Ad Investment 2000 Fund LLC, Community Media, Inc., A Partner Other Than the Tax Matters Partner v. Commissioner

AD INVESTMENT 2000 FUND LLC, COMMUNITY MEDIA, INC.,
A PARTNER OTHER THAN THE TAX MATTERS PARTNER,
PETITIONER v. COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT
AD GLOBAL 2000 FUND LLC, WARSAW TELEVISION CABLE
CORP., A PARTNER OTHER THAN THE TAX MATTERS
PARTNER, PETITIONER v. COMMISSIONER OF
INTERNAL REVENUE, RESPONDENT
Docket Nos. 9177–08, 9178–08. Filed April 16, 2014.
In anticipation of Ps’ affirmative defenses to accuracy-
related penalties (e.g., reasonable cause and good faith), R
248
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(248) AD INV. 2000 FUND LLC v. COMMISSIONER 249
moves (1) to compel production of letters expressing attorneys’
opinions as to whether it was more likely than not that antici-
pated tax benefits from transactions in question would be
upheld and (2) to sanction Ps for noncompliance with any
order directing production. Ps object on grounds that the let-
ters are privileged attorney-client communications. R argues
that Ps impliedly waived any privilege by putting into issue
the LLCs’ beliefs and state of mind. Ps deny that the LLCs
relied on the letters. Held: By putting the LLCs’ legal knowl-
edge and understanding into contention in order to establish
good-faith and state-of-mind defenses, Ps forfeit the LLCs’
privilege protecting attorney-client communications relevant
to the content and the formation of their legal knowledge,
understanding, and beliefs; an order directing production will
be issued. Held, further, if Ps fail to comply with the order
directing production, the Court will consider the sanction of
preventing Ps, in support of affirmative defenses, from intro-
ducing evidence of the LLCs’ reasonable beliefs and state of
mind.
Elliot Silverman, Howard Kleinhendler, and Orrin Eliot
Tilevitz, for petitioners.
Veronica L. Trevino, Kathryn F. Patterson, Jarrod R. Jen-
kins, and Elaine Harris, for respondent.
OPINION
HALPERN, Judge: In each of these consolidated cases,
respondent has moved (motions) for us to compel petitioner
to produce documents and to sanction petitioner if it fails to
comply with any resulting order to produce the documents.
Petitioners object (objection). We will grant the motions
insofar as they ask us to compel production of documents,
and we will set them for hearing insofar as they ask us to
sanction petitioners for failure to comply with our order.
Except as otherwise stated, all section references are to the
Internal Revenue Code of 1986, as amended and in effect for
2000.
Background
These consolidated cases are partnership-level actions
involving what respondent describes as a Son-of-BOSS tax
shelter. 1 On that basis, respondent has adjusted partnership
1A ‘‘Son-of-BOSS’’ tax shelter is a variant of the Bond and Options Sales
Continued
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250 142 UNITED STATES TAX COURT REPORTS (248)
items of the two partnerships 2 and determined that section
6662 accuracy-related penalties should apply to any resulting
underpayments of tax. In connection with his penalty deter-
minations, respondent alleges that his adjustments of part-
nership items are attributable to a tax shelter. He also
alleges that the underpayments of tax resulting from his
adjustments of partnership items are attributable to (1) a
substantial understatement of income tax, (2) a gross valu-
ation misstatement, or (3) negligence or disregard of rules
and regulations. The partnerships’ tax years in question are
both calendar year 2000. Petitioners have assigned error to
respondent’s adjustments and to his penalty determinations.
Respondent seeks to compel the production of six opinion
letters (opinions) from the law firm of Brown & Wood LLP.
Respondent represents, and petitioners do not contradict,
that the opinions express Brown & Wood’s opinion as to
whether, on the basis of representations made to it, it was
more likely than not that the anticipated tax benefits from
the transactions in question would be upheld for Federal
income tax purposes. Petitioners argue that they need not
produce the opinions since each is a privileged communica-
tion between attorney and client that need not be disclosed.
