                         119 T.C. No. 3



                    UNITED STATES TAX COURT



THOMAS E. JOHNSTON AND THOMAS E. JOHNSTON, SUCCESSOR IN INTEREST
    TO SHIRLEY L. JOHNSTON, DECEASED, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket Nos. 26005-96, 2266-97,        Filed August 8, 2002.
                12736-97.


         Held: In this case involving a question of
    Federal taxes, respondent’s motion in limine to deny
    petitioners’ entitlement to assert the attorney-client
    privilege, granted based on the Federal common law
    doctrine of implied waiver.

         Held, further, respondent’s motion for partial
    summary judgment, requesting collateral estoppel based
    on State court proceedings, denied.


    Lorraine G. Howell, for petitioners.

    Louis B. Jack, for respondent.



    1
       Cases of the following petitioners are consolidated
herewith: Thomas E. Johnston, docket No. 2266-97; and Eric T.
Johnston, docket No. 12736-97.
                                     - 2 -


                                    OPINION


     NIMS, Judge:       Respondent determined the following

deficiencies and penalties with respect to petitioners’ Federal

income taxes:

                                                            Penalties
       Petitioner           Year      Deficiency   Sec. 6662(a)    Sec. 6663


Thomas E. Johnston and *    1989     $1,546,160     $309,232      $1,159,620
* * Shirley L. Johnston,
Deceased

   Docket No. 26005-96


Thomas E. Johnston          1991       289,396         --           217,047

   Docket No. 2266-97
                            1992       341,908         --           256,431


Eric T. Johnston            1989       165,067        33,013            --

   Docket No. 12736-97



By answer respondent also asserted increased deficiencies and

penalties in docket Nos. 26005-96 and 2266-97.

     These consolidated cases are presently before the Court on

two motions filed by respondent.         Respondent filed a motion for

partial summary judgment with respect to docket Nos. 26005-96 and

2266-97 and a motion in limine with respect to docket Nos. 26005-

96, 2266-97, and 12736-97.         A hearing was subsequently held, and

these motions were taken under advisement.           Pursuant to orders of
                                - 3 -

the Court, petitioners thereafter filed an opposition to each of

respondent’s motions, and respondent filed responses to

petitioners’ objections.

     Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the years at

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

                             Background

     The information below is based upon examination of the

pleadings, moving papers, responses, and attachments submitted in

connection with these cases.   Factual recitations are meant to

provide context for our analysis of respondent’s motions and

endeavor to set forth matters that would appear not to be in

dispute.    They do not, however, constitute findings of fact for a

subsequent trial.

Estrella Properties, Ltd.

     Prior to and during the years at issue, Thomas E. Johnston

(Mr. Johnston) was involved in the real estate development

business.   As relevant herein, he conducted certain of his real

estate activities through his wholly owned corporation, Sea-Aire

Properties, Inc. (Sea-Aire).   In the mid-1970s, Mr. Johnston,

through Sea-Aire, became involved in Estrella Properties, Ltd.

(Estrella), a California limited partnership.   Estrella had been
                                    - 4 -

established to develop a portion of the Forster Ranch2 in San

Clemente, California.        From June 30, 1978, through March 30,

1989, ownership of Estrella was distributed as follows:

         Partner Name            Interest Percentage    Interest Type
Shannon Developers, Inc.             10 Percent            General
Leo A. Fitzsimon                      5 Percent            General
Borg-Warner Equity Corp.             79 Percent            Limited
Sea-Aire Properties, Inc.             6 Percent            Limited

     Shannon Developers, Inc. (Shannon),3 a corporation wholly

owned by Darrel S. Spence, was also designated as the managing

general partner.        Leo A. Fitzsimon received the ownership

interest reflected above after having been employed for several

years as a project manager and engineer for Estrella’s

development of the Forster Ranch.         Borg-Warner Equity Corp., or a

subsidiary (without distinction Borg-Warner), had provided the

funding used to finance the venture.

     On March 30, 1989, the partners in Estrella entered a

Partnership Settlement Agreement providing for disposition of

assets owned by the entity.        This arrangement was apparently

precipitated by dissatisfaction on the part of Borg-Warner with



     2
       This property is variously referred to in filings
submitted by the parties as both the Forster Ranch and the
Forester Ranch. For convenience we uniformly use the Forster
terminology.
     3
      It appears from documents submitted that Shannon
Developers, Inc., may have been known as Shannon Development Co.
in 1978 but had become Shannon Developers, Inc., by 1989.
                                - 5 -

the handling of partnership affairs.    Pursuant to the settlement

agreement, the Forster Ranch property, with the exception of 22

lots referred to as the equestrian lots, was sold, and the

proceeds were applied to reduce the unpaid balance on the funding

provided through Borg-Warner.   Certain other properties were

distributed to Shannon, Sea-Aire, and Mr. Fitzsimon in undivided

interests of 47.62 percent, 28.57 percent, and 23.81 percent,

respectively.   These properties included the equestrian lots and

the stock of Shorecliffs Golf Course, Inc.4 (Shorecliffs).

