Are You Prepared for e-Discovery?

Bankruptcy courts, practitioners, trustees and examiners are facing a new reality with which many federal court litigants and their counsel are already painfully familiar: The dire economic and legal consequences of failing to properly identify, preserve, collect, review and produce relevant ESI electronically stored information (ESI).

The identification, preservation and collection of ESI in bankruptcy must comply with the requirements of the revamped Federal Rules of Civil Procedure, incorporated in bankruptcy cases by the Bankruptcy Rules, which were amended effective Dec. 1, 2006 to expressly cover early disclosures relating to ESI and the discovery of ESI. In brief:

• Rule 26(b)(2)(B) requires a two-tiered approach to discovery that distinguishes between ESI that is and is not reasonably accessible. This requires you to know specifically what ESI the person or entity in question has, where it is, how it is stored and how much it will cost to access.
• Rule 26(f)(3) requires the parties to have a potentially detailed discussion during the early meeting of counsel regarding the forms in which they are going to produce their ESI. To participate meaningfully, you need to know what data you have, what its native attributes are, and whether it can and ought to be produced in image format instead of its native format, i.e., in the electronic format of the application software in which the data was created.
• Rule 26(f) contains a new requirement that the parties discuss issues relating to preservation of ESI, and Rule 37(f) contains a new so-called safe harbor for the routine, good faith destruction or deletion of responsive data. These provisions also require you to know what ESI you have, where it is, how it is stored, and what policies and procedures are used to implement, enforce and lift litigation holds.

The identification, preservation, col- lection and review of ESI during e-discovery should not be a reactive process undertaken at the last minute before production. Instead, the methodologies for the process should be thought through carefully as early in the proceeding as possible, even before demands for the production of ESI are received. Starting the process of ESI management early in the litigation and doing it with care will help to provide sufficient time to test the efficacy and efficiency of the identification, preservation, collection and review methods, and to identify and correct any problems that arise during the process.

Cases in Point

In Re Krause

Several bankruptcy decisions awarding sanctions for e-discovery misconduct underscore the importance of a careful and timely approach to the e-discovery process. The ruling in Parks v. Krause (In re Krause), 367 B.R. 740 (Bankr. D. Kan. 2007) also emphasizes the need for participants in bankruptcy proceedings to have a firm grasp of the technical aspects of e-discovery and to properly utilize the services of qualified e-discovery experts. The bankruptcy trustee in that case sought the severest of sanctions ' default judgment ' for the debtor's spoliation of relevant ESI by erasing it from his computers. The ESI would have revealed the debtor's assets and ownership interests in various entities. After requests for production were served seeking its production, the debtor installed an anti-virus software program on his computers with a “wiping” function that purged the ESI from them.

The bankruptcy court received extensive testimony from forensic e-discovery experts from both sides, including a “virtual 'live' tour” of forensic images of the debtor's computers, which “vastly simplified the court's understanding of the technical aspects of the spoliation issues.” The detailed technical analysis of the trustee and her expert, which are reflected in detail in the court's ruling, covered a variety of issues including the nature of the computers and their networks, the types of electronic files they did and did not contain and the ramifications of those facts, the nature of purported “deleted” electronic files, the types of application software used on the computers, the use of portable storage devices to back up the computers, alleged crashes of the computers, and the specific characteristics of the anti-virus software and how and when it was installed and the wiping of data occurred. Based on this detailed analysis, the court was able to conclude that the debtor purged the relevant ESI when he was under a legal obligation to preserve it, and granted the default judgment sought by the trustee.

Grochocinski v. Schlossberg

Grochocinski v. Schlossberg, 2009 WL 635447 (N.D. Ill. Mar. 11, 2009), presented a similar problem and required extensive e-discovery expert involvement. After initiating a suit to recover property the debtor had allegedly fraudulently transferred, the trustee notified the recipients of their duty to retain all electronic information relating to the adversary proceeding. The bankruptcy court entered an order granting the trustee's motion to compel access to the computer hard drives of Schlossberg, one of the recipients, which contained data relating to the transfers. Pursuant to the order, a computer forensics expert analyzed the computers and determined that a disk-cleaning program had been installed and run on them four months after the trustee's preservation demand (and just three days before the entry of the bankruptcy court's production order), destroying thousands of electronic files. The trustee requested sanctions, and the bankruptcy court granted them, ruling that facts alleged by the trustee against Schlossberg would be taken as proof against him and that he would not be permitted to contest them. As a consequence, the bankruptcy court entered judgment against Schlossberg, finding that the transfers to him were fraudulent.

