1 ETHICAL ISSUES ARISING IN DAY-TO-DAY TAX PRACTICE MICHAEL A. VILLA, JR. RYAN PATE* Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P. 901 Main Street, Suite 3700 Dallas, Texas (214) direct (225) cell State Bar of Texas 31 ST ANNUAL ADVANCED TAX LAW COURSE August 15-16, 2013 Houston CHAPTER 11 *Ryan Pate is a 2 nd year law student at the University of Texas. He holds a BBA in Accounting and a Masters of Taxation from Baylor University.
3 A REGISTERED LIMITED LIABILITY PARTNERSHIP INCLUDING PROFESSIONAL CORPORATIONS 901 MAIN STREET, SUITE 3700 DALLAS, TEXAS (214) Michael A. Villa, Jr. FAX (214) Associate TOLL FREE (800) DIRECT DIAL (214) Michael A. Villa, Jr. is a Senior Associate at the law Firm of Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P. Mr. Villa s practice concentrates on resolving federal tax controversies and white collar crime such as securities, tax and bank fraud. He represents individuals, closely-held businesses, and large corporations in IRS audits, appeals, and litigation. Mr. Villa represents individuals and entities in business disputes and lawsuits involving fraud, breach of contract, breach of fiduciary duty, deceptive trade practices act violations, non-compete violations, business torts, and other commercial disputes. Prior to joining the firm in 2007, he worked in Washington, D.C. as a Congressional intern to U.S. Senator John Breaux (Retired) and worked as an Associate with a regional law firm in New Orleans, Louisiana. In , he served as a Judicial Clerk to the Honorable James J. Brady, U.S. District Court, Middle District of Louisiana. EDUCATION LL.M. in Taxation, New York University School of Law, 2007 J.D. and Bachelor of Civil Law, Louisiana State University Paul M. Hebert Law Center, 2004 B.A., Louisiana State University, 2000 AREAS OF PRACTICE White Collar and Government Regulatory Litigation Income Tax Litigation Commercial Litigation RECENT PUBLICATIONS & SPEAKING ENGAGEMENTS American Bar Association Section of Taxation 2013 Meeting, Washington, DC (5/11/13) American Bar Association Section of Taxation 2013 Midyear Meeting, Orlando, FL (1/26/13) Louisiana Socity of CPAs Tax Conference, New Orleans, LA (12/13-14/2012) 14th Annual Meadows Collier Taxation Conference, Dallas 10/30/12 Tax Law 101 sponsored by the State Bar of Texas, Dallas - 8/15/12 American Bar Association Section of Taxation May Meeting, Washington, DC - 5/11/12 The Alphabet Soup of Treasury: What in the World are BSA/AML Exams and Who are the Examiners?, BarTabs published by the Collin County Bar Association, May 2012 Recent Trends in IRS Enforcement Activity & Specialized IRS Agents, BarTabs published by the Collin County Bar Association, March 2012
5 TABLE OF CONTENTS I. INTRODUCTION... 1 II. TEXAS DISCIPLINARY RULES OF PROFESSIONAL CONDUCT ETHICAL OBLIGATIONS OF TAX ATTORNEYS... 1 A. High-Minded Ethical Standards of the Legal Profession... 1 B. Representing Clients with Diminished Capacity... 2 C. Confidential Information... 3 D. Conflicts of Interest General Rule... 4 E. (i). Representing Organization as a Client... 5 F. Safeguarding the Interests of Former Clients... 6 G. Attorneys as Intermediaries... 6 H. Prohibited Transactions... 8 IV. CONCLUSION... 9 i
7 ETHICAL ISSUES ARISING IN DAY- TO-DAY TAX PRACTICE I. INTRODUCTION There are certain ethical issues that tax attorneys will undoubtedly encounter in their everyday practice. Many of those issues lead to difficult decisions among competing alternatives. This article focuses primarily on how tax attorneys can reach the most appropriate solutions to those day-to-day ethical dilemmas with a sound understanding of the Texas Disciplinary Rules of Professional Conduct and Circular 230. II. TEXAS DISCIPLINARY RULES OF PROFESSIONAL CONDUCT ETHICAL OBLIGATIONS OF TAX ATTORNEYS A. High-Minded Ethical Standards of the Legal Profession An attorney must constantly strive to act with the highest levels of honesty and loyalty in practice. Departing from these two traditional pillars of the legal profession erodes the venerated regard of our legal system. The Texas Disciplinary Rules of Professional Conduct were enacted in consideration of the immense importance placed on an attorney s strict adherence to these high-minded ethical standards. They impose ethical obligations that must be balanced with an attorney s role as a zealous advocate for his client. Rule 3.03 speaks to that delicate balance between zealous advocacy and candor to the tribunal by prohibiting an attorney from acting dishonestly. Tex. Disciplinary Rules Prof l Conduct 3.05, reprinted in Tex. Gov t Code Ann., tit. 2, subtit. G, app. A (Vernon 2005)(State Bar Rules art. X 9). Specifically, Rule 3.03 states that an attorney shall not knowingly: (1) make a false statement of material fact or law to a tribunal; (2) fail to disclose a fact to a tribunal when disclosure is necessary to avoid assisting a criminal or fraudulent act; (3) in an ex parte proceeding, fail to disclose to the tribunal an unprivileged fact which the lawyer reasonably believes should be known by that entity for it to make an informed decision; (4) fail to disclose to the tribunal authority in the controlling