by Scott B. Garner and Isabelle M. Carrillo

The recent decision in United States v. Ruehle (No. 09-50161, 2009 U.S. App. LEXIS 21450 (9th Cir. Sept. 30, 2009)) is a reminder that federal common law, and not California law, determines whether, in federal question cases, a communication between a lawyer and his client is protected as privileged. Because California takes a more client-friendly view of confidentiality – presuming that communications made in the course of the attorney-client relationship are confidential – while federal common law takes a stricter view that places the burden on the client of proving a communication was confidential, whether federal law or California law is applied can be critical to the determination of whether a communication is covered by the privilege or not. This distinction is evident in decisions like Ruehle, where California’s public policy of protecting client interests even at the expense of a lawyer’s or a third party’s contrary interests may be frustrated.

Indeed, even as the Ninth Circuit was issuing the Ruehle opinion, a Commission appointed by the State Bar of California was releasing for public comment proposed new rules regarding, among other things, the safeguarding of client confidences. In the face of the Ninth Circuit’s ruling, the confidentiality rules California ultimately adopts may be largely irrelevant in many circumstances.

One of the purposes of the appointment of the Commission is to redraft California’s ethics rules – currently contained in the California Rules of Professional Conduct – so that they are more consistent with the ABA Model Rules and, thus, more in conformity with other states. This would seem a worthy goal in a time when California lawyers routinely practice across state lines. Included within the rules to be re-written are the confidentiality rules that require lawyers to maintain their clients’ confidences, even in the face of outside pressures to divulge those confidences. Because of California’s strong public policy protecting client confidences, however, the confidentiality rule contained in the Commission’s Proposed Rule 1.6 deviates in significant ways from the parallel ABA Model Rule 1.6, which allows a lawyer to divulge his client’s confidences under various enumerated circumstances.

For example, like the ABA Model Rules, California ethics rules historically have allowed a lawyer to disclose client confidences if necessary to save another person from death or substantial bodily harm. (Cal. Bus. & Prof. Code §6068(e)(2) (2009); Cal. R. of Prof’l Conduct 3-100(B) (2009); ABA Model Rule 1.6(b)(1) (2009)). The ABA Model Rules, however, and the many states that follow them, take this concept a step further, allowing lawyers to disclose client confidences if necessary to prevent another from suffering financial harm – the so called “Enron exception” to the client confidentiality rules. (See, e.g., ABA Model Rule 1.6(b)(2) and (3)). California, however, so far has declined to adopt the Enron exception, and the Commission’s proposed rules also decline to adopt it, calling it a “misguided attempt[] to protect the public that ultimately [is] more harmful to the public.” (Commission for the Revision of the Rules of Prof’l Conduct, Proposed Rule 1.6, Explanation of Changes (Discussion Draft, Sept. 2009)).

The Commission provides the following two reasons for refusing to allow disclosure of client confidences in some of the same situations allowed by the ABA Model Rules, like, for example, to prevent financial harm to a third party: (1) Unlike in many states, California lawyers’ duty of confidentiality is based on legislative statute, Business & Professions Code section 6068(e)(1), and not just on state bar-enacted ethics rules; and (2) ABA “Model Rule 1.6 and its numerous exceptions are based on policy decisions that are inimical to California’s traditional emphasis on client protection.” (Id. at Introduction). In other words, in the Commission’s view, California historically has placed a higher premium on the confidential nature of the attorney-client relationship than the ABA has, and it intends to maintain this premium. Thus, the Commission has proposed a confidentiality rule in California “that more closely adheres to current rule 3-100, a rule that affords clients substantially more notice and protections than the Model rule.” (Id).

