Thomas E. Johnston and Thomas E. Johnston, Successor in Interest to Shirley L. Johnston v. Commissioner

119 T.C. No. 3UNITED STATES TAX COURT
THOMAS E. JOHNSTON AND THOMAS E. JOHNSTON, SUCCESSOR IN INTEREST
TO SHIRLEY L. JOHNSTON, DECEASED, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 26005-96, 2266-97, Filed August 8, 2002.
12736-97.
Held: In this case involving a question of
Federal taxes, respondent’s motion in limine to deny
petitioners’ entitlement to assert the attorney-client
privilege, granted based on the Federal common law
doctrine of implied waiver.
Held, further, respondent’s motion for partial
summary judgment, requesting collateral estoppel based
on State court proceedings, denied.
Lorraine G. Howell, for petitioners.
Louis B. Jack, for respondent.
1
Cases of the following petitioners are consolidated
herewith: Thomas E. Johnston, docket No. 2266-97; and Eric T.
Johnston, docket No. 12736-97.
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OPINION
NIMS, Judge: Respondent determined the following
deficiencies and penalties with respect to petitioners’ Federal
income taxes:
Penalties
Petitioner Year Deficiency Sec. 6662(a) Sec. 6663
Thomas E. Johnston and * 1989 $1,546,160 $309,232 $1,159,620
* * Shirley L. Johnston,
Deceased
Docket No. 26005-96
Thomas E. Johnston 1991 289,396 -- 217,047
Docket No. 2266-97
1992 341,908 -- 256,431
Eric T. Johnston 1989 165,067 33,013 --
Docket No. 12736-97
By answer respondent also asserted increased deficiencies and
penalties in docket Nos. 26005-96 and 2266-97.
These consolidated cases are presently before the Court on
two motions filed by respondent. Respondent filed a motion for
partial summary judgment with respect to docket Nos. 26005-96 and
2266-97 and a motion in limine with respect to docket Nos. 26005-
96, 2266-97, and 12736-97. A hearing was subsequently held, and
these motions were taken under advisement. Pursuant to orders of
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the Court, petitioners thereafter filed an opposition to each of
respondent’s motions, and respondent filed responses to
petitioners’ objections.
Unless otherwise indicated, all section references are to
sections of the Internal Revenue Code in effect for the years at
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
Background
The information below is based upon examination of the
pleadings, moving papers, responses, and attachments submitted in
connection with these cases. Factual recitations are meant to
provide context for our analysis of respondent’s motions and
endeavor to set forth matters that would appear not to be in
dispute. They do not, however, constitute findings of fact for a
subsequent trial.
Estrella Properties, Ltd.
Prior to and during the years at issue, Thomas E. Johnston
(Mr. Johnston) was involved in the real estate development
business. As relevant herein, he conducted certain of his real
estate activities through his wholly owned corporation, Sea-Aire
Properties, Inc. (Sea-Aire). In the mid-1970s, Mr. Johnston,
through Sea-Aire, became involved in Estrella Properties, Ltd.
(Estrella), a California limited partnership. Estrella had been
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established to develop a portion of the Forster Ranch2 in San
Clemente, California. From June 30, 1978, through March 30,
1989, ownership of Estrella was distributed as follows:
Partner Name Interest Percentage Interest Type
Shannon Developers, Inc. 10 Percent General
Leo A. Fitzsimon 5 Percent General
Borg-Warner Equity Corp. 79 Percent Limited
Sea-Aire Properties, Inc. 6 Percent Limited
Shannon Developers, Inc. (Shannon),3 a corporation wholly
owned by Darrel S. Spence, was also designated as the managing
general partner. Leo A. Fitzsimon received the ownership
interest reflected above after having been employed for several
years as a project manager and engineer for Estrella’s
development of the Forster Ranch. Borg-Warner Equity Corp., or a
subsidiary (without distinction Borg-Warner), had provided the
funding used to finance the venture.
On March 30, 1989, the partners in Estrella entered a
Partnership Settlement Agreement providing for disposition of
assets owned by the entity. This arrangement was apparently
precipitated by dissatisfaction on the part of Borg-Warner with
2
This property is variously referred to in filings
submitted by the parties as both the Forster Ranch and the
Forester Ranch. For convenience we uniformly use the Forster
terminology.
3
It appears from documents submitted that Shannon
Developers, Inc., may have been known as Shannon Development Co.
in 1978 but had become Shannon Developers, Inc., by 1989.