jurisdiction known to the lawyer to be directly adverse to the position of the client and not disclosed by opposing counsel; or (5) offer or use evidence that the lawyer knows to be false. Id. at 3.03(a)(1)-(5) Under Rule 3.03, it is a violation to bring a lawsuit that the law does not provide for, or, put another way, to make arguments to a tribunal based on improper characterizations of the law. In Resolution Trust Corp. v. Tarrant Cnty. Appraisal District, the court identified a violation of Rule 3.03 when the plaintiff (RTC) failed to raise jurisdictional issues at trial but subsequently raised them on appeal. Resolution Trust Corp. v. Tarrant Cnty. Appraisal District, 926 S.W.2d 797, 802 n.1 (Tex. App. Fort Worth 1996, no writ). RTC originally brought suit when the Tarrant County Appraisal District (the District) imposed a rollback tax on RTC s property after the property ceased to be used for agricultural purposes. Id. at 798. The District viewed the cessation of use for agricultural purposes as a change in use that shifted the District s basis of its appraisal of the property, for tax purposes, from production value to market value. Id. During oral argument, RTC claimed the court lacked jurisdiction based on the doctrine of sovereign immunity. Id. at 800. This was the first time RTC asserted this argument. Id. Although the doctrine of sovereign immunity allowed the court to permit RTC to raise this jurisdictional argument on appeal (for the first time), it noted that this tactic violated Rule Id. at 802 n.4. The violation was due to RTC s failure to disclose to the court a material fact or legal argument. Id. Disclosure of all material facts and arguments can be difficult, especially when certain arguments or facts are adverse to the client s position. However, attorneys may have an obligation to disclose arguments or facts unfavorable to their clients, even when opposing counsel fails to do so. A common question that arises with respect to the requirement to disclose certain information to a tribunal is whether the Internal Revenue Service (IRS) is classified as a tribunal. One ABA Opinion indicates that the IRS is neither a tribunal nor a quasi-tribunal. ABA Opinion 314, 51 ABAJ 671 (1965). The opinion, however, goes on to say that attorneys cannot make 1
8 false assertions, and must advise a client to correct misstatements made to the IRS. Id. Additionally, a duty to withdraw will arise if the lawyer believes that the Service relies on him as corroborating statements of his clients which he knows to be false unless it is obvious that the very act of dissociation would break client confidences. Id. A later ABA Opinion expands on an attorney s duty of candor toward the IRS by noting that counsel is under a duty not to mislead the Internal Revenue Service deliberately, either by misstatements or by silence or by permitting the client to mislead. ABA Opinion , 71 ABAJ 151 (1985). Circular 230, which regulates practice before the Department of the Treasury (Treasury), also gives guidance on how attorneys should handle client omissions of pertinent information from documents relating to IRS matters. 31 C.F.R. subtit. A, part 10 (2011). When an attorney knows that a client is not in compliance with the Internal Revenue Code (IRC), the attorney must advise the client promptly of the noncompliance, error, or omission. Id. at An attorney also has a duty to exercise diligence when preparing tax documents and determining the accuracy of representations made to clients and the IRS. Id. at 10.22(a). Furthermore, submitting false or misleading information to the IRS and giving false opinions on Federal tax questions, either intentionally or recklessly, resulting from misstatements of facts or law subjects an attorney to sanctions. Id. at 10.51(a). Another ethical obligation that is especially pertinent to tax attorneys is Rule 3.02, which prohibits an attorney from taking a position that unreasonably delays resolution of the matter. Tex. Disciplinary Rules Prof l Conduct Similarly, the IRC prohibits, and may impose penalties as result of, requests for collection due process (CDP) hearings that are made solely to delay the collection process. I.R.C. 6330(g). In other words, a tax attorney cannot, in the course of representing a client, use the CDP hearing to contest a tax liability simply because the client seeks to delay collection. With these foundational ethical considerations in mind, we now turn to some of the more common ethical dilemmas that a tax attorney can expect to encounter in day-today practice. B. Representing Clients with Diminished Capacity When a tax attorney is retained by an elderly client to manage the client s wealth by planning their estate, 2 the attorney must be ever mindful of the client s legal competency. This is because Rule 1.02(g) requires an attorney to take reasonable action to secure the appointment of a guardian or other legal representative for, or seek other protective orders with respect to, a client whenever the lawyer reasonably believes that the client lacks legal competence and that such action should be taken to protect the client. Tex. Disciplinary Rules Prof