USA v. Cavallo Nero Insurance, Inc.
MEMORANDUM OPINION & ORDER: IT IS ORDERED as follows: (1) The Recommended Disposition 25 is ADOPTED IN FULL as the findings of fact and conclusion of law of the Court; (2) The United States' Objection 26 is hereby OVERRULED; & (3) Parties shall file a Joint Status Report, indicating whether any issues remain in this case, within 10 days of the date of entry of this order. Signed by Judge Joseph M. Hood on 3/27/2017.(KM)cc: COR
UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF KENTUCKY
CENTRAL DIVISION at LEXINGTON
UNITED STATES OF AMERICA,
MICRO CAP KY INSURANCE
Civil Case No.
MEMORANDUM OPINION & ORDER
UNITED STATES OF AMERICA,
CAVALLO NERO INSURANCE, INC., )
Civil Case No.
MEMORANDUM OPINION & ORDER
Disposition of United States Magistrate Judge Robert E. Wier [DE
Recommended Disposition, and Respondents having failed to submit
a Response within the allotted time period, this matter is now
Most of the documents discussed in this opinion appear in the record of both
of the above-captioned cases.
However, for the sake of simplicity, all
citations to the record will correspond to the earlier case, United States of
America v. Micro Cap KY Insurance Company, Inc., Civ. A. No. 5:16-278.
ripe for the Court’s review.
For the reasons stated herein, Judge
Wier’s Recommended Disposition is hereby ADOPTED IN FULL and the
United States’ Objection is hereby OVERRULED.
Factual and Procedural Background
Dr. Michael J. Crowe and Dr. Artis P. Truett are co-owners of
Owensboro Dermatology Associates, PSC and Dermatology Property
Management, LLC (collectively, “the Dermatology businesses”).
10-1 at 3-4].
In 2008, Drs. Crowe and Truett established Beveled
Edge Insurance Company “as a captive insurance company providing
supplemental to those covered by their commercial policies.” 2
They jointly operated Beveled Edge for three years, then
decided to dissolve it and establish their own captive insurance
aforementioned business risks.
Drs. Crowe and Truett sought advice from attorneys at Moore
Ingram Johnson & Steele, LLP (“MIJS”), who assisted them in forming
Micro Cap KY Insurance Company, Inc. and Cavallo Nero Insurance,
Inc. (collectively, “Respondents”).
[Id. at 12-13].
were organized as C corporations and elected tax treatment as
Section 831(b) captive insurance companies.
[Id. at 4].
Once Beveled Edge’s surplus grew to a certain point, Drs. Crowe and Truett
planned to replace their commercial insurance policies with Beveled Edge
policies. [DE 10-1 at 3-4].
Captive Management, LLC, a subsidiary of MIJS, currently manages
Respondents under the terms of two Captive Management Agreements.
[Id.; DE 10-9].
In 2014, the Internal Revenue Service (“IRS”) began auditing
Beveled Edge, as well as the Dermatology businesses.
[DE 10-1 at
The IRS later initiated an investigation into Respondents’
income tax liabilities for the taxable years ending on December
31, 2012, December 31, 2013, and December 31, 2014.
§ 4; DE 1-1].
[DE 1, p. 2,
As part of this inquiry, Internal Revenue Agent
Thuy Luu issued an IRS summons to Respondents, directing them to
produce several categories of documents for examination. 3
Respondents produced all documents identified in the summons,
except for a series of email communications exchanged by Dr. Crowe,
Dr. Truett, and MISJ attorneys. 4 [Id.].
Respondents insisted that
they should not be required to disclose these emails because they
were subject to attorney-client privilege.
[DE 10-1 at 13].
Petitioner, the United States, acting on behalf of the IRS, then
initiated this action in an effort to secure full compliance with
the summons. 5
Agent Luu is assigned to the Small Business/Self-Employed Division of the IRS.
[DE 1-1 at 2].
