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State Attorney-Client Privilege Rule Incorporated into Federal Law
Because state law applies at the time a transaction is negotiated, the parties might assume — reasonably so — that state privilege law will govern communications with their attorneys and financial professionals. But what happens if, years later, a suit is filed in federal court and brings claims under federal law? Does state privilege law still apply?
The answer matters, because the Delaware attorney-client privilege protects a broader array of communications involving financial professionals than does federal privilege law. Would communications that were privileged when they were made lose such status years later? Would a federal court honor Delaware's privilege rule even though federal law typically would not treat the same communications as privileged?
The United States Bankruptcy Court for the District of Delaware recently addressed these questions. In a bench ruling, Judge Kevin Gross applied federal privilege law to a mix of federal and state law claims, and held that because the communications at issue arose from a merger governed by Delaware law, federal privilege law in this instance would apply the same broad rule that Delaware state law would apply to the communications. PAH Litigation Trust v. Water Street Healthcare Partners, L.P. (In re Physiotherapy Holdings, Inc.), Case No. 13-12965 (KG), Adv. No. 15-51238 (KG) (Bankr. D. Del. Apr. 26, 2018) (Apr. 26, 2018 Hr'g Tr.) [Adv. D.I. 842]. On the facts of the case, the court expanded the federal common law of privilege to incorporate the Delaware rule in situations where the communications arose from a Delaware transaction and the parties expected the communications to be confidential.
Physiotherapy's Facts
The facts of the case are straightforward. A company's owners sold their shares through a cash-out merger governed by Delaware law. A few years later, the company filed for bankruptcy with a prepackaged plan of reorganization. The plan formed a litigation trust to pursue potential claims. Following confirmation of the plan, the litigation trust sued the former owners, alleging that the payments they received in the sale were intentional and constructive fraudulent transfers under the Bankruptcy Code and state law.
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