l Conduct 1.02(g). Sometimes, this obligation interferes with an attorney s duty to abide by their client s decisions concerning the representation, as the following case aptly illustrates. John Roades represented Christine Franks for several years, beginning with appointing her son Michael as her attorney in fact. Franks v. Roades, 310 S.W.3d 615, 618 (Tex. App. Corpus Christi 2010, no pet.). Two years later, Roades appointed Franks s daughter, Carol, as her attorney in fact. Id. At this point, Franks s mental condition worsened to the extent that she was diagnosed with severe and global cognitive dysfunction and required 24-hour care, which Carol paid for out of Franks s funds. Id. at Michael disagreed with many of Carol s decisions as Franks s attorney in fact, even going so far as to threaten Carol and her family. Id. at 619. During all of this confusion, Carol was still meeting with Roades to discuss estate plans and guardianship options. Id. Due to Franks s debilitated mental state and the disputes with Michael, Carol retained Roades to file an application for guardianship of Franks, which Roades believed to be his obligation under Rule 1.02(g). Id. On the same day the guardianship application was filed, Franks and Michael visited Roades because Michael wanted Roades to re-appoint him as Franks s attorney in fact. Id. Since Franks had previously instructed Roades not to discuss any legal matters with Michael, Roades did not disclose the guardianship application at this meeting. Id. Once Michael learned of the guardianship application, he, predictably, contested it in court. Id. This dispute eventually ended in a settlement agreement. Id. at 620. A few years later, however, Franks sued Roades for negligence and breach of fiduciary duty. Id. The court held that Roades had not breached his fiduciary duty to Franks by failing to disclose the guardianship application at the meeting with Michael and Franks because he was acting in accordance with Franks s prior instructions. Id. at 628.
9 The court noted that there was no precedent establishing that Roades s duty of full disclosure continued despite his reasonable belief that his client was legally incompetent. Id. Furthermore, the court held that Roades did not breach his fiduciary duty to Franks by filing the guardianship application because Franks s medical diagnosis was enough for Roades to reasonably believe that he had an obligation under Rule 1.02(g) to seek a guardian for Franks. Id. Rule 1.03, which requires an attorney to keep his clients reasonably informed of matters concerning the representation, also speaks to situations involving legally incompetent clients. Tex. Disciplinary Rules Prof l Conduct The comments to Rule 1.03 indicate that full disclosure may not be practical when the client is legally incompetent. Id. at 1.03 cmt. 5. As a result, it may not be possible to maintain the usual attorney-client relationship. Id. As these situations arise, it is important for the attorney to act in the best interest of his client, not the client s family members, by carrying out the representation in accordance with the client s desires, until the attorney s ethical obligations require certain actions to be taken to ultimately protect the client even though the actions may be outside of the client s instructions. C. Confidential Information Rule 1.05(a) defines confidential information as both privileged and unprivileged client information. Tex. Disciplinary Rules Prof l Conduct 1.05(a). Privileged information is simply client information that is protected by the attorney-client privilege. Id. Unprivileged client information is a tremendously broad realm that encompasses all information relating to a client or furnished by the client, other than privileged information, acquired by the lawyer during the course of or by reason of the representation of the client. Id. The difficulty here is that the scope of confidential information is much broader than the attorney-client privilege. In other words, an attorney's duty of confidentiality is broader than just client communications, and extends to all confidential information, whether privileged or unprivileged, and whether learned directly from the client or from another source. Perillo v. Johnson, 205 F.3d 775, 799 (5 th Cir. 2000) (commenting on the extent of the confidentiality requirement). This means that tax attorneys must be very careful in disclosing any information about their clients, especially since Rule 1.05 only allows attorneys to use 3 discretion in deciding whether to disclose confidential information under the following circumstances: (1) When the lawyer has been expressly authorized to do so in order to carry out the representation. (2) When the client consents after consultation. (3) To the client, the client's representatives, or the members, associates, and employees of the lawyer's firm, except when otherwise instructed by the client. (4) When the lawyer has reason to believe it is necessary to do so in order to comply with a court order, a Texas Disciplinary Rule of Professional Conduct, or other law. (5) To the extent reasonably necessary to enforce a claim or establish