In copyright infringement case against German media
conglomerate, Ninth Circuit rules that, in civil case in which party seeks
outright disclosure of attorney‑client communications under crime‑fraud
exception: (1) both parties have right to present evidence to district court,
and (2) party seeking disclosure must prove by preponderance of evidence that
exception applies; and (3) on facts of this case, Plaintiffs have not
established crime‑fraud exception
In the main litigation transferred to a California federal
court, UMG Recording, Inc. and nineteen other media companies and individuals
(Plaintiffs), sued Bertelsmann AG (Defendant), a German media conglomerate,
along with Bertelsmann, Inc. and seven other Defendants, both individuals and
partnerships. Many of the copyright issues raised arise out of the demise and
bankruptcy of Napster, the online file‑sharing music service also pending in
the same court.
The complaint asserted Defendant’s vicarious and
contributory liability for alleged copyright infringement based on Defendants’
substantial loans to Napster which thereby involved itself in Napster’s alleged
infringements of Plaintiffs’ copyrights.
Plaintiffs alleged, inter alia, that Napster’s service
facilitated the unauthorized reproduction and distribution of copyrighted
digital music files. In July 2000, the district court ordered Napster to search
for, and remove from its service, files that rights holders had identified as
infringing. The Ninth Circuit substantially affirmed in February 2001.
Napster’s service was shut down in July 2001 after it failed
to comply with the terms of a modified preliminary injunction. In June 2002,
Napster filed for bankruptcy before the courts had ruled on its ultimate
liability for copyright infringement.
Between October 2000 and October 2001, Defendant lent
Napster about $85 million to finance its looked for transition to a licensed
digital music distribution system. Napster failed fully to launch the new
licensed system, however, before declaring bankruptcy. Defendant did not come
away with Napster’s assets in the bankruptcy proceedings.
In April 2003, Plaintiffs and others separately filed suit
against Defendant in a New York federal court, claiming that Defendant was
vicariously and contributorily liable for copyright infringement by Napster
and/or Napster’s users. More particularly, Plaintiffs claimed that, by lending
Napster millions of dollars, Defendant took effective control over Napster’s
infringing file‑sharing service, and prolonged its allegedly unlawful
operations.
The plan was seemingly to avoid the loss of Napster’s 40
million or so users before the new licensed digital music distribution system
became functional. The Multidistrict Litigation Panel transferred Plaintiffs’
suits against Defendant to the Northern District of California, where the In re
Napster, Inc. Copyright Litigation was pending.
Defendant moved to dismiss Plaintiffs’ suits for failure to
state a claim in July 2003. It argued that, as a matter of law, merely lending
money to an alleged copyright infringer cannot give rise to liability under
either a vicarious or contributory copyright infringement theory. Defendant
further contended that its loan did not enable it to take control of Napster.
The district court denied Defendant’s motion.
In November 2005, Plaintiffs moved to compel Defendant to
produce all attorney‑client communications relating to a $50 million loan,
convertible to equity, that Defendant had made to Napster in October 2000 while
Napster was appealing the initial preliminary injunction.
Plaintiffs charged that, starting in September 2000 when
drafting of the loan documents began, Defendant had taken part in a continuing
scheme to defraud the courts. They argued that the crime‑fraud exception to the
attorney‑client privilege applied to these communications relying on two
theories of “fraudulent deceit” as defined in the California Civil Code.
First, Plaintiffs argued that Defendant’s “loan” to Napster
was not in fact a loan. Instead, it consisted of cash tendered in exchange for
an equity stake in the company. According to Plaintiffs, Defendant had its
lawyers create sham loan documents aimed at disguising what was, in reality, a
purchase of control over Napster. Plaintiffs further charged that Defendant,
looking to future copyright infringement litigation, planned to use the
spurious loan documents to hoodwink the courts into deciding that it was not an
equity owner and thus was not liable for Napster’s wrongful actions.
In support of its “sham loan” theory, Plaintiffs pointed to
several pieces of circumstantial evidence. They cited internal Defendant
documents showing that the company’s executives and outside counsel tried to
structure the transaction in such a way as to avoid copyright liability.
