Tax Court mediation: a case study.

This past June, I participated in probably the first successful mediation of a Tax Court case under procedures the Chief Counsel published in October [1995..sup.1] Imagine a hotly contested valuation case with valuation experts arrayed on both sides, with the prospect of a week of trial, and the parties unable to reach an agreement, settled in less than two days with the assistance of a mediator. Based on this mediation and others I have participated in, I have some observations that may be helpful when you consider mediation as an alternative dispute resolution (ADR) procedure.

I will quickly come to the point: In more than 30 years of trying tax cases, mediation is the most constructive procedure I have encountered to resolve tax disputes. It is a cost-effective and time-efficient procedure for settling factual issues, such as valuation issues, including those involving transfer pricing. For these reasons, mediation is an ADR procedure that we should not merely know about. Mediation should be seriously considered when factual issues cannot be resolved in the normal course of administrative processing and Tax Court litigation.

Background

Mediation is sometimes confused with arbitration, but it is much different. Mediation is an informal dispute resolution process in which a neutral third person, called the mediator, helps the parties in a lawsuit to reach a mutually agreeable settlement. The mediator meets with the parties both jointly and separately, defines issues, and suggests possible ways of resolving disputes. There is no trial of the case. The mediator renders no decision, and does not dictate the terms of a settlement. The mediation process is confidential. Mediation is entirely voluntary (that is, optional), and a party may withdraw from the process at any time. At the conclusion of a successful mediation, there is a binding result only in the sense that the parties have reached a settlement of the issue, and have confirmed that settlement in an agreement they have signed. In arbitration, on the other hand, although the procedures are more informal than a court trial, evidence is presented in a formal way. There is essentially an out-of-court trial of the case before the arbitrator, rather than the judge. Although the decision whether to arbitrate a case in the Tax Court is voluntary, the arbitrator renders a decision or award that is [binding..sup.2]

Mediation is a way of settling a tax issue when the taxpayer's representatives and the Internal Revenue Service cannot settle the issue on their own. The parties themselves may not be able to reach a settlement because, for example, the taxpayer's representatives and the District Counsel attorneys cannot even discuss settlement in any meaningful way. Perhaps one side and often both sides have become so entrenched in, or so emotionally tied to, a position that settlement is viewed as "unconditional surrender." In a complex tax case, it is not unusual for IRS attorneys to refuse to adopt a single position or theory on an issue, and this moving target' approach makes it difficult to negotiate. Mediation, as the Chief Counsel says, "defuses emotions" by interposing the mediator between the [parties..sup.3] The process itself separates the parties, forces them off positional negotiating stances and focuses them on settlement possibilities. This is why mediation is a way of settling a case with District Counsel when settlement by bilateral negotiations seems impossible. In our case, we were unable to reach a settlement in negotiations both at Appeals and with District Counsel, but with the help of the mediator, we reached a settlement.

IRS Acceptance of Mediation

Last year, Appeals and the Chief Counsel embraced mediation as the new darling of the National Office's dispute resolution procedures. In January 1995, the National Office announced in Announcement 95-2 that Appeals would use mediation on a test basis for a year, and in February a hearing was held to obtain the views of practitioners. In September 1995, the National Office issued final procedures for Appeals mediations, stating that the test period would begin on October 30, [1995..sup.4] In mid-October, the Chief Counsel's procedures accepting mediation in docketed Tax Court cases became [public..sup.5] At this point, only the Justice Department's Tax Division refuses to agree to mediation in refund or other tax cases. Nevertheless, some district courts and circuit courts of appeals have mediation programs, and so mediation sometimes takes place over the Tax Division's objection. Recently, I was involved in an unsuccessful mediation of a tax case with Tax Division attorneys in the district court for the District of Columbia, not because the Justice Department's Tax Division agreed to it, but because the district court ordered [it..sup.6]

Under the test procedures in Appeals, mediation is available in an Appeals office case (1) at the option of the taxpayer and Appeals in order to negotiate their own settlement with the mediator acting as a facilitator; (2) limited to issues in the Coordinated Examination Program (CEP) cases assigned to Appeals Team Chiefs; (3) requested by the taxpayer or Appeals when agreement cannot be reached on an issue after established Appeals settlement discussions are unsuccessful; and (4) must be agreed to by the taxpayer and the Assistant Regional Director of Appeals-Large [Case..sup.7] Announcement 95-86 also includes a model agreement to mediate, a model consent to disclosure of return information for the purposes of the mediation, and a model mediator's report. This mediation agreement is useful for those taking advantage of the mediation procedures either in Appeals or in the Tax Court. In our Tax Court mediation, we used this form agreement as the mediation agreement.

