Public Policy Overrides the Confidentiality of Tax Returns in California in Connection With a Judgment Debtor Examination

The Court of Appeal of the State of California – First Appellate District in Li v. Yan (5/2/16 – Case no. A144994) affirmed the trial court’s ruling that a judgment debtor’s tax returns are not privileged from disclosure in all circumstances.

Li v. Yan arises out of an appeal of an Order Re Subpoena Duces Tecum made in the course of examination of judgment debtor proceedings attempted against attorney Demas Yan (“Yan”).

Plaintiff Charles Li (“Li”) is a 78 year-old Chinese American, with limited English and experience with the legal system. Yan is an attorney, who became a member of the bar in 2008. Between 2007 and 2009, Yan acted, first, while Yan was still a law student, as Li’s unlicensed attorney and then, after Yan was admitted to the bar, as his formally-retained lawyer. Ignoring blatant conflicts of interest, Yan advised and represented Li in an underlying matter involving a contract in which Yan himself was the obligor and Li was the assignee. At one point, while Yan was serving as Li’s attorney, he was simultaneously suing Li in a separate lawsuit related to the same contract.

As a result of Yan’s various misdeeds, in March 2010, Li sued Yan for professional negligence, breach of fiduciary duty, unlawful business practices, breach of contract, and fraud. The case proceeded to a bench trial where Li was ultimately awarded a total of $552,412.30, including $149,667.29 in prejudgment interest. Yan appealed the judgment and the Appellate Court affirmed the trial court’s judgment in an unpublished opinion (Li v. Yan (Jan. 28, 2016, A140798).

The present case arises out of Li’s efforts to examine Yan as a judgment debtor. Li served Yan with an order of examination including a document request demanding Yan produce his tax returns during a judgment debtor examination. Yan objected to the order of examination and, in relevant part, claimed his tax returns were privileged. The trial court denied Yan’s claim of privilege as to the tax returns and ordered they be produced. Yan appealed.

The Appellate Court affirmed the trial court’s denial of Yan’s claim of privilege as to the tax returns and confirmed that while there is no recognized federal or state constitutional right to maintain the privacy of tax returns, California courts have interpreted state taxation statutes as creating a statutory privilege against disclosing tax returns. The Appellate Court held that the privilege is not absolute and will not apply when (1) the circumstances indicate an intentional waiver of the privilege; (2) the gravamen of the lawsuit is inconsistent with the privilege; and (3) a public policy greater than that of the confidentiality of tax returns is involved. Because the purpose of a judgment debtor examination is to uncover all assets the judgment debtor has that could respond to the judgment and to “leave no stone unturned in the search for assets,” the court concluded that the privilege was “trumped” by this public policy.

In support of its decision, the Appellate Court cited evidence Yan made various fraudulent conveyances in an effort to shield assets and presented “a myriad of changing stories,” gave examples from Li’s attempted judgment debtor examinations where Yan refused to provide credible financial information and claimed ignorance of the source or amount of his income and found that Yan intentionally interfered with Li’s ability to obtain relevant information through the examination and then sought to hide behind the tax return privilege. The court ultimately held the trial court did not abuse its discretion in denying Yan’s claim of privilege as to his tax returns, stating “there is a strong public policy … to prevent fraud against creditors. And against lenders. And perhaps against the court.”

Li provides an important reminder of the limitations on the privilege regarding tax returns in California. While a party may assert the privilege to protect its privacy, that privilege will be overridden when public policy considerations are deemed to have priority, such as in situations of potential fraud and malfeasance. The fact that this case presented a particularly egregious example of a self-represented attorney does not lessen the importance of examining all aspects of the application of the privilege against production of tax returns to assure that it is appropriately utilized in the particular matter.

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May 6, 2016