The Ninth Circuit’s recent decision, however, has exposed the frailty of California’s stand against what appears to be a national trend favoring third party rights over a client’s right of confidentiality – particularly in the face of financial harm suffered by third parties. Ruehle arises of out the stock-option backdating scandals that permeated the news in the mid 2000s. While those scandals placed in the spotlight the conduct of in-house counsel, as well as officers and directors, the aftermath of these scandals also has placed the relationship between outside attorneys and their clients under a microscope. And, while Ruehle on its face may appear only to be relevant to attorneys who conduct internal investigations, the reality is that this opinion is instructional for all attorneys. Although Ruehle addressed a number of important ethical issues, what is perhaps most interesting about the opinion is the effect on the attorney-client privilege of the application of differing burdens of proof under California and federal law. The sharply contrasting conclusions by the district court and the Ninth Circuit, each placing the burden of proof on a different party, highlight the importance of who bears the burden of proof to the ultimate conclusion about whether a communication is privileged. In Ruehle, the Ninth Circuit reversed and remanded the district court’s order in the criminal stock options backdating case against former Broadcom CFO William J. Ruehle; the district court had suppressed statements made by Ruehle to attorneys at Irell & Manella during an internal investigation of Broadcom’s stock options practices. The district court had ruled that the Government could not use these statements, which already had been disclosed to Broadcom’s Board, its auditors Ernst & Young, and the Government, as evidence against Ruehle, as they were protected by Ruehle’s attorney-client privilege. (United States v. Nicholas, 600 F. Supp. 2d 1109, 1121 (C.D. Cal. 2009)). The district court found that, because Irell represented Ruehle individually in two shareholder actions related to the alleged stock option wrongdoing, Ruehle had an attorney-client relationship with Irell, notwithstanding that Irell only represented the company, and not Ruehle individually, in connection with the internal investigation. (Id. at 1115 (“There is no serious question in this case that when Mr. Ruehle met with the Irell lawyers on June 1, 2006, Mr. Ruehle reasonably believed that an attorney-client relationship existed,…”)). A finding of an attorney-client relationship, however, does not necessarily mean that any communications between the client and the lawyer are privileged.

The district court held a three-day evidentiary hearing to resolve whether Ruehle’s statements to the Irell attorneys indeed were privileged communications. The Irell attorneys testified that, during the relevant meeting with Ruehle in his office on June 1, 2006, they had provided Ruehle with an Upjohn (or corporate Miranda) warning to make clear that he understood Irell represented only Broadcom, and not him, in the internal investigation. Thus, according to the testimony of the Irell attorneys, Ruehle was informed that any statements he made to Irell would be protected only by Broadcom’s, and not Ruehle’s, attorney-client privilege, and thus only could be waived by Broadcom, and not by Ruehle. Ruehle, on the other hand, disputed that Irell had provided him an Upjohn warning, and argued that he had an individual attorney-client relationship with Irell, and that only he, and not Broadcom, could waive the attorney-client privilege as it pertained to his June 1, 2006 interview with Irell.

Applying California law and, in particular, California Evidence Code section 917(a), the district court stated that “communications made in the course of an attorney-client relationship are presumed confidential,” and accordingly found that Ruehle’s statements to Irell in the June 1, 2006 interview were confidential and protected by Ruehle’s attorney-client privilege. (Nicholas, 600 F. Supp. 2d at 1115). Specifically, the district court determined that Ruehle “reasonably believed that an attorney-client relationship existed, he was communicating with his attorneys in the context of this relationship for the purpose of obtaining legal advice, and that any information he provided to Irell would remain confidential.” (Id). Thus, the district court suppressed all evidence reflecting Ruehle’s statements to Irell regarding the stock options backdating, including those statements made in the June 1, 2006 interview.

The Government filed an interlocutory appeal of the suppression order, and the Ninth Circuit, considering it on an expedited basis, reversed the order. In analyzing the privilege issue, the Ninth Circuit – like the district court – evaluated the parties’ arguments with the premise that Ruehle reasonably believed Irell represented him in the civil lawsuits when they met on June 1, 2006, and, thus, Ruehle had an individual attorney-client relationship with Irell. (Ruehle, 2009 U.S. App. LEXIS 21450, at **17-18). But that was the end of the two courts’ agreement. Whereas the district court applied California statutory law to determine whether the communications at issue were privileged, the Ninth Circuit concluded that the issue must be determined by federal common law. That proved to be a potentially decisive distinction.

Unlike under California law, where a communication between a client and his lawyer is presumed to be privileged, with the burden of defeating that privilege falling squarely on the party challenging it, under federal law no such presumption of privilege exists; it is the “party asserting the attorney-client privilege [who] has the burden of establishing the relationship and the privileged nature of the communication.” (Id. at *18 (quoting United States v. Bauer, 132 F.3d 504, 507 (9th Cir. 1997))). Thus, the Ninth Circuit found the district court’s application of California’s presumption to be a “critical” legal error. (Id. at *24). “At the outset we note a fundamental flaw in the district court’s analysis.‘Issues concerning application of the attorney-client privilege in the adjudication of federal law are governed by federal common law.’” (Id. at *22 (quoting Bauer, 132 F.3d at 510)).