Moreover, by its express terms, the $50 million loan was
convertible to equity in Napster in lieu of repayment once the licensed digital
music distribution system got off the ground. In one e‑mail, for instance,
counsel for Defendant stated that the “loan has to look like a loan, otherwise
it will be characterized as equity and [Defendant] may have liability for
copyright infringement in the minds of some lawyers.”
Under their second fraud theory, Plaintiffs contended that
Defendant, through its lawyers, was trying to defraud the courts by omitting
from the loan documents a secret “side agreement;” it allowed Napster to
channel some of the $50 million into paying Napster’s litigation expenses.
Plaintiffs argued that Defendant stood to benefit if continuing litigation
allowed Napster’s existing service to stay operational until the anticipated
new system was in place, thereby avoiding dispersion of the customer base.
Plaintiffs cited several e‑mails in support of this theory plus other
circumstantial evidence gleaned from discovery depositions.
In opposition, Defendant protested that evidence that it
structured a corporate transaction to limit its liability did not prove either
that the loan documents were a sham or that they were meant to defraud the
courts. Defendant further contended that there was no such thing as a secret
side agreement about litigation expenses. It cited various items of testimony
in discovery depositions and elsewhere to support its position.
On April 20, 2006, the district court issued an order
compelling Defendant to reveal all attorney‑client communications which had to
do with the creation of the loan document and the use of that loan document in
the bankruptcy proceedings and before the district court. The court held that
Plaintiffs had made out a “prima facie” showing that the crime‑fraud exception
applied under Ninth Circuit precedent, describing this test as “quite lenient.”
The lower court also ruled that, in deciding whether the
crime‑fraud exception applied, it “need only consider the evidence offered by
the moving party,” and that it does not have to take into account “conflicting
evidence offered by the party seeking to uphold the privilege.” The court cited
several items of evidence offered by Plaintiffs and said that, in any event,
Defendant’s counter‑evidence would not have persuaded it.
After assessing the facts, the district court upheld the
Defendant’s privilege and rejected the Plaintiffs’ crime or fraud contentions.
Plaintiffs then filed an interlocutory appeal and a petition for mandamus. On
March 14 , the U.S. Court of Appeals for the Ninth Circuit reverses and
remands.
The underlying litigation being far from yielding a “final
judgment” under 28 U.S.C. Section 1291, the Court of Appeals concludes it has
appellate jurisdiction under the “collateral offshoot” doctrine. The issue in
this interlocutory appeal is whether Plaintiffs may invade Defendant’s attorney‑client
privilege because Defendant used, or intended to use, its counsel to commit a
fraud on the courts.
“We conclude that the attorney‑client privilege issue
presented in this interlocutory appeal is ‘completely separate from the merits
of the action.’ That is, the privilege issue is ‘too important to be denied
review and too independent of the cause itself to require that appellate
consideration be deferred until the whole case is adjudicated.’ Cohen v.
Beneficial Industrial Loan Corp., 337 U.S. 541, 546 (1949).” The Court,
therefore, need not reach the questions posed by the mandamus petition.
The Court then launches on the thorny questions presented.
“The attorney‑client privilege is the oldest and arguably most fundamental of
the common law privileges recognized under Federal Rule of Evidence 501. See
United States v. Zolin, 491 U.S. 554, 562 (1989). The assurance of
confidentiality promotes open attorney‑client communications, which are
‘central to the legal system and the adversary process.’ United States v. Hodge
& Zweig, 548 F.2d 1347, 1355 (9th Cir. 1977). The attorney‑client privilege
protects fundamental liberty interests by allowing individuals to seek the
legal advice they need ‘to guide them through [the] thickets’ of complex laws.
United States v. Chen, 99 F.3d 1495, 1499 (9th Cir. 1996).”
“Notwithstanding its importance, the attorney‑client
privilege is not absolute. The ‘crime‑fraud exception’ to the privilege
protects against abuse of the attorney‑client relationship. Hodge & Zweig,
id. As the Supreme Court wrote in Clark v. United States, 289 U.S. 1 (1933),
‘The privilege takes flight if the relation is abused. A client who consults an
attorney for advice that will serve him in the commission of a fraud will have
no help from the law. He must let the truth be told.’ Id. at 15.”