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the handling of partnership affairs. Pursuant to the settlement
agreement, the Forster Ranch property, with the exception of 22
lots referred to as the equestrian lots, was sold, and the
proceeds were applied to reduce the unpaid balance on the funding
provided through Borg-Warner. Certain other properties were
distributed to Shannon, Sea-Aire, and Mr. Fitzsimon in undivided
interests of 47.62 percent, 28.57 percent, and 23.81 percent,
respectively. These properties included the equestrian lots and
the stock of Shorecliffs Golf Course, Inc.4 (Shorecliffs).
Shorecliffs held title to a golf course of the same name which
had previously been acquired by Estrella and the business of
which was operated by Mr. Spence.
S.C. Equestrian Lots, Ltd.
Following the just-described settlement, the 22 equestrian
lots were contributed to form S.C. Equestrian Lots, Ltd. (SCE), a
California limited partnership. Sea-Aire served as the general
partner through at least July 1, 1992. Thereafter, Uppaway
Investments, Inc. (Uppaway), another entity related to Mr.
Johnston, seems to have been substituted as general partner.
Both Mr. Johnston and Mr. Fitzsimon were named as limited
4
The various documents and filings submitted by the parties
refer to this entity both as Shorecliffs Golf Course, Inc., and
as Shorecliff Golf Course, Inc. The plural form was selected by
petitioners and respondent in their memoranda addressing the
instant motions, and we for clarity adopt the plural throughout
our discussion.
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partners of SCE in partnership documents; Mr. Spence and/or
Shannon were not. A promissory note and option agreement dated
April 21, 1989, and executed by Mr. Johnston on behalf of Sea-
Aire, would appear to reflect the sale of Shannon’s undivided
interest in the lots to Sea-Aire.
Sale of Shorecliffs Golf Course
By late 1988 and continuing through the middle of 1989, Mr.
Spence was involved in negotiations for the sale of the golf
course owned by Shorecliffs. In this connection, a real estate
purchase option was entered for consideration of approximately
$500,000 on December 23, 1988, by Mr. Spence on behalf of
Shorecliffs as optionor and by Fon N. Leong and Agie J.C. Chen as
optionees.
In addition to the above negotiations relating to the sale
of the assets owned by Shorecliffs, discussions also ensued
during this period among the Shorecliffs shareholders with regard
to their respective interests in the entity. On May 11, 1989, a
stock sale option agreement was signed by or on behalf of
Shannon, Sea-Aire, and Mr. Fitzsimon. The option granted to
Shannon the right to purchase the Shorecliffs stock owned by Sea-
Aire and Mr. Fitzsimon. However, Mr. Spence and Mr. Johnston
purportedly had an oral understanding that Sea-Aire could choose
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to retain its interest in the company. Shannon did in fact
exercise its option to purchase the Shorecliffs stock owned by
Mr. Fitzsimon. Sea-Aire, on the other hand, retained its
interest in Shorecliffs.
On June 28, 1989, Mr. Spence and Mr. Johnston met with
attorney Thomas J. O’Keefe to discuss matters relating to the
pending sale of the Shorecliffs golf course. After certain
extensions and modifications of the terms contemplated by the
December 23, 1988, option agreement, a sale of the golf course
ultimately closed on June 30, 1989. The buyers were L.H.C.
Investments, Fon N. Leong, and Ruth Li Shu Leong. The total
purchase price of between $5 and $6 million was paid in part by a
$3 million promissory note secured by deed of trust.
State Court Litigation
The foregoing transactions eventually resulted in two suits
filed by Mr. Fitzsimon in the Superior Court of the State of
California, County of Orange. The first, Fitzsimon v. S.C.
Equestrian Lots, Ltd., No. 704870 (Cal. Super. Ct. June 9, 1995),
was brought in February of 1993 against, among others, SCE, Mr.
Johnston, Sea-Aire, Uppaway, Eric Johnston, Mr. Spence, Shannon,
and Shorecliffs. The complaint set forth 15 causes of action
based on grounds such as fraud, intentional misrepresentation,
breach of contract, breach of fiduciary duty, negligence, and
conversion. As most relevant for purposes of the motions now at
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bar, the complaint alleged: (1) That Mr. Johnston and Mr. Spence
fraudulently induced Mr. Fitzsimon to relinquish his interest in
Shorecliffs shortly before the multimillion-dollar sale, and (2)
that Mr. Fitzsimon was deprived of profits from the SCE venture
on account of self-dealing transactions and diversion of proceeds
by other partners. Requested relief included damages, imposition
of constructive trust, declaratory relief, injunctive relief,
dissolution of partnership, and accounting.
