Pritchard-Keang Nam Corp. v. Jaworski

• Decision Date: 30 January 1985
• Docket Number: PRITCHARD-KEANG,Nos. 84-1444,84-1445,s. 84-1444
• Parties: Fed. Sec. L. Rep. P 91,930, 17 Fed. R. Evid. Serv. 240 NAM CORP., Delaware, et al., Appellees, v. Leon JAWORSKI, et al., Appellants.NAM CORP., Delaware, et al., Appellees, v. INTERNATIONAL SYSTEMS & CONTROLS CORPORATION, Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 277

751 F.2d 277

Fed. Sec. L. Rep. P 91,930, 17 Fed. R. Evid. Serv. 240

PRITCHARD-KEANG NAM CORP., Delaware, et al., Appellees, v. Leon JAWORSKI, et al., Appellants.

PRITCHARD-KEANG NAM CORP., Delaware, et al., Appellees, v. INTERNATIONAL SYSTEMS & CONTROLS CORPORATION, Appellant.

Nos. 84-1444, 84-1445.

United States Court of Appeals Eighth Circuit.

Submitted June 15, 1984.

Decided Dec. 28, 1984.

Rehearing and Rehearing En Banc Denied Jan. 30, 1985.

Thomas M. Bradshaw, Hoskins, King, McGannon, Hahn & Hurwitz, Kansas City, Mo., V. Thomas Lankford, Jr., Carol L. Chomsky, Sharp, Green & Lankford, Washington, D.C., for appellant International Systems.

Thomas E. Deacy, Jr., Phillip B. Grubaugh, Deacy & Deacy, Kansas City, Mo., for appellants Fulbright & Jaworski.

Joseph J. Kelly, Jr., Jerome T. Wolf, Mark A. Thornhill, Kansas City, Mo., for Pritchard-Keang Nam Corp.; Spencer, Fane, Britt & Browne, Kansas City, Mo., of counsel.

Before LAY, Chief Judge, JOHN R. GIBSON, Circuit Judge, and HANSON, ^* Senior District Judge.

JOHN R. GIBSON, Circuit Judge.

The issue before us is whether the crime-fraud exception to the attorney-client privilege applies to a report prepared by the law firm of Watson, Ess, Marshall & Enggas for International Systems & Controls Corporation. The district court ruled that it did and certified its order under 28 U.S.C. Sec. 1292(b) (1982). We conclude that the district court abused its discretion in stripping the report of its privilege, and we reverse.

ISC is a transnational corporation that provided engineering and construction services through numerous subsidiaries. On May 24, 1976, its board of directors appointed a special audit committee to investigate allegations that ISC had improperly made payments or bribes to persons in or dealing with foreign governments. This step was taken apparently in response to inquiries to ISC from the Securities and Exchange Commission in March 1976. The audit committee was authorized to retain Arthur Young & Co., ISC's regular independent auditors, and the Kansas City law firm of Watson, Ess, Marshall & Enggas, as special independent counsel, to investigate "questionable" or "sensitive" payments to foreign agents. The sensitive payments problem was raised publicly in a Form 10-K annual report filed for the fiscal year ending June 30, 1977. The report explained that a special audit committee was investigating whether illegal, improper, or questionable payments had been made during the years 1970 to 1976. Noting that the investigation was incomplete, the annual report stated that sensitive payments may have been involved in dealings of certain ISC subsidiaries. Following its eighteen-month investigation, Watson, Ess submitted a draft report to the audit committee in December 1977. No "final" report was ever submitted. The committee reported receipt of the Watson, Ess findings to the ISC board on December 28, 1977. Following the recommendation of the audit committee, the board agreed to make the report available to ISC's general counsel, Fulbright & Jaworski. A copy of the report was sent to each of two Fulbright attorneys. The report was discussed further at a board meeting on January 14, 1978.

One month later, the SEC served a subpoena on ISC, seeking production of the Watson, Ess report and the data upon which the report was based. The subpoena was resisted on attorney-client privilege grounds. The disposition of this dispute has not been made clear. On April 4, 1978, ISC filed a Form 8-K Current Report with the SEC that contained a substantial discussion of the sensitive payments problem. The report was prepared by Charles Reed, an attorney with the Washington, D.C. firm of Surrey, Karasik & Morse. Among other things, it disclosed that the SEC was conducting a private investigation of the matters covered by the 8-K, which included certain conclusions contained in the Watson, Ess report. ¹

During the summer of 1978, ISC commenced negotiations with Keang Nam Enterprises for the sale of two ISC subsidiaries, J.F. Pritchard & Co. and Pritchard International Corp. These two companies provided construction and engineering services on a global scale. Fulbright represented ISC and its subsidiaries, and Keang Nam was represented primarily by Norbert Schlei, an attorney with Hughes, Hubbard & Reed. ISC Senior Vice President Herman Frietsch also played a principal role. The transaction involved the transfer of J.F. Pritchard's and Pritchard International's assets to a Keang Nam subsidiary. Included in J.F. Pritchard's assets was an account receivable from Sonatrach, the Algerian national oil company. Valued at roughly $7.8 million, the receivable had arisen from Pritchard's construction of a natural-gas processing plant at Hassi R'Mel, Algeria. As part of the agreement, ISC represented that the Hassi R'Mel receivable was collectible in full.

