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Tax Court Order Indicates That E-Discovery and Predictive Coding Are Here to Stay

by Chelsea Hess, Kevin Spencer, McDermott Will & Emery and McDermott Will & Schulte | Jul 18, 2016 | Court Procedure Matters, IRS Audits, IRS Guidance, Privilege and Non-Disclosure, Trial Courts, Uncategorized

On July 13, 2016, Judge Buch of the US Tax Court denied an Internal Revenue Service (IRS) motion to compel the production of electronically stored information (ESI) by Dynamo Holdings Limited Partnership and Beekman Vista, Inc., which was not delivered as part of a discovery response based on the mutually agreed-upon use of “predictive coding.” Predictive coding is an electronic discovery method that permits an efficient and effective approach when reviewing for relevance a large amount of data and documents. It is a relatively new discovery method that is gaining acceptance by courts around the country as an alternative to the costly and laborious physical review of data and documents. Judge Buch previously authorized the use of predictive coding in Dynamo Holdings, Ltd. vs. Commissioner, 143 T.C. No. 9 (2014).

The IRS and the taxpayers had agreed that the taxpayers would run a search for terms determined by the IRS on the potentially relevant documents. The taxpayers provided the IRS with samples of randomly selected documents from the universe of potentially relevant documents, from which the IRS identified the relevant documents. These selections were used to create a predictive coding model, which a computer can use to identify conceptually similar documents. The IRS also selected a “recall rate” of 95 percent. A search method’s recall rate is the percentage of all relevant documents in the search universe that are retrieved by that search method. The higher the recall rate, the fewer relevant but retrieved documents there will be. The taxpayers then delivered to the IRS all of the documents retrieved using the predictive coding model that were not privileged. More documents were identified in the initial search for terms than were identified using the predictive coding model. The IRS filed a motion to compel production of the documents identified in the initial terms search that were not produced.

The Tax Court denied the IRS’s motion, explaining that document review results are never perfect. The court stated that the IRS was seeking a perfect response, but that the Tax Court Rules and the Federal Rules of Civil Procedure require only that the responding party make a “reasonable inquiry” when making a discovery response. The court explained that “when the responding party is signing the response to a discovery demand, he is not certifying that he turned over everything, he is certifying that he made a reasonable inquiry and to the best of his knowledge, his response is complete.” The use of predictive coding does not change this standard, and the court held that the taxpayers satisfied the reasonable inquiry standard when they responded using predictive coding.

Practice Note: Due to the amount of data and documents generated by taxpayers in the normal course of business, discovery of ESI can be extremely burdensome and expensive for taxpayers. Nonetheless, it has become commonplace to see discovery requests for ESI. Although there is a substantial amount of guidance on this subject in other courts, the Tax Court has issued [...]

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Tax Court (Again) Rejects IRS Use of Secret Subpoenas

by McDermott Will & Schulte | Jul 11, 2016 | Court Procedure Matters, Privilege and Non-Disclosure, Trial Courts, Uncategorized

On July 8, 2016, Judge Mark V. Holmes of the US Tax Court issued an order in Ernest S. Ryder & Associates, Inc., APLC, et al., v. Commissioner, ordering the Internal Revenue Service (IRS) to serve on the taxpayer all non-party subpoenas that he had issued in the case, together with all responses and documents that nonparties produced after receiving those subpoenas. The order mirrored a prior order issued by Judge Holmes almost a year ago in Kissling v. Commissioner, Dkt. No. 19857 (July 16, 2015).

In both cases, the IRS served subpoenas on third parties (77 subpoenas in the most recent case) and argued to the court that there is no Tax Court rule that requires him to notify taxpayers about whom he is subpoenaing in a Tax Court case, and he would prefer to keep his pretrial preparation secret. Although Judge Holmes agreed that the Tax Court’s rules do not specifically require notice of non-party subpoenas, he disagreed with the IRS that this absence creates an implication that secret subpoenas are favored. Reviewing the history of its rules on subpoenas and the close connection with Fed. R. Civ. Proc. 45, which requires notice to other parties before service of non-party subpoenas for the production of documents, information, or tangible things, Judge Holmes adopted the notification requirement of Fed. R. Civ. Proc. 45 as a modification to the pretrial order that governed the case.

In our experience, the IRS does not view Kissling as the law in the Tax Court and questions its value. It remains to be seen whether the Tax Court will formally adopt the notification requirement in Fed. R. Civ. Proc. 45 or will continue to permit each judge to determine how to deal with secret subpoenas. Unless and until the court amends its rules, issues an opinion on the issue, or the IRS voluntarily follows the approach set forth by Judge Holmes, taxpayers and their counsel should consider as part of their pretrial preparation in Tax Court cases requesting from the IRS notice of all subpoenas issued to non-parties along with copies of all subpoenas, responses and documents produced by the non-parties. This request should be noted as being continuing in nature. If the IRS asserts that no subpoenas have been issued, taxpayers can use this representation against the IRS if they later discover that non-party subpoenas were issued. If the IRS refuses to respond or produce the requested information, taxpayers can point to these two orders as persuasive authority (albeit non-precedential and non-binding) that notice should be provided and the information should be produced.

Two Current Tax Controversies Utilize ‘Quick Peek’ Agreements to Resolve Privilege Disputes

by Joshua M. Ellenberg and Robin L. Greenhouse | May 31, 2016 | Alternative Dispute Resolution, Court Procedure Matters, Privilege and Non-Disclosure, Trial Courts, Uncategorized

Due to the enormous amount of electronic data stored by companies in the modern era, discovery requests can involve millions of documents which need to be reviewed prior to being turned over to the opposing party. In conducting their analysis of this overwhelming quantity of information, litigants must, amongst other things, detect and exclude any privileged material. Should a party inadvertently fail to do so before such records reach the hands of the opposing counsel, he/she will be deemed to waive privilege in many jurisdictions. Given the massive quantity of data, however, such mistakes are practically unavoidable.

Federal Rule of Evidence (FRE) 502 was enacted in 2008 in an attempt to combat the issue of inevitable human error and the costs associated with parties’ efforts to avoid it. FRE 502(d) allows parties to request the court to grant an order stipulating that a disclosure of privileged material does not waive any claims of privilege with respect to those documents. If the court agrees to enter the order, it is controlling on third parties and in any other federal or state proceeding.

FRE 502(d) has led to the possibility of “quick peek” agreements where the parties give over all or a portion of their documents to opposing counsel without any privilege review whatsoever so that the recipient can identify which material he would like to retain. The recipient, in turn, agrees not to assert a waiver claim on any document that the producing party intends to withhold from the requested documents as privileged. These arrangements can dramatically ease the temporal and financial burdens of conducting a privilege review because they allow the producing party to focus only on those documents desired by the recipient while at the same time preserving their right to claim privilege on such documents. (more…)