Why Bankruptcy Practicioners Should Care About Discovery

Charles E Bobinis
Bernstein-Burkley, P.C.

I. The Backdrop of Bankruptcy Culture

The day-in, day-out reality of Bankruptcy practice for practitioners is often likened to the emergency room of a busy urban hospital. Sometimes the patient is wheeled-in, barely clinging to life. The wounds must be cleansed, the bleeding stopped, sometimes with an incomplete knowledge of the patient’s full history and circumstance, and with foreknowledge that resuscitation may not be in the cards. All of this while striving to earn a living, and to uphold the ethics of the profession.

Concessions must be made to the necessity of achieving immediate, pragmatic results. The preferred tools of the bankruptcy profession are deal-making and consensual resolution. But the process of “adjusting debt” is far too serious, too sensitive to societal interests, to be handled in an unprincipled manner. Among the icons of Bankruptcy Code policy is fairness in process: uniform treatment of claims within preordained, prioritized classes1 scrutiny of insider transactions through the lens of fairness to creditors;2 and meaningful disclosure of the material facts in time for the constituencies of the bankrupt estate to seek protection of their respective interests.3 The Bankruptcy Code even looks back certain periods of time before the petition date, to avoid inequitable or preferential transfers on the eve of bankruptcy.4 Proceeding in bankruptcy court is truly a contest, but one generally intended for a level playing field, as Title 18 attests.5

Those officially entrusted with the property of the bankruptcy estate, even a Debtor in Possession, are fiduciaries under federal law to the community of interests of the bankruptcy estate, proscribed from acting “outside the normal course of business” without prior “notice and hearing.”6 Further, any party in interest in a Chapter 11 has an express right to request a hearing from the Court, on any matter, at any time (11 U.S.C. §1109(b). Under the Bankruptcy Code generally, a party in interest may seek to intervene in a proceeding for cause shown. B.R. 2018(A).

With active constituents, armed with enough information to render proceedings reasonably transparent, the process generally strikes an acceptable balance between principle and expediency at least with respect to issues the political process has allowed to be heard in bankruptcy. When the process works as it should, society receives a valuable service in the pragmatic resolution of failed economic commitments, and recycling of assets and economic opportunities. Ultimately, the authority of the bankruptcy system itself rests upon societal perception that it is home to a process at least reasonably fair, and mostly expedient.

The considerable powers of Bankruptcy, created by Congress and guarded by the courts, are nevertheless pregnant with possibilities for manipulation and abuse which some, unfortunately, find irresistible. Notwithstanding efforts to police and reform the practice by legislation (e.g., 11 U.S.C. §307), it ultimately falls to the bankruptcy bench and bar to bear the brunt of reasonable quality control.7

Disclosure of adequate information on a timely basis is essential for the process of consensual negotiation and resolution to roll out.8 While “prepackaged plans,” “liquidating 11s,” “first day orders,” “critical vendor payments,” extra-judicial deal-making, and the like are deemed pragmatic enablers of efficiency, they need always to be tempered with a degree of transparency appropriate to meaningful disclosure, so that the loyalty of constituents is maintained, and the societal interest is served. In the first instance it falls to informed bankruptcy counsel to discern the facts, and if necessary, deliver them publicly to the court with vigor and skill, to assure a “level playing field” for the constituent(s) served.

II. “Why Should I Care About discovery?”

Traditional investigative techniques, allies, mandatory information filings, first meeting of creditors and such, all have their place in the arsenal of bankruptcy counsel, but often prove woefully inadequate by themselves, especially in a complex case of any magnitude. A skillful adversary with time to plan against jurisdiction and to “make deals,” can render timely discernment and proof by other constituents, of motives and agendas, extremely challenging. This can quickly “decontent” the bankruptcy, unless key issues are quickly spotted and timely raised.

Today, over ninety-five percent of information arising from communication and record keeping is in electronic form (electronically stored information, or “ESI”). Faced with the sheer volume, proliferation and malleable nature of ESI, the courts officially recognized the rapidly expanding importance of ESI by adopting changes to the Federal Rules of Civil Procedure, including the Bankruptcy Rules, effective December, 2006.9 A flood of case decisions have since followed, addressing discovery sanctions and building upon the evolving tort of “spoliation of evidence.”10

For its part, the Supreme Court of the United States has gone even further, holding repeatedly that the case trustee, or surrogate, holds the Debtor’s attorney/client privilege, and has serious duties to investigate Debtor’s affairs.11

These rule changes, together with the advancing case law, mandate affirmative cooperation by counsel, and by their constituencies, in making information disclosures, including ESI, as reflected in B.R. 7026(a). Sometimes the “chamber rules” of individual judges go even further to require counsel to be prepared to address in detail at the initial Rule 7026(f) conference disclosure-related issues such as what ESI is readily available (e.g.., on the “operating system”), where cost-shifting may be appropriate (e.g. retrieval of ESI from backup tapes); what information is relevant (e.g. search term lists); and what protocols may reasonably be necessary for dealing with foreseeable issues such as: formatting, privilege, confidentiality, relevancy, access, and authentication. A case may be broken wide open by immediate access to a “smoking gun” resident on a home P.C., a walking laptop, a thumb drive or other information storage device. But, given the nature of ESI, you must act quickly.

