May 22, 2015 Durham, North Carolina

Transcription

1 2015 TAX COURT JUDICIAL CONFERENCE CONFLICTS AND CHAOS: THE IMPORTANCE OF TIMELY RECOGNIZING AND MANAGING CONFLICTS OF INTEREST AND RELATED PROBLEMS IN TAX LITIGATION Moderator: Judge L. Paige Marvel United States Tax Court Panelists: Ashton Hap Trice Chief, Branch 2 (Procedure and Administration) IRS Office of Chief Counsel Michael J. Desmond The Law Offices of Michael J. Desmond, APC Miriam L. Fisher Latham & Watkins, LLP May 22, 2015 Durham, North Carolina

2 2015 TAX COURT JUDICIAL CONFERENCE CONFLICTS AND CHAOS: THE IMPORTANCE OF TIMELY RECOGNIZING AND MANAGING CONFLICTS OF INTEREST AND RELATED PROBLEMS IN TAX LITIGATION * I. Key Authorities A. Tax Court Rules: The Tax Court s rules address conflicts of interest by both imposing specific requirements on attorneys so as to eliminate conflicts and by requiring that attorneys practicing before it abide by the Model Rules of Professional Responsibility. 1. Tax Court Rule 24(g): Tax Court Rule 24(g), which addresses the obligation of counsel with respect to conflicts of interest, provides as follows: If any counsel of record (1) was involved in planning or promoting a transaction or operating an entity that is connected to any issue in a case, (2) represents more than one person with differing interests with respect to any issue in a case, or (3) is a potential witness in a case, then such counsel must either secure the informed consent of the client (but only as to items (1) and (2)); withdraw from the case; or take whatever other steps are necessary to obviate a conflict of interest or other violation of the ABA Model Rules of Professional Conduct, and particularly rules 1.7, 1.8, and 3.7 thereof. The Court may inquire into the circumstances of counsel s employment in order to deter such violations. See Rule 201. Tax Court Rule 24(g). 2. Tax Court Rule 201(a): Tax Court Rule 201(a) requires practitioners before the Tax Court to practice in accordance with the letter and spirit of the Model Rules of Professional Conduct of the American Bar Association. Tax Court Rule 201(a). a. Practitioners before the Court shall carry on their practice in accordance with the letter and spirit of the Model Rules of Professional Conduct of the American Bar Association. Tax Court Rule 201(a). 3. Tax Court Rule 201(b): Tax Court Rule 201(b) enables the Tax Court to gather the information necessary to enforce its other rules (including Rules 201(a) and 24(g)) by giving the Court the authority to require a practitioner to furnish a statement, under oath, of the terms and * Judge Marvel and the panelists gratefully acknowledge the generous assistance of Latham & Watkins associate Nikhil Kumar in the preparation of these materials. Page 1 of 17

3 circumstances of his or her employment in any case. Tax Court Rule 201(b). a. The Court may require any practitioner before it to furnish a statement, under oath, of the terms and circumstances of his or her employment in any case. Tax Court Rule 201(b). B. Model Rules of Professional Conduct: The Model Rules of Professional Conduct provide specific guidance about attorneys responsibilities related to concurrent conflicts of interest, duties to former clients, imputation of conflicts of interest to other attorneys, and the attorney testifying as a witness. See MODEL RULES OF PROF L CONDUCT R. 1.7 (conflicts of interest current clients); R. 1.8 (specific rules regarding certain concurrent conflicts of interest); R. 1.9 (former client conflicts of interest); see also R. 1.0(e) & (b) (defining informed consent and informed in writing ). 1. Concurrent Conflicts of Interest: Model Rule 1.7 governs conflicts of interest with current clients. a. Model Rule 1.7 generally prohibits an attorney s representation of a client if the representation involves a concurrent conflict of interest. MODEL RULES OF PROF L CONDUCT R. 1.7(a). (1) A concurrent conflict of interest exists if the representation of one client would be directly adverse to another client, or if there is a significant risk that the representation of a client would be materially limited by the attorney s responsibilities to another client, former client, or a third party, or by a lawyer s personal interest. MODEL RULES OF PROF L CONDUCT R. 1.7(a). b. However, a lawyer may represent a client despite a concurrent conflict of interest if four requirements are met: (1) The lawyer must reasonably believe[] that she will be able to provide competent and diligent representation to each affected client; (2) The representation is not prohibited by law; (3) The representation doesn t involve assertion of claims by one client against another client represented by the attorney in the same litigation or other proceeding before a tribunal, AND; (4) The attorney obtains informed consent, confirmed in writing, by each affected client. Page 2 of 17