Schlossberg appealed to the district court on the ground that there was no evidence that he had wiped the computers clean himself and the bankruptcy court had failed to make a finding of bad faith by him. The district court was unpersuaded, because the bankruptcy court had determined that Schlossberg had acted in reckless disregard of his discovery obligations, which was sufficient to establish the requisite bad faith for a sanctions award. The district court also refused to second-guess the bankruptcy court's choice of sanctions, finding that the bankruptcy court had no duty to impose the least severe sanctions, only sanctions that were reasonable under the circumstances.

In re Atlantic Int'l Mortgage Co.

Oscher v. The Solomon Tropp Law Group, P.A. (In re Atlantic Int'l Mortgage Co.), 352 B.R. 503 (Bankr. M.D. Fla. 2006), demonstrates that parties should be prepared to provide extensive evidence to the court in e-discovery disputes (and that drastic sanctions are warranted even if disk wiping or cleaning programs are not used). The bankruptcy trustee in that case filed an adversary proceeding against the Solomon Tropp firm for turnover of property, avoidance of fraudulent and post-petition transfers, and damages, based on the firm's receipt of funds fraudulently obtained by the debtor's officers from the debtor's creditors. The trustee requested production of, among other things, the electronic records of deposits to and disbursements from Solomon Tropp firm's trust accounts.

The court granted the trustee's motion to compel despite the firm's
assertion that all documents except for privileged documents and “certain data that was unavailable due to software problems” had already been produced. The court allowed the trustee to waive the asserted privilege and ordered the firm to make its computer systems and relevant records available to the trustee and a computer expert. The firm, however, failed to meet the production deadline and continued to assert the privilege and obstruct the discovery. It also produced only a relatively small number of e-mails, despite the fact that all of its communications with the debtor were apparently by e-mail. In addition, the firm, after having notice of a duty to preserve electronic evidence, either lost or destroyed its computer backup tapes, deleted the e-mail account of the attorney responsible for working on the debtor's matters, and installed a new e-mail server without backing up or migrating the information on its old server. After a three-day evidentiary hearing on the discovery dispute, the court held that while it was not satisfied that the firm's conduct rose to the level required to sustain a default judgment, monetary sanctions were proper, in the amount of all of the attorneys' fees and costs incurred by the trustee in pursuing all discovery in the adversary case.

In re Quintus Corp.

Quintus Corp. v. Avaya, Inc. (In re Quintus Corp.), 353 B.R. 77 (Bankr. D. Del. 2006), sounds a warning call that parties doing business with a bankruptcy debtor must read the fine print in their agreements and heed their contractual and legal duties to preserve electronic evidence of those dealings. In that case, Avaya, Inc. purchased the bankruptcy debtor's assets and assumed a portion of its liabilities. The trustee later filed an adversary proceeding against Avaya for breach of contract for failing to pay certain liabilities that the trustee contended included debts reflected in proofs of claim filed by creditors in the bankruptcy. Despite its contractual duty to retain the Debtor's electronically stored accounting books and records for seven years after the purchase, Avaya deleted them a few months after the closing to give itself more computer space. As a consequence, the trustee was unable to establish what remained unpaid of the assumed liabilities, and sought the entry of summary judgment against Avaya as a sanction for the deletion.

The court noted that when Avaya deleted the books and records, it had a contractual duty to retain them and had not yet paid all of the liabilities they reflected. As a consequence, Avaya “should have anticipated litigation over its failure to comply” with that duty, and had a legal duty to preserve the records because they were “relevant to pending, imminent or reasonably foreseeable litigation.” Further, because the records were necessary for the court to resolve the merits of the contract dispute, their deletion was prejudicial to the trustee. The court therefore granted the severe sanction of judgment against Avaya for nearly $1.9 million. Importantly, the court also observed that the result would have been the same if it had granted the lesser sanction of an adverse inference that the deleted records would have been unfavorable to Avaya's position, because the court would have had to conclude that the debtor's records were consistent with the remaining liabilities reflected in the creditors' proofs of claim.

Conclusion

Part Two of this article discusses McCarty v. Global Financial Solutions, LLC (In re Simonson), 2008 WL 4830807 (Bankr. W.D. Wa., Oct. 27, 2008), which highlights the increasing frustration of bankruptcy courts with parties who take a laissez faire approach to their obligation to preserve and produce responsive and relevant ESI.

Dan P. Sedor and David M. Poitras are partners in the Los Angeles office of Jeffer Mangels Butler & Marmaro LLP. Sedor practices in the firm's litigation group and co-chairs the Discovery Technology Group. Poitras practices in the firm's bankruptcy group with a focus on complex Chapter 11 cases and out-of-court restructurings.

