Nos. 84-1444, 84-1445.United States Court of Appeals, Eighth Circuit.Submitted June 15, 1984.
Decided December 28, 1984. Rehearing and Rehearing En Banc Denied January 30, 1985.
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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.
Appeal from the United States District Court for the Western District of Missouri.
Before LAY, Chief Judge, JOHN R. GIBSON, Circuit Judge, and HANSON,[*] Senior District Judge.
JOHN R. GIBSON, Circuit Judge.
[1] The issue before us is whether the crimefraud 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. § 1292(b) (1982). We conclude that the district court abused its discretion in stripping the report of its privilege, and we reverse. [2] 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, FulbrightJaworski. 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. [3] 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
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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]
[4] 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. [5] The transaction was closed on October 20, 1978. As provided by the agreement, ISC secured for Keang Nam the following opinion from Fulbright:[6] 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.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]
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[7] 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. [8] 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. [9] 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. [10] On March 9, 1984, the court concluded:[11] 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. [12] 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]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.
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I.
[13] 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 question is choice of law.[4] It is unnecessary, however, to resolve this issue. For purposes of this appeal, the applicable state and federal principles are not materially different. Cf. Crues v. KFC Corp., 729 F.2d 1145, 1148 (8th Cir. 1984) (declined to reach choice of law issue regarding submissible case standards where Missouri and federal rules were substantially similar).
(Mo.Ct.App. 1967) (per curiam); see Faulkner, 175 Mo. at 595, 75 S.W. at 131 (communications “for the purpose of” being guided in the commission of a crime are not privileged). [15] The law in this circuit is that attorney-client communications lose their privileged character when the attorney is consulted “to further a continuing or contemplated criminal or fraudulent scheme.” In re Berkley Co., 629 F.2d 548, 553 (8th Cir. 1980) (citations omitted). Disclosure is not appropriate without a “prima facie showing that the legal advice was obtained in furtherance of illegal or fraudulent activity.” Id.; see United States v. Horvath, 731 F.2d 557, 561-62 (8th Cir. 1984). Timing is critical, for the prima facie showing requires that the “client was engaged in or planning a criminal or fraudulent scheme when he sought the advice of counsel to further the scheme.” In re Murphy, 560 F.2d 326, 338 (8th Cir. 1977) (citations omitted).
II.
[16] The first communication, from Watson, Ess to ISC, is not within the crimefraud exception. Arrangements were made for the preparation of the report in 1976. The work was completed by 1977, and presented to the special audit committee in December, 1977. The report was considered by the ISC board of directors on January 14, 1978. Keang Nam pleads that the negotiations for the Pritchard sale commenced in the summer of 1978. Written agreements were signed on July 28, August 25, and October 20. The sale was closed on October 20, 1978. The only claim of fraud surrounds the sale transaction and
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the representations that there were no sensitive payment problems with respect to the receivables in the contract. There is no indication that at the time of arranging for the Watson, Ess report or at the time the report was forwarded to ISC in December 1977 there was a fraudulent scheme with respect to the sale. The background of the Watson, Ess report supports the conclusion. The minutes of ISC’s board meeting of May 24, 1976, and the Watson, Ess letter accepting employment make plain that the investigation was to inform the board of sensitive payments and enable ISC to deal with the SEC investigation. The Watson, Ess Report was not furnished to ISC in furtherance of a fraud, and this communication is privileged.
III.
[17] The next issue is whether the second communication, delivery of the report from ISC to Fulbright, is stripped of the privilege. The district court concluded that ISC had committed a fraud because ISC knew the Fulbright opinion letter was inconsistent with the facts contained in the report. Assuming this conclusion is true, it does not resolve the essential question: was the report communicated with the purpose of perpetrating the fraud? The record requires that we answer this question “no.”
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section I supra.[5] Even if we were prepared to recognize this argument, it would not support discovery in this case. That the report may help prove that a fraud occurred does not mean that it was used in perpetrating the fraud.
[22] The district court properly articulated the principles o Murphy and Berkley: that the prima facie case requires a showing that the legal advice was obtained in furtherance of the fraudulent activity and was closely related to it. The court then focused, however, on whether there had been a fraud perpetrated because ISC, specifically Herman Frietsch, had knowledge that the opinion letter was inconsistent with the facts contained in the Watson, Ess report. Because it concerned itself with whether fraud had been perpetrated in the summer of 1978 (long after the deliveries of the Watson, Ess Report in December, 1977 and January, 1978), it improperly applied the correct legal standards. Thus, the court abused its discretion in subjecting the report to production.IV.