4 See MODEL RULES OF PROF L CONDUCT R. 1.7(b). 2. Duties to Former Clients: Model Rule 1.9 governs duties to former clients. a. Generally, a lawyer who has formerly represented a client in a matter cannot represent another person in the same or a substantially related matter in which that person's interests are materially adverse to the interests of the former client. MODEL RULES OF PROF L CONDUCT R. 1.9(a). (1) However, an attorney may continue such a representation if the former client gives informed consent to the representation, confirmed in writing. MODEL RULES OF PROF L CONDUCT R. 1.9(a). b. Furthermore, a lawyer cannot knowingly represent a person in the same or a substantially related matter in which a firm with which the lawyer formerly was associated had previously represented a client, whose interest are materially adverse to the person s, and about whom the lawyer had received protected information that is material to the matter. MODEL RULES OF PROF L CONDUCT R. 1.9(b). (1) However, an attorney may continue such a representation if the former client gives informed consent to the representation, confirmed in writing. MODEL RULES OF PROF L CONDUCT R. 1.9(b). c. Even if an attorney has obtained informed consent of the client such that his representation is not prohibited under Rule 1.9, the attorney may not use information relating to the previous representation to the disadvantage of the former client (unless the Model Rules permit such use or if the information has become generally known ) and cannot reveal information relating to the representation (except to the extent that the Model Rules permit or require such revelation). MODEL RULES OF PROF L CONDUCT R. 1.9(c). 3. Imputation of Conflicts of Interests a. Rule 1.10 states that while lawyers are associated in a firm, none shall knowingly represent a client when any one of them would be prohibited from doing so under Model Rules 1.7 and 1.9. MODEL RULES OF PROF L CONDUCT R. 1.10(a). Page 3 of 17

5 b. There are two exceptions to this general rule prohibiting a representation as a result of an imputed conflict. (1) An attorney may represent a client if the conflicted attorney is prohibited from doing so because of a personal interest, and a representation by the other attorney does not present a significant risk of materially limiting the representation of the client by the remaining lawyers in the firm. MODEL RULES OF PROF L CONDUCT R. 1.10(a)(1). (2) Additionally, an attorney may represent a client if the disqualified attorney is prohibited from doing so under Rule 1.9(a) or (b), the prohibition arises out of a disqualified attorney s association with a prior firm, the disqualified attorney is timely screened from any participation in the matter and is apportioned no part of the fee therefrom, written notice containing certain information about the attorney s compliance with the Rule is provided to the former client, and the former client is provided with certifications of compliance with the rule and screening procedures at reasonable intervals upon the former client s written request. MODEL RULES OF PROF L CONDUCT R. 1.10(a)(2). c. After a lawyer has terminated an association with a firm, the firm may generally represent a person with interests materially adverse to the interests of a client who is represented by the formerly associated lawyer. In such instances, a firm is prohibited from representing such a client only if (1) the matter is the same or substantially related, to that in which the formerly-associated lawyer represented the client and (2) any lawyer remaining in the firm has material information that is protected by Model Rule 1.6 or Rule 1.9. MODEL RULES OF PROF L CONDUCT R. 1.10(b). d. Rule 1.10 also permits a representation that would otherwise violate the Rule if the affected client waives the violation. MODEL RULES OF PROF L CONDUCT R. 1.10(c). (1) The conditions of this waiver are the same as those of the waiver under Rule 1.7, and therefore necessitate that four requirements be met: (1) the lawyer must reasonably believe[] that she will be able to provide competent and diligent representation to each affected client, (2) the representation is not prohibited by law, (3) the representation doesn t involve assertion of claims by one client against another client represented by the attorney in Page 4 of 17

6 the same litigation or other proceeding before a tribunal, and (4) the attorney obtains informed consent, confirmed in writing, by each affected client. MODEL RULES OF PROF L CONDUCT R. 1.10(c); See also id. at R Disqualification of Lawyers in a Firm with Former or Current Government Lawyers a. Former Government Lawyers: A lawyer who has previously served as a public officer or government employee, in addition to being subject to Rule 1.9(c), is also subject to the special Rule 1.11, which generally prohibits the representation of a client in connection with a matter in which the lawyer participated personally and substantially as a public officer or employee. MODEL RULES OF PROF L CONDUCT R (1) Notwithstanding the general prohibition, the lawyer may represent the client if the appropriate government agency gives its informed consent, confirmed in writing, to the representation. MODEL RULES OF PROF L CONDUCT R. 1.11(a)(2). (2) Rule 1.11 generally imputes the conflict to the firm in which a disqualified lawyer is associated, thereby prohibiting a lawyer in the firm with which the disqualified lawyer is associated from knowingly undertaking or continuing representation. MODEL RULES OF PROF L CONDUCT R. 1.11(b). (a) However, such an imputed conflict will not preclude a representation by an associated lawyer if the disqualified lawyer is timely screened from participation in the representation, is apportioned no part of the fee, and written notice is given promptly to the government agency so as to enable it to ensure compliance with the rule. MODEL RULES OF PROF L CONDUCT R. 1.11(b)(1) (2). b. Current Government Lawyers: A lawyer who is serving as a public officer or government employee is subject to Rules 1.7 (conflicts of interest with current clients) and 1.9 (duties to former clients). (1) Generally, the government lawyer may not participate in a matter in which the lawyer participated personally and substantially while in private practice or nongovernmental employment. MODEL RULES OF PROF L CONDUCT R. 1.11(d) Page 5 of 17