Bankruptcy courts, practitioners, trustees and examiners are facing a new reality with which many federal court litigants and their counsel are already painfully familiar: The dire economic and legal consequences of failing to properly identify, preserve, collect, review and produce relevant ESI electronically stored information (ESI).

The identification, preservation and collection of ESI in bankruptcy must comply with the requirements of the revamped Federal Rules of Civil Procedure, incorporated in bankruptcy cases by the Bankruptcy Rules, which were amended effective Dec. 1, 2006 to expressly cover early disclosures relating to ESI and the discovery of ESI. In brief:

• Rule 26(b)(2)(B) requires a two-tiered approach to discovery that distinguishes between ESI that is and is not reasonably accessible. This requires you to know specifically what ESI the person or entity in question has, where it is, how it is stored and how much it will cost to access.
• Rule 26(f)(3) requires the parties to have a potentially detailed discussion during the early meeting of counsel regarding the forms in which they are going to produce their ESI. To participate meaningfully, you need to know what data you have, what its native attributes are, and whether it can and ought to be produced in image format instead of its native format, i.e., in the electronic format of the application software in which the data was created.
• Rule 26(f) contains a new requirement that the parties discuss issues relating to preservation of ESI, and Rule 37(f) contains a new so-called safe harbor for the routine, good faith destruction or deletion of responsive data. These provisions also require you to know what ESI you have, where it is, how it is stored, and what policies and procedures are used to implement, enforce and lift litigation holds.

The identification, preservation, col- lection and review of ESI during e-discovery should not be a reactive process undertaken at the last minute before production. Instead, the methodologies for the process should be thought through carefully as early in the proceeding as possible, even before demands for the production of ESI are received. Starting the process of ESI management early in the litigation and doing it with care will help to provide sufficient time to test the efficacy and efficiency of the identification, preservation, collection and review methods, and to identify and correct any problems that arise during the process.

Cases in Point

In Re Krause

Several bankruptcy decisions awarding sanctions for e-discovery misconduct underscore the importance of a careful and timely approach to the e-discovery process. The ruling in Parks v. Krause (In re Krause), 367 B.R. 740 (Bankr. D. Kan. 2007) also emphasizes the need for participants in bankruptcy proceedings to have a firm grasp of the technical aspects of e-discovery and to properly utilize the services of qualified e-discovery experts. The bankruptcy trustee in that case sought the severest of sanctions ' default judgment ' for the debtor's spoliation of relevant ESI by erasing it from his computers. The ESI would have revealed the debtor's assets and ownership interests in various entities. After requests for production were served seeking its production, the debtor installed an anti-virus software program on his computers with a “wiping” function that purged the ESI from them.

The bankruptcy court received extensive testimony from forensic e-discovery experts from both sides, including a “virtual 'live' tour” of forensic images of the debtor's computers, which “vastly simplified the court's understanding of the technical aspects of the spoliation issues.” The detailed technical analysis of the trustee and her expert, which are reflected in detail in the court's ruling, covered a variety of issues including the nature of the computers and their networks, the types of electronic files they did and did not contain and the ramifications of those facts, the nature of purported “deleted” electronic files, the types of application software used on the computers, the use of portable storage devices to back up the computers, alleged crashes of the computers, and the specific characteristics of the anti-virus software and how and when it was installed and the wiping of data occurred. Based on this detailed analysis, the court was able to conclude that the debtor purged the relevant ESI when he was under a legal obligation to preserve it, and granted the default judgment sought by the trustee.

Grochocinski v. Schlossberg

Grochocinski v. Schlossberg, 2009 WL 635447 (N.D. Ill. Mar. 11, 2009), presented a similar problem and required extensive e-discovery expert involvement. After initiating a suit to recover property the debtor had allegedly fraudulently transferred, the trustee notified the recipients of their duty to retain all electronic information relating to the adversary proceeding. The bankruptcy court entered an order granting the trustee's motion to compel access to the computer hard drives of Schlossberg, one of the recipients, which contained data relating to the transfers. Pursuant to the order, a computer forensics expert analyzed the computers and determined that a disk-cleaning program had been installed and run on them four months after the trustee's preservation demand (and just three days before the entry of the bankruptcy court's production order), destroying thousands of electronic files. The trustee requested sanctions, and the bankruptcy court granted them, ruling that facts alleged by the trustee against Schlossberg would be taken as proof against him and that he would not be permitted to contest them. As a consequence, the bankruptcy court entered judgment against Schlossberg, finding that the transfers to him were fraudulent.

