Cavallaro v. U.S.

• Citation: 284 F.3d 236
• Decision Date: 01 April 2002
• Docket Number: No. 01-2237.,01-2237.
• Parties: William CAVALLARO; Patricia Cavallaro, Petitioners, Appellants, v. UNITED STATES, Respondent, Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (1st Circuit)

Page 236

284 F.3d 236

William CAVALLARO; Patricia Cavallaro, Petitioners, Appellants, v. UNITED STATES, Respondent, Appellee.

No. 01-2237.

United States Court of Appeals, First Circuit.

Heard February 8, 2002.

Decided April 1, 2002.

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William H. Paine with whom Mary B. Strother and Hale and Dorr LLP were on brief for appellants.

Edward T. Perelmuter, Attorney, Tax Division, Department of Justice, with whom Eileen J. O'Connor, Assistant Attorney General, Richard Farber, Attorney, Tax Division, Department of Justice, and Michael J. Sullivan, United States Attorney, of counsel, were on brief for appellee.

Before TORRUELLA, Circuit Judge, STAHL, Senior Circuit Judge, and LYNCH, Circuit Judge.

LYNCH, Circuit Judge.

This case raises important questions about the scope of the attorney-client privilege. William and Patricia Cavallaro ("Cavallaros") owned Knight Tool Co., Inc., founded in 1976. Their adult sons owned Camelot Systems, Inc., created in 1987. The Cavallaros and their sons merged their respective corporations in 1995 and, on July 1, 1996, the merged entity sold for approximately $97 million. Subsequently, the Internal Revenue Service began an investigation into the Cavallaros' correct estate and gift tax ("transfer tax") liabilities. The IRS suspected that the parties might have undervalued the Cavallaros' Knight company and overvalued the sons' Camelot company to disguise a gift to the sons in the form of post-merger stock.

In the course of this investigation, the IRS served a summons on Ernst & Young, an accounting firm that Camelot had retained in June of 1994. The summons requested that Ernst & Young produce "all records" in its possession regarding any work it did between 1984 and 1995 for the Cavallaros, their sons, and their respective corporations. The Cavallaros moved to quash the summons as overly broad and calling for privileged materials. They argued that the documents in Ernst & Young's possession were protected by the attorney-client privilege because the documents were created by, or provided to, Ernst & Young in the course of the efforts of the law firm Hale and Dorr to provide legal advice; particularly, advice sought in 1994 and 1995 concerning transfer tax and merger issues arising from the close relationship between Camelot and Knight. The IRS counterclaimed for enforcement of the summons. On July 27, 2001, the district court denied the Cavallaros' petition to quash and allowed the government's motion to enforce the summons. Cavallaro v. United States, 153 F.Supp.2d 52 (D.Mass.2001). Subsequently, the district court granted the Cavallaros' motion for stay pending appeal, thereby permitting the Cavallaros to continue to refrain from disclosing the documents that they allege are privileged.

As in the district court proceedings, three categories of documents requested by the IRS are at issue: (1) documents pertaining to the December 19, 1994, meeting — between the Cavallaros, their sons, a Camelot accountant, accountants from Ernst & Young, and at least one lawyer from Hale and Dorr — addressing transfer tax issues; (2) subsequent transfer tax communications arising from the December 19 meeting; and (3) documents related to communications addressing the 1995 merger of Knight and Camelot. All of the requested documents are in Ernst & Young's possession. They are all documents either created by Ernst & Young or transmitted to Ernst & Young, not documents preserved solely in Hale and Dorr's files.

On appeal, as in the district court, the Cavallaros argue that these documents are privileged under United States v. Kovel, 296 F.2d 918 (2d Cir.1961), despite having been either created by or disclosed to Ernst & Young, because Ernst & Young aided Hale and Dorr in providing legal advice. They also argue that the documents fall within the common-interest exception to the rule that disclosure to a third party waives the attorney-client privilege.

Assuming arguendo that this circuit would adopt the Kovel rule, we conclude that the documents are not privileged. We follow somewhat different reasoning than the district court. We need not decide whether, in all instances, the attorney or client (as opposed to some third party) must hire the accountant in order to sustain a privilege under Kovel. Kovel requires that to sustain a privilege an accountant must be "necessary, or at least highly useful, for the effective consultation between the client and the lawyer which the privilege is designed to permit." 296 F.2d at 922. Here, no party hired Ernst & Young for this purpose. Therefore, the attorney-client privilege did not extend to the documents in question under the Kovel doctrine. Having found that the documents were not covered by the attorney-client privilege, we also conclude that they cannot fall within the common-interest exception, which presumes a valid underlying privilege in the first place. Consequently, we do not reach the district court's conclusion that "[u]nder the strict confines of the common-interest doctrine, the lack of representation for [the sons and Camelot] vitiates any claim to a privilege," Cavallaro, 153 F.Supp.2d at 61, because Ernst & Young was providing accounting services and so the Kovel extension of the privilege is inapplicable to the summoned documents, all of which were created by or disclosed to Ernst & Young.

