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Dynamo Holdings Ltd. P’ship v. Comm’r of Internal Service, United States Tax Court Approves Use of Predictive Coding by Taxpayer Over Objections by the IRS.

Rejecting the Internal Revenue Service‘s argument that predictive coding is “new technology,” the United States Tax Court granted petitioner, Dynamo Holdings’ request to utilize the technology for the production of ESI. This case involved the tax treatment of transfers from Beekman Vista, Inc. to a related entity owned by a Canadian citizen.

The IRS filed a motion to compel petitioners’ production of ESI stored on two specific backup storage tapes or produce the tapes themselves. Although the petitioners agreed that the backup tapes contained relevant tax information, they asserted that the backup takes also contained confidential information including Personally Identifiable Information and information protected under HIPAA that they had a duty to protect. Petitioners argued that it would take months to review documents for responsive, privileged, and confidential information with an associated cost of at least $450,000. Arguing that the request for this information was a “fishing expedition,” the petitioners requested that the court either deny the IRS’s motion or in the alternative allow them to employ predictive coding to efficiently and cost effectively identify the non-privileged information responsive to the request for the ESI.

In response to petitioners assertion that it was a “fishing expedition,” the IRS argued that they needed the backup tapes to review the ESI’s metadata to verify the dates on which documents were created and to ascertain all the transfers associated with the proceeding. Arguing that predictive coding is “new technology,” the IRS suggested that petitioners avoid the cost and time associated with the review by giving the IRS access to all the data on the tapes subject to a clawback agreement.

When addressing the petitioners’ request to use predictive coding, the court characterized the request as “somewhat unusual,” and noted it was not “normally in the business of dictating to the parties the process that they should use when responding to discovery.” However, because this was the first time the court considered the issue of computer assisted review tools, it decided to address the issue of predictive coding.

In its analysis, the court viewed predictive coding as a “potential happy medium” between the competing interests of the acknowledged relevancy of the backup data, the inappropriateness of requiring the petitioners to produce all the ESI subject to a clawback agreement, and the time and expense associated with reviewing all the data for relevant, privileged and confidential information. Disagreeing with the IRS’s argument that predictive coding is “unproven technology,” the court noted that it understood that the “technology industry considers predictive coding to be widely accepted for limiting e-discovery to relevant document and effecting discovery of ESI without an undue burden.”

Finding that the petitioners made a reasonable request to use predictive coding to reduce time and expense and planned to use electronic discovery experts to meet with the IRS’s counsel to identify a search acceptable to them, the court saw no reason not to allow the use of the technology for ESI discovery. The Court found the testimony of the petitioner’s expert to support its position. The expert, who analyzed the parties “dueling approaches,” to the production of the ESI, found that the predictive coding approach would result in reduced review time and expense and yield a “focused set of information germane to the matter.” The expert estimated that employing predictive coding would result in 200,000 to 400,000 documents subject to review at an expense ranging from $80,000 to $85,000 whereas traditional review would involve 3.5 million to 7 million documents subject to review with an associated cost between $500,000 to $550,000. Noting that its discovery Rules (1D) are to “be construed to secure the just speedy and inexpensive determination of every case,” the court granted petitioners request to employ predictive coding and directed the IRS to file a motion to compel in the event it found the ESI production incomplete.

Dynamo Holdings Ltd. P’ship v. Comm’r of Internal Revenue, Nos. 2685-11, 8393-12 (T.C. Sept. 17, 2014)

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