7 (a) The attorney may, however, participate in such a matter if the appropriate government agency gives its informed consent, confirmed in writing. MODEL RULES OF PROF L CONDUCT R. 1.11(d)(2)(i). (2) Generally, the government attorney may not negotiate for private employment with any person who is involved as a party or as lawyer for a party in a matter in which the lawyer is participating personally and substantially. MODEL RULES OF PROF L CONDUCT R. 1.11(d)(2)(ii). (a) The Rule excepts from this general prohibition situations in which the lawyer is serving as a law clerk to a judge, adjudicative officer or arbitrator. Id. c. In Kosby v. Comm r, T.C. Memo , the Tax Court addressed a situation in which a private attorney was formerly employed by the IRS s Chief Counsel office, where he represented the Commissioner in cases involving the Queen Creek Pecans tax shelter. The current representation involved a notice of deficiency that adjusted the deductions and credits claimed by the petitioners based on their investment in the Queen Creek Pecans I tax shelter. The attorney had not disclosed his previous participation in the matter. Id. at (1) The Commissioner argued that the representation by the attorney violated Rule 1.11(a) of the Model Rules of Professional Conduct, applicable through Rule 201(a). Id. at (2) The court stated that the movant (here, the Commissioner) bears the burden of proving that the attorney s representation violates Model Rule 1.11(a). Id. at 12. (3) In determining whether the matter was the same matter for purposes of Rule 1.11(a), the court said that the term matter contemplate[d] a discrete and isolatable transaction or set of transactions between identifiable parties. Id. at The current matter need not involve a client with interests adverse to those of the client in the former matter. Id. at 14. (4) The court went on to state that the Rules requirement of personal and substantial involvement required more than merely a supervisory or other indirect role in the matter. The court found persuasive the facts that the attorney in Page 6 of 17

8 5. Lawyer as a Witness question was the counsel of record, handled the preparation of the case for trial and its eventual settlement, and his status of being the Commissioner s principal actor in the litigation (among other facts) and determined that the attorney in question was personally and substantially involved. Id. a. Generally, a lawyer cannot act as advocate at a trial in which the lawyer is likely to be a necessary witness. MODEL RULES OF PROF L CONDUCT R. 3.7(a). (1) However, such a lawyer may act as an advocate despite her likelihood of being a necessary witness (1) if the testimony would relate to an uncontested issue or to the nature and value of legal services rendered in the case, or (2) if the disqualification of the attorney would work substantial hardship on the client. MODEL RULES OF PROF L CONDUCT R. 3.7(a). b. As the Comments to the Model Rules note, the general prohibition against a lawyer serving as both an advocate and as a witness stems from a desire to ensure that the trier of fact is not confused or misled by statements of an advocate-witness that could be construed as either proof or an analysis of the proof. Comment [2] to MODEL RULES OF PROF L CONDUCT R c. Rule 3.7 does not itself preclude a lawyer from representing a client in a trial in which another lawyer in the lawyer s firm is likely to be called as a witness, but such a representation may be precluded independently under Rule 1.7 or Rule 1.9 (discussed above). See MODEL RULES OF PROF L CONDUCT R. 3.7(b). (1) The Comments to the Model Rules note that a tribunal is not likely to be misled when a lawyer acts as advocate in a trial in which another lawyer in the lawyer's firm will testify as a necessary witness. Comment [5] to MODEL RULES OF PROF L CONDUCT R d. Correspondingly, for IRS lawyers, the CCDM notes the specific difficulties attendant to situations in which the petitioner s attorney may be called as a witness. The CCDM states that petitioner s counsel should therefore be called as a witness only if necessary and only if there are no alternatives, and that the conflict be raised as soon as it is determined or anticipated that opposing Page 7 of 17

9 counsel should be called as a witness. C.C.D.M (Feb 7, 2013). (1) The Service must obtain internal approval prior to listing opposing counsel as a potential witness in a trial memorandum. Should opposing counsel fail to withdraw, the matter should be brought to the court s attention. C.C.D.M (Feb. 7, 2013). C. Circular In addition to the rule applicable to practitioners before the Tax Court and Model Rules of Professional Responsibility applicable to attorneys generally, attorneys who represent clients before the Internal Revenue Service must abide by the rules related to conflicting interests set forth in Circular C.F.R Section states that a practitioner generally may not represent a client before the IRS if the representation involves a conflict. a. A conflict of interest is defined to exist if the representation of one client would be directly adverse to another client or if [t]here is a significant risk that the representation of one or more clients will be materially limited because of the practitioner s representation of another client, former client, or third person, or because of the practitioner s personal interest. 31 C.F.R (a)(1) (2). b. However, a conflict of interest that would otherwise preclude a representation by an attorney may be waived if three requirements are met: (1) The practitioner must reasonably believe[] that she will be able to provide competent and diligent representation to each affected client; (2) The representation is not otherwise prohibited by law; and, (3) Each affected client gives informed consent to the representation at the time the conflict is known by the attorney, with a written confirmation following within 30 days. 31 C.F.R (b). This is a slightly more stringent requirement than under Model Rule 1.9(a), discussed at I.B.2.a.(1) above. 3. The Fifth Circuit has suggested that section of Circular 230 not only imposes requirements upon practitioners before the IRS, but also imposes a requirement on the IRS to inquire into compliance with the regulation. Page 8 of 17

