Check Your (Texas Audit) Privilege: It Might not be Available in Federal Court

Case and Context

The Sierra Club sued Woodville Pellets LLC (“Woodville”) in federal district court under the federal Clean Air Act’s citizen suit provision, claiming that the wood pellet manufacturer’s Texas plant has been and is emitting air contaminants in excess of limits established in a permit issued by the Texas Commission on Environmental Quality (“TCEQ”). To gather evidence in support of its claims, Sierra Club sought to compel Woodville and its environmental consultant to produce stack testing reports. Woodville moved to quash, arguing (among other things) that the stack testing reports were compiled under the Texas Audit Act and were therefore privileged.

Texas Audit Act

In recognition of limited state inspection and enforcement resources, Texas and many other states incentivize the regulated community to “self-police” in order to improve statewide environmental compliance. The Texas Audit Act is widely used by the regulated, who are incentivized by the regulator to look for, voluntarily disclose, and promptly correct violations in exchange for immunity from civil penalties. The Texas Audit Act also creates a state law privilege against compulsory disclosure of “audit reports,” at least under most circumstances.  It was this privilege that was at issue in the Woodville case. Regulated entities routinely hire third-party consulting firms to conduct environmental audits. Field notes, laboratory analyses, and other analytical data (such as stack test reports) often underpin a consultant’s and/or legal counsel’s “audit report,” all of which the Texas Audit Act designates as privileged in civil actions and administrative proceedings.  (As with all privileges, there are limitations on its use, and circumstances under which it can be waived, but these were not at issue in the Woodville case.)

The Court’s Decision

The question before the federal court was whether it should recognize a privilege created solely as a matter of state law. Federal courts only have jurisdiction to hear cases between citizens of different states (diversity jurisdiction) or that involve issues arising under the Constitution or other federal laws (federal question jurisdiction). The court framed the case as one based on federal questions alone, with no direct or pendent state law claims. Federal rules of evidence, including rules on privilege, govern federal question causes of action. However, even in such cases, federal courts may recognize and apply state privileges where the policies behind the privilege outweigh the policies favoring disclosure. Accordingly, the court applied a balancing test under Federal Rule of Evidence 501 to determine whether it should recognize the Texas Audit Act privilege. The court reasoned that the State’s audit privilege should not be respected in a strictly federal law proceeding, primarily because (1) the Texas Audit Act does not otherwise apply to a federal government agency, and (2) ruling otherwise would “run counter to encouraging the kind of openness that builds trust between regulators, the regulated community and the public.” Accordingly, Woodville was required to produce the test reports.

Limitations of District Court’s Decision

The court’s decision will cause environmental activist groups and could cause the federal government to routinely seek Texas Audit Act audit reports, including the analyses and data underpinning them, via discovery requests in federal citizen suits and Department of Justice-initiated environmental enforcement cases. But the court left much unsaid, and the record does not reflect a thorough briefing, so it is uncertain how the Fifth Circuit Court of Appeals would rule on any appeal or how the next federal district court would resolve similar issues.  For example:

• The court presupposed that the case presented a “federal question” with no state law claims. That isn’t self-evidently true. The Environmental Protection Agency (“EPA”) has approved Texas’s air program in the State’s implementation plan. While that makes it federally enforceable, Texas’s air program is a collection of state laws, including the Texas Clean Air Act and underlying TCEQ regulations, aimed at meeting federal air quality standards, and TCEQ is exclusively responsible for issuing air permits, including the permit at issue.  There is no “federal permit” or “federal program” to enforce, even though it is federally enforceable (e., can be litigated in federal court).
• Even if it were a strictly federal question case, the court’s rationale under the Federal Rule of Evidence 501 balancing test is not bulletproof. For example, the court found that rejecting the privilege claims would not significantly impair open communications between the regulated community and the regulator, and that withholding the stack test reports would counter the openness that builds trust between regulators, the regulated community, and the public. But another court could reach the opposite conclusion, and for good reason:  Since its inception, the Texas Audit Act has incentivized the regulated community, including new owners of existing facilities, to self-police, openly disclose identified compliance issues to the regulator, and work with the TCEQ or the Texas Railroad Commission, as the case may be, to promptly achieve compliance. And the federal government has approved the Texas Audit Act after very close examination and even a cycle of revisions to address issues related to compliance with federal laws. Environmental activist groups previously challenged EPA’s approval of Texas’s Title V permitting program, claiming that that the Texas Audit Act prevents Texas from having adequate enforcement authority and “impermissibly makes audit documents privileged.” Public Citizen, Inc. v. U.S. Environmental Protection Agency, 343 F.3d 449, 461-62 (5th Cir. 2003). But EPA in that case had rightly rejected those claims, asserting that the Texas Audit Act’s provision of limited immunity from civil penalties does not preclude Texas from possessing adequate enforcement authority and that the Texas Audit Act maintained Texas’s authority to view any documents held by the regulated community that otherwise were required to be collected, maintained, or reported under the law.  Id. The Fifth Circuit Court of Appeals held that EPA’s approval was not arbitrary or capricious.  Id.  The district court in the Woodville case did not address the reasoning or outcome of EPA’s or the appellate court’s Public Citizen.
• Legal counsel often directly hires third-party environmental consultants to audit a client’s facilities in order for counsel to conclude, as a legal matter, whether a client is in compliance with complex and confusing regulations and permit conditions. The court’s decision did not address whether the stack test reports could have been deemed attorney-client privileged or attorney work product.

Takeaways

It remains to be seen whether Woodville will appeal the court’s decision, or how a subsequent federal district court presented with a different set of facts and legal arguments would decide the issue. In order to bolster privilege claims under the Texas Audit Act and other environmental audit programs, and unless and until subsequent case law developments put the state privilege on firmer footing in federal court, the regulated community as a best practice should enlist legal counsel to manage third-party consultants, ensure proper audit document handling, and otherwise shepherd environmental audits.

Reprinted with permission from the “AUGUST 31, 2021 edition of the “TEXAS LAWYER”© 2021 ALM Media Properties, LLC. All rights reserved.

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