“The attorney need not have been aware that the client
harbored an improper purpose. Because both the legal advice and the privilege
are for the benefit of the client, it is the client’s knowledge and intent that
are relevant. [Cites]. The planned crime or fraud need not have succeeded for
the exception to apply. The client’s abuse of the attorney‑client relationship,
not his or her successful criminal or fraudulent act, vitiates the privilege.
[Cite]. Despite the fundamental importance and long history of the attorney‑client
privilege and the crime‑fraud exception, the procedures for preserving the
privilege against a crime‑fraud challenge are surprisingly unclear.”
“Among [the unanswered questions are], first, what
procedures are to be followed when an order to compel outright disclosure
(rather than in camera review) is at stake? Second, what is the burden of proof
on the party seeking to compel outright disclosure under the crime‑fraud
exception?”
“The two questions relevant to this appeal are subsets of
the questions noted above that were left unanswered by Zolin. First, in a civil
case, should the district court consider not only the evidence adduced by the
party seeking to vitiate the attorney‑client privilege by invoking the crime‑fraud
exception, but also the evidence adduced by the party seeking to preserve the
privilege? Second, in a civil case, what is the burden of proof for the party
seeking to establish the crime‑fraud exception? We address these questions in
turn.”
“We begin our analysis with Zolin, in which the Internal
Revenue Service sought to vitiate the attorney‑client privilege under the crime‑fraud
exception. The question in Zolin was whether a party seeking to establish that
the crime‑fraud exception applies must rely entirely on sources independent of
the disputed attorney‑client communications, or whether a district court ‘may
ever honor’ a request that it conduct in camera review of some of the
communications to assist in the determination that the privilege has been
vitiated. Zolin supra, at 560‑61, 565.”
“The Court first looked to Federal Rule of Evidence 104(a),
which provides that ‘[p]reliminary questions concerning . . . the existence of
a privilege . . . shall be determined by the court . . . . In making its
determination it is not bound by the rules of evidence except those with
respect to privileges.’ Zolin, supra at 565. Neither [side] in this case
requested that the district court conduct in camera review of the disputed
communications.”
“We have never squarely ruled on the question whether a
party in a civil case, seeking to preserve the attorney‑client privilege
against a crime‑fraud challenge, has the right to present countervailing
evidence when the district court is deciding whether to order outright
disclosure. ...We hold that in civil cases where outright disclosure is
requested, the party seeking to preserve the privilege has the right to
introduce countervailing evidence. In so holding, we agree with the well‑reasoned
decision of Judge Aldisert for the Third Circuit in Haines v. Liggett Group,
Inc., 975 F.2d 81, 96‑97 (3d Cir. 1992). That court wrote: ‘Deciding whether
the crime‑fraud exception applies is another matter [from deciding whether to
conduct in camera review]. If the party seeking to apply the exception has made
its initial showing, then a more formal procedure is required than that
entitling plaintiff to in camera review. The importance of the privilege, ...
as well as fundamental concepts of due process require that the party defending
the privilege be given the opportunity to be heard, by evidence and argument,
at the hearing seeking an exception to the privilege.’”
“We are not convinced that in all cases it is necessary for
the district court to conduct a live hearing with oral argument; in appropriate
cases, the court may decide the matter on the papers. But we are convinced, ...
that, in a civil case, the party resisting an order to disclose materials
allegedly protected by the attorney‑client privilege must be given the
opportunity to present evidence and argument in support of its claim of
privilege.”
The second key point addressed by the Appellate Court deals
with burden of persuasion issues. “The Court in Zolin adhered to the cryptic
statement made more than fifty years earlier in Clark that the burden of proof
on the party seeking to vitiate a privilege was to make ‘a showing of a prima
facie case sufficient to satisfy the judge that the light should be let in.’
Clark, supra, at 14.”
“We have never squarely addressed the question whether our ‘reasonable
cause to believe’ standard, applicable in grand jury cases, is also applicable
in civil cases. In [cite], a criminal appeal rather than a grand jury case, we
wrote without elaboration: ‘All the government needed to show was evidence
that, if believed by the jury, would establish the elements of an ongoing
violation.’”
“For several reasons, we conclude that, in a civil case, the
burden of proof that must be carried by a party seeking outright disclosure of
attorney‑client communications under the crime‑fraud exception should be
preponderance of the evidence. First, requiring a moving party to establish the
existence of the crime‑fraud exception by a preponderance of the evidence is
consonant with the importance of the attorney‑client privilege.”