[23] Keang Nam strongly urges that it has made a prima facie showing of fraud. All the parties have devoted considerable discussion to what the prima facie standard means and how it applies here. It is unnecessary to further resolve these issues in this appeal because the relationship between the fraud alleged and the communications does not justify piercing the privilege.[6]
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[24] Decisions regarding the attorney-client privilege should not be based on a rigid analysis. Rather, the focus is on whether the detriment to justice from foreclosing inquiry into pertinent facts is outweighed by the benefits to justice from a franker disclosure in the lawyer’s office. C. McCormick, McCormick on Evidence § 87, at 205 (E. Cleary 3d ed. 1984). The Watson, Ess report resulted from ISC’s efforts to investigate allegations of prior misconduct. Allowing disclosure of the report could deter such inquiries, which should not be chilled as a matter of policy. See Diversified Industries v. Meredith, 572 F.2d 596, 610 (8th Cir. 1978) (en banc) (corporations should be encouraged to “seek out and correct wrongdoing in their own house and to do so with attorneys”). Moreover, denying production of the report will not substantially inhibit inquiry into facts relevant to the underlying lawsuit. The privilege protects the report as a communication; it does not shield the facts contained in the report[7] from being discovered and proven through other sources. On balance, we are convinced that the policies behind the privilege and the law expressed in prior decisions weigh against allowing production. The district court order of March 9 is reversed.(a) the laws of the country in which the subsidiary [that made the payment] has projects, which laws prohibited the use of certain types of agents, (b) a covenant against the use of certain types of agents in a contract between the subsidiary and its client, a government-owned entity in the country, or (c) an affidavit executed on behalf of the Company that no payments were made to certain types of agents.
Id. at 10. A complaint later filed by the SEC shows that these incidents were connected to the Hassi R’Mel project, the subject of this lawsuit.
This appeal concerns only the order dated March 9, 1984, which was limited to whether the crime-fraud exception is applicable. Thus, the waiver issue is not subject to review. See United States v. Bear Marine Servs., 696 F.2d 1117, 1118 n. 1 (5th Cir. 1983); Time, Inc. v. Ragano, 427 F.2d 219, 221 (5th Cir. 1970); 16 C. Wright, A. Miller, E. Cooper E. Gressman Federal Practice and Procedure § 3929, at 143-44 (1977).
(D.C. Cir. 1982), in which Judge Wright stated that work-product materials may be subject to discovery if “the client actually committed or attempted a crime or fraud subsequent to receiving the benefit of counsel’s work product.” Id. at 815 (citing In re Grand Jury Proceedings (FMC Corp.), 604 F.2d 798, 803 (3d Cir. 1979); In re Murphy, 560 F.2d at 338). The cases cited by Judge Wright do not support this proposition. Moreover, this portion of the opinion was not joined by the other two judges on the Sealed Case panel. 676 F.2d at 797 (Tamm, J., concurring in result); id. at 825 (Wald, J., concurring only in selected portions of opinion and result). Berkley and Murphy defined the crime-fraud exception in detail and stressed that the legal advice must be sought or obtained in furtherance of or in relation to the fraudulent activity. That the fraud merely follows the attorney-client communication does not alone support discovery. Finally, the weight of authority supports our construction of the crime-fraud exception. See, e.g., In re Grand Jury Subpoena Duces Tecum, 731 F.2d 1032, 1039 (2d Cir. 1984) (crime or fraud need have “been the objective of the client’s communication”); C. McCormick, McCormick on Evidence § 95, at 229 (E. Cleary 3d ed. 1984) (communication is not privileged “where the client’s purpose is the furtherance of a future intended crime or fraud”).
In its effort to make a prima facie showing, Keang Nam introduced testimony from Norbert Schlei, the attorney who was its primary negotiator in the J.F. Pritchard transaction. Schlei testified that during the summer of 1978 he had asked Frietsch and a Fulbright lawyer about sensitive payments. Frietsch told Schlei that Schlei should talk to the law firm of Surrey, Karasik Morse, a Washington firm that did some SEC work for ISC. Although Frietsch told Schlei that he would have a Surrey lawyer call Schlei, Schlei never was contacted. Schlei called Charles Reed, a Surrey lawyer with whom he was acquainted. Reed told Schlei that everything he knew about ISC’s sensitive payments problem was contained in public reports that had been filed with the SEC. Reed offered to forward the reports to Schlei and stated that he would answer further questions after Schlei had read the reports. Schlei did not fellow up on either offer.
Schlei’s contacts with the Surrey firm are explained further in his testimony that was introduced by Fulbright. Schlei testified that during the summer of 1978 he knew that the SEC was conducting an investigation of ISC concerning sensitive payments in its overseas operations. Schlei also testified that he knew that Surrey, Karasik represented ISC in matters dealing with SEC investigations. Finally, Schlei testified that prior to the closing he had read ISC’s annual report for the year ending June 30, 1977. This report discussed the sensitive payments investigation that ISC had commenced in cooperation with the SEC. International Systems Controls Corp., 1977 Form 10-K Annual Report 8-9.
Considering the evidence in a light most favorable to Keang Nam, Schlei’s testimony casts serious doubt upon Keang Nam’s right to rely on the Fulbright opinion.