Respondent appears to accept that the opinions constitute
attorney-client communications but argues that, under the
common law doctrine of implied waiver, the attorney-client
privilege is waived when the client places otherwise privi-
leged matters in controversy. Respondent argues that peti-
tioners placed the opinions into controversy by relying on
affirmative defenses to the penalties that turn on the part-
nerships’ beliefs or state of mind.
It is true that, in defense to respondent’s determinations of
an accuracy-related penalty based on a substantial under-
statement of income tax, see sec. 6662(b)(2), petitioners aver:
Strategy (BOSS) tax shelter. ‘‘The purpose of all Son-of-BOSS tax shelters
is to create ‘artificial tax losses designed to offset income from other trans-
actions.’ ’’ 6611, Ltd. v. Commissioner, T.C. Memo. 2013–49, at *11 (quoting
Napoliello v. Commissioner, 655 F.3d 1060, 1062 (9th Cir. 2011), aff ’g T.C.
Memo. 2009–104).
2 Apparently, the two LLCs, AD Investment 2000 Fund LLC (ADI) and
AD Global 2000 Fund LLC (ADG), have elected to be taxed as partner-
ships. See sec. 301.7701–3(a), Proced. & Admin. Regs. Consistent with the
parties’ usage, we will refer to the entities as partnerships.
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(248) AD INV. 2000 FUND LLC v. COMMISSIONER 251
‘‘There is or was substantial authority for the Partnership’s
and its partners’ tax treatment of any items resulting in an
underpayment of tax, and the Partnership and its partners
reasonably believed that their tax treatment of such items
was more likely than not the proper [tax] treatment’’. See
sec. 6662(d)(2)(C). 3 In defense to respondent’s determination
of accuracy-related penalties generally, petitioners aver: ‘‘Any
underpayment of tax was due to reasonable cause and with
respect to which the Partnership and its partners acted in
good faith.’’ See sec. 6664(c)(1). Petitioners deny, however,
that their averments bring professional advice (i.e., the opin-
ions) into question.
With respect to petitioners’ first defense, to respondent’s
determination of an accuracy-related penalty based on a
substantial understatement of income tax, the key point
appears to be whether each partnership (acting through its
principals or its agents) reasonably believed (belief require-
ment) that its tax treatment of partnership items was more
likely than not the proper tax treatment. The belief require-
ment is found in section 6662(d)(2)(C)(i)(II) and elaborated
upon in section 1.6662–4(g)(4), Income Tax Regs. Section
1.6662–4(g)(1)(i)(B), Income Tax Regs., provides that the
belief requirement is satisfied if ‘‘[t]he taxpayer reasonably
believed at the time the return was filed that the tax treat-
ment of that item was more likely than not the proper treat-
ment.’’ The regulations provide that a taxpayer may satisfy
the belief requirement by either of two methods. They pro-
vide that the requirement is satisfied if either
(A) [first method] The taxpayer analyzes the pertinent facts and
authorities in the manner described in paragraph (d)(3)(ii) of this sec-
tion, and in reliance upon that analysis, reasonably concludes in good
faith that there is a greater than 50-percent likelihood that the tax
treatment of the item will be upheld if challenged by the Internal Rev-
enue Service; or
(B) [second method] The taxpayer reasonably relies in good faith on
the opinion of a professional tax advisor, if the opinion is based on the
tax advisor’s analysis of the pertinent facts and authorities in the
manner described in paragraph (d)(3)(ii) of this section and unambig-
uously states that the tax advisor concludes that there is a greater than
3 As
acknowledged by the parties during a conference call with the Court
to clarify the point, we are concerned here only with partnership-level de-
fenses to the penalty. Cf. sec. 301.6221–1(c) and (d), Proced. & Admin.
Regs. But see sec. 1.6662–4(g)(5), Income Tax Regs.
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252 142 UNITED STATES TAX COURT REPORTS (248)
50-percent likelihood that the tax treatment of the item will be upheld
if challenged by the Internal Revenue Service.
[Sec. 1.6662–4(g)(4)(i), Income Tax Regs.]