Shorecliffs held title to a golf course of the same name which

had previously been acquired by Estrella and the business of

which was operated by Mr. Spence.

S.C. Equestrian Lots, Ltd.

     Following the just-described settlement, the 22 equestrian

lots were contributed to form S.C. Equestrian Lots, Ltd. (SCE), a

California limited partnership.   Sea-Aire served as the general

partner through at least July 1, 1992.   Thereafter, Uppaway

Investments, Inc. (Uppaway), another entity related to Mr.

Johnston, seems to have been substituted as general partner.

Both Mr. Johnston and Mr. Fitzsimon were named as limited



     4
       The various documents and filings submitted by the parties
refer to this entity both as Shorecliffs Golf Course, Inc., and
as Shorecliff Golf Course, Inc. The plural form was selected by
petitioners and respondent in their memoranda addressing the
instant motions, and we for clarity adopt the plural throughout
our discussion.
                               - 6 -

partners of SCE in partnership documents; Mr. Spence and/or

Shannon were not.   A promissory note and option agreement dated

April 21, 1989, and executed by Mr. Johnston on behalf of Sea-

Aire, would appear to reflect the sale of Shannon’s undivided

interest in the lots to Sea-Aire.

Sale of Shorecliffs Golf Course

     By late 1988 and continuing through the middle of 1989, Mr.

Spence was involved in negotiations for the sale of the golf

course owned by Shorecliffs.   In this connection, a real estate

purchase option was entered for consideration of approximately

$500,000 on December 23, 1988, by Mr. Spence on behalf of

Shorecliffs as optionor and by Fon N. Leong and Agie J.C. Chen as

optionees.

     In addition to the above negotiations relating to the sale

of the assets owned by Shorecliffs, discussions also ensued

during this period among the Shorecliffs shareholders with regard

to their respective interests in the entity.   On May 11, 1989, a

stock sale option agreement was signed by or on behalf of

Shannon, Sea-Aire, and Mr. Fitzsimon.   The option granted to

Shannon the right to purchase the Shorecliffs stock owned by Sea-

Aire and Mr. Fitzsimon.   However, Mr. Spence and Mr. Johnston

purportedly had an oral understanding that Sea-Aire could choose
                                - 7 -

to retain its interest in the company.     Shannon did in fact

exercise its option to purchase the Shorecliffs stock owned by

Mr. Fitzsimon.   Sea-Aire, on the other hand, retained its

interest in Shorecliffs.

     On June 28, 1989, Mr. Spence and Mr. Johnston met with

attorney Thomas J. O’Keefe to discuss matters relating to the

pending sale of the Shorecliffs golf course.     After certain

extensions and modifications of the terms contemplated by the

December 23, 1988, option agreement, a sale of the golf course

ultimately closed on June 30, 1989.     The buyers were L.H.C.

Investments, Fon N. Leong, and Ruth Li Shu Leong.     The total

purchase price of between $5 and $6 million was paid in part by a

$3 million promissory note secured by deed of trust.

State Court Litigation

     The foregoing transactions eventually resulted in two suits

filed by Mr. Fitzsimon in the Superior Court of the State of

California, County of Orange.   The first, Fitzsimon v. S.C.

Equestrian Lots, Ltd., No. 704870 (Cal. Super. Ct. June 9, 1995),

was brought in February of 1993 against, among others, SCE, Mr.

Johnston, Sea-Aire, Uppaway, Eric Johnston, Mr. Spence, Shannon,

and Shorecliffs.   The complaint set forth 15 causes of action

based on grounds such as fraud, intentional misrepresentation,

breach of contract, breach of fiduciary duty, negligence, and

conversion.   As most relevant for purposes of the motions now at
                                - 8 -

bar, the complaint alleged:    (1) That Mr. Johnston and Mr. Spence

fraudulently induced Mr. Fitzsimon to relinquish his interest in

Shorecliffs shortly before the multimillion-dollar sale, and (2)

that Mr. Fitzsimon was deprived of profits from the SCE venture

on account of self-dealing transactions and diversion of proceeds

by other partners. Requested relief included damages, imposition

of constructive trust, declaratory relief, injunctive relief,

dissolution of partnership, and accounting.

     Following waiver by the parties of a jury, a bench trial

began in late June of 1994.    The Johnstons and their related

entities were represented by counsel.    The Superior Court

thereafter rendered its findings in a special verdict form

executed on October 6, 1994.    Among other things, the court found

that Mr. Spence, Shannon, Mr. Johnston, and Sea-Aire

intentionally defrauded Mr. Fitzsimon in connection with sale of

the Shorecliffs golf course.    The special verdict also included a

finding that Mr. Spence was an alter ego of Shannon and that Mr.