Some venues provide “default” ediscovery orders. In the absence of formal stipulation by counsel, the default order may not only require more detailed disclosure of ESI sources, custodians, and protocols, but also formal designation of an “ediscovery coordinator” for each party, who will be directly in the line of fire should “shortcomings” in information retrieval and disclosure surface later.12 A working knowledge of the ediscovery process itself commends these practices to fix accountability, even more so in the bankruptcy context where they resonate with the bedrock bankruptcy policy of meaningful disclosure, found throughout the Code (e.g., Sections 308, 330, 340, 342, 521, 704(a)(7), 727(a), 1106, 1107, 1108, 1109(b), 1125, 1221, 1328(e), B.R. 1007, 1008, 1017(c), 2004, 2013, 2015, 2017, 2018, 3002, 3016, 7016, 7026 and 7037).

Even in those courtrooms where Rule 7026(a) is not officially invoked, the individual judge usually has standing “expectations” of how counsel should handle disclosures with each other. Moreover, high profile “spoliation” and sanction cases under the federal rules have not only assigned responsibility to counsel to explain and “shepherd” the client’s preservation and production obligations, but in some jurisdictions have held counsel personally liable for damages based upon what later appeared to the court to be material breaches of those duties by counsel or by the client.13

In the bankruptcy context in particular, it is often difficult if not impossible, to identify early on all information that will eventually be deemed relevant, especially in a case of any complexity. It can take many months, even several years, for some motions, adversary proceedings, objections to claims and the like, to roll out. Very often, facts are not recognized as “relevant” until raised into issue by another party. It is not unheard of for a debtor (Trustee, or Committee) to inherit an information system, server, etc., which is obsolete or unserviceable, and which can fail and destroy information at any time. Merely accessing a computer file can alter related “meta data,” if appropriate protocols are not observed. This can affect information such as “access dates,” which could be highly material in your case, and affect its weight or admissibility as evidence. A forensic copy of the drive should be made first, to capture the drive contents as they were. Examination and analysis can then be done using a copy of the drive.

In this environment, Debtor’s Counsel, Trustee, Trustee’s Counsel, Committee’s Counsel, and counsel for other active constituents, should have experienced advice available from inception of involvement, laying the foundation for responsible information collection and management, and for later rolling out of ediscovery and ediscovery responses. Flying blind through periods when information retention and management obligations should be addressed, is running an unnecessary risk of exposure to liability on discovery and disclosure related claims, in addition to forfeit of powerful tactical advantages.

There is a “safe harbor” for routine information management, including destruction and attrition of information pursuant to an established, principled information retention and destruction policy.14 Once “litigation is likely,” however, relevant information must be protected by an affirmative and continuing “litigation hold,” which should be documented.15 While “perfection” is not required in information management, demonstrably reasonable and good faith efforts most certainly are. Both counsel and client can be held liable in many jurisdictions for what appears to the court in hindsight, to have been “unreasonable” failure to preserve relevant information.16 This liability falls on top of exposure for breach of fiduciary duties by Trustees, Debtors-in-Possession, etc., which varies by circuit from a standard of simple negligence through recklessness or wanton misconduct. It is more cost-effective to build you information house on rock, and avoid these costly and embarrassing problems, right from the start.

For bankruptcy counsel, being prepared with meaningful information presents both an unparalleled opportunity to heighten the transparency and integrity of the bankruptcy process, and to leverage the position of your client during those “give and take” negotiations. Momentum builds momentum. (Who wants to be the last Defendant standing, when the rest have settled and have agreed to testify?). Imagine the “traction” generated by forensic recovery of the six deleted drafts of the “business plan,” which expose the final, official version as a progressive work of fiction. The prospect of recovering probative information from a “damaged” drive, via “clean room restoration,” can unnerve an adversary, and shake loose information from other parties.

Sometimes silence is pregnant with meaning. What inference can the court draw from the untimely “scrubbing” of those drives which demonstrably contained probative information on a case-dispositive issue?17 What inference should the Court draw from the fact that the attachment is “missing” to that email with the highly incriminating subject line? Our courts are empowered to enter appropriate relief against a party who has spoliated relevant evidence, from inference instructions or presumptions, costs and attorneys fees, through the award of damages.18

Preparation is a shield also, minimizing exposure in the maze of potential spoliation traps and pitfalls that arise absent early planning and documenting of information management.