Brenda Clayton, who provided accounting services to the Dermatology businesses,
was also included in some of these email threads. [DE 10-1 at 13].
Initially, the scope of the Petition was unclear. Although the IRS summons
sought the disclosure of all documents identified in the IRS summons,
Respondents stated that they had provided the bulk of those documents, reserving
only those that they thought were subject attorney-client privilege. [DE 1, 10
Thus, the United States seemed to request the disclosure of the
potentially privileged documents, as well as the re-disclosure of all other
Once the United States filed its Petition to Enforce IRS
Summons [DE 1], the Court referred the matter to Judge Wier [DE 3]
for the preparation of a recommended disposition.
scheduled a Show Cause Hearing, at which counsel for Respondents
tendered privilege logs to the Court and the United States.
Although Judge Wier permitted the United States to file a
Respondents to submit a Reply thereto, he ultimately found it
necessary to conduct an in camera review of the documents at issue.
[Id.; DE 24].
summons enforcement was inappropriate.
Judge Wier found
privilege, as each document “predominately involve[d] legal advice
within the retention of  counsel.” 6
[Id. at 2].
Judge Wier also
rejected the United States’ argument that each Respondent had
waived its attorney-client privilege by allowing the information
documents identified in the summons. The United States later clarified that it
simply sought to obtain the allegedly privileged documents. [DE 24].
In issuing his Recommended Disposition, Judge Wier stated that he was
“operat[ing] under the express assumption that Respondents have produced all
documents responsive to the subpoenas except those expressly listed on the
privilege logs.” [DE 26 at 2]. Moreover, he assumed that the “email attachments
referenced and included within the production (e.g., completed forms, claim
settlement papers, consent documents, etc.) not marked as privileged were, in
fact produced.” [Id.]. The United States did not indicate otherwise in its
Objections, and thus, the Court proceeds under the same assumption in ruling on
at issue to be shared with the principal of the other Respondent,
reasoning that Drs. Crowe and Truett “jointly retained the law
compliance” and had a “clear commonality of interests.”
The United States then filed the Objection presently before
Standard of Review
Pursuant to 28 U.S.C. § 636(b)(1)(B) and Federal Rule of Civil
Procedure 72(b), a district court judge may refer dispositive
matters to a magistrate judge for the preparation of a report and
The magistrate judge must conduct the necessary
proceedings and enter a recommended disposition in a timely manner.
Fed. R. Civ. P. 72(b)(1).
If a party files objections to that
recommended disposition, the district court judge must review the
contested portions de novo and “accept, reject, or modify the
recommended disposition; receive further evidence; or return the
matter to the magistrate judge with instructions.”
Fed. R. Civ.
disagreement with a magistrate’s suggested resolution, or simply
summarizes what has been presented before, is not an ‘objection’
as that term is used in this context.”
VanDiver v. Martin, 304 F.
Supp. 2d 934, 937-38 (E.D. Mich. 2004).
At the same time, many
circuits have held that “arguments not made before a magistrate
judge are normally waived.”
See, e.g., United States v. Melgar,
227 F.3d 1038, 1040 (7th Cir. 2000).
Although the Sixth Circuit
has not squarely addressed this issue, it has “indicated that a
party’s failure to raise an argument before the magistrate judge
constitutes a waiver.”
The Glidden Co. v. Kinsella, 386 F. App’x
535, 544 n. 2 (6th Cir. 2010) (citing Murr v. United States, 200
F.3d 895, 902 n. 1 (6th Cir. 2000)).
In this case, the United States argues, for the first time,
that Respondents have waived their attorney-client privilege by
filing a Petition against the Commissioner of Internal Revenue in
the United States Tax Court.
Specifically, Respondents, who are
styled as Petitioners in that proceeding, placed their attorneyclient communications at issue in that case by asserting in their
Petition that they “relied solely on the advice of counsel for all
positions taken on the income tax returns for the 2012, 2013 and
2014 tax years.”