a defense on behalf of the lawyer in a controversy between the lawyer and the client. (6) To establish a defense to a criminal charge, civil claim or disciplinary complaint against the lawyer or the lawyer's associates based upon conduct involving the client or the representation of the client. (7) When the lawyer has reason to believe it is necessary to do so in order to prevent the client from committing a criminal or fraudulent act. (8) To the extent revelation reasonably appears necessary to rectify the consequences of a client's criminal or fraudulent act in the commission of which the lawyer's services had been used. Tex. Disciplinary Rules Prof l Conduct 1.05(c). To give an example of an ethical dilemma that can arise with respect to confidential information, consider the following hypothetical. Taxpayer has hired you to represent her in a voluntary disclosure of a foreign bank account, held in Switzerland. You begin by reviewing her account records, interviewing her, and preparing her offshore voluntary disclosure letter, which is to be signed under penalty of perjury. Taxpayer claims that her grandfather set up the account many years ago. Therefore, she has very little documentation and no account statements.
10 The IRS has requested that Taxpayer sign and return the disclosure letter before the account statements can be obtained from Switzerland. After meeting with Taxpayer to review the little documentation that she has, you prepare her disclosure letter, which she signs and returns. Several months later, you receive the account records from Switzerland. They reveal that Taxpayer has up to three additional bank accounts, one of which is owned by a trust that Taxpayer never mentioned. When you discuss this with Taxpayer, she tells you that some of the documents she previously gave you were fakes. She also tells you about an additional foreign bank account that she has in Syria. Taxpayer makes it clear that she does not wish to disclose her account in Syria, and also indicates that her foreign financial advisor told her that it did not need to be disclosed. Finally, assume that you believe that Taxpayer should disclose her account in Syria. The issue here is difficult because it involves several competing interests: the client s interest in nondisclosure, the attorney s interest in providing legal services in line with the client s goals, and the attorney s interest in adhering to the high ethical standards of the legal profession. First, the information concerning the Syrian account is obviously confidential information under Rule 1.05(a). Id. at 1.05(a). Thus, we must turn to Rule 1.05(c). The circumstances from Rule 1.05(c) simply give attorneys the choice of whether to reveal confidential information. Id. at 1.05(c). In fact, Rule 1.05 only compels an attorney to disclose confidential information in very limited circumstances. Id. at 1.05(e)-(f). For example, an attorney is required to reveal confidential information when it is reasonably necessary to prevent a client from committing a criminal or fraudulent act that is likely to result in death or substantial bodily harm to a person. Id. at 1.05(e). An attorney is also compelled to disclose confidential information when required to do so by Rule 1.04(b). Id. at 1.05(f). Rule 1.04(b) provides: In the course of representing a client a lawyer shall not knowingly: (b) fail to disclose a material fact to a third person when disclosure is necessary to avoid making the lawyer a party to a criminal act or knowingly assisting a fraudulent act perpetrated by a client. Id. at 1.04(b). Thus, the real 4 issue becomes whether the client is, in fact, committing a criminal or fraudulent act by failing to disclose the Syrian account. Though reasonable minds may differ on whether the account is required to be disclosed, it is typically best to err on the side of caution. D. Conflicts of Interest General Rule Conflicts of interest are almost certain to arise in the everyday practice of tax law, especially on the planning side. Some of the more common conflicts occur during the representation of husbands and wives, corporations and shareholders/officers, and related family members. Rule 1.06 identifies three basic situations where conflicts of interest can occur. Id. at 1.06(a)-(b). The first situation giving rise to a conflict of interest is when an attorney represents opposing parties to the same litigation. Id. at 1.06(a). This scenario is always prohibited. Id. Second, conflict arises when an attorney s representation of a client involves a substantially related matter in which that person's interests are materially and directly adverse to the interests of another client of the lawyer or the lawyer's firm. Id. at 1.06(b)(1). Lastly, conflict arises when an attorney s representation of a client reasonably appears to be or become adversely limited by the lawyer's or law firm's responsibilities to another client or to a third person or by the lawyer's or law firm's own interests. Id. at 1.06(b)(2). In State Bar of Texas v. Dolenz, the court found an attorney (Dolenz) in violation of Rule 1.06(b)(1). State Bar of Tex. v. Dolenz, 3 S.W.3d 260, 272 (Tex. App. Dallas 1999, no pet.). Dolenz represented an artist (Vail) in a suit against the trustee of a trust that Vail was a beneficiary of. Id. at 263. Dolenz subsequently continued to represent Vail and even set up a separate trust for Vail in which Dolenz named himself sole beneficiary. Id. In order to pay Dolenz for his legal services, Vail signed four promissory notes payable to Dolenz and secured by Vail s paintings. Id. Dolenz then assigned these notes to his daughter, Mrs. Lievrouw. Id. When Vail failed to make payments on the promissory notes, Mrs. Lievrouw retained Dolenz as her attorney and sued Vail. Id. at 264. The court stated that two matters are substantially related, within the meaning of Rule 1.06, when a genuine threat exists that a lawyer may divulge in one matter confidential information obtained in the other because the facts and issues involved in both are so similar. Id. at Based on the evidence, the court held that the jury could reasonably infer that
11 Vail s payment for Dolenz s legal fees was substantially related to Mrs. Lievrouw s suit against Vail. Id. at 271. Also, the court held that the interests of Mrs. Lievrouw and Vail were materially and directly adverse by virtue of the fact that they were on opposite sides of the lawsuit. Id. Rule 1.06(c) provides an exception that permits an attorney to represent multiple clients in Rule 1.06(b) circumstances. Tex. Disciplinary Rules Prof l Conduct 1.06(c). This exception applies when (1) the lawyer reasonably believes the representation of each client will not be materially affected; and (2) each affected or potentially affected client consents to such representation after full disclosure of the existence, nature, implications, and possible adverse consequences of the common representation and the advantages involved, if any. Id. at 1.06(c)(1)-(2). The court held in the case of In re Allen that this exception applied to permit an attorney to represent two beneficiaries (Allen, Jr. and Hagin) and a trustee. In re Allen, No CV, 2003 WL , at *4 (Tex. App. Houston [1 Dist] June 5, 2003, no pet.)(memo op.). The suit was brought by a third beneficiary (Ford) to compel an accounting, to remove the trustee, to revoke the family trust, and to seek damages for breach of fiduciary duty. Id. at *1. Allen, Jr., Hagin, and the trustee all strongly disagreed with Ford s allegations and all signed affidavits stating their consent to representation by the same attorney after the attorney advised them of the potential consequences. Id. at *2. That consent, coupled with the alignment of the clients interests, led the court to apply the Rule 1.06(c) exception and allowed the clients to be represented by the same attorney. Id. at *3. Another variation to the general conflict of interest rules is found in Rule 1.06(d), which states: A lawyer who has represented multiple parties in a matter shall not thereafter represent any of such parties in a dispute among the parties arising out of the matter, unless prior consent is obtained from all such parties to the dispute. Tex. Disciplinary Rules Prof l Conduct 1.06(d). In re Taylor presents an example of a Rule 1.06(d) conflict arising during the divorce proceedings of a couple who had previously been jointly represented by an attorney (Filer). In re Taylor, 67 S.W.3d 530, (Tex. App. Waco 2002, no pet.). The husband (Terry) hired Filer to prepare the Stockholder Agreement for his newly incorporated business. Id. at 531. The Stockholder Agreement valued the net worth of the business at $200,000 and was signed by both Terry and his wife (Barbara). Id. Filer also prepared wills and medical and financial powers of attorney for the couple. Id. Three years later, Terry hired an attorney from the same firm as Filer to represent him in the divorce proceedings, without first obtaining Barbara s consent. Id. at 532. The court found that the stock of Terry s business was worth over five times the value of the couple s next largest community asset. Id. Thus, the court held the divorce proceedings to be a dispute arising out of the same matter (the preparation of the Stockholder Agreement) for which the couple had previously been jointly represented by Filer. Id. at 533. The court then referred to Rule 1.06(f), which precludes attorneys of the same firm from representing a client when any attorney at the firm is precluded from representing that client under Rule Id. Accordingly, all of the attorneys from Filer s firm were barred from representing Terry in the divorce proceedings. Id. at 534. E. (i). Representing Organization as a Client Tax attorneys should be acutely aware of conflicts of interest that may arise when representing an entity, particularly closely held entities. It is imperative to be ever mindful of the fact that the entity itself is the client, not the individual employees of the entity. A lawyer employed or retained by an organization represents the entity. Tex. Disciplinary Rules Prof l Conduct 1.12(a). While representing an entity, the attorney-client relationship with the entity must be taken into consideration during the ordinary dealings with the entity, in order to avoid improper disclosures and