scholz appear to have been engaged in providing assistance to Eber, Double, and Chatzky in their representation of Potter and UNICO.
DISCUSSION
I. Standards
The Internal Revenue Code authorizes the IRS to issue summonses to third parties to testify and produce records for purposes of ascertaining the correctness of a tax return or determining the tax liability of any person. See 26 U.S.C.A. §§ 7602 and 7609; United States v. Derr, 968 F.2d 943, 945 (9th Cir. 1992). District courts have jurisdiction to review petitions to quash a summons and to order its enforcement. See 26 U.S.C.A. §§ 7604(a) and 7609(h)(1) (West 2000).
To enforce a summons, the IRS must establish a prima facie case: (1) that there is a legitimate purpose for the investigation; (2) that the material sought in the summons, is relevant to that purpose; (3) that the material sought is not already within the possession of the IRS; and (4) that those administrative steps which are required by the Internal Revenue Code have been taken. United States v. Powell, 379 U.S. 48, 57-58 (1964). This burden is typically satisfied "by the introduction of the sworn declaration of the revenue agent who issued the summons that the Powell requirements have been met." Fortney, 59 F.3d at 120. Once the government establishes its prima facie case, the party moving to quash the summons carries the burden of disproving the existence of a valid purpose or that enforcement of the summons would be an abuse of the court's process. Powell, 379 U.S. at 58.
IRS summonses are "subject to the traditional privileges and limitations, including the attorney-client privilege." Upjohn Co. v. United States, 449 U.S. 383, 398, 101 S.Ct. 677, 686 (1981). The burden of proving the protection of the attorney-client privilege lies with the party attempting to invoke the privilege to resist enforcement of the summonses. Powell, 379 U.S. at 58.
II. The United States Has Established a Prima Facie Case
A. Legitimate Purpose
The government must first show that the summonses were issued for a legitimate purpose. Here, Revenue Agent Allen is conducting an investigation in order to determine Potter's individual income tax liability for the tax years ending December 31, 1998 and December 31, 1999, and in order to determine UNICO's Federal tax liabilities for the taxable years ending June 30, 1998 and June 30, 1999. This investigation is legitimate pursuant to 26 U.S.C. § 7602, which authorizes the IRS to summons such information as may be relevant or material to the determination of income. This information includes anything that might shed light on the question of income. See Unite States v. Harrington, 388 F.2d 520 (2nd Cir. 1968).
B. Relevant to Purpose of Investigation
The United States must also show that the information sought by the summonses is relevant to the purpose of the investigation. The information sought is deemed relevant if it "might throw light upon the correctness of the taxpayer's return . . . ." Tedder v. United States, 77 F.3d 1166, 1168-69 (9th Cir. 1996); see also United States v. Arthur Young Co., 465 U.S. 805, 813-814 (1984). This standard requires the IRS to show that it has a "realistic expectation rather than an idle hope that something might be discovered" from the summoned information, hi. Here, the government seeks the testimony of Michael Chatzky. Mr. Chatzky is the president of Release Me, Inc., a corporation that on January 1, 1998, entered into a contract with Pixley for the right to the services of Dean Gordon Potter from January 1, 1998 through December 31, 2004. On that same day, Release Me, Inc. also entered into an agreement with UNICO under which UNICO acquired all fights to Mr. Potter's services for that same time period. Therefore, an interview of Mr. Chatzky, as a party to two of the contracts signed on January 1, 1998, which involved the two taxpayers the IRS is currently investigating, is relevant to the purpose of these investigations.
Furthermore, the three summonses at issue request only documents that are relevant to the IRS's investigation of Dean Gordon Potter and UNICO. In each, the request clearly states that all items requested are in reference to UNICO and Dean Gordon Potter, and consequently the request is not overly broad.
C. The IRS Does Not Possess This Information
The United States must show that the information and documents sought by the summonses are not already the Service's possession. Revenue Agent Allen declares that at the time the summonses were issued, the IRS did not possess any of the summoned documents. (Amend. Decl. of IRS Agent Allen, ¶ 10.) Subsequent to the issuance of the summonses, Mr. Chatzky provided some of the documents requested, excluding a group of documents he withheld as privileged. Mr. Chatzky has not appeared yet to be interviewed, however. Currently at issue are the documents that Mr. Chatzky has withheld as privileged, and therefore, the IRS does not possess the documents or information.
