Lawsuit Danger Alert: Be Careful How You Dispose of Old Records

Changes in law that take effect this December will increase your chances of being sued for unmanaged attrition of records when litigation is likely. Protect yourself now!

I.  An Issue That’s Now Taking the Spotlight.

As if you didn’t have enough to worry about, litigation-wise, a threat is moving to the forefront. It’s called “spoliation of evidence,” and it’s been around for a while-but upcoming changes in the Federal Rules of Civil Procedure are making this risk even riskier.

Without any reference at all to the actual merits of a controversy, businesses have suffered the disaster of an adverse verdict of thousands, millions, or even billions of dollars, when a court determines in hindsight that “relevant” records were destroyed with “culpable intent” after the company had “reason to know” that it may be sued in a particular matter. Several recent, high-profile cases indicate that these kinds of claims are catching on. See: Glover v. Costco Wholesale Corp., 153 Fed. App. 774, 2005 U.S. App. Lexis 23943, CA. 2 (negligence is a sufficiently “culpable state of mind” to ground spoliation sanction); Coleman Holdings, Inc. v. Morgan Stanley & Co., Inc. , 2005 W.L. 679071, (Fla. Cir. Ct., March 1, 2005) (jury instruction on “adverse inference” grounding $1.45 billion verdict); Zubulake v. UBS Warburg, LLC, 229 FRD 422, 2004 U.S. Dist. Lexis 13574 (S.D.N.Y., 2004) ($20.2 million in punitive damages awarded in employment discrimination case following spoliation instruction).

As of December 1, 2006, the magnitude of this risk will increase dramatically for those businesses that ignore the legal requirements imposed upon them by amendments to the Federal Rules of Civil Procedure. In the works for over ten years, the rule amendments are intended to “catch up” with the dramatic and far-ranging effects of evolving information technology and the way businesses communicate and handle electronically stored information (ESI). In practice , these amendments will focus the attention of would-be plaintiffs and their attorneys on the possibility of raiding corporate larders-not based on the merits of an actual claim, but on shortcomings of the architecture and management of modern information systems. The resulting “feeding frenzy” is likely to splash over into litigation in the state courts as well. If you are ignorant of these developments, you and your business will likely become victims.

You can and should take steps to manage this risk.

II. The Importance of a Robust and Established “Hold” Procedure.

The courts have acknowledged that businesses have a right to purge information from their records, both paper and electronic. See proposed F.R.C.P. 37 (effective December 1, 2006):

Rule 37. Failure to Make Disclosures or Cooperate in Discovery; Sanctions

* * * * * * * * * *

(f)  Electronically stored information . Absent exceptional circumstances, a court may not impose sanctions under these rules on a party for failing to provide electronically stored information lost as a result of the routine, good-faith operation of an electronic information system.

Committee Note

Subdivision (f). Subdivision (f) is new. It focuses on a distinctive feature of computer operations, the routine alteration and deletion of information that attends ordinary use. Many steps essential to computer operation may alter or destroy information, for reasons that have nothing to do with how that information might relate to litigation. As a result, the ordinary operation of computer systems creates a risk that a party may lose potentially discoverable information without culpable conduct on its part. Under Rule 27(f), absent exceptional circumstances, sanctions cannot be imposed for loss of electronically stored information resulting from the routine, good-faith operation of an electronic information system.

III. Timing Is Critical.

However, deliberate destruction (or even “merely” negligent purging in some jurisdictions) of “relevant information” will not be tolerated once the business “has reason to know that litigation is likely.” This critical point does not just start upon the receipt of the suit papers, but can go back in time as far as the making of a claim or demand, or even the occurrence of an event indicating the “likelihood” of litigation.

IV. “Deemed Violations”-A Serious Matter.

Once this triggering threshold is deemed in retrospect to have been reached, a business, its in-house counsel, and its retained outside counsel all will be held to an affirmative duty to communicate a ” litigation hold ” on the destruction of relevant information to ” key witnesses, IT, and paper records managers, and to others who may possess information relevant to the litigation. Businesses and their lawyers have suffered reprimands, sanctions, and imposition of liability for failure to discharge this duty (notwithstanding even “automatic” rewriting over drives).