The United States acknowledges that its argument
is untimely, but insists, without elaboration, that “exceptional
proceedings and those of the Tax Court case.”
[DE 27 at 10].
The record reflects that Respondents filed their Petition in
the Tax Court on September 9, 2016, more than a month before the
parties began to litigate the sufficiency of the privilege log and
Respondents’ initial Petition in the Tax Court clearly articulates
a “reasonable cause” defense, the United States insists that it
was unable to raise the waiver argument in this Court until it
filed its Objection to Judge Wier’s Recommended Disposition on
February 22, 2017.
The United States fails to explain why this
After all, the United States does not suggest that it was
unaware of the Tax Court proceeding, 7 and the “reasonable cause”
defense was certainly raised at the outset of that case.
it appears that the United States could, and should, have raised
this issue before Judge Wier, the Court finds that its argument is
However, even if the Court were to consider the United
States’ argument on the merits, it would fail, for reasons stated
It is true that use of the “reasonable cause” defense may
result in a waiver of the attorney-client privilege in a variety
of proceedings, including those before the Tax Court.
Investment 2000 Fund, LLC v. C.I.R., 142 T.C. 248, 254-55 (2014)
(finding that, “[i]f petitioners persist” in their reasonable
knowledge of the contents of the opinions and the opportunity to
put those opinions into evidence”); see also New Phoenix Sunrise
Such an argument would be difficult to maintain, as the same parties are
essentially involved in both cases. After all, the United States is proceeding
against Respondents on behalf of the IRS in this case, and Respondents are
proceeding against the IRS Commissioner in the Tax Court case.
(concluding that “[t]he tax court correctly held that [petitioner]
had voluntarily waived its privilege by raising a reasonable cause
defense premised on acclaim of reasonable reliance on the [law
firm’s] tax opinion”).
That being said, the assertion of the “reasonable cause”
defense in a pleading does not lead to the automatic disclosure of
Ad Investment 2000, 142 T.C. at 258-59.
merely gives the Commissioner grounds to compel the production of
documents subject to the attorney-client privilege.
Tax Court Rules 70, 72.
Id.; see also
Even when such a motion to compel is well-
taken, case law suggests that disclosure may not result.
example, in Ad Investment 2000, the Tax Court found that the
petitioners had waived their attorney-client privilege by putting
protected communications at issue, and ordered the petitioners to
produce the privileged documents.
However, the Tax Court
simultaneously indicated that the petitioners could still protect
their documents from disclosure by abandoning their “reasonable
cause” defense. 8
Id. (stating that, if the petitioners “persist,
they sacrifice the privilege to withhold the contents of the
By raising the “reasonable cause” defense in their Petition,
Respondents gave the Commissioner grounds to request that the Tax
Specifically, the Tax Court stated that, if the petitioners failed to produce
those documents, it would prohibit them from relying on any evidence in support
of their reasonable cause defense. Id.
Court compel production of documents subject to the attorneyclient privilege.
The Commissioner has not yet made such a
request, and even if he had, case law indicates that production
does not necessarily follow. 9
Thus, the United States essentially
asks the Court to order the disclosure of privileged material based
on what it believes will happen in another forum.
Given the early
stage of the Tax Court litigation, this Court hesitates to rely
too heavily on the United States’ predictions.
disclosure of privileged documents may later result in that forum.
This Court does not wish to force their hand by
privileged. Thus, the United States’ argument fails on the merits.
Accordingly, for the reasons stated herein,
IT IS ORDERED as follows:
The Recommended Disposition [DE 26] is hereby ADOPTED IN
FULL as the findings of fact and conclusions of law of
The record of the Tax Court proceeding is available online. See United
States Tax Court,
(last visited Mar. 27, 2017).
The parties shall file a Joint Status Report, indicating
whether any issues remain in this case, within ten (10)
days of the date of entry of this Order.
This the 27th day of March, 2017.
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