Johnston was an alter ego of Sea-Aire and Uppaway.    As regards

the equestrian lots dispute, it was stipulated that SCE should be

dissolved and a final accounting conducted.

     An accounting referee was appointed by the court to provide

recommendations on the accounting matters.    After extensive

comment from the parties, the court on June 9, 1995, entered its

judgment addressing both the Shorecliffs and the SCE
                                - 9 -

transactions.    Mr. Fitzsimon was awarded compensatory damages

against Mr. Spence, Mr. Johnston, and their related entities, as

well as punitive damages against Mr. Spence and Shannon.    A

constructive trust was imposed on the $3 million note secured by

deed of trust.    The ruling with respect to alter ego status was

also explicitly reiterated.

     The judgment was appealed by Mr. Johnston and his related

entities to the Court of Appeal of the State of California,

Fourth Appellate District, Division Three.    Fitzsimon v. S.C.

Equestrian Lots, Ltd., No. G018290 (Cal. Ct. App. May 25, 1999).

The appellate court affirmed in an unpublished opinion filed on

May 25, 1999, and the decision became final with issuance of a

remittitur by the Court of Appeal on July 29, 1999.

     The second suit brought by Mr. Fitzsimon, Fitzsimon v. Good,

Wildman, Hegness & Walley, No. 733226 (Cal. Super. Ct.5), was an

action against Mr. O’Keefe and his firm for professional

malpractice, fraud, and spoliation of evidence.    Before trial the

defendants brought several motions in limine to exclude documents

and testimony, including notes made by Mr. O’Keefe at the June

28, 1989, meeting.    The trial court ruled that the materials were

protected by the attorney-client privilege, on grounds that (1)


     5
       The materials submitted by the parties do not divulge any
specific dates of relevant action by the Superior Court in this
case. It seems likely, however, that the suit would have been
filed, and the nonsuit judgment entered (see infra text), in
1999.
                              - 10 -

the privilege was not waived by deposition or trial testimony in

the earlier case, and (2) the crime-fraud exception was

inapplicable.   After these rulings, the parties stipulated to a

nonsuit judgment in order to permit appeal.   The appellate court,

in an unpublished opinion filed on August 24, 1999, affirmed.

Fitzsimon v. Good, Wildman, Hegness & Walley, No. G020125 (Cal.

Ct. App. Aug. 24, 1999).

                            Discussion

I.   Motion in Limine

     Respondent’s motion in limine asks the Court to enter an

order in advance of trial ruling that “petitioner Thomas E.

Johnston is not entitled to assert attorney-client privilege to

prevent his former attorney, Thomas O’Keefe, from testifying

about or producing records pertaining to certain confidential

communications made by petitioner during the course of the

representation”.   Framed more narrowly, respondent’s request is

principally concerned with notes made by Mr. O’Keefe regarding

the June 28, 1989, meeting with Mr. Johnston and Mr. Spence.

Respondent alleges that these notes are not protected by the

attorney-client privilege on three alternative grounds:   (1)

Waiver by petitioners’ having placed the nature of attorney-

client communications at issue through claimed reliance on

counsel’s advice; (2) waiver by Mr. O’Keefe’s having testified

about privileged matters, during proceedings in Superior Court,
                                - 11 -

prior to claiming the privilege; and (3) the crime-fraud

exception, applicable due to participation by Mr. O’Keefe in Mr.

Johnston’s scheme to defraud Mr. Fitzsimon of his interest in the

Shorecliffs golf course.

       A.   Applicable Law

       As a threshold matter, we address the question of governing

law.    In general, section 7453 and Rule 143(a) provide that Tax

Court proceedings are to be conducted in accordance with the

rules of evidence applicable in trials without a jury in the

United States District Court for the District of Columbia.

Consistent with this directive, we observe the Federal Rules of

Evidence.     Rule 501 of the Federal Rules of Evidence controls

issues of privilege and specifies as follows:

            Except as otherwise required by the Constitution
       of the United States or provided by Act of Congress or
       in rules prescribed by the Supreme Court pursuant to
       statutory authority, the privilege of a witness,
       person, government, State, or political subdivision
       thereof shall be governed by the principles of the
       common law as they may be interpreted by the courts of
       the United States in the light of reason and
       experience. However, in civil actions and proceedings,
       with respect to an element of a claim or defense as to
       which State law supplies the rule of decision, the
       privilege of a witness, person, government, State, or
       political subdivision thereof shall be determined in
       accordance with State law.

       The foregoing rule establishes a structure where “Issues

concerning application of the attorney-client privilege in the

adjudication of federal law are governed by federal common law.”