10 United States v. Feaster, 494 F.2d 871, 875 (5th Cir. 1974) ( Although the conflicting interest regulation appears directed more to attorneys appearing before the IRS than to the IRS itself, we are convinced that on the facts of this case the IRS had, if nothing more, an obligation to inquire into the matter to determine whether Barrister had complied with the regulation's full disclosure requirements. ). 4. Under section of Circular 230, after notice and an opportunity for a proceeding, the Treasury Secretary or his/her delegate may censure, suspend, or disbar any practitioner from practicing before the IRS, and may impose a monetary penalty. The actions that give rise to such sanctions include a willful failure to comply with a regulation in Circular C.F.R (a), (c), 10.52(a)(1). D. IRS Procedural Guidance: For IRS attorneys, the Service provides specific guidance regarding how conflicts of interest should be handled. 1. General Procedures for Resolving Conflicts of Interest a. Informal Resolution: Generally, conflicts of interest should be addressed with opposing counsel as early as possible. Respondent s counsel should make every effort to contact petitioner s counsel to discuss and resolve the conflict informally before formal means of resolution are pursued. Resolution of conflicts should be accompanied by written documentation that the client has provided informed consent. C.C.D.M (Feb. 7, 2013). b. Formal Process: If informal efforts to resolve the conflict of interest are unsuccessful, the attorney should send a conflict letter to opposing counsel. Such a letter is intended to formally advise opposing counsel of an actual or potential conflict of interest and request that opposing counsel take appropriate action to resolve the conflict, including by withdrawing, obtaining a client waiver, or divesting herself of any financial interest that gives rise to the conflict. C.C.D.M (Feb. 7, 2013). (1) Conflict letters must be approved internally (and supported by a background memorandum) prior to being sent to opposing counsel. C.C.D.M (Feb. 7, 2013). (2) Any motion to disqualify an opposing counsel must be reviewed internally within the IRS. C.C.D.M (Feb. 7, 2013). Page 9 of 17

11 2. Lawyer as Witness a. See I.B.5.d, above. E. Informed Consent 1. Rule 24(g), relevant provisions of the Model Rules, and Circular 230 emphasize the importance of informed consent in purging a waivable conflict of interest. Unfortunately, obtaining truly informed consent is more difficult that it looks. 2. The comments to Model Rule 1.7 illustrate the difficulty. They provide as follows: a. Informed consent requires that each affected client be aware of the relevant circumstances and of the material and reasonably foreseeable ways that the conflict could have adverse effects on the interest of that client. See Rule 1.0(e) (informed consent). Comment [18] to MODEL RULES OF PROF L CONDUCT R b. The information required depends on the nature of the conflict and the nature of the risks involved. Id. c. When representation of multiple clients in a single matter is undertaken, the information must include the implications of the common representation, including possible effects on loyalty, confidentiality, and the attorney-client privilege and the advantages and risks involved. See Comments [30] and [31] (effect of common representation on confidentiality). Id. 3. The Comments also emphasize that Under some circumstances it may be impossible to make the disclosure necessary to obtain consent. The Comment gives as an example the following: [W]hen the lawyer represents different clients in related matters and one of the clients refuses to consent to the disclosures necessary to permit the other client to make an informed decision, the lawyer cannot properly ask the latter to consent. Comment [19] to MODEL RULES OF PROF L CONDUCT R II. Specific Applications A. Defending Against Accuracy-Related Penalties 1. Conflict of interest issues often arise in cases where a taxpayer asserts a reasonable cause defense to the IRS s assertion of accuracy-related penalties, claiming that they reasonably and in good faith relied on the advice of a practitioner. See Comment 10 to MODEL RULES OF PROF L Page 10 of 17

12 CONDUCT R. 1.7 ( [I]f the probity of a lawyer s own conduct in a transaction is in serious question, it may be difficult or impossible for the lawyer to give a client detached advice ). 2. One of the elements of a reliance on counsel defense is actual, good faith reliance, and, for purposes of asserting a reasonable cause defense to accuracy-related penalties under Code 6664(c), the courts have held that reliance on an advisor with a conflict of interest cannot, by definition, be in good faith. a. In Neonatology Associates v. Commissioner, 115 T.C. 43 (2000), aff d, 299 F.3d 221 (2002), the Tax Court considered whether the taxpayer actually relied in good faith on the advisor, finding that the insurance agent on whom the taxpayers claimed to have relied was not a qualified tax professional and that he had a disqualifying conflict of interest: Petitioners mere reliance on Mr. Cohen was unreasonable, given the primary fact that he was known by most of them to be involved intimately with and to stand to gain financially from the sale of both the transactions at issue. Id. at 99. b. In 106 Ltd. v. Commissioner, 136 T.C. 67 (2011), aff d, 684 F.3d 84 (D.C. Cir. 2012), the Tax Court cited Neonatology s analysis of the reliance on advice of counsel penalty defense, finding that the taxpayer could not, in good faith, rely on an advisor who was also a promoter of the underlying transaction. See Countryside Ltd. P ship v. Commissioner, 132 T.C. 347 (2009) (distinguishing between a trusted advisor and a promoter with a conflict of interest, while suggesting that the distinction between the two is not always clear). See also Mortensen v. Commissioner, 440 F.3d 375, 387 (6th Cir. 2006), aff g, T.C. Memo , Countryside Ltd. Partnership v. Commissioner, 132 T.C. 347 (2009); Rawls Trading LP v. Commissioner, 138 T.C. 271 (2012). 3. In American Boat Co. v. United States, 583 F.3d 471 (7th Cir. 2009), the Seventh Circuit acknowledged that a taxpayer is not reasonable in relying on an adviser burdened with an inherent conflict of interest about which the taxpayer knew or should have known. But the court refused to adopt a bright line rule that any time an adviser incorporates a potential tax shelter into a restructuring plan, the taxpayer may not reasonably rely on that adviser's legal advice. Id. 4. Canal Corporation and Subsidiaries v. Commissioner, 135 T.C. 199 (2010) involved a leveraged partnership transaction entered into by Wisconsin Tissue Mills, Inc. (WISCO), a subsidiary of the taxpayer. The taxpayer contributed its interest in WISCO to a partnership, the partnership borrowed funds and distributed the loan proceeds back to the taxpayer. In reporting the transaction, the taxpayer relied on the debt- Page 11 of 17