“Second, the phrase ‘prima facie case,’ used by the Court in
Clark and then fifty years later in Zolin, is not inconsistent with a
preponderance of the evidence standard. ... As it relates to the crime‑fraud
exception, ‘[t]he prima facie standard has always been poorly defined,
inconsistently interpreted and generally misunderstood.’ Paul R. Rice, Attorney‑Client
Privilege in the United States Section 8.6, at 44 (2d ed. 1999).”
“Zolin is therefore not directly on point, but we believe
that it signals that preliminary questions concerning the existence or non‑existence
of the attorney‑client privilege—including whether the crime‑fraud exception
‘terminate[s] the privilege,’—must be established under Rule 104(a). And we
know from Bourjaily v. United States, 483 U.S. 171 (1987), that preliminary
questions of fact under Rule 104(a) must be established by a preponderance of
the evidence.”
“Finally, the problem of limited access to proof by the
party seeking to vitiate the attorney‑client privilege is mitigated by the
possibility of in camera review of the communications by the district court
under the far less demanding standard of Zolin. We do not regard in camera
review as a panacea, for a ‘blanket rule allowing in camera review ... would
place the policy of protecting open and legitimate disclosure between attorneys
and clients at undue risk.’”
“But judicious use of in camera review, combined with a
preponderance burden for terminating privilege, strikes a better balance
between the importance of the attorney‑client privilege and deterrence of its
abuse than a low threshold for outright disclosure. Looking at the evidence
presented in this case under the preponderance standard, we hold that even if
all of the evidence proffered by [Plaintiffs] is believed, there is an
insufficient basis to hold that the attorney‑client privilege may be vitiated
under the crime‑fraud exception.”
“... [Plaintiffs] rely on two theories of fraud on the
court. The first is that the entire loan was a sham intended for use in future
legal proceedings as a means of disguising [Defendant’s] purchase of control of
Napster. [Plaintiffs’] second theory is that [Defendant] undertook a scheme to
defraud the courts by hiding a side agreement that allowed Napster to use a
portion of the loan proceeds to pay its litigation expenses.”
“Even if we credit the Barry e‑mail, the Timm memorandum,
and the Barry deposition testimony relied on by the district court, and even if
we conclude that [Defendant] agreed with Napster that the term ‘overhead costs’
in the loan documents would include litigation expenses, we would not conclude
that this evidence establishes an intentional, material misrepresentation
directly ‘aimed at the court.’”
“Taken either alone or along with [Defendant’s] evidence,
[Plaintiffs’] evidence does not establish that the loan terms constituted a
fraud. Rather, the evidence shows routine wrangling over contract terms and a
lawyerly attempt to make inconspicuous the fact that some of the money could be
used for litigation expenses. Second, even if we were to conclude that the
written terms of the loan misrepresented the parties’ agreement to allow some
of the funds to be used for litigation expenses, [Plaintiffs’] evidence nowhere
suggests that [Defendant] selected these terms with the intent to defraud the
courts.”
“Third, even assuming, arguendo, that [Defendant’s] failure
to spell out in the loan documents that ‘overhead costs’ included litigation
expenses was an intentional misrepresentation, we do not see how it could have
deceived a court into concluding that Bertelsmann provided no financial support
to, or had no financial stake in, the existing Napster company.”
“For the foregoing reasons, in a civil case in which
outright disclosure of attorney‑client communications is sought under the crime‑fraud
exception, we hold that (1) both parties have a right to present evidence to
the district court, and (2) the party seeking disclosure must prove by a
preponderance of the evidence that the exception applies. We further hold that
on the facts of this case the crime‑fraud exception has not been established.”
[Slip op. 7‑15].
Citation: In re: Napster, Inc. Copyright Litigation,
479 F.3d 1078 (9th Cir. 2007).
**** Terik Hashmi is a business consultant serving businesses in the marketing realm. Among his clients are a medical service provider and an Online Reputation Management company. - Attorney Website at: https://terikhashmiattorney.com/ - Attorney Profile at: https://solomonlawguild.com/terik-hashmi%2C-esq# - Attorney News at https://attorneygazette.com/terik-hashmi%2C-consultant#eec97f53-49a0-4c94-869a-4847514cb694