Schlossberg appealed to the district court on the ground that there was no evidence that he had wiped the computers clean himself and the bankruptcy court had failed to make a finding of bad faith by him. The district court was unpersuaded, because the bankruptcy court had determined that Schlossberg had acted in reckless disregard of his discovery obligations, which was sufficient to establish the requisite bad faith for a sanctions award. The district court also refused to second-guess the bankruptcy court's choice of sanctions, finding that the bankruptcy court had no duty to impose the least severe sanctions, only sanctions that were reasonable under the circumstances.

In re Atlantic Int'l Mortgage Co.

Oscher v. The Solomon Tropp Law Group, P.A. (In re Atlantic Int'l Mortgage Co.), 352 B.R. 503 (Bankr. M.D. Fla. 2006), demonstrates that parties should be prepared to provide extensive evidence to the court in e-discovery disputes (and that drastic sanctions are warranted even if disk wiping or cleaning programs are not used). The bankruptcy trustee in that case filed an adversary proceeding against the Solomon Tropp firm for turnover of property, avoidance of fraudulent and post-petition transfers, and damages, based on the firm's receipt of funds fraudulently obtained by the debtor's officers from the debtor's creditors. The trustee requested production of, among other things, the electronic records of deposits to and disbursements from Solomon Tropp firm's trust accounts.

The court granted the trustee's motion to compel despite the firm's
assertion that all documents except for privileged documents and “certain data that was unavailable due to software problems” had already been produced. The court allowed the trustee to waive the asserted privilege and ordered the firm to make its computer systems and relevant records available to the trustee and a computer expert. The firm, however, failed to meet the production deadline and continued to assert the privilege and obstruct the discovery. It also produced only a relatively small number of e-mails, despite the fact that all of its communications with the debtor were apparently by e-mail. In addition, the firm, after having notice of a duty to preserve electronic evidence, either lost or destroyed its computer backup tapes, deleted the e-mail account of the attorney responsible for working on the debtor's matters, and installed a new e-mail server without backing up or migrating the information on its old server. After a three-day evidentiary hearing on the discovery dispute, the court held that while it was not satisfied that the firm's conduct rose to the level required to sustain a default judgment, monetary sanctions were proper, in the amount of all of the attorneys' fees and costs incurred by the trustee in pursuing all discovery in the adversary case.

In re Quintus Corp.

Quintus Corp. v. Avaya, Inc. (In re Quintus Corp.), 353 B.R. 77 (Bankr. D. Del. 2006), sounds a warning call that parties doing business with a bankruptcy debtor must read the fine print in their agreements and heed their contractual and legal duties to preserve electronic evidence of those dealings. In that case, Avaya, Inc. purchased the bankruptcy debtor's assets and assumed a portion of its liabilities. The trustee later filed an adversary proceeding against Avaya for breach of contract for failing to pay certain liabilities that the trustee contended included debts reflected in proofs of claim filed by creditors in the bankruptcy. Despite its contractual duty to retain the Debtor's electronically stored accounting books and records for seven years after the purchase, Avaya deleted them a few months after the closing to give itself more computer space. As a consequence, the trustee was unable to establish what remained unpaid of the assumed liabilities, and sought the entry of summary judgment against Avaya as a sanction for the deletion.

The court noted that when Avaya deleted the books and records, it had a contractual duty to retain them and had not yet paid all of the liabilities they reflected. As a consequence, Avaya “should have anticipated litigation over its failure to comply” with that duty, and had a legal duty to preserve the records because they were “relevant to pending, imminent or reasonably foreseeable litigation.” Further, because the records were necessary for the court to resolve the merits of the contract dispute, their deletion was prejudicial to the trustee. The court therefore granted the severe sanction of judgment against Avaya for nearly $1.9 million. Importantly, the court also observed that the result would have been the same if it had granted the lesser sanction of an adverse inference that the deleted records would have been unfavorable to Avaya's position, because the court would have had to conclude that the debtor's records were consistent with the remaining liabilities reflected in the creditors' proofs of claim.

Conclusion

Part Two of this article discusses McCarty v. Global Financial Solutions, LLC (In re Simonson), 2008 WL 4830807 (Bankr. W.D. Wa., Oct. 27, 2008), which highlights the increasing frustration of bankruptcy courts with parties who take a laissez faire approach to their obligation to preserve and produce responsive and relevant ESI.

Dan P. Sedor and David M. Poitras are partners in the Los Angeles office of Jeffer Mangels Butler & Marmaro LLP. Sedor practices in the firm's litigation group and co-chairs the Discovery Technology Group. Poitras practices in the firm's bankruptcy group with a focus on complex Chapter 11 cases and out-of-court restructurings.