The Internal Revenue Service (the "IRS") has recently issued final regulations relating to the classification for federal tax purposes of certain publicly traded partnerships ("PTPs") as corporations. This is important to private investment funds organized as partnerships because Section 7704(a) of the Internal Revenue Code treats and taxes a PTP as a corporation unless the PTP meets certain gross income requirements. (Generally, at least 90% of the gross income of the partnership must consist of passive income, such as interest, dividends, real property rents, gain from the sale of capital assets, and other specified categories of income). Section 7704 applies to all domestic and foreign entities taxed as partnerships, including limited liability companies and other entities treated as partnerships for federal tax purposes. Under Section 7704(b) of the Code, a partnership is a PTP if interests in the partnership are traded on an established securities market or are readily tradable on a secondary market (or the substantial equivalent thereof). This has implications for funds listed on foreign exchanges such as The Irish Stock Exchange.
     Recognizing the need for certainty in the tax classification of entities in advance of Regulations, the IRS, in 1988, issued Notice 88-75, 1988-2 C.B. 386, granting several limited safe harbor exceptions from the definition of a PTP. Relying on the legislative history, the Notice set forth guidelines to determine when partnership interests are "readily tradable on a secondary market (or the substantial equivalent thereof)." The Notice provided that private placements of partnership interests should be disregarded for purposes of determining whether interests in a partnership are to be considered readily tradable on a secondary market or the substantial equivalent thereof. The Notice specifically exempted all interests in a partnership issued in a transaction not registered under the Securities Act of 1933, if either (1) the partnership did not have more than 500 partners or (2) the initial offering price of each unit was at least $20,000 and under the partnership agreement no unit could be subdivided for resale into units that would cost less than $20,000. Because of the Investment Company Act limitations, this was an easy set of tests to meet.
     However, in May 1995, the IRS issued Proposed Regulations under Section 7704 of the Code. Like Notice 88-75, the Proposed Regulations generally provided that private placements of partnership interests should be disregarded for purposes of determining if a partnership is publicly traded. However, the Proposed Regulations made significant changes: Under the Proposed Regulations, a distinction was made between "readily tradable on a secondary market" and "readily tradable on the substantial equivalent of a secondary market," and the private placement safe harbor was made applicable solely for purposes of determining whether partnership interests are readily tradable on the substantial equivalent of a secondary market. Thus, interests in a partnership not registered under the Securities Act of 1933 nevertheless could be interests in a PTP if they were considered readily tradable on a secondary market. In addition, the private placement exemption was made unavailable to a partnership having more than 50 partners at any time during the partnership's taxable year if the sum of the percentage interests in partnership capital or profits transferred during that year exceeded 10% of the total interests in partnership capital or profits.

     Never assume that whenever an attorney communicates with a client, anything that is said - or, for that matter, written - will always be protected by attorney-client privilege. In Georgia-Pacific Corp. v. GAF Roofing Manufacturing Corp. (U.S.D.C., S.D.N.Y. filed January 25, 1996), U.S. Federal Judge Patterson recently ruled that a lawyer who is engaged to negotiate a contract is exercising a non-legal function. It was held that communications between the lawyer and the client regarding the status of the negotiations and potential negotiation trade offs are matters which involve business judgments - not legal advice. The conversations are not protected by attorney-client privilege and the lawyer can be forced to testify about what he told his client. The court cited an earlier decision of New York's highest court which held that the privilege applies only in situations when the lawyer is "exercising a lawyer's traditional function" and ordered production of a memorandum from a lawyer to corporate management that discussed various issues, including a report by the lawyer concerning his discussions with opposing counsel regarding the company's potential exposure in a litigation. The privilege protects confidential communications between a lawyer and a client during the course of professional employment. Georgia-Pacific says that a negotiation status report without specific legal advice is not such a function and is not protected.
     Georgia-Pacific is a good example of a growing number of cases that blur the distinction between business judgments and legal advice, and challenge the conventional wisdom that lawyers should not be compelled to testify about what they tell their clients. The lawyer in Georgia-Pacific was in-house counsel and the court noted that such lawyers often play a mixed business/legal role. Perhaps, a different result would have occurred had outside counsel - which may be subject to a less strict standard - been engaged to represent the client in the negotiation. While that fact may not be determinative, it certainly should not be overlooked when a decision is made to engage counsel. Vince Syracuse heads our Litigation Department and can explain this matter further for you should the need arise.

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