ethical violations. While the lawyer in the ordinary course of working relationships may report to, and accept direction from, an entity s duly authorized constituents the lawyer shall proceed as reasonably necessary in the best interest of the organization without involving unreasonable risks of revealing information relating to the representation to persons outside the organization. Id. In situations where the representation of an entity relates to a dispute involving both claims against the entity and individual claims against the employees of the entity, there is a high possibility for conflicts of interest that would require the individual employees to retain separate counsel. It is imperative to ensure that the individual employees become aware of their need for separate counsel. 5
12 In dealing with an organization s directors, officers, employees, members, shareholders or other constituents, a lawyer shall explain the identity of the client when it is apparent that the organization s interests are adverse to those of the constituents with whom the lawyer is dealing or when explanation appears reasonably necessary to avoid misunderstanding on their part. Id. at 1.12(e). Engaging in representation of both the entity and the individual employees of the entity can result in disqualification under Rule F. Safeguarding the Interests of Former Clients An attorney s client has an interest in both the preservation of confidential information as well as the attorney s firm commitment to upholding the duty of loyalty to the client. In re Am. Airlines, Inc., 972 F.2d 605, 616 (5 th Cir. 1992). Rule 1.09 was enacted to protect these interests in order to ensure the fairness of particular trials, but also to safeguard the integrity of the attorney-client relationship. Id. at 619. Rule 1.09 forbids an attorney from representing a person in a matter adverse to any of the attorney s former clients, without first obtaining the consent of the former client, when: (1) in which such other person questions the validity of the lawyer's services or work product for the former client; (2) if the representation in reasonable probability will involve a violation of Rule 1.05; or (3) if it is the same or a substantially related matter. Tex. Disciplinary Rules Prof l Conduct 1.09(a)(1)-(3). When an attorney chooses to leave their firm to either form their own or join a different firm, conflicts of interest commonly arise when their former clients are involved in disputes with clients they represent at their new firm. This may be especially true for uniquely specialized tax attorneys. In re Epic Holdings, Inc. involved a scenario where a for-profit hospital company hired a tax law firm to assist in the complex formation of a new corporation. In Re Epic Holdings, Inc., 985 S.W.2d 41, 43 (Tex. 1998). Some of the attorneys that were involved with setting up the new corporation later decided to open their own firms. Id. at Two of those firms were then hired by a client (plaintiff) to sue the above mentioned corporation. Id. The plaintiff claimed that in forming the corporation, a circle of power was created that allowed directors to perpetuate their control over the corporation despite the fact that they owned no stock. Id. at 50. The court affirmed the disqualification of the plaintiff s counsel under Rule 1.09(a)(1) & (3) because counsel did question the work their former firm performed when they were still members of it, and that the relationship between that work and [the current] claims is substantial. Id. at 52. An attorney can also be disqualified from representing a client in a dispute with a former client if the attorney s former representation resulted in the acquisition of confidential information that in reasonable probability will be used to [the former client s] disadvantage. City of El Paso v. Salas-Porras Soule, 6 F.Supp.2d 616, 624 (W.D.Tex. 1998). In City of El Paso, the plaintiff brought suit to recover funds from the defendant in connection with a condemnation proceeding. Id. at 618. The plaintiff s attorney had previously provided significant tax advice to the defendant s corporation. Id. at 619. The court determined that the plaintiff s attorney could use information obtained in the course of providing tax advice to the defendant s corporation to impeach the defendant s testimony concerning their financial position. Id. at 624. This determination made it reasonably probable that the plaintiff s attorney would use confidential information to the defendant s disadvantage. Id. As a result, the court disqualified the plaintiff s attorney under Rule 1.09(a)(2). Id. It is important to note that disqualification under Rule 1.09 can result even when an attorney does not do anything to harm a former client. If the rule did not operate in this manner, the client s interests in his attorney s loyalty and confidentiality would diminish and the public would become increasingly skeptical of legal practitioners and the legal profession as a whole. Id. at 625. For this reason, it is imperative for attorneys to avoid engaging in legal representation that may put them at odds with or in positions adverse to their former clients, without first obtaining their former clients consent. G. Attorneys as Intermediaries An intermediary can be thought of as one who works as a link between people in order to effectuate common goals or reach points of reconciliation. Tax attorneys