D. Administrative Steps Were Followed
Finally, Powell requires the government to show that administrative steps regarding the issuance and service of the summonses have been followed. Powell, 379 U.S. at 57-58. Revenue Agent Allen declares that "all the administrative steps required by the Internal Revenue Code" have been followed. (Amend. Decl. of IRS Agent Allen, ¶ 13.) Consequently, the government has met its burden and has established a prima facie case for enforcement of the issued summonses.
II. Because the Government Has Made a Prima Facie Case, the Burden Shifts to the Taxpayer
Petitioners base their petition to quash the summonses on the attorney-client privilege and/or the work product privilege. Petitioners also state in their petition that the summonses are "overbroad." The government contends that the documents being withheld by Chatzky are not privileged because they relate only to business transactions between Release Me, Inc. and Potter and/or UNICO.
A. Attorney-Client Privilege
Petitioners assert that Revenue Agent Allen has now been provided with all of the requested documents with the exception of 12 documents that Petitioners allege are precluded from disclosure under the attorney-client privilege. The government argues that Chatzky was acting as a corporate officer in his relationship to Potter and UNICO, and therefore the attorney-client privilege does not apply to any of the documents it has requested of him.
The party seeking to invoke the privilege carries the burden of proving to a reasonable certainty that the elements of an attorney-client privilege exist. See Clarke v. American Commerce National Bank, 974 F.2d 127, 129 (9th Cir. 1992); United States v. Abrahams, 905 F.2d 1276, 1283 (9th Cir. 1990).
Federal common law governs whether information sought by the IRS is protected by the attorney-client privilege. See United States v. Blackman, 72 F.3d 1418, 1423 (9th Cir. 1995); See also Clarke, 974 F.2d at 129 ("Issues concerning application of the attorney-client privilege in the adjudication of federal law are governed by federal common law.") (citing United States v. Zolin, 491 U.S. 554, 562 (1989); Fed.R.Evid. 501).
The attorney-client privilege protects only communications made in the course of seeking legal advice from a professional legal adviser in his or her capacity as such. Olender v. United States, 210 F.2d 795, 806 (9th Cir. 1954). The purpose of the privilege is to encourage clients to make full disclosure to their attorneys. Fisher v United States, 425 U.S. 391, 403 (1976). However, because the attorney-client privilege has the effect of withholding relevant information from the factfinder, it is applied only when necessary to achieve its limited purpose of encouraging full and frank disclosure by the client to his or her attorney. Id.; see also Tornay v. United States, 840 F.2d 1424, 1426 (9th Cir. 1988).
"A client is entitled to hire a lawyer, and have his secrets kept, for legal advice regarding the client's business affairs." United States v. Chen, 99 F.3d 1495, 1501 (9th Cir. 1996). "Where the general purpose concerns legal rights and obligations, a particular incidental transaction would receive protection, though in itself it were merely commercial in nature." Id. (citation omitted). Legal advice is not involved "when the facts show that the lawyer was `employed without reference to his knowledge and discretion in law.'" Id. (citation omitted). The attorney-client privilege still applies, however, where business advice is incorporated into legal advice. Western Trails, Inc. v. Camp Coast to Coast, 139 F.R.D. 4, 8 (D.D.C. 1991).
Blanket assertions of the attorney-client privilege are extremely disfavored. Clarke, 974 F.2d at 129. The privilege is ordinarily raised as to each record sought to allow the court to rule with specificity.Id.; see also United States v. Hodgson, 492 F.2d 1175, 1177 (10th Cir. 1974) (noting that an attorney must raise attorney-client privilege as to each record sought and each question asked); United States v. El Paso Co., 682 F.2d 530, 541-42 (5th Cir. 1982) (attempt to invoke privilege rejected, due in part to the failure to "particularize its assertion of the privilege" with respect to each specific document), cert. denied, 466 U.S. 944 (1984). Further, a district court may conduct an in camera inspection of alleged confidential communications to determine whether the attorney-client privilege applies. See Kerr v. United States Dist. Ct. for N. Dist. of Cal., 426 U.S. 394, 404-405 (1976); see also Clarke, 974 F.2d at 129.