Following waiver by the parties of a jury, a bench trial
began in late June of 1994. The Johnstons and their related
entities were represented by counsel. The Superior Court
thereafter rendered its findings in a special verdict form
executed on October 6, 1994. Among other things, the court found
that Mr. Spence, Shannon, Mr. Johnston, and Sea-Aire
intentionally defrauded Mr. Fitzsimon in connection with sale of
the Shorecliffs golf course. The special verdict also included a
finding that Mr. Spence was an alter ego of Shannon and that Mr.
Johnston was an alter ego of Sea-Aire and Uppaway. As regards
the equestrian lots dispute, it was stipulated that SCE should be
dissolved and a final accounting conducted.
An accounting referee was appointed by the court to provide
recommendations on the accounting matters. After extensive
comment from the parties, the court on June 9, 1995, entered its
judgment addressing both the Shorecliffs and the SCE
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transactions. Mr. Fitzsimon was awarded compensatory damages
against Mr. Spence, Mr. Johnston, and their related entities, as
well as punitive damages against Mr. Spence and Shannon. A
constructive trust was imposed on the $3 million note secured by
deed of trust. The ruling with respect to alter ego status was
also explicitly reiterated.
The judgment was appealed by Mr. Johnston and his related
entities to the Court of Appeal of the State of California,
Fourth Appellate District, Division Three. Fitzsimon v. S.C.
Equestrian Lots, Ltd., No. G018290 (Cal. Ct. App. May 25, 1999).
The appellate court affirmed in an unpublished opinion filed on
May 25, 1999, and the decision became final with issuance of a
remittitur by the Court of Appeal on July 29, 1999.
The second suit brought by Mr. Fitzsimon, Fitzsimon v. Good,
Wildman, Hegness & Walley, No. 733226 (Cal. Super. Ct.5), was an
action against Mr. O’Keefe and his firm for professional
malpractice, fraud, and spoliation of evidence. Before trial the
defendants brought several motions in limine to exclude documents
and testimony, including notes made by Mr. O’Keefe at the June
28, 1989, meeting. The trial court ruled that the materials were
protected by the attorney-client privilege, on grounds that (1)
5
The materials submitted by the parties do not divulge any
specific dates of relevant action by the Superior Court in this
case. It seems likely, however, that the suit would have been
filed, and the nonsuit judgment entered (see infra text), in
1999.
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the privilege was not waived by deposition or trial testimony in
the earlier case, and (2) the crime-fraud exception was
inapplicable. After these rulings, the parties stipulated to a
nonsuit judgment in order to permit appeal. The appellate court,
in an unpublished opinion filed on August 24, 1999, affirmed.
Fitzsimon v. Good, Wildman, Hegness & Walley, No. G020125 (Cal.
Ct. App. Aug. 24, 1999).
Discussion
I. Motion in Limine
Respondent’s motion in limine asks the Court to enter an
order in advance of trial ruling that “petitioner Thomas E.
Johnston is not entitled to assert attorney-client privilege to
prevent his former attorney, Thomas O’Keefe, from testifying
about or producing records pertaining to certain confidential
communications made by petitioner during the course of the
representation”. Framed more narrowly, respondent’s request is
principally concerned with notes made by Mr. O’Keefe regarding
the June 28, 1989, meeting with Mr. Johnston and Mr. Spence.
Respondent alleges that these notes are not protected by the
attorney-client privilege on three alternative grounds: (1)
Waiver by petitioners’ having placed the nature of attorney-
client communications at issue through claimed reliance on
counsel’s advice; (2) waiver by Mr. O’Keefe’s having testified
about privileged matters, during proceedings in Superior Court,
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prior to claiming the privilege; and (3) the crime-fraud
exception, applicable due to participation by Mr. O’Keefe in Mr.
Johnston’s scheme to defraud Mr. Fitzsimon of his interest in the
Shorecliffs golf course.
A. Applicable Law
As a threshold matter, we address the question of governing
law. In general, section 7453 and Rule 143(a) provide that Tax
Court proceedings are to be conducted in accordance with the
rules of evidence applicable in trials without a jury in the
United States District Court for the District of Columbia.
Consistent with this directive, we observe the Federal Rules of
Evidence. Rule 501 of the Federal Rules of Evidence controls
issues of privilege and specifies as follows:
Except as otherwise required by the Constitution
of the United States or provided by Act of Congress or
in rules prescribed by the Supreme Court pursuant to
statutory authority, the privilege of a witness,
person, government, State, or political subdivision
thereof shall be governed by the principles of the
common law as they may be interpreted by the courts of
the United States in the light of reason and
experience. However, in civil actions and proceedings,
with respect to an element of a claim or defense as to
which State law supplies the rule of decision, the
privilege of a witness, person, government, State, or
political subdivision thereof shall be determined in
accordance with State law.