National Office officials said that Appeals expected to be inundated with requests for mediation, but that Appeals would be very selective in deciding which major corporate issues to mediate under the new program. Of the 200 to 250 cases expected to reach Appeals during the year, Robert Brauer, the Deputy National Director of Appeals, said that Appeals will accept only a dozen or two for [mediation..sup.8] Recently, Vincent Canciello, the IRS's National Director of Appeals, reportedly said that, of nine cases in which mediation was requested, four cases were rejected because they did not qualify for mediation. Two cases were successfully mediated, and three cases are still in [process..sup.9] Appeals is still considering whether it will continue its mediation program.

Availability of Mediation in Tax Court Cases

Appeals limits mediation to issues in the Coordinated Examination Program (CEP) assigned to Appeals Team Chiefs. Mediation in Tax Court cases is not limited to CEP cases, but mediation of a Tax Court case is not available in all types of cases. There are several specific case selection criteria. Chief Counsel considers fact-based cases to be best suited for [mediation..sup.10] In international tax cases, transfer pricing issues certainly fit this requirement, and based on statements by Tax Court judges about transfer pricing cases, the Tax Court would welcome mediation on this issue. Chief Counsel, however, will not agree to mediate Industry Specialization issues, Appeals Coordinated Issues, or issues designated for [litigation..sup.11] In addition, District Counsel attorneys are instructed not to agree to mediation if the taxpayer refused mediation at the Appeals level, or if mediation was tried at Appeals without success. Finally, if the taxpayer has requested competent authority assistance or intends to do so, mediation will limit the actions of the U.S. competent authority. The U.S. competent authority will only attempt to obtain correlative adjustments based on the mediation agreement, but will take no actions that modify or amend the mediation.

The Chief Counsel's procedures say that mediation in a Tax Court case is not supposed to be used as a substitute for established settlement procedures; ie., settlement at Appeals and negotiation between the parties. Similarly, Tax Court mediation is not supposed to be used as a tactic to delay discovery or a trial. I wonder how District Counsel will apply this restriction. Unlike the typical (non-tax) case, the taxpayer's adversary in court - the IRS - has already had the widest possible discovery. During the course of an examination, revenue agents may obtain any information from taxpayers that "may be relevant" (not "is relevant" or "relevant to the subject matter of the litigation" under the Tax Court's discovery rules). District Counsel (and Tax Division attorneys for that matter) too often disregard the information that agents have collected or the time and expense the taxpayer has already expended in producing documents and making information available during the examination. This can happen even where District Counsel has advised the examination team during the examination. Moreover, and this can be extremely expensive and time-consuming, District Counsel attorneys handling cases in the Tax Court are not constrained, absent some court intervention, on the number of interrogatories that can be propounded to the taxpayer. Although district courts condemn the use of "canned" interrogatories and limit the number of interrogatories, the Tax Court has no such limitations.

In short, one of the reasons why mediation should be attractive to taxpayers and their counsel is to avoid or minimize the burden of costs in both administrative discovery and court discovery. If mediation will be available only after District Counsel attorneys have exhausted their collective imaginations for interrogatories to ask and documents to request, the cost-reduction benefit of mediation will be diluted or lost.

That Chief Counsel has accepted mediation as an ADR procedure does not mean that District Counsel in the field will agree to mediate a case. One problem is the lack of familiarity with the procedure. In our case, I had to educate the District Counsel attorney about the mediation process and the Chief Counsel's procedures and explain why we were not at all interested in binding arbitration. Another problem is suspicion. Some District Counsel attorneys and taxpayers' counsel believe that if their adversary makes a proposal, it must be especially advantageous for the proponent, and, of course, disadvantageous to their case. The voluntary nature of the mediation process helps dispel this suspicion. Either party may withdraw from the mediation, and, of course, neither party is forced to agree to a settlement proposal.

In summary, if you believe mediation is the right approach, be prepared to convince the District Counsel's office at the highest level that mediation is a proper way to deal with the case. The District Counsel attorney should not be assumed to have the final word on using or not using mediation. Since mediation is not likely to work unless an attorney with settlement authority is at the mediation and the District Counsel attorney assigned to the case does not have that authority, I believe that the District Counsel him or herself will inevitably be drawn into the discussion about using mediation. In our Tax Court mediation, this is precisely what happened. The District Counsel attorney assigned to the case did not agree to mediation. The District Counsel did. Once the District Counsel agreed to mediation, we were able to agree on the details of the mediation with surprising ease.