“Relevant information” can be broadly defined to include not just admissible evidence, but information that could “reasonably lead to discovery of admissible evidence.” It won’t be sufficient to produce static images on a CD. Today’s savvy litigators want to examine the “meta-data” that reveals the sources, evolution, and interconnectedness of data. (Imagine what a hostile lawyer can learn by retrieving “deleted” drafts of a sensitive document!) In the recent case of Cooper v. Schoffstall , Pa. 212 MAP 2004 (9-7-06), the Supreme Court of Pennsylvania interpreted the “for cause” discovery methodology as permitting a Court to authorize inquiry into an expert’s financial records, including tax returns, to discern the degree to which his past earnings as an expert witness may call his objectivity into question.

If you give your adversary’s imagination a “toe-hold” to argue that you are hiding something, you could be in for a bad time. Chillingly, even “attorney work product” and “attorney/client communication” privileges can be deemed set-aside by the “crime-fraud” exception, following in-camera review of information by the court. Mistakes, oversights and misstatements can easily be misconstrued, with disastrous consequences.

Following are some examples of criminal or disciplinary provisions that could take you unawares:

Bankruptcy/Insolvency

Bankruptcy Code – 11 U.S.C. §727(a)(3):

The court shall grant the debtor a discharge, unless the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor’s financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case.

Crimes Code (Bankruptcy Crimes) – 18 U.S.C. §152(8):

A person who after the filing of a case under title 11 or in contemplation thereof, knowingly and fraudulently conceals, destroys, mutilates, falsifies, or makes a false entry in any recorded information (including books, documents, records, and papers) relating to the property or financial affairs of a debtor shall be fined under this title, imprisoned not more than 5 years, or both.

Crimes Code (Bankruptcy Crimes) – 18 U.S.C. §152(9):

A person who after the filing of a case under title 11, knowingly and fraudulently withholds from a custodian, trustee, marshal, or other officer of the court or a United States Trustee entitled to its possession, any recorded information (including books, documents, records, and papers) relating to the property or financial affairs of a debtor shall be fined under this title, imprisoned not more than 5 years, or both.

“Normal” Business in a Post-Enron World

Sarbanes-Oxley was enacted by the Republican Congress in 2002, under pressure from the series of business scandals typified by Enron.

Sarbanes-Oxley is primarily focused upon publicly traded companies and companies in bankruptcy. However, by an insidious process of “incorporation” it affects many insurance and government contracts, as well as lenders’ covenants, and may also overlap with tax, environmental, labor/employment, or industry-specific requirements. Auditing accountants of public companies have direct document retention responsibilities under Sarbane’s-Oxley lasting five (5) years.

Crimes Code (Sarbanes-Oxley Act of 2002) – 18 U.S.C. §1519 (Destruction, alteration, or falsification of records in connection with Federal investigations or bankruptcy):

Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.

District of Columbia Code (Criminal Offenses) – DC ST §22-723 (Tampering with physical evidence; penalty):

(a) A person commits the offense of tampering with physical evidence if, knowing or having reason to believe an official proceeding has begun or knowing that an official proceeding is likely to be instituted, that person alters, destroys, mutilates, conceals, or removes a record, document, or other object, with intent to impair its integrity or its availability for use in the official proceeding.

(b) Any person convicted of tampering with physical evidence shall be fined not more than $5,000, imprisoned for not more than 3 years, or both.

District of Columbia Rules of Court (Rules of Professional Conduct) – DC R RPC Rule 3.4:

A Lawyer Shall Not:

(a) Obstruct another party’s access to evidence or alter, destroy or conceal evidence, or counsel or assist another person to do so, if the lawyer reasonably should know that the evidence is or may be the subject of discovery or subpoena in any pending or imminent proceeding. Unless prohibited by law, a lawyer may receive physical evidence of any kind from the client or from another person. If the evidence received by the lawyer belongs to anyone other than the client, the lawyer shall make a good faith effort to preserve it and to return it to the owner, subject to Rule 1.6.