The transaction was closed on October 20, 1978. As provided by the agreement, ISC secured for Keang Nam the following opinion from Fulbright:

To the best of our knowledge, except as disclosed in Schedule 5.6.1 to the Agreement and Exhibit A attached hereto, there is no litigation, proceeding or governmental investigation pending or threatened against or relating to the properties or business of the Seller [J.F. Pritchard & Co.] or PIC, or the transactions contemplated by the Agreement and the Amendment. ²

On July 9, 1979, the SEC filed a lawsuit charging ISC and its officers with numerous violations of the federal securities laws. Many of the violations alleged arose out of questionable and illicit payments in connection with foreign operations. The SEC alleged, among other things, that in 1975 J.F. Pritchard paid approximately $400,000 to a former Algerian military officer for "purported 'consulting services' " on the Hassi R'Mel project. In addition, the complaint described a $1.1 million payment to an Arab agent in connection with the same project. When the Hassi R'Mel contract was executed, in February 1975, Algerian law proscribed payments to government officials and the use of intermediaries in bidding and negotiating Algerian government contracts.

In January 1980, ISC filed a Form 8-K Current Report with the SEC. The report was submitted as part of an agreement between the SEC and ISC settling the July 9 lawsuit. ISC admitted that several million dollars had been paid to foreign individuals connected with the Hassi R'Mel project. The company maintained, however, that the payments did not violate Algerian law.

Keang Nam commenced this diversity action in December 1981. It alleged that the publicity surrounding the Algerian payments had made the Hassi R'Mel receivable worthless. Apparently, the government of Algeria refused to honor the debt when it realized the extent of the payments made. Pleading that ISC is insolvent, Keang Nam seeks to recoup its losses on the Hassi R'Mel receivable from Fulbright. Keang Nam alleges that Fulbright was negligent in rendering the opinion letter of October 20, 1978. It contends that Fulbright knew or should have known of the potential for investigation and litigation surrounding Hassi R'Mel and that the opinion letter was false.

Keang Nam sought production of the Watson, Ess report, and Fulbright raised the claim of attorney-client privilege. ISC was allowed to intervene for the purpose of defending against disclosure. The district court found that the report was protected by the attorney-client privilege and that ISC had not waived the privilege by delivering the report to the SEC in 1978. In analyzing the crime-fraud exception, the court held that whether ISC perpetrated a fraud on Keang Nam through Fulbright turned "on the knowledge held by ISC personnel when the opinion letter was delivered. * * * If ISC knew the opinion letter was inconsistent with facts contained in the Report, then they perpetrated a fraud on plaintiffs. Consequently the Report would be stripped of its attorney-client privilege." Pritchard-Keang Nam Corp. v. Jaworski, No. 81-1034-CV-W-4, slip op. at 5-6 (W.D.Mo. Sept. 26, 1983). The court ordered that discovery be conducted concerning this issue. At the conclusion of this discovery on November 8, 1983, the court issued an order requiring production of the report for in camera review.

On March 9, 1984, the court concluded:

After careful review of the Watson Ess Report, the Court is of the opinion that ISC had sufficient knowledge that the opinion letter issued by Fulbright & Jaworski would be misleading on the issue of whether certain actions by ISC employees or its subsidiaries violated certain ordinances in foreign countries, specific contract terms and affidavits required by certain governmental agencies. ISC had sufficient knowledge that the opinion letter was inconsistent with the facts contained in the Watson Ess Report. Consequently, pursuant to this Court's order entered September 26, 1983, the Watson Ess Report is stripped of its attorney-client privilege and should be subject to a motion to compel discovery by the plaintiffs.

Pritchard-Keang Nam Corp. v. Jaworski, No. 81-1034-CV-W-4, slip op. at 1-2 (W.D.Mo. Mar. 9, 1984). Production was stayed until this court could act on an application for appeal.

ISC argues that Keang Nam has not made a sufficient showing that ISC retained Fulbright in furtherance of a fraud and has not established a close relationship between the alleged fraud and the Watson, Ess Report. Fulbright argues that ISC's communications to its attorneys were not made in furtherance of a crime or fraud, and that ISC failed to make the requisite prima facie showing of fraud. The application of the crime-fraud exception is committed to the district court's discretion. In re Berkley & Co., 629 F.2d 548, 553 (8th Cir.1980). ³

I.

The Watson, Ess report was the subject of two communications: delivery from Watson, Ess to ISC; and delivery from ISC to Fulbright. In considering these communications, the threshold...