III. Tools Available to the Bankruptcy Practitioner

While the volume and varied sources of information facing practitioners today can be daunting to some, technology has come to our aid, offering real time, real world, practical solutions. Fortunately, the cost of technology, and of related expertise, has been relentlessly “moving down market.”

Every law firm, and every case, deserves special consideration according to the circumstances. For the big firm on the big cases, most now have in-house lawyers “expert” in ediscovery and information management. For regional and smaller firms with the occasional “big” bankruptcy/ litigation case, and many cases of more modest size, there are technical experts, and bankruptcy litigation counsel experienced in the unique challenges of bankruptcy litigation and ediscovery, who have no particular interest in your “book of business.” They are available to serve as consultant or even special counsel, and ready to then “go home.” They can assist on matters ranging from information management through computer search and forensics, to electronic discovery, pretrial matters and, should it still be necessary, presentation of electronic evidence at the trial itself. This may be a lot more cost effective than trying to gear up or carry the ability in house.

There are many types and levels of IT assistance available for various situations calling for particular applications. I offer my personal experience as a guide.

Costs are probably not what you think. A “straightforward” forensic copying of a computer drive can usually be obtained for around $1,000.00. Searching for deleted or partially overwritten “fragments” in the “voids” and “partition spaces” of the drive can progressively add significant cost, because more “manual” forensic work is involved.

Does your case turn upon an email communication? If the email is on a web-based server (such as AOL or Yahoo) you may have limited options: at least one federal district court has held that the Electronic Communications Privacy Act proscribes the service of a subpoena duces tecum upon an internet provider.19 However, quick action to forensically copy and examine the P.C. drive may still yield a “temporary” image of the communication still resident on the P.C. drive itself.

There are presently available cost-effective technologies capable of rapidly mining vast information sources, and assisting in the identification, assessment, and organization of relevant information. In collaboration with experienced bankruptcy litigation counsel, information management experts can blend various search methodologies to create a powerful “search matrix” tuned to the particulars of the case, and perfectly capable of finding the “smoking guns” from among hundreds of thousands, or even millions of documents, sometimes over a weekend. These information efficiencies permit, for example, a case trustee to examine more matters and issues, and in real time, than previously possible, to better serve the estate.

Such “search Matrix” are usually web-based, and offer multiple “chairs” for remote website access. Professionals, in one or more specialties and firms, can mine the information base from their office desktops, and collaborate in document “baskets” or comment sections on the “kiosk.” Website security is “fanatical,” and use of the site is closely monitored, with layered access based upon assigned “need to know.”

Depending on the particular circumstance, you may find useful an upfront “Dossier” on particular “key players;” or a timeline summary of documents, with relevant contents, on key issues, which can provide fairly deep insight into where your investigation needs to focus.

There are even “inductive” search methodologies which can identify linguistic/ conceptual “flags” of malfeasance independent of facts known to be in issue, and pull up the words in context in the document(s) for instant review.

These tools can be invaluable to a Trustee, or Committee with standing, who, having unrestricted right to examine a vast reservoir of information of the debtor, needs to get their arms around the issues as quickly as possible. Given the host of proceedings, constant accretion of new information and surfacing of new issues typical throughout the life of a bankruptcy case, the ability to return again and again to the matrix with new or “tweaked” searches is extremely cost-effective and powerful.

Related “meta data” or systems information, not only bears witness to the history of related electronic information, establishes verifiable timelines, and provides proof of any efforts to alter or destroy information, it also enhances the powers of the search matrix, making processing, review and analysis of information even easier, while reducing processing costs. So, you need to be gathering information in the most useful format, right from the start.

For you hunters, I liken the ediscovery process to hunting whitetails. You need to strike out into the woods to do some scouting until you cross the “hot” trails. When you find trails that “meet,” with plenty of sign, you are in the game. Ultimately, it is the understanding of how the game use the woods, that sets up your shot. These tools are able to scout these “trails” many times faster, and with more accuracy, than even large groups of lawyers can. You just have to be able to tell the matrix what “sign” to look for, and be willing to interact with the matrix as you climb up the case learning curve.

The processed information can be electronically “hash marked” for chain of custody and authentication purposes,20 bates marked for easy indexing and reference, and combined with whatever case/document management tools or methods you prefer, (such as Concordance or Summation or an “old-fashioned” trial notebook) to present the information with maximum effect in discovery, settlement negotiations or trial.