The foregoing rule establishes a structure where “Issues
concerning application of the attorney-client privilege in the
adjudication of federal law are governed by federal common law.”
Clarke v. Am. Commerce Natl. Bank, 974 F.2d 127, 129 (9th Cir.
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1992); see also United States v. Zolin, 491 U.S. 554, 562 (1989);
United States v. Mass. Inst. of Tech., 129 F.3d 681, 684 (1st
Cir. 1997); United States v. Blackman, 72 F.3d 1418, 1423-1424
(9th Cir. 1995); Gannet v. First Natl. State Bank, 546 F.2d 1072,
1075-1076 (3d Cir. 1976). Conversely, State attorney-client
privilege rules apply where the underlying cause of action rests
on State law. Rhone-Poulenc Rorer, Inc. v. Home Indem. Co., 32
F.3d 851, 861-862 (3d Cir. 1994).
Petitioners argue that the cases at bar involve the latter
situation. Petitioners claim:
The issue here is not whether Petitioner has
waived his attorney-client privilege in the within U.S.
Tax Court proceeding involving federal statutes of the
Internal Revenue Code. The issue here is whether
Petitioner waived his attorney-client privilege in
Fitzsimon v. S.C.Equestrian, et al, a 1994 State Court
proceeding involving causes of action under the laws of
the State of California. * * *
We, however, disagree. The matter before us is a
redetermination of petitioners’ Federal income tax liabilities
under Title 26 of the United States Code. It therefore falls
squarely within the above-described parameters for an
adjudication of Federal law.
Moreover, contrary to petitioners’ suggestion, the issue
here is precisely whether the privilege has been waived for
purposes of this Tax Court proceeding, regardless of whether it
was waived for purposes of earlier litigation in California.
Although certain of respondent’s bases for contending that the
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privilege is inapplicable here stem from conduct occurring before
or considered by the State courts, this fact does not transform
the Federal tax nature of, or inject any State law cause of
action into, the present proceeding. We also point out that one
of the grounds relied upon in respondent’s motion (wherein
petitioners are alleged to have placed communications at issue by
their litigation posture in this Court) deals exclusively with
what has transpired before us. We conclude that Federal common
law governs.
B. Analysis
As construed under Federal common law, the attorney-client
privilege exists “to encourage full and frank communication
between attorneys and their clients and thereby promote broader
public interests in the observance of law and administration of
justice.” Upjohn Co. v. United States, 449 U.S. 383, 389 (1981).
The privilege applies to communications made in confidence both:
(1) By a client to an attorney for the purpose of obtaining legal
advice, and (2) by an attorney to a client where containing legal
advice or revealing confidential information on which the client
seeks advice. Id. at 390; Bernardo v. Commissioner, 104 T.C.
677, 682 (1995); Hartz Mountain Indus. v. Commissioner, 93 T.C.
521, 525 (1989); Karme v. Commissioner, 73 T.C. 1163, 1183
(1980), affd. 673 F.2d 1062 (9th Cir. 1982). The burden of
establishing that the attorney-client privilege is applicable to
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particular communications or documents rests with the party
asserting the privilege. Clarke v. Am. Commerce Natl. Bank,
supra at 129; Bernardo v. Commissioner, supra at 682.
As previously indicated, one of the grounds on which
respondent alleges that Mr. O’Keefe’s notes are not protected
here is that petitioners waived the privilege by claiming
reliance on advice of counsel. This contention invokes the
doctrine of what is referred to as implied waiver. Ideal Elec.
Sec. Co. v. Intl. Fid. Ins. Co., 129 F.3d 143, 151 (D.C. Cir.
1997); Home Indem. Co. v. Lane Powell Moss & Miller, 43 F.3d
1322, 1326 (9th Cir. 1995). While the precise reach of the
theory can be a subject of some controversy, courts typically
employ some version of one of several general approaches. See,
e.g., Frontier Ref., Inc. v. Gorman-Rupp Co., 136 F.3d 695, 699-
700 (10th Cir. 1998) (cataloging various standards); Zenith Radio
Corp. v. United States, 764 F.2d 1577, 1579 (Fed. Cir. 1985)
(same). These include the so-called automatic waiver rule, under
which a party automatically waives the privilege by asserting a
claim or defense to which otherwise privileged matter is
relevant, see Indep. Prods. Corp. v. Loew’s Inc., 22 F.R.D. 266,
276-277 (S.D.N.Y. 1958); a balancing test that weighs the need
for discovery against the need to protect the secrecy of the
communication, see Greater Newburyport Clamshell Alliance v. Pub.