Respondent concedes that petitioners’ averments raise only
the first method (self-determination), and not the second
method (reliance on professional advice), to show that the
partnerships satisfy the belief requirement. Nevertheless,
respondent argues, petitioners have placed the opinions into
controversy by relying on a reasonable cause, good-faith
defense and by putting the partnerships’ beliefs into issue.
Respondent states: ‘‘Under the first method, * * * those tax
opinions remain relevant to the subjective inquiries into
reasonableness and good faith.’’ He adds: ‘‘Putting reasonable
belief in issue places the Partnership[’s], and specifically
James Haber’s, state of mind at issue.’’ He explains: ‘‘Mr.
Haber [‘de facto manager of the partnership vehicle[s]’]
received the subject tax opinions before taking the ques-
tioned positions and presumably before making his alleged
self-determination of authorities.’’ The opinions are relevant,
respondent argues, because, if they contradict Mr. Haber’s
claimed self-determination, they may show that his self-
determination was not reasonable, and, if consistent with his
self-determination, they may show that he made no self-
determination. Respondent also argues:
The subject tax opinions are also relevant to the good faith element of
the penalty defense[s]. * * * The facts contained in the subject tax opin-
ions necessarily reflect communications made by Mr. Haber on behalf of
ADG [or ADI] and the ADG [or ADI] Partners for the purpose of
securing tax advice. Evidence that Mr. Haber solicited advice on the
basis of facts that were incomplete or altogether false, compared to the
facts about the * * * [option partnership strategy] adduced at trial,
would indicate that he knew that the tax benefits claimed were not
proper. This would show bad faith.
Petitioners respond: ‘‘[T]he petitions do not assert any
advice-of-counsel defense, nor do they mention (or even
allude to) any advice from their attorneys. The Petitions do
allege that * * * [the partnerships] and their partners
reasonably believed the positions on the Partnerships’ tax
returns to be correct, but such a defense need not rely on
professional advice.’’ They argue: ‘‘A generalized ‘good faith’
defense, not specifically relying on the advice of counsel is
not a waiver of the attorney-client privilege. [Pritchard v.
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(248) AD INV. 2000 FUND LLC v. COMMISSIONER 253
Cnty. of Erie] In re County of Erie, 546 F.3d 222, 229 (2d Cir.
2008); In re Grand Jury, 219 F.3d [175] at 183 [(2d. Cir.
2000)]; United States v. White, 887 F.2d 267, 270–71 (D.C.
Cir. 1989)’’. In response to respondent’s arguments that the
opinions are relevant to factual questions presented by the
partnerships’ belief, reasonable cause, and good-faith
defenses, petitioners respond: ‘‘[T]he mere fact that attorney-
client communications would be ‘relevant’ is not a sufficient
basis to waive the privilege. Rhone-Poulenc Rorer Inc. v.
Home Indemnity Co., 32 F.3d 851, 863–64 (3d Cir. 1994).’’
Respondent relies principally on Johnston v. Commis-
sioner, 119 T.C. 27, 37 (2002), in which the taxpayer
‘‘asserted reliance on qualified experts as an affirmative
defense to respondent’s fraud penalty allegations.’’ Inter-
preting that reference to qualified experts to include legal
counsel, id. at 37–38, we undertook the approach of deter-
mining whether there was an implied waiver as outlined in
Hearn v. Rhay, 68 F.R.D. 574, 581 (E.D. Wash. 1975). We
considered whether (1) assertion of the privilege was a result
of some affirmative act, such as filing suit, by the asserting
party; (2) through this affirmative act, the asserting party
put the protected information at issue by making it relevant
to the case; and (3) application of the privilege would have
denied the opposing party access to information vital to his
defense. Johnston v. Commissioner, 119 T.C. at 36. We held
that all three elements of the Hearn test for implied waiver
had been satisfied. Id. at 40. Respondent argues that he has
established that the three elements of the Hearn test are
satisfied in these cases. He adds that the Hearn test has
been endorsed by the Court of Appeals for the D.C. Circuit.
See Sanderlin v. United States, 794 F.2d 727 (D.C. Cir.
1986).