13 financed distribution exception (Treas. Reg (b)) to the disguised sale rules. The IRS challenged application of the exception, arguing that WISCO s indemnity obligation should be ignored under the anti-abuse rule in Treas. Reg (j). a. On the merits, the Tax Court held that WISCO s indemnity agreement should be disregarded, that the debt-financed distribution exception therefore did not apply, and that the transaction constituted a taxable disguised sale. b. The Court also found that accuracy-related penalties applied, rejecting the taxpayer s reasonable cause defense. In rejecting the penalty defense, the Court cited a number of problems with the should -level opinion that the taxpayer relied on, including: (i) inadequate analysis of level of equity needed to support partnership s debt; (ii) use of hedge phrases in the opinion such as it appears ; (iii) inadequate consideration of whether there was substance to the indemnity agreement; (iv) the advisor s high, fixed fee; and (v) the advisor s conflict of interest from being involved in planning the transaction. B. Referencing Canal Corporation, Karen Hawkins, Director of the IRS s Office of Professional Responsibility has indicated that in cases where a taxpayer successfully asserts a reliance on advice of counsel defense to penalties (and thus avoided a conflict of interest problem), it may be appropriate to consider the practitioner s compliance with other practice standards including due diligence and competence requirements. Hawkins To Flag Advisers Of Clients With Successful Reasonable Cause Defense, TAX NOTES TODAY, 2011 TNT (Oct. 24, 2011). C. Planning or Promoting a Transaction 1. Conflicts of interests created when an advisor is involved in planning and promoting a transaction and also represents a taxpayer on audit who engaged in the transaction have been a focus of recent attention by the IRS s Office of Professional Responsibility. Attorney Censured by the Office of Professional Responsibility for Mishandling Conflicts of Interest, IR (June 22, 2012). 2. In Para Technologies Trust, counsel for petitioners Para Technologies Trust, Tom Anderson, and Fred Ferber was also formerly counsel to Nassau Life Insurance Company, Ltd., which promoted certain business trust structures. Petitioners had formed Para Tech as a trust similar to those promoted by Nassau Life. At issue was whether counsel must cease representation of a particular petitioner because of a conflict of interest. Para Technologies Trust v. Comm r, T.C. Memo , at 10. Page 12 of 17

14 a. Conflict Among Petitioners: The potential conflict of interest was raised early in the litigation and the court noted that it was too early... to anticipate all of the arguments that will be made, and the foregoing possibilities may not be the positions that petitioners should or will adopt at trial. Nevertheless, the court determined that there was a serious possibility that the interests of Para Technologies Trust and Anderson could become adverse. Id. at 10. b. Conflict with Counsel s Personal Interests: The court also raised the possibility that counsel s personal interests, arising out of the fact that the trust was structured partially based on opinion letters previously written by counsel, may conflict with petitioner s interests. Id. at c. Potential Witness: Finally, the court noted the possibility that counsel may be called as a witness to testify about matters discussed in his tax opinion. Id. at d. No Waiver: The court determined that any consent provided by petitioners was not as a result of a full and fair disclosure that enabled them to understand the inherent potential conflicts, between them, noting the petitioners lack of sophistication in this area and a lack of written consents or waivers. Id. at 15. e. Result: Based on the potential for various conflicts of interest, the Tax Court disqualified the petitioners counsel from participating in the case. Id. D. Joint Representation of Spouses Who File a Joint Return 1. The Service has noted that a particular type of conflict of interest may arise from the dual representation of spouses in the context of innocent spouse claims under Internal Revenue Code Section See C.C.D.M (Feb. 7, 2013). 2. In Harbin, the attorney represented a husband and wife in a deficiency case in which neither party asserted an innocent spouse claim. While that deficiency case progressed, the attorney also represented both spouses in a contentious divorce. The court determined that such a joint representation created a conflict of interest because the spouses interests in the deficiency case were adverse. By failing to obtain informed consent, the court determined that the attorney was materially limited in his ability to represent the petitioner s interest in seeking innocent spouse relief. Thus, the court concluded that the petitioner did not participate meaningfully in the prior deficiency case, and was therefore not barred Page 13 of 17