Once there is agreement to mediate, Tax Court approval is the next step. In the Tax Court case which we mediated, the IRS and taxpayer filed a joint motion to mediate. Although no Tax Court rule expressly provides for mediation, Rule 124, which permits arbitration, as well as Rule 1, which provides for interpretation of the rules in accordance with the interests of justice, support a motion for [mediation..sup.12]

Both the Chief Counsel and the Tax Court will be tested if mediation is to become a viable procedure in Tax Court cases. If a case appears on a trial calendar, and the District Counsel's office or the Tax Court judge is not willing to grant delays for the trial of the case, the taxpayer may find the availability of mediation restricted. To avoid this kind of a problem, the taxpayer should decide early in the case whether it wants to try mediation, and will have to watch the time taken in Appeals and in discovery. This suggests that in a large case, when a Tax Court judge has been assigned, that the case plan should include time for mediation, and that in other cases, the court should be informed as soon as possible about the parties' need for time to use mediation.

Helpfully, the Chief Counsel's procedures suggest that the parties enter a stipulation regarding the case to enable the court to continue to supervise the [proceedings..sup.13] The procedures also suggest that if the case has already been placed on the calendar, the parties file a joint motion for a continuance from the trial [session..sup.14] In our mediated case, District Counsel joined in a motion to remove the case from the trial calendar to permit the mediation. Based on our experience, when the parties have agreed to mediate, the Tax Court judge will not insist that a case be retained on a trial calendar.

Selection of the Mediator

One of the most critical matters that the parties must agree upon is the mediator. In my experience, the mediator is critical to a successful mediation. Understandably enough, the Chief Counsel's directive and mediation procedures say that the mediator should be an expert in the negotiated settlement [process..sup.15] The directive also says that District Counsel's selection of the mediator should be based on such criteria as mediation training or previous mediation experience, a substantive knowledge of tax law (though I am not sure that this qualification fits with the view that mediation is especially suited for fact-based cases), or knowledge of industry practices. Selection of a mediator will also take into account the projected travel costs, hourly fees, and other expenses that will be incurred by both parties, especially since the District Counsel will have to pay for the IRS'S share of the mediation expenses through the procedures for government procurement.

Both the Appeals and the Chief Counsel's procedures are biased in favor of using Appeals mediators. Although taxpayers will naturally be reluctant to agree to the selection of an Appeals Officer, District Counsel attorneys are told to consider selecting an Appeals mediation officer to reduce costs for both parties and "reserve limited Counsel resources for expert witnesses and other expenses if settlement is not reached and trial becomes [necessary.".sup.16] Even if the Appeals mediator is not acceptable to the taxpayer, the directive suggests that the parties may agree on the procedure for selecting the mediator, and, for example, seek the assistance of other government offices, the Federal Mediation and Conciliation Service, and the Administrative Conference.

If the taxpayer wants to select a mediator from a private law firm, the mediator and the firm will have to consider the disqualification rules. These rules not only disqualify the lawyer and the firm from representing the taxpayer on the same transactions or issues, but also disqualify the mediator from having any involvement in or financial participation in the firm's representing the taxpayer on the same transactions or issues in later tax years. The mediator and his or her firm may represent the taxpayer on matters unrelated to the mediation.

I suggest some other guidelines. The mediator plays a pivotal role of forcing the parties to look at their respective positions from the view of a neutral third party. In my opinion, knowledge of the tax law is not essential to a successful mediation of a tax case, and, as a practical matter, there is no one who has a long track record in mediating tax cases. Consequently, I would look for a mediator who has a reputation for being successful in mediations on complex non-tax issues. Once the parties appear at the mediation, they are in the hands of the mediator. Since District Counsel attorneys are not constrained by the same financial and other considerations taxpayers are, the mediator in a tax case will have to have insight into what pressure will move a government attorney toward settlement. This requires the mediator to have both the willingness and the skill to put pressure on the District Counsel attorneys that differs from the way he or she will deal with the taxpayer's side. It was important to me in our mediation that the mediator had handled mediations with government attorneys - as it turned out government attorneys involved in forfeiture cases.

The Mediation Agreement

As described in the Chief Counsel's procedures, the steps in the mediation process in a Tax Court case are roughly the same as the typical mediation. First, the parties must confirm their agreement to mediate in writing. In general, the mediation agreement will reflect the issues that will be the subject of the mediation, the identity of the mediator, the place of the mediation, and other procedural matters that will govern the mediation process. Matters the Chief Counsel thinks should be included in the mediation agreement are listed in the Chief Counsel's directive and in the Manual, but the final Appeals procedures have a form agreement that can be used.