Petitioners respond that, although adopted by this Court in
Johnston, the Hearn approach has been explicitly rejected by
the U.S. Court of Appeals for the Second Circuit in Pritchard
v. Cnty. of Erie (In re Cnty. of Erie), 546 F.3d 222, 229 (2d
Cir. 2008). Petitioners contend that, in Pritchard, the Court
of Appeals held that to impliedly waive the attorney-client
privilege, ‘‘a party must rely on privileged advice from his
counsel to make his claim or defense.’’ Id. The Court of
Appeals for the Second Circuit is the presumptive venue for
appeal of these cases. See sec. 7482(b)(1)(B). For that reason,
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254 142 UNITED STATES TAX COURT REPORTS (248)
petitioners add that, under the rule of Golsen v. Commis-
sioner, 54 T.C. 742 (1970), aff ’d, 445 F.2d 985 (10th Cir.
1971), Pritchard governs in these cases.
Discussion
I. Golsen Doctrine
Section 7453 provides in pertinent part that Tax Court
proceedings are conducted in accordance with the rules of
evidence applicable to trials without a jury in the U.S. Dis-
trict Court for the District of Columbia. The Federal Rules
of Evidence apply to proceedings before the U.S. District
Court for the District of Columbia. See Fed. R. Evid. 1101.
The Federal Rules of Evidence incorporate the common law
rules of privilege. See Fed. R. Evid. 501, 1101(c). Under the
rule of Golsen v. Commissioner, 54 T.C. at 757, this Court
will ‘‘follow a Court of Appeals decision which is squarely in
point where appeal from our decision lies to that Court of
Appeals’’. Because the facts in front of us are materially
distinguishable from those of Pritchard, we need not consider
whether under the Golsen rule we should follow the Court of
Appeals for the Second Circuit’s opinion in that case.
II. Claim of Privilege
A. Introduction
‘‘As construed under Federal common law, the attorney-
client privilege exists ‘to encourage full and frank commu-
nication between attorneys and their clients and thereby pro-
mote broader public interests in the observance of law and
administration of justice.’ ’’ Johnston v. Commissioner, 119
T.C. at 34 (quoting Upjohn v. United States, 449 U.S. 383,
389 (1981)). Nevertheless:
It is well established doctrine that in certain circumstances a party’s
assertion of factual claims can, out of considerations of fairness to the
party’s adversary, result in the involuntary forfeiture of privileges for
matters pertinent to the claims asserted. * * *
In some circumstances, courts have ruled that it would be unfair for a
party asserting contentions to an adjudicating authority to then rely on
its privileges to deprive its adversary of access to material that might
disprove or undermine the party’s contentions. * * *
[In re Grand Jury Proceedings John Doe Co. v. United States, 350 F.3d
299, 302 (2d Cir. 2003).]
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(248) AD INV. 2000 FUND LLC v. COMMISSIONER 255
See also, e.g., Chevron Corp. v. Pennzoil Co., 974 F.2d 1156,
1162 (9th Cir. 1992) (‘‘Where a party raises a claim which in
fairness requires disclosure of the protected communication,
the privilege may be implicitly waived.’’). ‘‘Whether fairness
requires disclosure has been decided by the courts on a case-
by-case basis, and depends primarily on the specific context
in which the privilege is asserted.’’ United States v. Doe (In
re Grand Jury Proceedings), 219 F.3d 175, 183 (2d Cir. 2000).
When a person puts into issue his subjective intent in
deciding how to comply with the law, he may forfeit the
privilege afforded attorney-client communications. See, e.g.,
United States v. Exxon Corp., 94 F.R.D. 246, 248 (D.D.C.