The privilege extends to cover both the substance of the client's confidential communications and the attorney's advice in response thereto. In re Fischel, 557 F.2d at 211. All other communications from the attorney to the client are protected if the attorney's communications would reveal confidential client communications. In re Sealed Case, 737 F.2d 94, 99 (D.C. Cir. 1984). Furthermore, confidential communications passing through persons acting as the attorney or client's agent are also covered by the privilege. United States v. Kovel, 296 F.2d 918, 921 (2nd Cir. 1961). The privilege also covers papers prepared by the attorney or by a third party at the attorney's request for the purpose of advising the client, insofar as the papers are based on and would tend to reveal the client's confidential communications. Id. (citing United States v. Judson, 322 F.2d 460 (9th Cir. 1963)).
Upon review of the supporting papers and the twelve documents at issue, the Court concludes that Documents G and I may fall within Chatzky's representation of Potter or UNICO for purposes of rendering legal advice and assistance in overseas investment and estate planning. However, Documents A, B, C, D, E, F, H, J, K and L do not fall within the attorney-client privilege and should be turned over to the IRS in response to the summonses.
1) Documents G, I May Be Privileged
Documents G and I appear to contain draft legal documents relating to the creation of legal relationships between Potter and/or UNICO and other corporations. Standing alone, the text of the legal documents appear to be non-privileged information relating to the clients's business dealings. However, the documents are in draft form, prepared by the clients' attorneys, and they are the subject of other attorneys' handwritten legal comments and advice. Consequently, at this point, the Court will not order the release of Documents G and I because privileged communications may be so interwoven with non-privileged information that disclosure of the latter would necessarily disclose the former. See In re Fischel, 557 F.2d 209, 212 (9th Cir. 1977). The Court denies Respondent's motion to compel these documents; however, the Court's denial of Respondent's motion is without prejudice to a renewal of the motion by the government establishing facts that the privilege has been waived or that the documents should be revealed because of the substantial business interactions between Chatzky and Potter.
2) Documents A, B, C, D, E, F, H, J, K, and L Must be Produced
The fact that Petitioners engaged in business dealings with Chatzky and his company Release Me, Inc. complicates the issue of whether Chatzky was providing legal advice or engaging in business dealings when communicating with Petitioners' lawyers. It is clear that Chatzky had a substantial business interest in the creation of Potter and UNICO's international tax planning. Yet, rather than electing to retain outside counsel, the parties created a situation whereby Chatzky served as both attorney and corporate officer for a business that benefited from its relationship with Potter and UNICO, making it difficult to believe their assertion that all documents passing through Chatzky retain the attorney-client privilege. After examining the documents, the Court concludes that Petitioners have not met their burden to show that Documents A, B, C, D, E, F, H, J, K, and L are protected under the attorney-client privilege, and therefore these documents must be produced pursuant to the IRS summonses.
Documents C, F and J, although discoverable, contain information regarding another Eber client. The information concerning this other individual must be redacted as it does not fall under the scope of the IRS summonses because it is not related to Potter and/or UNICO.
Document A is a letter dated March 21, 1998, from Peter Double to Heidi Scholz. Document B is a letter dated March 23, 1998, from Peter Double to Alan Eber. Both letters involve the implementation of the estate plan, with the primary purpose of sharing business advice. Neither letter appears to include confidential communications from the client to his attorneys; rather, the letters seem to involve business negotiations over funding and contracts. Therefore, the Court concludes that the privilege does not cover these documents.
Document C is a letter dated June 8, 1998, from Alan Eber to Heidi Scholz stating that he is enclosing three documents describing Potter's offshore life insurance program. This letter does not reveal any communications between Potter and his attorneys, and is not covered by the attorney-client privilege. Document D is an undated, unaddressed general memorandum with the subject listed as "International Tax Planning." Nothing about the document suggests that it involves the confidential communications between Potter/UNICO and his attorneys; rather, the document appears to be a common handout provided to clients or associates who may be interested in creating international life insurance policies and, as such, is not privileged.
Document E is a fax dated April 24, 1998, from Chatzky to Peter Double regarding Potter's estate planning. The fax contains Chatzky's suggestions for changes to draft legal documents and shares his thoughts regarding the formation of other legal relationships. The Court sees nothing in the document, however, that might tend to reveal confidential client communications. Document F is a fax dated July 22, 1998, from Rod Haikin to Chatzky, Heidi Scholz, and Marion Holmes. The fax concerns only financial transactions between Potter and Release Me, Inc. and Pixley and addresses Chatzky in his role as an officer of Release Me, Inc. rather his role as a legal advisor. Document H is a fax dated June 4, 1998, from Haikin to Heidi Scholz. The fax appears to be related to business operational matters and transactions and does not have the purpose of providing legal advice.