In my experience, the vital term in the mediation agreement is the commitment to have present at the mediation the District Counsel or some other person in the management of the District Counsel's office - a decision-maker. In the cases I have mediated with Tax Division attorneys, the mediation has been unsuccessful because no official in the Tax Division with settlement authority participated in the mediation. Ironically, one of the subjects that the Chief Counsel's directive "strongly" recommends District Counsel attorneys to include in the mediation agreement is not merely a list of the individuals who will participate in the mediation on behalf of the taxpayer, but the identity of the official who will have the authority to make decisions on the taxpayer's [behalf..sup.17] Curiously, while the directive suggests having someone present to prepare computations and encourages the participation of Appeals, the directive does not mention identifying the District Counsel official who will have authority to make the final decision on behalf of the [IRS..sup.18] The Appeals procedures provide for the participation not only of the Appeals Team Chief, but also of the Assistant Regional Director of Appeals-large Case, or other "appropriate persons."

The Mediation Process

Before the mediation session, the parties submit a written presentation describing the case of the respective party to the mediator. Obviously, the mediator knows very little about the case and what each party's evidence is. This written presentation must educate the mediator in the applicable law and the evidence in the case and, unlike Tax Court post-trial briefs, do so in a limited number of pages. This is not an easy exercise and almost as much time and effort can be expended in preparing the mediation brief as in the mediation itself. But this should not be too surprising. After all, in order to make an effective presentation and ensure a favorable result, the taxpayer will have to prepare the case as if the mediation were the trial. Critical evidence on the elements that the taxpayer must prove should be identified, gathered, and presented in a summary and yet telling way. Experts should be asked to assist in the preparation of the mediation brief.

At the mediation session, the parties first meet in a joint session with the mediator. Each side presents an opening statement. This opening statement not only continues the process of informing the mediator of the party's case, but it presents the taxpayer with the opportunity to show the District Counsel attorneys how the taxpayer's case will be presented in the Tax Court if the case is not settled in the mediation. District Counsel attorneys have the same opportunity, of course. As the mediation progresses, the attorneys on both sides will learn how a third party assesses their case, and they will start to re-evaluate the strengths and weaknesses of their respective cases. The opening joint session thus provides a test run for the attorneys. It is natural for the advocate to be become so close to the case that he or she cannot see how a judge could possibly decide the case other than favorably. Consequently, the opening statement and what follows is a good "reality check" for the attorneys.

But the attorneys will not be the only ones to get perhaps a more realistic view of the case. The District Counsel's opening statement may also be the first time that the IRS'S case has been presented in a coherent fashion to the taxpayer's management. If the District Counsel is to have the same reality check as the taxpayer, the District Counsel attorney's supervisor and even the District Counsel should also be present at the mediation. Mediation is simply not likely to have its potential effect if the supervisor with final authority on a settlement is only available by telephone, does not hear the opening statement, or otherwise does not participate in the mediation. The supervisor is the equivalent of the taxpayer's responsible decision-maker. If the supervisor is not at the mediation, the supervisor will receive information about the taxpayer's case through the District Counsel attorney and, needless to say, will not hear it presented with the same force as taxpayer's counsel.

At the opening joint meeting, the mediator can take notes and will usually ask questions. I have found it extremely effective if the mediator not only actively takes notes during the taxpayer's presentation but, after the taxpayer's attorney is finished, summarizes the main points. The mediator should do the same after the District Counsel attorney's presentation. This process may be difficult to follow, but it is critical. That is why the selection of the mediator is one of the most important decisions in mediation, and why not everyone can be a successful mediator. By summarizing each party's case, the mediator demonstrates that the mediator understands each side's case, is in control of the process, and will be able to present each, side's case to the other. This will significantly improve the likelihood of an agreement.

After the joint meeting, the mediator will each side separately, and attempt to move the ward some resolution of the case. The techniques the mediator uses to move a party's counsel from an entrenched position can be impressive. In one mediation I participated in, the mediator used a kind of shock therapy, jolting the lawyers with whom I was associated into changing their original evaluation of the case. If impressive, the experience was not pleasant. The lawyers, including myself, took issue with the mediator's frontal attacks on deeply felt positions, but we nevertheless/did move considerably toward the ultimate settlement. It also was absolutely clear that, if the adversary had made those attacks, the settlement process would have ended - immediately. Although individual mediators have their own personalities, and will use different methods in dealing with the parties, I sense that a little shock therapy in a Tax Court mediation may be useful. District Counsel attorneys are not often conscious of or moved by the financial risk of loss. Taxpayers and their counsel do not always recognize that a case can be brilliantly tried and argued, but lost all the same.