1981) (‘‘Most courts considering the matter have concluded
that a party waives the protection of the attorney-client
privilege when he voluntarily injects into the suit the ques-
tion of his state of mind.’’). Professor Rice, in his treatise,
Attorney-Client Privilege in the United States, makes a
similar point: ‘‘The most common situation in which courts
have found waiver is where the client claims that he acted
on the ‘good faith’ belief that his conduct was reasonable and
legal.’’ Paul R. Rice, 2 Attorney-Client Privilege in the United
States, sec. 9:53, at 434 (2013–2014 ed. 2013). United States
v. Bilzerian, 926 F.2d 1285 (2d Cir. 1991), involved an appeal
from convictions for financial crimes. The trial court had
ruled that, if the defendant testified regarding his good-faith
efforts to comply with the securities laws, he would open the
door to cross-examination with respect to the basis for his
belief regarding the lawfulness of his actions and that such
cross-examination would allow inquiry into communications
that he had with his attorney (‘‘discussions ordinarily pro-
tected by the attorney-client privilege’’). Id. at 1291. The
defendant did not testify. On appeal, he contended that his
testimony would not have disclosed the content or even the
existence of any privileged communications or asserted a reli-
ance on counsel. Id. For that reason, he argued, the attorney-
client privilege would not be waived by his testimony and,
therefore, the trial court committed reversible error in
denying his motion in limine seeking to protect the privilege.
Id. at 1292. The Court of Appeals disagreed that his testi-
mony would not waive the privilege, holding that, even if his
testimony did not advert to protected communications, he
would implicitly waive the privilege if he asserted a claim
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256 142 UNITED STATES TAX COURT REPORTS (248)
‘‘that in fairness requires examination of protected commu-
nications.’’ Id. The Court of Appeals then found:
This waiver principle is applicable here for Bilzerian’s testimony that he
thought his actions were legal would have put his knowledge of the law
and the basis for his understanding of what the law required in issue.
His conversations with counsel regarding the legality of his schemes
would have been directly relevant in determining the extent of his
knowledge and, as a result, his intent. [Id.]
The court concluded: ‘‘The trial court’s ruling left defendant
free to testify without getting into his state of mind, but cor-
rectly held that if he asserted his good faith, the jury would
be entitled to know the basis of his understanding that his
actions were legal.’’ Id. at 1294. In Cox v. Adm’r U.S. Steel
& Carnegie, 17 F.3d 1386, 1419 (11th Cir. 1994), relying on
Bilzerian, the Court of Appeals for the Eleventh Circuit
stated: ‘‘USX could have denied criminal intent without
affirmatively asserting that it believed that its change in
pension fund policy was legal. Having gone beyond mere
denial, affirmatively to assert good faith, USX injected the
issue of its knowledge of the law into the case and thereby
waived the attorney-client privilege.’’ More recently, in
Pritchard, 546 F.3d at 228–229, although finding no implied
waiver of the attorney-client privilege and noting that the
petitioners therein did not claim a good-faith or state-of-mind
defense, the Court of Appeals for the Second Circuit general-
ized: ‘‘[T]he assertion of a good-faith defense involves an
inquiry into state of mind, which typically calls forth the
possibility of implied waiver of the attorney-client privilege.’’
In Anderson v. Nixon, 444 F. Supp. 1195, 1200 (D.D.C. 1978),
Judge Gesell put the rule thus: ‘‘[A] client waives his
attorney privilege when he brings suit or raises an affirma-
tive defense that makes his intent and knowledge of the law
relevant.’’
B. Belief Requirement
To satisfy the belief requirement by the first method (i.e.,
under section 1.6662–4(g)(4)(i)(A), Income Tax Regs.) peti-
tioners must show that the partnerships ‘‘analyze[d] the
pertinent facts and [legal] authorities * * * and in reliance
upon that analysis, reasonably * * * conclude[d] in good
faith that there * * * [was] a greater than 50-percent likeli-
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(248) AD INV. 2000 FUND LLC v. COMMISSIONER 257
hood that the tax treatment of the item * * * [would] be
upheld if challenged by the Internal Revenue Service’’. Peti-
tioners’ averments that the partnerships satisfied the belief
requirement by the first method put into dispute the partner-
ships’ knowledge of the pertinent legal authorities. Peti-
tioners’ averments also put into contention the partnerships’
understanding of those legal authorities and their application
of the legal authorities (i.e., the law) to the facts. Finally, the
averments put into contention the basis for the partnerships’
belief that, if challenged, their tax positions would more
likely than not succeed in the courts. Petitioners have thus
placed the partnerships’ legal knowledge, understanding, and
beliefs into contention, and those are topics upon which the
opinions may bear. If petitioners are to rely on the legal
knowledge and understanding of someone acting for the part-
nerships to establish that the partnerships reasonably and in
good faith believed that their claimed tax treatment of the
items in question was more likely than not the proper treat-
ment, it is only fair that respondent be allowed to inquire
into the bases of that person’s knowledge, understanding,
and beliefs including the opinions (if considered). See, e.g.,
Cox, 17 F.3d 1386; Bilzerian, 926 F.2d 1285; Anderson, 444
F. Supp. 1195.
Apparently, each partnership received the opinions well
before its 2000 tax returns were due. Petitioners do not claim
that those acting for the partnerships ignored the opinions.
