On January 4, 2019, the California Court of Appeal, First Appellate District issued an opinion reminding us that under California law, tax returns are privileged and improper disclosure of them can even potentially rise to tortious invasion of privacy claims in overturning a demurrer as to that claim. Strawn v. Morris, Polich & Purdy, LLP, No. A150562, 2019 Cal. App. LEXIS 9 (Ct. App. Jan. 4, 2019).

Federal and state tax returns have been held to be privileged from disclosure under California law. Id at *13; Wilson v. Superior Court, 63 Cal. App. 3rd 825, 828 (1976); Webb v. Standard Oil Co., 49 Cal. 2nd 509, 512-513 (1957).  As highlighted by the opinion, the purpose of the privilege “is to encourage voluntary filing of tax returns and truthful reporting of income, and thus to facilitate tax collection.” Strawn at *13; Weingarten v. Superior Court, 102 Cal. App. 4th 268, 274 (2002); Webb at 513. 

The facts of Strawn are gripping even in the briefest summary:  Dennis Strawn was prosecuted for arson in connection with a fire that damaged his home and pickup truck, but that case against him was dismissed.  Nonetheless his insurer, State Farm, denied his claim against his policy insuring the damaged property on the basis that he intentionally caused the fire.  Strawn at *2. Strawn responded by suing Morris Polich & Purdy, LLP, the law firm representing State Farm, and the partner handling the case, Douglas Wood.  Strawn had communicated to Wood that he refused to waive privilege as to the tax returns, but authorized his accountant to provide underlying financial records used to prepare the tax records.  Nevertheless, his accountant’s office “mistakenly provided the returns along with the other financial information.” Id at 3*.  Since Wood had been “expressly informed” that Strawn had not waived privilege, and rather than notifying Strawn of the error, Wood instead sent the returns to State Farm and its forensic accountant — this formed the basis upon which Strawn sued Wood for invasion of privacy.  Id at 4*.

The court confirmed that Strawn had sufficiently alleged a “legally protected privacy interest.”    But it also indicated that the tax privilege is “not absolute” and that it could have been overcome by an adequate showing resulting in a court order.  Id at 16.  The privilege should be evaluated in balancing the public policy of preventing insurance fraud against the right of confidentiality as to the tax returns, especially after evaluating whether the financial information disclosed by Strawn was sufficient to evaluate his financial condition, but faulted the unilateral decision without any court involvement.  Id.  The court also left open whether the alleged invasion of privacy could be proved to be “sufficiently serious in … nature, scope, and actual or potential impact to constitute an egregious breach of the social norms underlying the privacy right” after evidence was presented on the issue.  Id at 17 [citing Hill v. National Collegiate Athletic Assn., 7 Cal. 4th 1, 37 (1994)] . Nonetheless, the court concluded that Strawn had not failed to state a cause of action for invasion of privacy.  Id at 17.

The lessons from an eDiscovery perspective are important, as counsel may encounter tax returns in the course of document review in view of the rule articulated in State Comp. Ins. Fund v. WPS, Inc., 70 Cal.App.4th 644 (1999) and reaffirmed by Rico v. Mitsubishi Motors Corp., 42 Cal.4th 807 (2007) and McDermott Will & Emery LLP v. Superior Court, 10 Cal. App. 5th 1083 (2017).    While that rule is typically construed in the context of attorney-client privilege, in its own language, the rule in Rico also applies not only to attorney-client privileged document but also where documents “otherwise clearly appear to be confidential and privileged and where it is reasonably apparent that such materials were provided or made available through inadvertence.”  State Fund. at 656.  The broader rule stated in State Fund is as follows:

“When a lawyer who receives materials that obviously appear to be subject to an attorney-client privilege or otherwise clearly appear to be confidential and privileged and where it is reasonably apparent that the materials were provided or made available through inadvertence, the lawyer receiving such materials should refrain from examining the materials any more than is essential to ascertain if the materials are privileged, and shall immediately notify the sender that he or she possesses material that appears to be privileged. The parties may then proceed to resolve the situation by agreement or may resort to the court for guidance with the benefit of protective orders and other judicial intervention as may be justified.”

State Comp. Ins. Fund. at 656-657.  It is well established that violation of the State Fund rule can lead to the disqualification of an entire law firm from representation in a matter (Rico, 42 Cal. 4th at 810,819; McDermott, 10 Cal.App.5th at 1113-1114), but Strawn underscores the possibility of privacy torts when privileged documents such as tax returns are transmitted even outside the litigation context under California law.

Link:  http://www.courts.ca.gov/opinions/documents/A150562.DOC