Comment to DC R RPC Rule 3.4:

[2] Documents and other items of evidence are often essential to establish a claim or defense. Subject to evidentiary privileges, the right of an opposing party, including the government, to obtain evidence through discovery or subpoena is an important procedural right. The exercise of that right can be frustrated if relevant material is altered, concealed or destroyed. To the extent clients are involved in the effort to comply with discovery requests, the lawyer’s obligations are to pursue reasonable efforts to assure that documents and other information subject to proper discovery requests are produced. Applicable law in many jurisdictions makes it an offense to destroy material for purpose of impairing its availability in a pending proceeding or a proceeding whose commencement can be foreseen. Falsifying evidence is also generally a criminal offense. Paragraph (a) applies to evidentiary material generally, including computerized information.

[4] A lawyer should ascertain that the lawyer’s handling of documents or other physical objects does not violate any other law. * * * This Rule does not set forth the scope of a lawyer’s responsibilities under all applicable laws. It merely imposes on the lawyer an ethical duty to make reasonable efforts to comply fully with those laws. The provisions of paragraph (a) prohibit a lawyer from obstructing another party’s access to evidence, and from altering, destroying or concealing evidence. These prohibitions may overlap with criminal obstruction provisions and civil discovery rules, but they apply whether or not the prohibited conduct violates criminal provisions or court rules. Thus, the alteration of evidence by a lawyer, whether or not such conduct violates criminal law or court rules, constitutes a violation of paragraph (a).

V.  Who Pays? Shifting Expense Burdens (of Retrieval and Production of Information).

You can become subject to this “litigation hold” not only as a prospective party to a lawsuit, but also under amended F.R.C.P. 45, as a nonparty witness (including a business) when you receive a subpoena. You merely have to “be on notice” to preserve information. For nonparty witnesses, the opportunity to prevent disclosure on the basis of hardship, and/or keeping the (usually) expensive compliance costs on the seeker, is much greater. However, broad discretion resides in the court as far as “cost-shifting.”

Generally, you as responding party bear the cost of production of “accessible” information, while “inaccessible” information should be retrieved at the expense of the party seeking the information.

While “back-up tapes” and “disaster archives” of a party that are “not readily accessible” most often shift the burden of persuasion and expense of retrieval to the party seeking them, evidence of “suspicious” deletion of relevant information from operating systems or operating accessibility to those archival information pools has often been cited as sufficient reason to compel the production and/or shift the cost of retrieval to the respondent. “Sampling” (random searches) has also been allowed, which frequently permutates into a foot-in-the-door progression of retrieval and disclosure, increasingly at the responding party’s expense. Mistakes in IT architecture or management can have disastrous consequences.

Respondents to an “ESI” request are expected to act in a timely manner. Parties are expected to address known issues of privilege, or other bases of a protective order, as part of the Rule 26(f) disclosure process, very early-on in Federal Court litigation.

In the context of litigation, it is important for the respondent’s counsel to be “out in front of” the opposition, seeking a protective order and/or skillfully negotiating a “MAD” (mutually assured destruction) understanding with opposing counsel. (What’s good for the goose is good for the gander.)

So what can you as a businessperson do to protect yourself from this exposure?

VI.  Your Records Retention and Disposal Practices Must Pass the Test of Being Deemed “Reasonable” in Hindsight by an Unknown Judge.

First, have a disciplined, well-defined information storage, management and destruction policy. So long as the information is purged routinely, pursuant to such a system, and without “reason to know” litigation is likely, you are within your rights in purging information.

You may wish to designate an official “records-manager officer,” and routinely segregate information you know is important, while deleting information that is not.

There should be a clear-cut, established procedure for the regular retention and destruction of information pursuant to identified criteria and documented compliance with those company policies and procedures.

Second, have a documented and robust “litigation hold’ procedure in place. Make sure it’s broadly construed by your management and employees so that you can demonstrate to the court that an honest and energetic effort has been made, and nothing has intentionally been left outside of the “spotlight,” once you had “reason to know litigation was likely.” Make sure key witnesses, IT, and document storage personnel are officially noticed, and that the “hold” is in fact observed (issue memorializing “reminders” of the hold from time to time).

VII. So, How Do You Know When You Are “Safe”?

The bottom line? We do not want our clients to become victims of this tactical fad, nor do we want to become victims ourselves. We look forward to your successfully managing this risk and will assist in any way that we can. Unfortunately, the risk can only be managed, not eliminated.