Clarke v. Am. Commerce Natl. Bank, 974 F.2d 127, 129 (9th Cir.
                               - 12 -

1992); see also United States v. Zolin, 491 U.S. 554, 562 (1989);

United States v. Mass. Inst. of Tech., 129 F.3d 681, 684 (1st

Cir. 1997); United States v. Blackman, 72 F.3d 1418, 1423-1424

(9th Cir. 1995); Gannet v. First Natl. State Bank, 546 F.2d 1072,

1075-1076 (3d Cir. 1976).   Conversely, State attorney-client

privilege rules apply where the underlying cause of action rests

on State law.   Rhone-Poulenc Rorer, Inc. v. Home Indem. Co., 32

F.3d 851, 861-862 (3d Cir. 1994).

     Petitioners argue that the cases at bar involve the latter

situation.   Petitioners claim:

          The issue here is not whether Petitioner has
     waived his attorney-client privilege in the within U.S.
     Tax Court proceeding involving federal statutes of the
     Internal Revenue Code. The issue here is whether
     Petitioner waived his attorney-client privilege in
     Fitzsimon v. S.C.Equestrian, et al, a 1994 State Court
     proceeding involving causes of action under the laws of
     the State of California. * * *

     We, however, disagree.    The matter before us is a

redetermination of petitioners’ Federal income tax liabilities

under Title 26 of the United States Code.    It therefore falls

squarely within the above-described parameters for an

adjudication of Federal law.

     Moreover, contrary to petitioners’ suggestion, the issue

here is precisely whether the privilege has been waived for

purposes of this Tax Court proceeding, regardless of whether it

was waived for purposes of earlier litigation in California.

Although certain of respondent’s bases for contending that the
                              - 13 -

privilege is inapplicable here stem from conduct occurring before

or considered by the State courts, this fact does not transform

the Federal tax nature of, or inject any State law cause of

action into, the present proceeding.   We also point out that one

of the grounds relied upon in respondent’s motion (wherein

petitioners are alleged to have placed communications at issue by

their litigation posture in this Court) deals exclusively with

what has transpired before us.   We conclude that Federal common

law governs.

     B.   Analysis

     As construed under Federal common law, the attorney-client

privilege exists “to encourage full and frank communication

between attorneys and their clients and thereby promote broader

public interests in the observance of law and administration of

justice.”   Upjohn Co. v. United States, 449 U.S. 383, 389 (1981).

The privilege applies to communications made in confidence both:

(1) By a client to an attorney for the purpose of obtaining legal

advice, and (2) by an attorney to a client where containing legal

advice or revealing confidential information on which the client

seeks advice.   Id. at 390; Bernardo v. Commissioner, 104 T.C.

677, 682 (1995); Hartz Mountain Indus. v. Commissioner, 93 T.C.

521, 525 (1989); Karme v. Commissioner, 73 T.C. 1163, 1183

(1980), affd. 673 F.2d 1062 (9th Cir. 1982).   The burden of

establishing that the attorney-client privilege is applicable to
                              - 14 -

particular communications or documents rests with the party

asserting the privilege.   Clarke v. Am. Commerce Natl. Bank,

supra at 129; Bernardo v. Commissioner, supra at 682.

     As previously indicated, one of the grounds on which

respondent alleges that Mr. O’Keefe’s notes are not protected

here is that petitioners waived the privilege by claiming

reliance on advice of counsel.   This contention invokes the

doctrine of what is referred to as implied waiver.   Ideal Elec.

Sec. Co. v. Intl. Fid. Ins. Co., 129 F.3d 143, 151 (D.C. Cir.

1997); Home Indem. Co. v. Lane Powell Moss & Miller, 43 F.3d

1322, 1326 (9th Cir. 1995).   While the precise reach of the

theory can be a subject of some controversy, courts typically

employ some version of one of several general approaches.   See,

e.g., Frontier Ref., Inc. v. Gorman-Rupp Co., 136 F.3d 695, 699-

700 (10th Cir. 1998) (cataloging various standards); Zenith Radio

Corp. v. United States, 764 F.2d 1577, 1579 (Fed. Cir. 1985)

(same).   These include the so-called automatic waiver rule, under

which a party automatically waives the privilege by asserting a

claim or defense to which otherwise privileged matter is

relevant, see Indep. Prods. Corp. v. Loew’s Inc., 22 F.R.D. 266,

276-277 (S.D.N.Y. 1958); a balancing test that weighs the need

for discovery against the need to protect the secrecy of the

communication, see Greater Newburyport Clamshell Alliance v. Pub.

Serv. Co., 838 F.2d 13, 20-22 (1st Cir. 1988); the three-pronged
                               - 15 -

test of Hearn v. Rhay, 68 F.R.D. 574, 581 (E.D. Wash. 1975); and

a purportedly more restrictive test where waiver is effected only

if a litigant directly injects an attorney’s advice into issue,

see Rhone-Poulenc Rorer, Inc. v. Home Indem. Co., supra at 863-

864.