Serv. Co., 838 F.2d 13, 20-22 (1st Cir. 1988); the three-pronged
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test of Hearn v. Rhay, 68 F.R.D. 574, 581 (E.D. Wash. 1975); and
a purportedly more restrictive test where waiver is effected only
if a litigant directly injects an attorney’s advice into issue,
see Rhone-Poulenc Rorer, Inc. v. Home Indem. Co., supra at 863-
864.
On the facts of the instant cases, it would appear that the
same result would obtain under any of the foregoing approaches.
We observe, however, that the approach of Hearn v. Rhay, supra,
has been both discussed with approval by the United States
District Court for the District of Columbia, whose rules of
evidence are applicable under section 7453, see United States v.
Exxon Corp., 94 F.R.D. 246, 248-249 (D.D.C. 1981), and explicitly
adopted by the Court of Appeals for the Ninth Circuit, the venue
for appeal in these cases, see United States v. Amlani, 169 F.3d
1189, 1195 (9th Cir. 1999). This Court, too, has previously
quoted Hearn v. Rhay, supra, with positive implication. Karme v.
Commissioner, supra at 1184.
Hearn v. Rhay, supra at 581, sets forth the following three
factors which must be extant for a finding of implied waiver:
(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. * * *
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To similar effect, this Court stated in Bernardo v. Commissioner,
supra at 691 (fn. ref. omitted), that the taxpayers did not
impliedly waive the privilege where they did not “affirmatively
raise a claim that can only be effectively disproven through the
discovery of attorney-client communications”. Given this
precedent and section 7453, we structure our discussion here
within the three criteria of the foregoing test.
The statutory notices issued to Mr. Johnston determine
deficiencies and section 6663 fraud penalties for each of the
years 1989, 1991, and 1992. After petitions were filed in these
cases, respondent submitted answers affirmatively setting forth
the facts upon which respondent relied in support of the fraud
determinations, as required by Rule 36(b) with respect to issues
on which respondent bears the burden of proof. Mr. Johnston, in
accordance with Rule 37(b), then followed with replies denying
the majority of respondent’s affirmative allegations. The
replies also included additional material addressing affirmative
defenses. The reply relating to Mr. Johnston’s 1989 tax year
stated:
By way of Affirmative Defense to the matters
affirmatively alleged by Respondent in its answer,
Petitioners allege as follows:
* * * * * * *
12) In preparing Petitioner’s returns for 1989,
Petitioners relied upon advice of qualified experts for
the underlying information developed and reported on
Petitioner’s income tax return for 1989.
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A nearly identical reference to the “advice of qualified experts”
was made in the reply dealing with the 1991 and 1992 tax years.
It is on the above-quoted statement pertaining to 1989 that
respondent bases contentions of implied waiver.
Petitioners’ response to respondent’s argument consists, in
its entirety, of the paragraph reproduced below:
Respondent argues, (p.7), that the Petitioner
relied on Advice of Counsel in his defense of the
within proceeding in his Reply referring to “qualified
experts” assisting him in preparing his 1989 tax
return. However, the Petitioner’s reference in his
Reply to “qualified experts” assisting him was his
accountant who assisted him in the filing of his Form
1040X for the calendar year 1989 [1-R]. He does not
refer to a lawyer. Therefore, there has been no
defense of advice of counsel and Respondent’s argument
is misplaced.
It is within the just-described context that we turn to
consideration of the three requirements for implied waiver. As
previously indicated, the first mandates that the privilege be
asserted as the result of some affirmative act. Here, Mr.
Johnston asserted reliance on qualified experts as an affirmative
defense to respondent’s fraud penalty allegations.
In Hearn v. Rhay, supra at 576-577, the plaintiff brought
suit claiming that his civil rights were violated during his
incarceration in a State penitentiary. The defendants asserted
the affirmative defense of qualified immunity based upon having
acted in good faith, and the plaintiff sought discovery of legal
advice the defendants received with respect to his confinement.
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Id. at 577-578. In those circumstances, the court held that
asserting the privilege in furtherance of an affirmative defense
satisfied the first element for qualified waiver. Id. at 581.
Other courts have similarly opined that raising affirmative
defenses can result in a waiver of the attorney-client privilege.
The United States District Court for the District of Columbia,
for instance, has refused to uphold the privilege where the
defense “of good faith reliance was affirmatively pleaded by the
party seeking to use the attorney-client privilege as a shield
against discovery.” United States v. Exxon Corp., supra at 248.
Accordingly, the first requisite is met here if Mr. Johnston’s
reference to qualified experts is deemed to encompass legal
counsel.
We conclude that to now narrow “advice of qualified experts”
solely to assistance received from the accountant aiding Mr.