In the course of the American Bar Association's attempt to draft model rules, there was a debate about the role of [mediators..sup.19] One side contends that mediators should only facilitate the settlement of disputes, helping the parties find their own solutions. The other side believes that mediators should also evaluate the parties' respective positions and tell them their chances of success, in the opinion of the mediator. The drafters of the ABA's standards for mediators adopted the requirement that the mediator "[r]ecognize that mediation is based on principles of self-determination by the parties." By adopting this general standard while commenting that mediators "should refrain from providing professional advice," the drafters appear to support the facilitator role for the mediator. Critics have pointed out that if a mediator is prohibited from providing professional advice, the mediator will not be able to fulfill the mediator's obligation to suggest options for the participants.

Both the Appeals mediation procedures and the Tax Court mediation procedures provide that the mediator does not have settlement authority and will not render a decision on any issue in dispute. These statements do not necessarily prevent the mediator from playing an activist role. The mediator, can help the parties reach their own settlement in part by pointing out weaknesses in the respective cases. But just how far the IRS will permit the mediator to go remains to be seen.

The objective of mediation is a settlement. Apart from shaking the parties in their own views of the case, the mediator can suggest ways of settling the case that the parties may not have thought of or, simply by starting the process of thinking about alternatives settlement possibilities, fashion a settlement on a basis that the parties have not thought of when they started the mediation. If a settlement is reached on some or all of the issues, the parties will come together again with the mediator to memorialize their agreement, though the formal documentation may take some additional time. The directive suggests that the stipulation of settled issues or decision document be prepared by the District Counsel attorneys as part of the mediation process or very shortly thereafter to prevent later disagreement. Taxpayers'counsel should be similarly prepared to finalize an agreement at the mediation. Some attorneys go to mediations with basic terms already on a floppy disc and take a laptop computer.

All of these steps can take place in a surprisingly short period of time. Statistics show that most mediations last no longer than a single day, though that day may concededly seem long. Multiple Appeals conferences are common in large cases, but my experience is that mediation works best in a compressed time period. Accordingly, I would like to see one or more issues resolved at a single mediation session, even if multiple mediation sessions were required to dispose of all the issues in the case. The successful mediation we had took less than two days.

Conclusion

Mediation can be an effective way to settle difficult issues. Experience in non-tax cases, especially in state courts, has been quite favorable. But when one of the parties is a government agency, such as the IRS, the dynamics of mediation may not work without the willingness of the government attorneys (District Counsel) to participate fully by having supervisory personnel at the mediation session. Not every mediator is suited to the mediation of a tax case because special efforts are needed to deal with government attorneys and to break down the wall of mistrust both sides often build in a tax case.

(1) Robert F. Hudson, Jr., a senior tax partner in Baker & McKenzie's Miami office, and C. Coleman G. Edmunds, a tax associate in the office, were the other members of the team. (2) Tax Court Rules of Practice and Procedure. Rule 124. (3) Internal Revenue Manual, Tax Litigation (35)3(20)1 Preliminary Considerations). (4) Announcement 95-86, 1995-44 I.R.B. (Oct. 30. 1995). (5) Chief Counsel Notice N(35)000-135, 1995 DTR 215. (6) The U.S. District Court for the District of Columbia publishes a pamphlet describing its Dispute Resolution Programs, including mediation. (7) Announcement 95-86, 1995-44 I.R.B. 27 (Oct. 30, 1995). (8) "Mediation Program Begins with Cautious Optimism," 95 TNT 207-02 (Oct. 23, 1995). (9) "Officials at ALI-ABA Program Discuss Handling Tax Controversies," 96 TNT 206-4 (Oct. 22, 1996). (10) Internal Revenue Manual, Tax Litigation (35)3(20)2 (Case Selection Criteria). (11) See Internal Revenue Manual Ex. 8700-1(ISP Issues) and [sections] 8776 (ACI Issues). (12) The Chief Counsel's procedures adopt this view. Internal Revenue Manual, Tax Litigation (35)3(20)1 (Preliminary Considerations). (13) Chief Counsel Notice N(35)000-135, supra. (14) Id. (15) Internal Revenue Manual, Tax Litigation (35)3(20)4 (Mediator Selection Guidelines). (16) Id. (17) Chief Counsel Notice N(35)000-135, supra. (18) Id. See also Internal Revenue Manual, Tax Litigation (35)3(20)5 (Agreement to Mediate). (19) See "Model Ethics Rules Limit Mediator Role," ABA J., at 25 (Jan. 1996).