       On the facts of the instant cases, it would appear that the

same result would obtain under any of the foregoing approaches.

We observe, however, that the approach of Hearn v. Rhay, supra,

has been both discussed with approval by the United States

District Court for the District of Columbia, whose rules of

evidence are applicable under section 7453, see United States v.

Exxon Corp., 94 F.R.D. 246, 248-249 (D.D.C. 1981), and explicitly

adopted by the Court of Appeals for the Ninth Circuit, the venue

for appeal in these cases, see United States v. Amlani, 169 F.3d

1189, 1195 (9th Cir. 1999).    This Court, too, has previously

quoted Hearn v. Rhay, supra, with positive implication.    Karme v.

Commissioner, supra at 1184.

       Hearn v. Rhay, supra at 581, sets forth the following three

factors which must be extant for a finding of implied waiver:

       (1) assertion of the privilege was a result of some
       affirmative act, such as filing suit, by the asserting
       party; (2) through this affirmative act, the asserting
       party put the protected information at issue by making
       it relevant to the case; and (3) application of the
       privilege would have denied the opposing party access
       to information vital to his defense. * * *
                              - 16 -

To similar effect, this Court stated in Bernardo v. Commissioner,

supra at 691 (fn. ref. omitted), that the taxpayers did not

impliedly waive the privilege where they did not “affirmatively

raise a claim that can only be effectively disproven through the

discovery of attorney-client communications”.       Given this

precedent and section 7453, we structure our discussion here

within the three criteria of the foregoing test.

     The statutory notices issued to Mr. Johnston determine

deficiencies and section 6663 fraud penalties for each of the

years 1989, 1991, and 1992.   After petitions were filed in these

cases, respondent submitted answers affirmatively setting forth

the facts upon which respondent relied in support of the fraud

determinations, as required by Rule 36(b) with respect to issues

on which respondent bears the burden of proof.       Mr. Johnston, in

accordance with Rule 37(b), then followed with replies denying

the majority of respondent’s affirmative allegations.       The

replies also included additional material addressing affirmative

defenses.   The reply relating to Mr. Johnston’s 1989 tax year

stated:

          By way of Affirmative Defense to the matters
     affirmatively alleged by Respondent in its answer,
     Petitioners allege as follows:

                *    *    *    *    *    *      *

          12) In preparing Petitioner’s returns for 1989,
     Petitioners relied upon advice of qualified experts for
     the underlying information developed and reported on
     Petitioner’s income tax return for 1989.
                             - 17 -

A nearly identical reference to the “advice of qualified experts”

was made in the reply dealing with the 1991 and 1992 tax years.

It is on the above-quoted statement pertaining to 1989 that

respondent bases contentions of implied waiver.

     Petitioners’ response to respondent’s argument consists, in

its entirety, of the paragraph reproduced below:

          Respondent argues, (p.7), that the Petitioner
     relied on Advice of Counsel in his defense of the
     within proceeding in his Reply referring to “qualified
     experts” assisting him in preparing his 1989 tax
     return. However, the Petitioner’s reference in his
     Reply to “qualified experts” assisting him was his
     accountant who assisted him in the filing of his Form
     1040X for the calendar year 1989 [1-R]. He does not
     refer to a lawyer. Therefore, there has been no
     defense of advice of counsel and Respondent’s argument
     is misplaced.

     It is within the just-described context that we turn to

consideration of the three requirements for implied waiver.    As

previously indicated, the first mandates that the privilege be

asserted as the result of some affirmative act.    Here, Mr.

Johnston asserted reliance on qualified experts as an affirmative

defense to respondent’s fraud penalty allegations.

     In Hearn v. Rhay, supra at 576-577, the plaintiff brought

suit claiming that his civil rights were violated during his

incarceration in a State penitentiary.   The defendants asserted

the affirmative defense of qualified immunity based upon having

acted in good faith, and the plaintiff sought discovery of legal

advice the defendants received with respect to his confinement.
                              - 18 -

Id. at 577-578.   In those circumstances, the court held that

asserting the privilege in furtherance of an affirmative defense

satisfied the first element for qualified waiver.   Id. at 581.

Other courts have similarly opined that raising affirmative

defenses can result in a waiver of the attorney-client privilege.

The United States District Court for the District of Columbia,

for instance, has refused to uphold the privilege where the

defense “of good faith reliance was affirmatively pleaded by the

party seeking to use the attorney-client privilege as a shield

against discovery.”   United States v. Exxon Corp., supra at 248.

Accordingly, the first requisite is met here if Mr. Johnston’s

reference to qualified experts is deemed to encompass legal

counsel.