Johnston in preparing his amended return would be to support a
belated characterization belied by the record. We initially note
that Mr. Johnston’s reply for the 1989 tax year was filed on
September 22, 1997. Petitioners’ opposition to the motions in
limine was filed on May 31, 2001, more than three and one-half
years later. In addition, the incongruity between the original
plural “experts” and the subsequent singular “accountant” is
difficult to reconcile.
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Moreover, petitioners elsewhere in the opposition state:
“Thomas O’Keefe, Esq., a certified tax specialist, represented
the Petitioner as tax counsel rendering tax advice over a period
of many years, and in particular in 1989, the period during which
events occurred that are raised in Respondent’s Motion in Limine
herein.” To similar effect, petitioners remark that “Thomas
O’Keefe, Esq., a certified tax specialist, had been a long time
attorney for Mr. Johnston and entities owned and controlled by
him”, and at yet another location characterize Mr. O’Keefe as
“long time tax counsel of Petitioner, Mr. Johnston”.
Additionally, the bill from Mr. O’Keefe to Shorecliffs and Mr.
Johnston for legal fees incurred in June of 1989 contains the
following description dated “06/28/89”:
Meeting with Tom Johnston, Darrell Spence and Frank
Nish re Shorecliffs; Review of sale transaction;
Prepared demand on escrow and notice and
acknowledgement [sic] regarding earth subsidence issues
to Buyer; Tax research and strategy planning regarding
basis, installment deal, sub-s and Exchange issues.
There is also the fact that income from the Shorecliffs sale
was reported on neither the original nor the amended 1989 return.
Hence, to the extent that reliance on expert advice can excuse
the alleged fraudulent failure to report this transaction, such
reliance was not only or in the first instance on the accountant
aiding in preparation of the amended return. We are satisfied
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that petitioners’ affirmative defense contemplated more than just
the cited accountant and is appropriately read to include Mr.
O’Keefe, who concededly provided tax advice in 1989.
The second requirement asks whether through this affirmative
act the asserting party puts the protected information at issue
by making it relevant to the case. This element, too, has been
satisfied here. As the Court of Appeals for the Ninth Circuit
explained in an analogous context: “to the extent that * * *
[the defendant] claims that its tax position is reasonable
because it was based on advice of counsel, * * * [the defendant]
puts at issue the tax advice it received.” Chevron Corp. v.
Pennzoil Co., 974 F.2d 1156, 1162-1163 (9th Cir. 1992).
Likewise, petitioners seek to defend against the fraud
allegations on grounds of reliance on experts. That defense
places at issue the tax advice Mr. Johnston received with respect
to his 1989 return. Petitioners have also admitted that Mr.
O’Keefe rendered tax advice to Mr. Johnston during 1989. In
addition, the California appellate court’s unpublished opinion in
Fitzsimon v. Good, Wildman, Hegness & Walley, No. G020125, slip
op. at 6 (Cal. Ct. App. Aug. 24, 1999), contains the following
statement: “Our review of the exhibits demonstrates there is
substantial evidence for the trial court to have concluded
defendants were hired by plaintiff’s partners and to obtain tax
advice and to research tax liability issues concerning a real
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estate sale.” Given these circumstances, petitioners, by raising
the affirmative defense of reliance, must be said to have placed
at issue in the present proceeding all tax advice received with
respect to the 1989 transactions in dispute, including
communications with Mr. O’Keefe.
Finally, the third inquiry is directed toward whether
allowing the privilege would deny the opposing party access to
information vital to its defense. The Courts of Appeals have
cautioned that privileged communications do not become
discoverable where they simply are relevant to issues raised in
the litigation or where they are only one of several forms of
indirect evidence about an issue. United States v. Amlani, 169
F.3d at 1195; Frontier Ref., Inc. v. Gorman-Rupp Co., 136 F.3d at
701-702; Zenith Radio Corp. v. United States, 764 F.2d at 1580-
1581. Rather, the information must be “vital”, Hearn v. Rhay, 68
F.R.D. at 581, such that it would be “manifestly unfair” to deny
access due to consequent prejudice to the opposing party’s
defense, Home Indem. Co. v. Lane Powell Moss & Miller, 43 F.3d at
1326-1327. Stated otherwise, the attorney-client privilege “may
not be used both as a sword and a shield.” Chevron Corp. v.
Pennzoil Co., supra at 1162.