Document J is a fax dated December 22, 1998 from Marion Holmes to "Malin." Marion Holmes apparently works for Chatzky, however Petitioners have failed to provide information as to her status as an agent of any of the parties. Further, Petitioners do not provide any information regarding the addressee of the fax, "Malin," other than noting that the fax was sent to a "third party." (See Decl. of Alan Eber, ¶ 7.) Attorney-client communications in the presence of a third party not the agent of either are generally not protected by the privilege. Weatherford v. Bursey, 429 U.S. 545, n. 4 (1977) (citing 8 J. Wigmore, Evidence s 2311, pp. 601-602 (McNaughton rev. ed. 1961)). Even if the information contained in this fax revealed attorney-client communications, a fact that has not been determined, Petitioners have failed to show that this third party is or was an agent of the attorneys. Consequently, the privilege does not apply to Document J.
Document K is a fax dated April 28, 1998, from Peter Double to Heidi Scholz. In the fax, Double appears to be offering an updated contract page and requesting a change in Potter's fees under the contracts. Consequently, the Court concludes that the fax is more related to business dealings than to legal advice and is not covered by the privilege.
Document L is a fax dated May 6, 1998, from Peter Double to "Heidi/Grace/Marion." As with Document J, Petitioners have not provided any information as to the status of "Grace" or "Marion" as agents of the client or the attorneys. Sharing attorney-client communications with a third party waives the attorney-client privilege. See Weatherford v. Bursey, 429 U.S. at n. 4. By failing to show that these additional individuals are agents, Petitioners have failed to meet their burden to show that the privilege applies to Document L.
Petitioners have not shown that Documents A, B, C, D, E, F, H, J, K and L are protected under attorney-client privilege. Consequently, these documents shall be produced pursuant to the summonses.
B. Attorney Work Product Privilege
Petitioners also state in their petition that the documents are protected by the attorney work-product privilege. However, Petitioners provide the Court with nothing more than a general allegation that the work-product privilege applies. Further, in subsequent supporting papers, Petitioners appear to abandon this argument.
The work product privilege covers material prepared for use at trial and is "broader than the attorney-client privilege." U.S. v. Nobles, 422 U.S. 225, 238 n. 11 (1975). The work product rule protects all documents and tangible things prepared in anticipation of litigation or for trial. F.T.C. v. Grolier, Inc., 462 U.S. 19, 25 (1983). As with the attorney-client privilege, the person asserting the work product privilege cannot make a blanket assertion of the privilege, but must state document-by-document what information the privilege applies. See United States v. Bornstein, 977 F.2d 112, 115 (4th Cir. 1992).
The Court concludes that the privilege log submitted by Petitioners is too general to allow the Court to form any meaningful conclusion as to whether any of the documents potentially claimed as work product are actually work product. Because Petitioners have not met their burden of showing that the work-product privilege applies to any of the documents, all of the documents not covered by the attorney-client privilege shall be produced.
C. Overbreadth
Petitioners argue that the summonses directed to Chatzky are "vastly overbroad." However, Petitioners provide no example of how the summonses seek improper information or lack appropriate precision, and after independent review, the Court sees nothing to suggest that the summonses are overbroad.
26 U.S.C. § 7602(a)(1) provides that the IRS can only examine books and records "which may be relevant or material" to the purpose for which the IRS is conducting the investigation. Information is relevant if it "might throw light upon the correctness of the taxpayer's return . . . ."Tedder, 77 F.3d at 1168-69. In the present case, the summons issued to Chatzky seeks all records or information pertaining to financial transactions of Potter and/or UNICO for approximately a three-year period. This information could throw light on the correctness of Potter's or UNICO's returns and identifies the requested documents with sufficient precision; thus, it is not overbroad.
CONCLUSION
For the reasons set forth above, the Court grants in part and denies in part Petitioners' Amended Petition to Quash Third Party IRS Summonses (Docket # 3). Additionally, the Court grants in part and denies in part Respondent's Amended Motion for Summary Enforcement of the IRS Summonses (Docket # 5).