     We conclude that to now narrow “advice of qualified experts”

solely to assistance received from the accountant aiding Mr.

Johnston in preparing his amended return would be to support a

belated characterization belied by the record.   We initially note

that Mr. Johnston’s reply for the 1989 tax year was filed on

September 22, 1997.   Petitioners’ opposition to the motions in

limine was filed on May 31, 2001, more than three and one-half

years later.   In addition, the incongruity between the original

plural “experts” and the subsequent singular “accountant” is

difficult to reconcile.
                              - 19 -

     Moreover, petitioners elsewhere in the opposition state:

“Thomas O’Keefe, Esq., a certified tax specialist, represented

the Petitioner as tax counsel rendering tax advice over a period

of many years, and in particular in 1989, the period during which

events occurred that are raised in Respondent’s Motion in Limine

herein.”   To similar effect, petitioners remark that “Thomas

O’Keefe, Esq., a certified tax specialist, had been a long time

attorney for Mr. Johnston and entities owned and controlled by

him”, and at yet another location characterize Mr. O’Keefe as

“long time tax counsel of Petitioner, Mr. Johnston”.

Additionally, the bill from Mr. O’Keefe to Shorecliffs and Mr.

Johnston for legal fees incurred in June of 1989 contains the

following description dated “06/28/89”:

     Meeting with Tom Johnston, Darrell Spence and Frank
     Nish re Shorecliffs; Review of sale transaction;
     Prepared demand on escrow and notice and
     acknowledgement [sic] regarding earth subsidence issues
     to Buyer; Tax research and strategy planning regarding
     basis, installment deal, sub-s and Exchange issues.

     There is also the fact that income from the Shorecliffs sale

was reported on neither the original nor the amended 1989 return.

Hence, to the extent that reliance on expert advice can excuse

the alleged fraudulent failure to report this transaction, such

reliance was not only or in the first instance on the accountant

aiding in preparation of the amended return.   We are satisfied
                              - 20 -

that petitioners’ affirmative defense contemplated more than just

the cited accountant and is appropriately read to include Mr.

O’Keefe, who concededly provided tax advice in 1989.

     The second requirement asks whether through this affirmative

act the asserting party puts the protected information at issue

by making it relevant to the case.     This element, too, has been

satisfied here.   As the Court of Appeals for the Ninth Circuit

explained in an analogous context:     “to the extent that * * *

[the defendant] claims that its tax position is reasonable

because it was based on advice of counsel, * * * [the defendant]

puts at issue the tax advice it received.”     Chevron Corp. v.

Pennzoil Co., 974 F.2d 1156, 1162-1163 (9th Cir. 1992).

     Likewise, petitioners seek to defend against the fraud

allegations on grounds of reliance on experts.     That defense

places at issue the tax advice Mr. Johnston received with respect

to his 1989 return.   Petitioners have also admitted that Mr.

O’Keefe rendered tax advice to Mr. Johnston during 1989.     In

addition, the California appellate court’s unpublished opinion in

Fitzsimon v. Good, Wildman, Hegness & Walley, No. G020125, slip

op. at 6 (Cal. Ct. App. Aug. 24, 1999), contains the following

statement:   “Our review of the exhibits demonstrates there is

substantial evidence for the trial court to have concluded

defendants were hired by plaintiff’s partners and to obtain tax

advice and to research tax liability issues concerning a real
                               - 21 -

estate sale.”   Given these circumstances, petitioners, by raising

the affirmative defense of reliance, must be said to have placed

at issue in the present proceeding all tax advice received with

respect to the 1989 transactions in dispute, including

communications with Mr. O’Keefe.

     Finally, the third inquiry is directed toward whether

allowing the privilege would deny the opposing party access to

information vital to its defense.   The Courts of Appeals have

cautioned that privileged communications do not become

discoverable where they simply are relevant to issues raised in

the litigation or where they are only one of several forms of

indirect evidence about an issue.   United States v. Amlani, 169

F.3d at 1195; Frontier Ref., Inc. v. Gorman-Rupp Co., 136 F.3d at

701-702; Zenith Radio Corp. v. United States, 764 F.2d at 1580-

1581.   Rather, the information must be “vital”, Hearn v. Rhay, 68

F.R.D. at 581, such that it would be “manifestly unfair” to deny

access due to consequent prejudice to the opposing party’s

defense, Home Indem. Co. v. Lane Powell Moss & Miller, 43 F.3d at

1326-1327.   Stated otherwise, the attorney-client privilege “may

not be used both as a sword and a shield.”   Chevron Corp. v.

Pennzoil Co., supra at 1162.