I.

The following facts are undisputed except where otherwise noted. In 1976, the Cavallaros formed Knight Tool Co., Inc., to manufacture tools to be used by companies such as McDonnell Douglas, Polaroid, and Raytheon to assemble their products. Seven years later, in 1983, William Cavallaro and one of his three sons, Kenneth, developed a rudimentary glue-dispensing machine, which, for several years, was commercially unsuccessful due, at least in part, to difficulty in marketing the machine.

In 1987, the Cavallaros formed a new company, Camelot Systems, Inc., to give the Cavallaros' three sons an opportunity to pursue the glue-dispensing machine business. In addition to paying its own employees, Knight paid the salaries of Camelot's employees. The three sons were named as Camelot's sole shareholders and, although Knight continued to make the glue-dispensing machines, Camelot became the machines' only distributor. Knight was Camelot's biggest supplier. In fact, Camelot's only business was selling glue-dispensing machines and accessories manufactured by Knight. The sons, working at Camelot, completely redesigned the Knight glue-dispensing machine and developed several new models of the machine. As a result, Camelot became a lucrative business.

In 1992, the Cavallaros contacted attorney Louis Hamel Jr. Hamel was a long-time senior partner at the Hale and Dorr law firm, specializing in trusts and estates, exempt organizations, and pensions. He, along with other Hale and Dorr attorneys, periodically counseled the Cavallaros regarding Knight corporate matters.

The Cavallaros again contacted Hamel, in October 1994, this time for help with estate and retirement planning. Hamel considered, among other things, potential transfer tax issues arising in the context of the close business and family relationships between Knight and Camelot. Between December 19, 1994, and December 31, 1995, Hale and Dorr provided legal advice to Knight and the Cavallaros, acting on Knight's behalf, with respect to the merger of Knight into Camelot. Hale and Dorr advised the Cavallaros on, among other things, the drafting of affidavits purporting to establish the pre-merger values of Knight and Camelot.

While the Cavallaros were receiving legal advice from Hale and Dorr, their sons, as agents of Camelot, had begun receiving tax planning advice from Ernst & Young. Camelot began meeting with Ernst & Young in June of 1994. On November 16, 1994, Ernst & Young documented its relationship with Camelot in a letter of engagement, stating that Ernst & Young would be providing a "Review of Corporate Structure and Recommendations," a "Tax Checkup," and "Transfer Planning." The letter, addressed to David Frac, Camelot's Chief Financial Officer, further stated that "[a]ll advice and other services we provide pursuant to this engagement are solely for the benefit of Camelot ... and not for the benefit of anyone other than the corporation and its shareholders." Frac signed the letter and returned it to Ernst & Young.

A draft of the invoice, however, for Ernst & Young's services rendered through December 31, 1994, which explicitly included tax services rendered pursuant to the November 14 engagement letter, refers to services rendered to both Camelot and Knight. It was addressed and mailed to Mrs. Cavallaro at Knight. In addition, Lawrence Goodman, of Ernst & Young, testified in his October 27, 2000, deposition that, in 1994, he was involved in providing tax advice to Camelot, Knight, and the Cavallaros. He also testified that around November or December of 1995, an Ernst & Young employee began providing services to both Camelot and Knight. The district court, nonetheless, concluded that "the undisputed evidence is that Ernst & Young was paid by, and worked solely for, Camelot and its shareholders." Cavallaro, 153 F.Supp.2d at 58.

On December 15, 1994, Ernst & Young sent a letter to William Cavallaro recommending the merger of Knight and Camelot and suggesting a strategy for minimizing transfer tax liability. Ernst & Young understood that the Cavallaros and their sons would consider selling their respective companies, and proceeded to explain how the parties might structure the corporate relationship in order to facilitate a transfer of some of the proceeds from such a sale from the Cavallaros to their children while minimizing tax liability. Ernst & Young stated that the letter would "serve as the discussion document" for an upcoming meeting between Ernst & Young, Hale and Dorr, the Cavallaros, their sons, Kevin McGillivary (an...