Because, like the district court, the Ninth Circuit accepted that Ruehle reasonably believed he had an attorney-client relationship with Irell, it had to determine whether Ruehle also had a reasonable expectation that his statements made in the interview with Irell were confidential and, accordingly, protected by his individual attorney-client privilege. Recognizing that under federal law the privilege is “strictly construed” – which is contrary to California law, which takes a more liberal view of the privilege – the Ninth Circuit applied an eight-part test to determine if the attorney-client privilege covers the information sought to be withheld:

(1) Where legal advice of any kind is sought (2) from a professional legal adviser in his capacity as such, (3) the communications relating to that purpose, (4) made in confidence (5) by the client, (6) are at his instance permanently protected (7) from disclosure by himself or by the legal adviser, (8) unless the protection be waived. (Id. at **20, 24 (quoting In re Grand Jury Investigation, 974 F.2d 1068, 1071 n.2 (9th Cir. 1992))).

Placing the burden on Ruehle to establish the privileged nature of his statements to the Irell attorneys, the Ninth Circuit found that Ruehle had failed to “identify with particularity which of his communications to the Irell attorneys are within his claim of privilege,…” which “weighs in favor of disclosure; . . .” (Ruehle, 2009 U.S. App. LEXIS 21450, at *25). In particular, the Court held that Ruehle did not meet the fourth factor of the eight-part test: that the statements were “made in confidence.” (Id). Rather, it found that Ruehle made those statements with the knowledge and purpose that those statements would be disclosed to Ernst & Young as part of the stock option backdating investigation. The Ninth Circuit expressly rejected the opposite finding by the district court that Ruehle intended that the statements be maintained as confidential and had no reason to believe that they would be disclosed, determining that the factual finding was “clearly erroneous.” (Id. at *27).

In the end, the Ninth Circuit held that Ruehle had not met his burden under federal law that the statements he made to Irell attorneys in June 2006 were covered by his individual attorney-client privilege.

The Ninth Circuit’s opinion begs the question – if the district court had applied federal common law and the eight-part factor test, would it have held that the statements were privileged? Stated differently, if the Ninth Circuit had applied California law, including the presumption of privilege, would it have affirmed the district court’s suppression order? While admittedly each court interpreted the facts of the June 1, 2006 meeting, including Ruehle’s perceptions at that meeting, differently, it remains less than clear whether the different factual findings were more or less significant than the disparate applications of the burden of proof.

While the different factual findings may be limited to the facts of the Ruehle case, the issue of which burden to apply is far more universal. It certainly would be an unfortunate result if the difference in burdens as applied under California law and under federal law could result in the same communication being covered by the privilege in one case and not covered in another. Yet that appears to be a very likely scenario, given the holding in Ruehle. In many situations, clients and attorneys may not know at the time they have communications whether the privileged nature of their communications will end up being adjudicated in a state or federal court. Indeed, even in the context of an internal investigation – which certainly could end up in federal court in a securities lawsuit or SEC proceeding – the privilege also could be adjudicated by a state court judge in a state law shareholder derivative lawsuit. And, to add to the uncertainty, a state court’s determination easily could be overturned – if not legally than practically.

For example, suppose under facts similar to those described above in Ruehle, a state court determined in a breach of fiduciary duty lawsuit against Ruehle that the plaintiff failed to meet its burden of defeating the privileged nature of Ruehle’s communications with Irell. While a federal court in a parallel proceeding may not actually overturn that ruling, it could find that the same communications between Ruehle and Irell were not privileged because Ruehle could not meet his burden to prove an expectation of confidentiality. Once those communications were disclosed in a federal action by order of the federal judge, they would be forever waived in all contexts, including in the state court action. This is not the kind of certainty lawyers and clients want and need, not only from the privilege rules, but also from court orders adjudicating those privilege rules. Given the different application of burdens by state and federal courts, however, certainty may continue to be elusive, as it was for Ruehle and his Irell attorneys. Moreover, California may find itself with an uphill battle trying to preserve its historical emphasis on maintaining client rights even in the face of financial danger to third parties.