     In connection with the affirmative defense posture presented

in Hearn v. Rhay, supra at 581, the court explained that “one

result of asserting the privilege has been to deprive plaintiff
                             - 22 -

of information necessary to ‘defend’ against defendants’

affirmative defense, for the protected information is also

germane to plaintiff’s burden of proving malice or unreasonable

disregard of his clearly established constitutional rights.”    The

analogous scenario in United States v. Exxon Corp., 94 F.R.D. at

249, led the court to observe as follows:

     Exxon’s affirmative defenses necessarily revolve around
     whether Exxon did, in fact, primarily or solely rely
     upon a particular DOE regulation or communication when
     the company made its pricing decisions. Thus, the only
     way to assess the validity of Exxon’s affirmative
     defenses, voluntarily injected into this dispute, is to
     investigate attorney-client communications where
     Exxon’s interpretation of various DOE policies and
     directives was established and where Exxon expressed
     its intentions regarding compliance with those policies
     and directives. * * *

A parallel situation exists here.

     Under section 7454(a) and Rule 142(b), respondent bears the

burden of establishing fraud by clear and convincing evidence.

Petitioners have asserted reliance on professionals as an

affirmative defense to the fraud allegations.   To “defend”

against this defense, respondent must show that such reliance

either was unreasonable or did not in fact occur.   Respondent can

do so only through knowledge of what tax advice Mr. Johnston

received, and such would include communications from Mr. O’Keefe.

Additionally, having invoked reliance on “experts”, petitioners

cannot now be entitled selectively to withhold communications

from particular experts, especially those who petitioners concede
                              - 23 -

provided tax advice, while allowing communications from others to

be disclosed.   Rebuttal of the affirmative defense will depend on

the sum of tax advice received on the disputed transactions;

respondent will be prejudiced if only portions (presumably those

not detrimental to petitioners’ position) are available.

     To rephrase a conclusion of the Court of Appeals for the

Ninth Circuit, petitioners “cannot invoke the attorney-client

privilege to deny * * * [respondent] access to the very

information that * * * [respondent] must refute in order to

demonstrate” the unreasonableness or nonexistence of the claimed

reliance.   Chevron Corp. v. Pennzoil Co., supra at 1163.   Doing

so would engender precisely the sort of unfairness that the

implied waiver doctrine was devised to avoid.

     We therefore hold that all three elements of the Hearn v.

Rhay, supra, test for implied waiver have been established.     We

shall grant respondent’s motion in limine on this basis.

Furthermore, since we reach our ruling based solely on

petitioners’ posture and defenses before this Court, we need not

consider the potential impact of the State court decision in

Fitzsimon v. Good, Wildman, Hegness & Walley, supra, which

addressed only respondent’s alternative grounds of waiver by

disclosure and the crime-fraud exception.
                              - 24 -

II.   Motion for Partial Summary Judgment

      Respondent’s motion for partial summary judgment asks that

petitioners be collaterally estopped from relitigating the

following 10 issues allegedly determined in Fitzsimon v. S.C.

Equestrian Lots, Ltd., No.704870 (Cal. Super. Ct. June 9, 1995):

      (1) Mr. Johnston intentionally defrauded Mr. Fitzsimon of

his interest in the Shorecliffs golf course;

      (2) Mr. Spence and Mr. Johnston sold the Shorecliffs golf

course to a third party for $6 million;

      (3) Mr. Spence and Mr. Johnston kept the proceeds from the

sale;

      (4) Mr. Spence’s and Mr. Johnston’s combined basis in the

Shorecliffs golf course did not exceed $800,000;

      (5) Mr. Fitzsimon’s 23.81-percent share of the cash

generated by the Shorecliffs sale, after adjustments for certain

amounts actually paid to Mr. Fitzsimon pursuant to the fraudulent

stock option sale agreement, was $478,998.55;

      (6) during the year 1991, Mr. Spence had no interest in the

SCE partnership;

      (7) Sea-Aire and Uppaway are alter egos of Mr. Johnston;

      (8) during the year 1991, Mr. Johnston’s total partnership

interest in the SCE partnership was 76.19 percent, consisting of
                                 - 25 -

a 71.19-percent interest in his name and a 5-percent interest in

the name of Uppaway that was attributable to Mr. Johnston

personally;

     (9) during the year 1991, Mr. Johnston’s distributable share

of SCE partnership net income was $1,141,417, consisting of

$1,066,511 for his 71.19-percent personal interest and $74,906

for the 5-percent interest of Sea-Aire/Uppaway; and

     (10) Mr. Johnston’s distributive share of SCE’s net loss for

1992 was $2,362.

Petitioners dispute each of the foregoing points.

     A.   Standard for Summary Judgment

     Rule 121(a) allows a party to move “for a summary

adjudication in the moving party’s favor upon all or any part of

the legal issues in controversy.”     Rule 121(b) directs that a

decision on such a motion shall be rendered “if the pleadings,

answers to interrogatories, depositions, admissions, and any

other acceptable materials, together with the affidavits, if any,

show that there is no genuine issue as to any material fact and

that a decision may be rendered as a matter of law.”     The moving

party bears the burden of demonstrating that no genuine issue of

material fact exists and that he or she is entitled to judgment

as a matter of law.    Estate of Chenoweth v. Commissioner, 88 T.C.

