Typically, throughout the course of a litigated case, the attorney representing a corporation will be requested by the corporation’s independent auditors for opinions in connection with an audit of the company’s financial statements for the year. Surprisingly, this “auditor’s request letter” usually comes directly from the corporation, on the corporation’s letterhead and signed by an authorized representative of the corporation. The independent auditor simply has sent the corporation a form template for the corporation to send on the corporation’s letterhead to all of the corporation’s legal counsel.

Usually, the language is identical in all auditors’ requests and takes the following format:

“Dear Mr. McGrath,

In connection with an audit of the financial statements for ABC Corporation as of January 1, 2009 through December 31, 2009, please furnish to our independent auditors, Ernst & Young (fax number 913-888-1065) a description and evaluation of certain matters with respect to which you have been engaged and to which you have devoted substantial attention on behalf of ABC Corporation in the form of legal consultation or representation. Your response should include matters, which existed as of January 1, 2009, and arising subsequently, to the date of your reply.
Pending or threatened litigation (excluding unasserted claims):
Please list all pending or threatened litigation, excluding unasserted claims. Materiality for purposes of this letter includes items involving amounts which could potentially exceed $10,000. Information regarding each matter should include:

1. The nature of the litigation;
2. The progress of the litigation to date;
3. How ABC Corporation is responding or intends to respond to the litigation, e.g. to contest the case vigorously or to seek an out-of-court settlement; and
4. An evaluation of the likelihood of an unfavorable outcome and an estimate, if one can be made, of the amount or range of potential loss.”

The typical auditor’s letter goes on with other factors related to the lawsuit and financial statements.

The question becomes, can the adverse party in litigation discover what the attorney communicated to the independent auditor. That is, is it a waiver of attorney-client privilege? If so, the adversary can discover how ABC Corporation intends to respond to the litigation, either by seeking an out-of-court settlement or by vigorously contesting it. More importantly, the adversary can discover ABC’s attorney’s evaluation of the likelihood of an unfavorable outcome and an estimate as to the range of potential losses.

In United States v. Textron, Inc. and Subsidiaries, 2009 WL 136752, the Internal Revenue Service issued an administrative summons to Textron, Inc. seeking tax accrual papers prepared by Textron. The requested material identified questionable positions Textron took on its returns, estimated the chances these would not withstand IRS scrutiny, and calculated the amount of additional tax liability that would result were the positions revised. The reason for doing this was to allow Textron to maintain an adequate reserve fund, properly report its assets and liabilities, and obtain independent certification of its financial statements. As part of the auditing process, Textron showed the working papers to its independent auditors, Ernst & Young.

Textron refused to comply with the subpoena. It contended that the work papers were covered by the attorney-client privilege and, because they were created in anticipation of possible litigation with the IRS, constituted protected work product. The District Court found the work papers were both privileged attorney-client communications and protected work product. On appeal, however, the United States Court of Appeals held that the disclosure to Ernst and Young waived the privilege.

Caution always needs to be used in an attorney’s disclosure to an independent auditor’s request. If the opposing counsel subpoenas the auditor’s request letter, it is likely that the auditor’s request letter may include the attorney’s evaluation of the likelihood of an unfavorable outcome and an estimate as to the range of potential loss.

Pat McGrath