Dealing with accountants and auditors: avoiding sanctions in complex cases.

• Author: Rothschild, Gita F.

THE best way to avoid court sanctions when dealing with discovery issues relating to accountants and auditors, when they are not parties themselves, is to understand thoroughly the scope of information subject to being discovered, to make timely motions for protective orders when information is privileged, confidential, irrelevant or unduly burdensome, and to take all reasonable measures necessary to ensure that accountants and auditors understand the time constraints on compliance with discovery requests.

WHAT'S DISCOVERABLE?

In general, the rules of discovery are applied to accountants and auditors (hereinafter the collective "accountants") similarly as to other persons. Under Rule 26(b)(1) of the Federal Rules of Civil Procedure and its state counterparts, parties may discover from them "any matter, not privileged, which is relevant to the subject matter involved in the pending action." In addition to an accountant's personal knowledge, parties commonly seek to discover financial documents accountants have in their possession. These documents can include financial statements, worksheets and other working papers, results of audits, tax benefits information, tax returns, and cash flow projections.

Since parties often perceive an accountant's knowledge and documentation prepared for clients to be personal or highly confidential, there is a natural reluctance to produce them. Often heavy pressure is placed on counsel to assert that the information sought is privileged. Of course, whenever counsel in good faith can assert that the information sought is privileged, irrelevant or unduly burdensome, they should resist production and file a motion requesting the court to declare the information privileged or subject to a protective order. Lawyers have an ethical responsibility, however, to ensure that non-privileged information relevant to the underlying litigation be produced, despite its personal or confidential nature.

Under certain circumstances, counsel can assert that information sought from accountants is privileged. These claims of privilege generally fall within either the work product doctrine, the attorney-client privilege, or an accountant-client privilege. In addition, discovery of tax returns is sometimes protected by statute.

1. Documents Prepared in Anticipation of Litigation

   If accountants are hired specifically to assist a party or its attorney in preparation for litigation, the information they have may be protected from discovery under the work product doctrine.(1) To prevent discovery, a party must show that "the primary motivating purpose behind the creation of the document was to aid in possible future litigation."(2)

   Nevertheless, under certain circumstance, a party may still discover audit information, even if prepared in anticipation of litigation. The adverse party must show substantial need and that application of the privilege would result in undue hardship.(3) In ascertaining the existence of undue hardship, a court may consider such factors as whether the information sought is obtainable through other sources -- for example, depositions -- and whether the expense involved in obtaining the information is unreasonable. The importance of the information sought to a party's claim or defense often determines whether there is substantial need.

   A party also may discover work product where the documents sought relate to legal advice given for ongoing criminal or fraudulent activity. The "crime-fraud exception" has been applied where a party makes a prima facie showing of a sufficiently serious ongoing violation and a valid relationship between the work product sought and the violation.(4)

   Finally, court rules limiting the discoverability of information prepared by "experts" hired to assist counsel in preparation for litigation are applicable to accountants. Thus, under Rule 26(b)(4)(b) a party may discover:

   facts known or opinions held by [the

   accountant] who has been retained or specially

   employed by another party in anticipation of

   litigation or preparation for trial and who is

   not expected to be called as a witness at trial,

   only ... upon a showing of exceptional

   circumstances under which it is impracticable

   for the party seeking discovery to obtain

   facts or opinions on the same subject by

   other means.

   For example, in Inspiration Consolidated Copper Co. v. Lumbermens Mutual Casualty Co., the federal district court stated:

   an independent accountant may wear two

   hats, that of a general auditor subject to

   normal discovery, and that of an expert specially

   retained for litigation, in which case

   discovery respecting preparation of the claim is

   limited by Rule 26(b)(4)(b) if he is not to be

   a witness at the trial.(5)

2. Accountant-client Privilege

   There is no accountant-client privilege under the common law.(6) Several states, however, have enacted legislation creating an accountant-client privilege. A commentary lists the following states: Arizona, Colorado, Florida, Georgia, Illinois, Indiana, Kansas. Louisiana, Maryland, Michigan, New Mexico and Pennsylvania.(7)

   1. Exceptions

      Even in jurisdictions that recognize the accountant-client privilege, there are limitations to its invocation. Since statutes creating the privilege are in derogation of the common law, courts strictly construe their provisions and "any change in the common law effected by the statute must be clearly indicated."(8)

      For example, some courts refuse to permit a party to invoke the privilege if the accountant was jointly retained by the adverse party.(9) Other courts have failed to extend the accountant-client privilege to preclude an accountants' testimony regarding their examination of books, records or accounts.(10) A Florida Court of Appeal has interpreted that state's statutorily created privilege to apply only to certified public accountants or public accountants.(11)

      The accountant-client privilege also may not attach to documents provided to an accountant to perform a financial analysis. A bankruptcy court in Florida held that business records provided to accountants for use in performing audits and communications between the accountants and third parties were not protected from discovery by the Florida statute. This is true even if the accountant has made notations on the documents. Under these circumstances, the court concluded, the documents should be produced in redacted form.(12)

   2. Waiver

      Like most privileges, a party can expressly waive the accountant-client privilege, as, for instance, when a corporation's president states on the stand at trial that the corporation's accountant may testify.(13) In addition, a party may waive the privilege implicitly by electing to call the accountant as a witness at trial,(14) or if the documents prepared by the accountant are necessary to resolve an issue in the litigation. For instance, in Nashville City Bank and Trust Co. v. Reliable Tractor Inc.,(15) a federal district court in Georgia held that the defendants, who were limited partners who had executed a note assigned to the plaintiff bank, could not claim that Georgia's accountant-client privilege...