15 from seeking relief from joint and several liability under section Harbin v. Comm'r, 137 T.C. 93 (2011). 3. In contrast, the court permitted concurrent representation of petitioners where the attorney had explained the conflict to both petitioners, including in the judge s chambers, that the petitioners understood the matter both before and during the trial, both petitioners intended that counsel represent both of them concurrently, and that both petitioners intended that counsel take a position that exposed one of the petitioners to increased liabilities. Downing v. Comm'r, T.C. Memo , at 27 28, n.12. E. Attorney as a Witness 1. In Duffey v. Commissioner, the Tax Court utilized a multi-step analysis to determine that petitioners counsel should be disqualified under Rule 3.7 because of an assertion that the respondent intends to call him as a witness during trial. 91 T.C. 81, 84 (1988). a. First, the court asked whether opposing counsel is likely to be a necessary witness at trial. Id. Because of counsel s position as a preparer of returns and counsel to the trusts at issue, his testimony would be uniquely valuable, on a principal issue in the case, and, therefore, his testimony was desirable, even necessary, on the issue. Id. at 84. b. The court then asked whether Model Rule 3.7(a) s three exceptions apply so as to permit the representation. The court focused on the issue of whether the disqualification of the attorney would work a substantial hardship and concluded that it would not. Specifically, the court stated that the petitioner had ample time to engage a different attorney, as the matter was brought to the attention of petitioners and the Court well before trial. Id. 2. Even if counsel is not disqualified due to being called as a witness, practitioners should be cognizant of the risk that the testimony may be evaluated against the backdrop of the witness s representation. See, e.g., Long Term Capital Holdings v. United States, 330 F. Supp. 2d 122, 147 (D. Conn. 2004) ( The substance and credibility of Kuller's testimony is evaluated in... [the] context of the witness s firm acting as trial counsel.), aff d, 150 Fed. Appx. 40 (2d Cir. 2005). Page 14 of 17

16 III. Consequences of Unresolved Conflicts of Interest A. Disqualification of a Party s Counsel 1. The Tax Court has suggested that parties that intentionally delay filing their motion to disqualify or that use the motion as a strategic litigation tactic will not succeed in obtaining the removal of opposing counsel. a. See, e.g., Kosby v. Comm r, T.C. Memo ( Upon learning of the possible conflict of interest, respondent's attorneys acted promptly in calling the matter to Mr. Everett's attention and then in making their motion to the Court. There is no evidence that they intentionally delayed filing the motion to disqualify. Furthermore, there is no evidence that respondent is using the disqualification motion as a strategic litigation tactic. ) (internal citations omitted). 2. Granting or denying a motion to disqualify an attorney is within the discretion of the trial court. The Eighth Circuit stated that the potential for abuse means that disqualification motions should be subjected to particularly strict judicial scrutiny. Harker v. Comm r, 82 F.3d 806, 808 (8th Cir. 1996) (quoting Optyl Eyewear Fashion Int'l Corp. v. Style Cos., 760 F.2d 1045, 1050 (9th Cir. 1985)). 3. Motions by the Service to disqualify opposing counsel due to a conflict of interest must be reviewed internally at the IRS prior to being submitted to the court. C.C.D.M (Feb. 7, 2013). B. Reopening the Record a. The IRS notes that a court may issue orders to resolve the conflict that fall short of disqualifying the attorney. Such an order may include furnish[ing] client assurances by a particular date. Id. 1. The existence of a conflict of interest may not come to the court s attention until late in a proceeding. This can be a particular issue in the Tax Court, where substantive consideration of the case is often reserved until post-trial briefing. When a conflict is identified after all evidence has been presented at trial, difficult questions can arise as to whether the record should be reopened in order to address or remove the conflict. 2. Reopening the record generally is within the court s discretion. The court will not reopen the record if the evidence is cumulative or impeaching, immaterial to the issues involved, or would probably not have changed the outcome of the case. Butler v. Comm r, 114 T.C. 276, (2000) (citing Zenith Radio Corp. v. Hazeltine Research, Inc., 401 U.S. 321 (1971)). The decision to reopen the record should be made against the backdrop of the Tax Court s established policy... to try all issues raised Page 15 of 17

17 in a case in one proceeding and to avoid piecemeal and protracted litigation. Markwardt v. Comm r, 64 T.C. 989, 998 (1975). 3. Standard of Appellate Review C. Fraud on the Court a. The Ninth Circuit stated that the appropriate standard of review of the Tax Court s decision not to reopen a record for submission of new evidence is abuse of discretion. Specifically, it instructs that an appellate court should not review the decision not to reopen a record unless there are extraordinary circumstances which reveal a clear abuse of discretion. Devore v. Comm r, 963 F.2d 280, 282 (9th Cir. 1992) (quoting Nor-Cal Adjusters v. Comm r, 503 F.2d 359, 363 (9th Cir. 1974)). Relevant circumstances include the relative positions of the parties, sophistication in tax matters, and participation in financial affairs. Id. b. The Second Circuit has similarly stated that an appellate court should reverse a discretionary denial by the Tax Court of postopinion motions only if there are shown to be 'extraordinary circumstances. Wilson v. Comm r, 500 F.2d 645, 648 (2d Cir. 1974). 1. Recognizing and managing actual or potential conflicts of interest is important because it minimizes and hopefully eliminates the prospect that a party may challenge the Tax Court s decision by alleging that an existing but undisclosed conflict of interest tainted the proceedings and operated as a fraud on the Court. 2. In Calderone v. Commissioner, T.C. Memo , the taxpayers moved for leave to file a motion under Rule 162 to vacate stipulated decisions that were entered in the case, asserting that the decisions were the result of fraud on the Tax Court. The taxpayers argued that the taxpayers counsel and government counsel committed a fraud on the Court by not appropriately informing the Court that there were problems under Rule 24(g)(1) with the continued representation of the taxpayers by their counsel. a. In concluding that the conduct of counsel did not constitute a fraud on the Court, the Tax Court relied on a number of important principles: (1) A fraud on the Court is a fraud that harms the integrity of the judicial process. Hazel-Atlas Glass Co. v. Hartford- Empire Co., 322 U.S. 238, 245 (1944); Standard Oil Co. of California v. United States, 429 U.S. 17 (1976). Page 16 of 17