13 often act as intermediaries when they structure businesses or plan the estates of wealthy families. Interestingly, Rule 1.07 prohibits attorneys from acting as intermediaries unless the following three requirements are met: (1) The lawyer consults with each client concerning the implications of the common representation, including the advantages and risks involved, and the effect on the attorneyclient privileges, and obtains each client's written consent to the common representation; (2) the lawyer reasonably believes that the matter can be resolved without the necessity of contested litigation on terms compatible with the clients' best interests, that each client will be able to make adequately informed decisions in the matter and that there is little risk of material prejudice to the interests of any of the clients if the contemplated resolution is unsuccessful; and (3) the lawyer reasonably believes that the common representation can be undertaken impartially and without improper effect on other responsibilities the lawyer has to any of the clients. Tex. Disciplinary Rules Prof l Conduct 1.07(a)(1)-(3). While these requirements appear to be straightforward, the role of an intermediary is most certainly not. Consider Rule 1.07(b), which imposes an obligation on the intermediary to communicate, to each of his clients, the considerations relevant to decisions that must be made during the course of the representation, so that they are adequately informed. Id. at 1.07(b). This relates to Rule 1.03, which requires attorneys to communicate with their clients in a timely fashion in order for the clients to be able to make informed decisions. Id. at In practice, however, clients of an attorney acting as an intermediary will commonly divulge information to the attorney with instructions to keep the information concealed from the other clients. How can one client make informed decisions 7 without being privy to all the information relevant to the matter of the representation? Assume you represent a husband and wife in a civil dispute with the IRS concerning the couple s joint return for the 2012 tax year. The dispute later becomes criminal once the IRS discovers fraudulent Schedule C expenses relating to the husband s business. The husband, your primary contact, informs you that the wife is unaware of these fraudulent Schedule C expenses. The husband asks you not to disclose this information to the wife. At this point, common representation will be untenable. Even if the husband permits you to disclose all information to his wife, common representation will still likely be problematic. For example, assume the husband is the sole target of the criminal investigation. You may want to discuss global criminal and civil resolutions with IRS-CI and the civil agent. After negotiations with the IRS, a plea and civil closing agreement may be drafted. Since the case involves a joint return, the civil agreement must be signed by both the husband and wife to the extent that the taxpayers want to reach a global civil and criminal resolution. If both the husband and wife sign the agreement, it will possibly lead to an expedited and favorable resolution of the case for the husband. In a situation like this, the wife may have innocent spouse defenses available to the civil tax and penalty liabilities. See generally I.R.C The wife s innocent spouse defenses, however, may be affected or precluded by her signing of the closing agreement. On the other hand, the wife s failure to sign the closing agreement could adversely affect the husband s ability to globally resolve the civil and criminal tax liability. Since you represent the couple jointly, you may not be in the best position to protect the wife s interests. As a result, separate counsel would be better suited to protect the wife s interests. When representing couples, it is important to be mindful of times when one spouse may need separate counsel, especially in situations involving potential innocent spouse defenses. The situation described above is relatively common and difficult to handle. To avoid or mitigate situations like this, attorneys acting as intermediaries or as counsel for multiple parties should be sure to inform their clients, prior to the engagement, that the attorney is required to preserve the confidentiality of information, except with respect to the clients. Id. at 1.07 cmt. 6. In many cases, it may be proper to advise the clients to retain separate counsel. Furthermore, if the clients end up suing each other over a dispute, the attorney-client