They claim only that the regulations provide an alternative
pursuant to which the partnerships may satisfy the belief
requirement by self-determination (without relying on profes-
sional advice). That is true. See sec. 1.6662–4(g)(4)(i), Income
Tax Regs. It is, however, beside the point. The point is that,
by placing the partnerships’ legal knowledge and under-
standing into issue in an attempt to establish the partner-
ships’ reasonable legal beliefs in good faith arrived at (a
good-faith and state-of-mind defense), petitioners forfeit the
partnerships’ privilege protecting attorney-client communica-
tions relevant to the content and the formation of their legal
knowledge, understanding, and beliefs. E.g., Cox, 17 F.3d
1386; Bilzerian, 926 F.2d 1285. Pritchard, 546 F.3d 222, is
not to the contrary. The Court of Appeals there stated: ‘‘Peti-
tioners do not claim a good faith or state of mind defense.
They maintain only that their actions were lawful or that
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258 142 UNITED STATES TAX COURT REPORTS (248)
any rights violated were not clearly established. In view of
the litigation circumstances, any legal advice rendered by the
County Attorney’s office is irrelevant to any defense so far
raised by Petitioners.’’ Id. at 229.
C. Reasonable Cause Exception
Section 6664(c)(1) provides that the accuracy-related pen-
alty shall not be imposed with respect to any portion of an
underpayment if the taxpayer shows there was reasonable
cause for, and that he acted in good faith with respect to,
that portion. Section 1.6664–4(b)(1), Income Tax Regs., pro-
vides:
The determination of whether a taxpayer acted with reasonable cause
and in good faith is made on a case-by-case basis, taking into account
all pertinent facts and circumstances. * * * Generally, the most impor-
tant factor is the extent of the taxpayer’s effort to assess the taxpayer’s
proper tax liability. Circumstances that may indicate reasonable cause
and good faith include an honest misunderstanding of * * * law that is
reasonable in light of all of the facts and circumstances, including the
experience, knowledge, and education of the taxpayer. * * *
As stated, petitioners aver: ‘‘Any underpayment of tax was
due to reasonable cause and with respect to which the Part-
nership and its partners acted in good faith.’’ Petitioners do
not in the objection contest respondent’s claim in the motions
that the opinions ‘‘are * * * relevant to the good faith ele-
ment of the penalty defense.’’ For the reasons set forth with
respect to the belief requirement, petitioners have with
respect to the section 6664(c)(1) reasonable cause exception
forfeited the privilege that would otherwise apply to the opin-
ions.
D. Conclusion
Petitioners’ averments in support of their affirmative
defenses to respondent’s determination of accuracy-related
penalties put into contention the state of mind of those who
acted for the partnerships and the partnerships’ good-faith
efforts to comply with the tax law. If petitioners persist in
those defenses, it would be unfair to deprive respondent of
knowledge of the contents of the opinions and the oppor-
tunity to put those opinions into evidence. If petitioners per-
sist, they sacrifice the privilege to withhold the contents of
the opinions.
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(248) AD INV. 2000 FUND LLC v. COMMISSIONER 259
III. Conclusion
As stated, we will grant the motions insofar as they ask us
to compel production of documents. We will set the motions
for hearing insofar as they ask us to sanction petitioners for
failure to comply with our order granting the motions, with
an eye, if there is noncompliance, toward prohibiting peti-
tioners from introducing evidence that the partnerships met
the belief requirement by self-determination or that someone
acting for the partnerships had a good-faith and honest mis-
understanding of law.
An appropriate order will be issued.
f
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