18 (2) The party asserting a fraud on the Court bears a heavy burden of establishing specific facts to show a convincing case of palpable fraud on the court. Kenner v. Commissioner, 387 F.2d 689, 691 (7th Cir. 1968). (3) A necessary element of fraud on the Court is the Court s lack of knowledge regarding a material fact so that damage to the judicial process is sustained. Spence- Parker v. Md. Ins. Group, 937 F. Supp. 551, 562 (E.D. Va. 1996). b. In reaching its conclusion that there was no fraud on the Court, the Court noted that there was a split of authority between two Courts of Appeals as to whether prejudice is a necessary element of fraud on the Court. Compare Dixon v. Commissioner, 316 F.3d 1041, 1046 (9th Cir. 2003), revg. T.C. Memo , with Drobny v. Commissioner, 113 F.3d 670 (7th Cir. 1997), affg. T.C. Memo Without deciding the issue, the Tax Court concluded that even if prejudice was an element that had to be proven, the taxpayers had failed to prove prejudice. Calderone, T.C. Memo , at 22. Page 17 of 17

19 APPENDIX I. TAX COURT RULES Rule 24(g) Conflict of Interest: If any counsel of record (1) was involved in planning or promoting a transaction or operating an entity that is connected to any issue in a case, (2) represents more than one person with differing interests with respect to any issue in a case, or (3) is a potential witness in a case, then such counsel must either secure the informed consent of the client (but only as to items (1) and (2)); withdraw from the case; or take whatever other steps are necessary to obviate a conflict of interest or other violation of the ABA Model Rules of Professional Conduct, and particularly rules 1.7, 1.8, and 3.7 thereof. The Court may inquire into the circumstances of counsel s employment in order to deter such violations. See Rule 201. Rule 201: Conduct of Practice Before the Court o (a) General: Practitioners before the Court shall carry on their practice in accordance with the letter and spirit of the Model Rules of Professional Conduct of the American Bar Association. o (b) Statement of Employment: The Court may require any practitioner before it to furnish a statement, under oath, of the terms and circumstances of his or her employment in any case. II. MODEL RULES OF PROFESSIONAL CONDUCT Rule 1.0: Terminology o (b) "Confirmed in writing," when used in reference to the informed consent of a person, denotes informed consent that is given in writing by the person or a writing that a lawyer promptly transmits to the person confirming an oral informed consent. See paragraph (e) for the definition of "informed consent." If it is not feasible to obtain or transmit the writing at the time the person gives informed consent, then the lawyer must obtain or transmit it within a reasonable time thereafter. o (e) "Informed consent" denotes the agreement by a person to a proposed course of conduct after the lawyer has communicated adequate information and explanation about the material risks of and reasonably available alternatives to the proposed course of conduct. A-i

20 Rule 1.7: Conflict of Interest Current Clients o (a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if: (1) the representation of one client will be directly adverse to another client; or (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer. o (b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if: (1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; (2) the representation is not prohibited by law; (3) the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and (4) each affected client gives informed consent, confirmed in writing. Rule 1.8: Conflict of Interest Current Clients: Specific Rules o (a) A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless: (1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing in a manner that can be reasonably understood by the client; (2) the client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel on the transaction; and (3) the client gives informed consent, in a writing signed by the client, to the essential terms of the transaction and the lawyer's role A-ii

21 in the transaction, including whether the lawyer is representing the client in the transaction. o (b) A lawyer shall not use information relating to representation of a client to the disadvantage of the client unless the client gives informed consent, except as permitted or required by these Rules. o (c) A lawyer shall not solicit any substantial gift from a client, including a testamentary gift, or prepare on behalf of a client an instrument giving the lawyer or a person related to the lawyer any substantial gift unless the lawyer or other recipient of the gift is related to the client. For purposes of this paragraph, related persons include a spouse, child, grandchild, parent, grandparent or other relative or individual with whom the lawyer or the client maintains a close, familial relationship. o (d) Prior to the conclusion of representation of a client, a lawyer shall not make or negotiate an agreement giving the lawyer literary or media rights to a portrayal or account based in substantial part on information relating to the representation. o (e) A lawyer shall not provide financial assistance to a client in connection with pending or contemplated litigation, except that: (1) a lawyer may advance court costs and expenses of litigation, the repayment of which may be contingent on the outcome of the matter; and (2) a lawyer representing an indigent client may pay court costs and expenses of litigation on behalf of the client. o (f) A lawyer shall not accept compensation for representing a client from one other than the client unless: (1) the client gives informed consent; (2) there is no interference with the lawyer's independence of professional judgment or with the client-lawyer relationship; and (3) information relating to representation of a client is protected as required by Rule 1.6. o (g) A lawyer who represents two or more clients shall not participate in making an aggregate settlement of the claims of or against the clients, or in a criminal case an aggregated agreement as to guilty or nolo contendere pleas, unless each client gives informed consent, in a writing signed by the client. The lawyer's disclosure shall include the existence and nature of all the claims or pleas involved and of the participation of each person in the settlement. A-iii