In connection with the affirmative defense posture presented
in Hearn v. Rhay, supra at 581, the court explained that “one
result of asserting the privilege has been to deprive plaintiff
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of information necessary to ‘defend’ against defendants’
affirmative defense, for the protected information is also
germane to plaintiff’s burden of proving malice or unreasonable
disregard of his clearly established constitutional rights.” The
analogous scenario in United States v. Exxon Corp., 94 F.R.D. at
249, led the court to observe as follows:
Exxon’s affirmative defenses necessarily revolve around
whether Exxon did, in fact, primarily or solely rely
upon a particular DOE regulation or communication when
the company made its pricing decisions. Thus, the only
way to assess the validity of Exxon’s affirmative
defenses, voluntarily injected into this dispute, is to
investigate attorney-client communications where
Exxon’s interpretation of various DOE policies and
directives was established and where Exxon expressed
its intentions regarding compliance with those policies
and directives. * * *
A parallel situation exists here.
Under section 7454(a) and Rule 142(b), respondent bears the
burden of establishing fraud by clear and convincing evidence.
Petitioners have asserted reliance on professionals as an
affirmative defense to the fraud allegations. To “defend”
against this defense, respondent must show that such reliance
either was unreasonable or did not in fact occur. Respondent can
do so only through knowledge of what tax advice Mr. Johnston
received, and such would include communications from Mr. O’Keefe.
Additionally, having invoked reliance on “experts”, petitioners
cannot now be entitled selectively to withhold communications
from particular experts, especially those who petitioners concede
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provided tax advice, while allowing communications from others to
be disclosed. Rebuttal of the affirmative defense will depend on
the sum of tax advice received on the disputed transactions;
respondent will be prejudiced if only portions (presumably those
not detrimental to petitioners’ position) are available.
To rephrase a conclusion of the Court of Appeals for the
Ninth Circuit, petitioners “cannot invoke the attorney-client
privilege to deny * * * [respondent] access to the very
information that * * * [respondent] must refute in order to
demonstrate” the unreasonableness or nonexistence of the claimed
reliance. Chevron Corp. v. Pennzoil Co., supra at 1163. Doing
so would engender precisely the sort of unfairness that the
implied waiver doctrine was devised to avoid.
We therefore hold that all three elements of the Hearn v.
Rhay, supra, test for implied waiver have been established. We
shall grant respondent’s motion in limine on this basis.
Furthermore, since we reach our ruling based solely on
petitioners’ posture and defenses before this Court, we need not
consider the potential impact of the State court decision in
Fitzsimon v. Good, Wildman, Hegness & Walley, supra, which
addressed only respondent’s alternative grounds of waiver by
disclosure and the crime-fraud exception.
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II. Motion for Partial Summary Judgment
Respondent’s motion for partial summary judgment asks that
petitioners be collaterally estopped from relitigating the
following 10 issues allegedly determined in Fitzsimon v. S.C.
Equestrian Lots, Ltd., No.704870 (Cal. Super. Ct. June 9, 1995):
(1) Mr. Johnston intentionally defrauded Mr. Fitzsimon of
his interest in the Shorecliffs golf course;
(2) Mr. Spence and Mr. Johnston sold the Shorecliffs golf
course to a third party for $6 million;
(3) Mr. Spence and Mr. Johnston kept the proceeds from the
sale;
(4) Mr. Spence’s and Mr. Johnston’s combined basis in the
Shorecliffs golf course did not exceed $800,000;
(5) Mr. Fitzsimon’s 23.81-percent share of the cash
generated by the Shorecliffs sale, after adjustments for certain
amounts actually paid to Mr. Fitzsimon pursuant to the fraudulent
stock option sale agreement, was $478,998.55;
(6) during the year 1991, Mr. Spence had no interest in the
SCE partnership;
(7) Sea-Aire and Uppaway are alter egos of Mr. Johnston;
(8) during the year 1991, Mr. Johnston’s total partnership
interest in the SCE partnership was 76.19 percent, consisting of
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a 71.19-percent interest in his name and a 5-percent interest in
the name of Uppaway that was attributable to Mr. Johnston
personally;
(9) during the year 1991, Mr. Johnston’s distributable share
of SCE partnership net income was $1,141,417, consisting of
$1,066,511 for his 71.19-percent personal interest and $74,906
for the 5-percent interest of Sea-Aire/Uppaway; and
(10) Mr. Johnston’s distributive share of SCE’s net loss for
1992 was $2,362.
Petitioners dispute each of the foregoing points.
A. Standard for Summary Judgment
Rule 121(a) allows a party to move “for a summary
adjudication in the moving party’s favor upon all or any part of
the legal issues in controversy.” Rule 121(b) directs that a
decision on such a motion shall be rendered “if the pleadings,
answers to interrogatories, depositions, admissions, and any
other acceptable materials, together with the affidavits, if any,
show that there is no genuine issue as to any material fact and
that a decision may be rendered as a matter of law.” The moving
party bears the burden of demonstrating that no genuine issue of
material fact exists and that he or she is entitled to judgment
as a matter of law. Estate of Chenoweth v. Commissioner, 88 T.C.