In Brotech Corporation v. Delmarua Chemicals , 2003 Pa.Super. 281, 831 A.2d 613; 2003 Pa.Super. Lexis, 2327, two judges of the Pennsylvania Superior Court came to diametrically opposed conclusions, based upon the same record.

The majority, in reversing the Trial Court’s entry of a summary judgment as a sanction against the party for spoliation of evidence, noted that a discovery sanction must be procedurally supported by the existence of a motion for discovery sanctions. Further, the majority reasoned that the other party had ample opportunity to examine the evidence, albeit only a few days before trial, and was not in fact prejudiced in preparing its defense.

The dissent vigorously pointed out that the respondent failed to make discovery as requested for over two years, and produced the requested discovery only 11 days before the start of trial. The dissent further noted that there had never been a satisfactory explanation for the failure to make timely discovery, and that the court case below was characterized by contentious discovery behavior.

Broad discretion of the Trial Court is reviewed under a five-point test:

  • the nature and severity of the discovery violation;
  • the willfulness or the existence of bad faith in the failure to make discovery;
  • the prejudice to the opposing party;
  • the ability to cure the discovery violation with a lesser sanction; and
  • the relative importance of the precluded evidence in light of the failure to comply with the discovery.

The dissent conceded that the sanction for spoliation (in Pennsylvania State Court) is granted only in cases of willful failure to make discovery, and where the opposing party is actually prejudiced.

The dissent would have sustained the Trial Court’s entry of discovery sanctions in the form of summary judgment against the respondent!

Theoretically, the Supreme Court of Pennsylvania and the Third Circuit Court of Appeals have both adopted the same test for “spoliation.” See Schroeder v. Commonwealth of PA Dept. of Transp. , 551 PA 243, 710 A.2d 23, 1998 PA Lexis, 564; Tenaglia v. Procter and Gamble, Inc., 1999 Pa.Super. 220, 737 A.2d 306, 1999 Pa. Super. Lexis 2790 (the Pennsylvania Supreme Court has adopted the spoliation test adopted by the Third Circuit Court of Appeals in Schmid v. Milwaukee Electric Tool Corp., 13 F.3d 76 (3 rd Cir., 1994)).

The more recent federal case of Paramount Pictures Corp. v. John Davis , 234 F.R.D. 102, 2005 U.S. Dist. Lexis 31065, defines “spoliation” as the destruction or significant alteration of evidence, or failure to preserve property for another’s use as evidence in pending or reasonably foreseeable litigation.

Noting the Third Circuit Decision in a case out of New Jersey , Mosaid Xtechs v. Samsung Elecs, 348 F.Supp. 2d 332 (D.N.J., 2004), the Court noted the preconditions for a finding of spoliation:

  • that the evidence in question be within the party’s control;
  • that there has been an actual suppression or withholding of evidence;
  • that the evidence destroyed was relevant to claims or defenses; and
  • that it was reasonably foreseeable that the evidence would later be discoverable.

The Court noted that the range of sanctions for spoliation are on a continuum from dismissal of a claim or granting of judgment in favor of the prejudiced party, to the suppression of evidence, to adverse inference instruction, to fines and the imposition of attorneys’ fees and costs.

While there is no bright line rule, the Court’s discretion in granting or denying spoliation sanctions should generally consider (1) the degree of fault of the party who altered or destroyed the evidence, (2) the degree of prejudice suffered by the opposing party, and (3) whether there is a lesser sanction that will avoid substantial unfairness to the opposing party; and where the offending party is seriously at fault, will serve to deter such conduct by others in the future. The Court should choose the most appropriate sanction for spoliation that would be the least onerous corresponding to the degree of willfulness of the destructive act and the prejudice suffered by the victim.

The Court should consider the extent to which the responsible party acted deliberately to impair the ability of the other side to effectively litigate its case, as well as the degree of actual prejudice suffered by the party and whether that party had a meaningful opportunity to examine evidence before it was destroyed.

Yet, the fact remains that these are usually “judgment calls” about which reasonable minds can, and often do, differ. Don’t be caught unprepared, or it can really cost you. Get your information system in order. While there are no guarantees in this or any other legal area, at least you’ll be able to sleep at night knowing that you did everything possible to prevent litigation. That alone will make your efforts worthwhile.

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