22 o (h) A lawyer shall not: (1) make an agreement prospectively limiting the lawyer's liability to a client for malpractice unless the client is independently represented in making the agreement; or (2) settle a claim or potential claim for such liability with an unrepresented client or former client unless that person is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel in connection therewith. o (i) A lawyer shall not acquire a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting for a client, except that the lawyer may: (1) acquire a lien authorized by law to secure the lawyer's fee or expenses; and (2) contract with a client for a reasonable contingent fee in a civil case. o (j) A lawyer shall not have sexual relations with a client unless a consensual sexual relationship existed between them when the clientlawyer relationship commenced. o (k) While lawyers are associated in a firm, a prohibition in the foregoing paragraphs (a) through (i) that applies to any one of them shall apply to all of them. Rule 1.9: Duties to Former Clients o (a) A lawyer who has formerly represented a client in a matter shall not thereafter represent another person in the same or a substantially related matter in which that person's interests are materially adverse to the interests of the former client unless the former client gives informed consent, confirmed in writing. o (b) A lawyer shall not knowingly represent a person in the same or a substantially related matter in which a firm with which the lawyer formerly was associated had previously represented a client (1) whose interests are materially adverse to that person; and (2) about whom the lawyer had acquired information protected by Rules 1.6 and 1.9(c) that is material to the matter; A-iv

23 unless the former client gives informed consent, confirmed in writing. o (c) A lawyer who has formerly represented a client in a matter or whose present or former firm has formerly represented a client in a matter shall not thereafter: (1) use information relating to the representation to the disadvantage of the former client except as these Rules would permit or require with respect to a client, or when the information has become generally known; or (2) reveal information relating to the representation except as these Rules would permit or require with respect to a client. Rule 1.10: Imputation of Conflicts of Interest General Rule o (a) While lawyers are associated in a firm, none of them shall knowingly represent a client when any one of them practicing alone would be prohibited from doing so by Rules 1.7 or 1.9, unless (1) the prohibition is based on a personal interest of the disqualified lawyer and does not present a significant risk of materially limiting the representation of the client by the remaining lawyers in the firm; or (2) the prohibition is based upon Rule 1.9(a) or (b) and arises out of the disqualified lawyer s association with a prior firm, and (i) the disqualified lawyer is timely screened from any participation in the matter and is apportioned no part of the fee therefrom; (ii) written notice is promptly given to any affected former client to enable the former client to ascertain compliance with the provisions of this Rule, which shall include a description of the screening procedures employed; a statement of the firm's and of the screened lawyer's compliance with these Rules; a statement that review may be available before a tribunal; and an agreement by the firm to respond promptly to any written inquiries or objections by the former client about the screening procedures; and (iii) certifications of compliance with these Rules and with the screening procedures are provided to the former client by the screened lawyer and by a partner of the firm, at A-v

24 reasonable intervals upon the former client's written request and upon termination of the screening procedures. o (b) When a lawyer has terminated an association with a firm, the firm is not prohibited from thereafter representing a person with interests materially adverse to those of a client represented by the formerly associated lawyer and not currently represented by the firm, unless: (1) the matter is the same or substantially related to that in which the formerly associated lawyer represented the client; and (2) any lawyer remaining in the firm has information protected by Rules 1.6 and 1.9(c) that is material to the matter. o (c) A disqualification prescribed by this rule may be waived by the affected client under the conditions stated in Rule 1.7. o (d) The disqualification of lawyers associated in a firm with former or current government lawyers is governed by Rule Rule 1.11: Special Conflicts Of Interest For Former And Current Government Officers And Employees o (a) Except as law may otherwise expressly permit, a lawyer who has formerly served as a public officer or employee of the government: (1) is subject to Rule 1.9(c); and (2) shall not otherwise represent a client in connection with a matter in which the lawyer participated personally and substantially as a public officer or employee, unless the appropriate government agency gives its informed consent, confirmed in writing, to the representation. o (b) When a lawyer is disqualified from representation under paragraph (a), no lawyer in a firm with which that lawyer is associated may knowingly undertake or continue representation in such a matter unless: (1) the disqualified lawyer is timely screened from any participation in the matter and is apportioned no part of the fee therefrom; and (2) written notice is promptly given to the appropriate government agency to enable it to ascertain compliance with the provisions of this rule. o (c) Except as law may otherwise expressly permit, a lawyer having information that the lawyer knows is confidential government information A-vi