14 privilege will not attach to protect communications that occurred during the joint representation. Id. Hence the tremendous importance of ensuring that potential clients are well aware of the potential risks associated with joint representation. H. Prohibited Transactions The trust and confidence involved with the attorneyclient relationship, in addition to an attorney s legal training and experience, gives an attorney a significant advantage over a client. Due to this advantage, there is the potential for manipulation, fraud, and deceit. Moreover, the complex nature of the tax law arena arguably bolsters the potential for deception. Rule 1.08 addresses these concerns by imposing the following three requirements that must be met before an attorney may enter into a business transaction with a client: (1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed in a manner which can be reasonably understood by the client; (2) the client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and (3) the client consents in writing thereto. Tex. Disciplinary Rules Prof l Conduct 1.08(a)(1)-(3). It is important to note that the term business transactions does not include commercial transactions. Id. at 1.08(j). A commercial transaction occurs when a client provides goods or services to his attorney as if his attorney were simply another customer. Id. In these situations, the requirements from Rule 1.08(a) do not apply because the attorney no longer has an advantage in the transaction. Id. at 1.08 cmt. 2. Rosas v. Comm n for Lawyer Discipline involves a prohibited transaction that led to the disbarment of an attorney (Rosas). Rosas v. Comm n for Lawyer Discipline, 335 S.W.3d 311, (Tex. App. San Antonio 2010, pet. denied). Mallery hired Rosas to help him avoid a foreclosure sale on an investment property he owned, after he fell behind on his mortgage payments. Id. at 314. The two decided that the best solution would be for Mallery to transfer the property to Rosas. Id. They agreed on a price of $5,000. Id. Rosas then sent the transfer documents to Mallery, which Mallery signed and returned. Id. Rosas, however, did not tell Mallery that the documents transferred title to Rosas while Mallery remained liable for the mortgage payments. Id. at 315. When Rosas failed to pay the $5,000, Mallery filed a complaint with the State Bar of Texas claiming Rosas had stolen his property. Id. The court affirmed the trial court s finding that Rosas had violated Rule 1.08(a) because an attorney-client relationship existed between Rosas and Mallery, which Rosas used to manipulate Mallery, and there was no commercial transaction involved since Mallery s real estate experience did not relate to the legal aspects of real estate transactions. Id. at While this case depicts a more egregious ethical violation, it is always important to remember to keep clients informed, treat them in a fair and reasonable manner, and obtain their consent in writing in order to ensure compliance with the law and preserve the integrity of one s professional reputation. Another type of prohibited transaction, found in Rule 1.08(b), is particularly relevant to estate planners and prohibits an attorney from preparing an instrument giving the lawyer or a person related to the lawyer as a parent, child, sibling, or spouse any substantial gift from a client, including a testamentary gift, except where the client is related to the donee. Tex. Disciplinary Rules Prof l Conduct 1.08(b). This can make it difficult for an attorney to prepare wills for their close friends, which the next case illustrates. Shields, an attorney, prepared a will for his very close friend, Lippitt. Shields v. Tex. Scottish Rite Hosp. for Crippled Children, 11 S.W.3d 457, 458 (Tex. App. Eastland 2000, pet. denied). In the will, Lippitt bequeathed $2,029, of stocks, bonds, cash, and bank accounts to Shields, and left the residuary estate to the Texas Scottish Rite Hospital for Crippled Children (Scottish Rite). Id. The residuary estate included real property valued at $2,304, Id. at n.2. The court did not even consider the close personal friendship of Shields and Lippitt, and instead looked to whether the bequest to Shields violated public policy. Id. at 459. The court found that the Texas Disciplinary Rules of Professional Conduct evidence the public policy of the State. Id. Since Shields, who was not related to Lippitt, was clearly in violation of Rule 1.08(b), the court held that the bequest ran contrary to public policy and thus failed and passed to Scottish Rite under the residuary clause. Id. at In questionable situations such as this, it is best to hire an independent 8
15 attorney (an attorney from another firm) to provide the legal services. IV. CONCLUSION In the field of tax law, there are certain ethical dilemmas that arise in everyday practice, ethical dilemmas that require a sound understanding of the Texas Disciplinary Rules of Professional Conduct and Circular 230 in order to be dealt with appropriately. When faced with these ethical dilemmas, tax attorneys should always seek to preserve the integrity of the legal profession by adhering to the high ethical standards discussed throughout this article. This must be accomplished by striking the appropriate balance between zealous advocacy and ethical behavior. Finally, high-minded ethical behavior benefits clients by protecting their interests, and also benefits the tax attorney himself by protecting his professional reputation and the reputation of the legal profession. 9