1577, 1578 (1987). Facts are viewed in the light most favorable
to the nonmoving party. Id. However, where a motion for summary
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judgment has been properly made and supported by the moving
party, the opposing party may not rest upon mere allegations or
denials contained in that party’s pleadings but must by
affidavits or otherwise set forth specific facts showing that
there is a genuine issue for trial. Rule 121(d).
B. Standard for Collateral Estoppel
Collateral estoppel exists for “the dual purpose of
protecting litigants from the burden of relitigating an identical
issue and of promoting judicial economy by preventing unnecessary
or redundant litigation.” Meier v. Commissioner, 91 T.C. 273,
282 (1988); see also Montana v. United States, 440 U.S. 147, 153-
154 (1979); Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326
(1979). In general, the doctrine of collateral estoppel, also
referred to as issue preclusion, forecloses relitigation of
issues actually litigated and necessarily decided in a prior
suit. Parklane Hosiery Co. v. Shore, supra at 326 n.5; Meier v.
Commissioner, supra at 282; Peck v. Commissioner, 90 T.C. 162,
166 (1988), affd. 904 F.2d 525 (9th Cir. 1990).
This Court, expanding upon three factors identified by the
Supreme Court in Montana v. United States, supra at 155, has set
forth five prerequisites necessary for the application in factual
contexts of collateral estoppel:
(1) The issue in the second suit must be identical in
all respects with the one decided in the first suit.
(2) There must be a final judgment rendered by a court
of competent jurisdiction.
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(3) Collateral estoppel may be invoked against parties
and their privies to the prior judgment.
(4) The parties must actually have litigated the issues
and the resolution of these issues must have been
essential to the prior decision.
(5) The controlling facts and applicable legal rules
must remain unchanged from those in the prior
litigation. [Peck v. Commissioner, supra at 166-167;
citations omitted.]
Additionally, where collateral estoppel premised on a State court
proceeding is sought to be used offensively in Federal court,
reference is made to the controlling State law to determine the
propriety of such offensive use. Bertoli v. Commissioner, 103
T.C. 501, 508 (1994). California courts have sanctioned use of
offensive collateral estoppel. See Imen v. Glassford, 247 Cal.
Rptr. 514, 518-519 (Cal. 1988); Estate of Gump v. Gump, 2 Cal.
Rptr. 2d 269, 286 (Cal. Ct. App. 1991).
C. Analysis
Having considered the state of the record in these cases,
the points as to which respondent would have us apply collateral
estoppel, and the matters which could remain for trial, we
conclude that the purposes of the doctrine would not be served at
this juncture by resort to issue preclusion. On a fundamental
level, as previously discussed, collateral estoppel exists to
prevent unnecessary and redundant litigation. Yet given the
particular facts under review, we see little to be gained when
measured against this standard.
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The facts pertaining to the Shorecliffs transaction are
closely intertwined with each other, as are those relating to the
SCE partnership. Consequently, to the extent that any of the
related matters must be litigated, much of the evidence and
argument will of necessity go to the relevant transactions as a
whole. Because we are satisfied after review of the record that
at least a majority of the above-enumerated points lacks the
requisite basis for issue preclusion, it becomes apparent that
significant redundancy is unavoidable.
Furthermore, cognizant of the rather unconventional nature
of the California trial court’s disposition (in the form only of
a special verdict and judgment) and the otherwise troublesome
state of the record in these cases, we cannot take lightly the
principle that “issue preclusion must be applied carefully so
that fairness to litigants is not compromised for efficiency and
economy.” Monahan v. Commissioner, 109 T.C. 235, 242 (1997); see
also United States v. Silliman, 167 F.2d 607, 614 (3d Cir. 1948)
(“Such a rule of public policy [collateral estoppel] must be
watched in its application lest a blind adherence to it tend to
defeat the even firmer established policy of giving every
litigant a full and fair day in court.”).
Hence, absent a clearer picture of what transpired in State
court and in light of the interdependence of many pertinent
- 29 -
matters, we believe that the issues in these cases are more
appropriately dealt with in a unified manner. We thus will deny
respondent’s motion for partial summary judgment.
To reflect the foregoing,
Appropriate orders will
be issued granting
respondent’s motion in limine
in all docket Nos. and denying
respondent’s motion for
partial summary judgment in
docket Nos. 26005-96 and
2266-97.