These powerful tools are particularly at home in the bankruptcy context where getting to the operative facts, quickly and cost-effectively, has always been at the heart of the game.

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1 11 U.S.C. §507.

2 11 U.S.C. §548; 11 U.S.C. §1129(b)(1).

3 11 U.S.C. §521; §1125(a)(1); §704(a)(7), §727(a)(3), (4) and (5); B.R. 1007; B.R. 2002; B.R. 4002 and B.R. 9016; In the Matter of Zouhair Hilal, 534 F.3d 498; 2008 U.S. App. LEXIS 14218; see Trade Company Ltd v. Fleetboston Financial Corp., 03 Civ. 10254 (JFK), S.D.N.Y., 2008 U.S. Dist. LEXIS 67221; Tradex Corporation v. Phoebe Morse, 339 B.R. 823, 2006 U.S. Dist. LEXIS 15641; Free at Last Bonds v. Kai Franklin-Graham, Case No. 05-91520-MGD, Chapter 7 Adversary Proceeding No. 05-06585; 2008 Bankr. LEXIS 1909.

4 11 U.S.C. §544, §547 and §548.

5 18 U.S.C. §152, §153, §156, §158, §1519, §2701 and §3057(b); but see 11 U.S.C. §362(b)(6), (7) and (17), §555, §556, §560, §561 and §562.

6 11 U.S.C. §102(1)(A), (B); 11 U.S.C. §363(b); B.R. 2018.

7 11 U.S.C. §105(a); 11 U.S.C. §341(d); 11 U.S.C. §704(a); 11 U.S.C. §705; B.R. 2004; B.R. 2005; B.R. 7032 and B.R. 9011.

8 11 U.S.C. §1125(a)(1).

9 B.R. 7016; B.R. 7026; B.R. 7033; B.R. 7034; B.R. 7037 and B.R. 9016.

10Parks v. Krause, 367 B.R. 740, 2007 Bankr. LEXIS 1937, (Bankr. Ks., 2007); Reconsideration Denied, 2007 Bankr. LEXIS 2797; Centimark Corporation v. Pegnato Roof Management, Inc., 2008 U.S. Dist. LEXIS 37057, Civil Action No. 05-708 (W.D.Pa., 2008); Travelers Property Casualty Company of America v. Cooper Crouse Hinds, LLC, 2007 U.S. Dist. LEXIS 64572, Civil No. 05-CV-6399, (E.D.Pa., 2007); American Eagle Outfitters, Inc. v. Lyle & Scott Limited 2007 U.S. Dist LEXIS 71965, Civil Action No. 06-607 (W.D.Pa., 2007); Wachtel v. Guardian Life Ins., 2007 U.S. Dist. LEXIS 43842, 2007 W.L. 1752036 (D.N.J., 2007).

11See Commodity Futures Trading Com. V. Weintraub, 471 U.S. 343, 105 S.Ct. 1986, 85 L.Ed.2d 372, 1985 U.S. LEXIS 5; 11 U.S.C. §704(4), (5), (6), (7) and (8).

12 See Local Rule – Appendix K, United States District Court for the Northern District of Ohio.

13Qualcomm v. Broadcom, 2008 WL 66932, No. 05-CV-1958-B(BLM), (S.D. Cal., January 7, 2008); Remanded in Part to Magistrate for further factual findings, March 5, 2008; Zubulake v. UBS Warburg LLC, 2004 WL 1620866, (S.D.N.Y., 2004); Telecom Int’l America, Ltd. v. AT&T Corp., 189 F.R.D. 76, (S.D.N.Y., 1999).

14B.R. 7037(e).

15 Telecom, supra.; Zubulake, supra.; Qualcomm, supra.

16 Centimark, supra.; Travelers, supra.

17 Krause, supra.

18 Schmid v. Milwaukee Electric Corp., 13 F.3d 76, 1994 U.S. App. LEXIS 20, (3rd Cir., 1994); in accord; Schroeder v. PennDOT, 551 Pa. 243, 710 A.2d 23, 27 (Pa., 1998). Under Schmid/Schroeder, the court must consider in deciding sanctions (i) the degree of fault of the party who altered or destroyed evidence; (ii) the degree of prejudice suffered by the opposing party; (iii) 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.

19 In re Subpoena Duces Tecum to AOL, Inc.,550 F.Supp.2d 606; 2008 U.S. Dist. LEXIS 39349 (E.D.Va., 2008).

20 See Mack v. Markel American Insurance Company, 2007 U.S. Dist. LEXIS 330200, (D.C.Md., 2007); for general discussion of issues arising with use of electronic evidence.

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For additional information on perfection of security interests and the usage of other credit enhancements, please see the other articles in this Publications section.

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