USA v. Cavallo Nero Insurance, Inc.

Filing 27

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,

)
)
)
)
)
)
)
)
)
)

Petitioner,
v.
MICRO CAP KY INSURANCE
COMPANY, INC.,
Respondent.

Civil Case No.
5:16-cv-278-JMH-REW

MEMORANDUM OPINION & ORDER

*******
UNITED STATES OF AMERICA,

)
)
Petitioner,
)
)
v.
)
)
CAVALLO NERO INSURANCE, INC., )
)
Respondent.
)
)

Civil Case No.
5:16-cv-279-JMH-REW

MEMORANDUM OPINION & ORDER

*******
I.

Introduction
This

matter

is

before

the

Court

upon

the

Recommended

Disposition of United States Magistrate Judge Robert E. Wier [DE
26]. 1

Petitioner

having

filed

an

Objection

[DE

27]

to

the

Recommended Disposition, and Respondents having failed to submit
a Response within the allotted time period, this matter is now

1

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.
1

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.
II.

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].

[DE

In 2008, Drs. Crowe and Truett established Beveled

Edge Insurance Company “as a captive insurance company providing
direct

property

Dermatology

and

casualty

businesses]

to

insurance

cover

risks

policies
of

the

to

[the

business

supplemental to those covered by their commercial policies.” 2
[Id.].

They jointly operated Beveled Edge for three years, then

decided to dissolve it and establish their own captive insurance
companies

to

insure

their

aforementioned business risks.

respective

portions

of

the

[Id.].

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].

Respondents

were organized as C corporations and elected tax treatment as
Section 831(b) captive insurance companies.

2

[Id. at 4].

MIJS

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].
2

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.
3-4].

[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

[Id.].

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

[DE 1].

3

Agent Luu is assigned to the Small Business/Self-Employed Division of the IRS.
[DE 1-1 at 2].
4
Brenda Clayton, who provided accounting services to the Dermatology businesses,
was also included in some of these email threads. [DE 10-1 at 13].
5
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
at 13].
Thus, the United States seemed to request the disclosure of the
potentially privileged documents, as well as the re-disclosure of all other
3

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.

Judge Wier

scheduled a Show Cause Hearing, at which counsel for Respondents
tendered privilege logs to the Court and the United States.
21].

[DE

Although Judge Wier permitted the United States to file a

Response

to

the

tendered

privilege

logs,

and

also

allowed

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].
After
Recommended

reviewing

these

Disposition,

in

documents,
which

he

summons enforcement was inappropriate.
that

Respondents

had

properly

Judge

Wier

concluded
[DE 26].

invoked

the

issued

that

his

further

Judge Wier found
attorney-client

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].
6
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
those Objections.
4

at issue to be shared with the principal of the other Respondent,
reasoning that Drs. Crowe and Truett “jointly retained the law
firm

for

the

purposes

of

captive

formation,

management

compliance” and had a “clear commonality of interests.”
3].

and

[Id. at

The United States then filed the Objection presently before

the Court.
II.

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
recommendation.

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.

P. 72(c).
“An

‘objection’

that

does

nothing

more

than

state

a

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
5

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
circumstances

exist

because

of

the

timing

proceedings and those of the Tax Court case.”

of

the

current

[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
the

necessity

of

in

camera

review

in

this

case.

Although

Respondents’ initial Petition in the Tax Court clearly articulates
6

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.
was so.

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.

Because

it appears that the United States could, and should, have raised
this issue before Judge Wier, the Court finds that its argument is
waived.

However, even if the Court were to consider the United

States’ argument on the merits, it would fail, for reasons stated
below.
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.

See Ad

Investment 2000 Fund, LLC v. C.I.R., 142 T.C. 248, 254-55 (2014)
(finding that, “[i]f petitioners persist” in their reasonable
cause

defense,

“it

would

be

unfair

to

deprive

respondent

of

knowledge of the contents of the opinions and the opportunity to
put those opinions into evidence”); see also New Phoenix Sunrise
Corp.

v.

C.I.R.,

408

F.

App’x

7

908,

919-20

(6th

Cir.

2010)

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.
7

(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
privileged documents.

Ad Investment 2000, 142 T.C. at 258-59.

It

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.

For

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.

Id.

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
opinions”).
By raising the “reasonable cause” defense in their Petition,
Respondents gave the Commissioner grounds to request that the Tax

8

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.
8

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.

If Respondents

persist

defense,

in

asserting

the

“reasonable

cause”

then

disclosure of privileged documents may later result in that forum.
However,

this

Respondents.
ordering

is

a

strategic

decision

that

must

be

made

by

This Court does not wish to force their hand by

the

disclosure

of

documents

that

are

otherwise

privileged. Thus, the United States’ argument fails on the merits.
IV.

Conclusion
Accordingly, for the reasons stated herein,
IT IS ORDERED as follows:
(1)

The Recommended Disposition [DE 26] is hereby ADOPTED IN
FULL as the findings of fact and conclusions of law of
the Court;

9

The record of the Tax Court proceeding is available online. See United
States Tax Court,
https://www.ustaxcourt.gov/UstcDockInq/DocketDisplay.aspx?DocketNo=16019825
(last visited Mar. 27, 2017).
9

(2)

The

United

States’

Objection

[DE

27]

is

hereby

OVERRULED; and
(3)

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.

10