1577, 1578 (1987).    Facts are viewed in the light most favorable

to the nonmoving party.    Id.   However, where a motion for summary
                                - 26 -

judgment has been properly made and supported by the moving

party, the opposing party may not rest upon mere allegations or

denials contained in that party’s pleadings but must by

affidavits or otherwise set forth specific facts showing that

there is a genuine issue for trial.      Rule 121(d).

     B.    Standard for Collateral Estoppel

     Collateral estoppel exists for “the dual purpose of

protecting litigants from the burden of relitigating an identical

issue and of promoting judicial economy by preventing unnecessary

or redundant litigation.”     Meier v. Commissioner, 91 T.C. 273,

282 (1988); see also Montana v. United States, 440 U.S. 147, 153-

154 (1979); Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326

(1979).     In general, the doctrine of collateral estoppel, also

referred to as issue preclusion, forecloses relitigation of

issues actually litigated and necessarily decided in a prior

suit.     Parklane Hosiery Co. v. Shore, supra at 326 n.5; Meier v.

Commissioner, supra at 282; Peck v. Commissioner, 90 T.C. 162,

166 (1988), affd. 904 F.2d 525 (9th Cir. 1990).

     This Court, expanding upon three factors identified by the

Supreme Court in Montana v. United States, supra at 155, has set

forth five prerequisites necessary for the application in factual

contexts of collateral estoppel:

     (1) The issue in the second suit must be identical in
     all respects with the one decided in the first suit.
     (2) There must be a final judgment rendered by a court
     of competent jurisdiction.
                              - 27 -

     (3) Collateral estoppel may be invoked against parties
     and their privies to the prior judgment.
     (4) The parties must actually have litigated the issues
     and the resolution of these issues must have been
     essential to the prior decision.
     (5) The controlling facts and applicable legal rules
     must remain unchanged from those in the prior
     litigation. [Peck v. Commissioner, supra at 166-167;
     citations omitted.]

Additionally, where collateral estoppel premised on a State court

proceeding is sought to be used offensively in Federal court,

reference is made to the controlling State law to determine the

propriety of such offensive use.    Bertoli v. Commissioner, 103

T.C. 501, 508 (1994).   California courts have sanctioned use of

offensive collateral estoppel.    See Imen v. Glassford, 247 Cal.

Rptr. 514, 518-519 (Cal. 1988); Estate of Gump v. Gump, 2 Cal.

Rptr. 2d 269, 286 (Cal. Ct. App. 1991).

     C.   Analysis

     Having considered the state of the record in these cases,

the points as to which respondent would have us apply collateral

estoppel, and the matters which could remain for trial, we

conclude that the purposes of the doctrine would not be served at

this juncture by resort to issue preclusion.    On a fundamental

level, as previously discussed, collateral estoppel exists to

prevent unnecessary and redundant litigation.    Yet given the

particular facts under review, we see little to be gained when

measured against this standard.
                              - 28 -

     The facts pertaining to the Shorecliffs transaction are

closely intertwined with each other, as are those relating to the

SCE partnership.   Consequently, to the extent that any of the

related matters must be litigated, much of the evidence and

argument will of necessity go to the relevant transactions as a

whole.   Because we are satisfied after review of the record that

at least a majority of the above-enumerated points lacks the

requisite basis for issue preclusion, it becomes apparent that

significant redundancy is unavoidable.

     Furthermore, cognizant of the rather unconventional nature

of the California trial court’s disposition (in the form only of

a special verdict and judgment) and the otherwise troublesome

state of the record in these cases, we cannot take lightly the

principle that “issue preclusion must be applied carefully so

that fairness to litigants is not compromised for efficiency and

economy.”   Monahan v. Commissioner, 109 T.C. 235, 242 (1997); see

also United States v. Silliman, 167 F.2d 607, 614 (3d Cir. 1948)

(“Such a rule of public policy [collateral estoppel] must be

watched in its application lest a blind adherence to it tend to

defeat the even firmer established policy of giving every

litigant a full and fair day in court.”).

     Hence, absent a clearer picture of what transpired in State

court and in light of the interdependence of many pertinent
                             - 29 -

matters, we believe that the issues in these cases are more

appropriately dealt with in a unified manner.   We thus will deny

respondent’s motion for partial summary judgment.

     To reflect the foregoing,



                                        Appropriate orders will

                                   be issued granting

                                   respondent’s motion in limine

                                   in all docket Nos. and denying

                                   respondent’s motion for

                                   partial summary judgment in

                                   docket Nos. 26005-96 and

                                   2266-97.
