Late Production of Electronic Documents Amounts to “Gross Negligence,” and Warrants Monetary Sanctions Against Defendants and Counsel

Phoenix Four, Inc. v. Strategic Res. Corp., 2006 WL 1409413 (S.D.N.Y. May 23, 2006)

In this opinion, the court ruled on plaintiff’s motion for sanctions against certain defendants and their counsel Mound Cotton Wollan & Greengrass (“Mound Cotton”) for destruction and late production of evidence. Plaintiff requested: (1) an adverse inference instruction; (2) that defendants be precluded from making a summary judgment motion; (3) that defendants be precluded from raising certain claims and defenses, submitting any dispositive motions or asserting any defenses that cite to, or rely on, information contained in the recently retrieved documents, and that they be deemed to have admitted certain facts; (4) monetary sanctions; and (5) any other sanctions deemed appropriate. The court granted monetary sanctions only.

Plaintiff Phoenix Four, Inc. (“Phoenix”) sued Strategic Resources Corporation (“SRC”), Paul Schack, Christian M. Van Pelt, James J. Hopkins III (the “SRC Defendants”) and others for breach of fiduciary duty, common law fraud, and negligent misrepresentation. Phoenix was an investment company, and SRC was Phoenix’s investment adviser. Phoenix was SRC’s sole client. The individual defendants were founders, shareholders, officers, and directors of SRC and members of Phoenix’s Board of Directors.

In 2003-2004, a dispute arose between Phoenix and SRC, and Phoenix stopped paying fees to SRC in the spring of 2004; SRC ceased operations shortly thereafter. Between August and October 2004, SRC delivered to Phoenix and its representatives all paper and electronic accounting records that belonged to it. SRC’s landlord subsequently commenced proceedings to evict SRC from its offices in Carnegie Hall Towers, New York, and SRC vacated its office space in March 2005, prior to the commencement of this lawsuit. The SRC Defendants left behind Phoenix marketing documents, old prospectuses, and trade publications, and at least ten computer workstations. SRC’s landlord subsequently disposed of the abandoned documents and computers. The SRC Defendants did take about fifty boxes containing business records pertaining to SRC and Phoenix, two servers, and at least two computer workstations. Defendant Schack, who subsequently started a new business venture, housed these items in his new office and used at least one of the servers in his new business.

Phoenix filed litigation against SRC in May 2005. Prior to and immediately following receipt of Phoenix’s first set of document demands in August 2005, Mound Cotton, counsel to the SRC Defendants, discussed with them the need to locate and gather pertinent paper and electronic documents. Schack and Hopkins searched the computer system in Schack’s new office and informed Mound Cotton that they had failed to locate any electronic files or folders that pertained to Phoenix or SRC. They did not search the servers, however, as Schack was unaware that there was any pertinent information on them. The SRC Defendants also advised Mound Cotton that “because SRC was no longer in operation, there were no computers or electronic document collections to look through or search.” Mound Cotton attorneys reviewed hard copy materials made available by the SRC Defendants and subsequently produced these documents, about fifty boxes in all, to Phoenix in December 2005.

The deadline for discovery was March 12, 2006. Around late February or early March 2006, a freelance computer technician (Peter Pinti) made a service call to Schack’s office in response to complaints about a malfunctioning server (one of the two that the SRC Defendants had taken with them from SRC’s Carnegie Hall Towers office). After directly accessing the hard drive on the server, Pinti discovered about 25 gigabytes of data – as much as 2,500 boxes – stored in a dormant, partitioned section of the server. Apparently, the computer system in Schack’s office was configured in such a way that the desktop workstations did not have a “drive mapping” to that partitioned section of the hard drive. “In other words, ‘someone using a computer connected to that server could not ‘view’ or gain access to that section of the hard drive and would have no way of knowing of its existence.'”

Schack immediately contacted his attorneys and was instructed to download the information and deliver it to them. A few days later, Schack asked Pinti to back up the data. Pinti first downloaded the data onto DLT tapes but Mound Cotton’s technology vendor was unable to extract the data from the tapes. On March 13 or 14, Pinti again downloaded the data onto DVDs. Mound Cotton received the DVDs on March 15, 2006, and tried to review the documents quickly for privilege, relevance, and responsiveness.

On March 20, 2006, Mound Cotton alerted Phoenix to the recently discovered documents and advised that it would inform Phoenix of the nature of the documents “as soon as [it] knew more about [them].” Between March 20 and April 10, 2006, counsel for Phoenix and the SRC Defendants met almost daily at depositions being taken in the case and discussed the status of the production and also corresponded about the production. On April 12, 2006, Mound Cotton informed Phoenix that it would produce the documents in “TIFF” format but Phoenix rejected that format. On April 13, 2006, Mound Cotton told Phoenix that it would provide the documents in an electronically searchable “Case Vault” format. Phoenix never responded to the offer.

A week later, Phoenix filed this motion for sanctions. The next day, Mound Cotton requested a telephone conference with the court. At the conference on April 24, 2006, Phoenix agreed to accept the recently discovered documents in hard copy. Mound Cotton confirmed that it would roll out the production, estimated to be 200-300 boxes, beginning on April 26, 2006. By that time, Phoenix had already taken the depositions of Schack, Van Pelt, and Hopkins.

Ruling on the motion, the court faulted the defendants’ abandonment of computers and their late production of electronic documents. The court also criticized the attorneys representing the SRC Defendants, finding that counsel’s failings constituted gross negligence:

As to Mound Cotton’s obligation, Judge Scheindlin has defined the contours of counsel’s duty to locate relevant electronic information in Zubulake v. UBS Warburg LLC, 229 F.R.D. 422 (S.D.N.Y.2004) (“Zubulake V”). Counsel has the duty to properly communicate with its client to ensure that “all sources of relevant information [are] discovered.” Id. at 432. To identify all such sources, counsel should “become fully familiar with [its] client’s document retention policies, as well as [its] client’s data retention architecture.” Id. This effort would involve communicating with information technology personnel and the key players in the litigation to understand how electronic information is stored. See id.

Mound Cotton failed in its obligation to locate and timely produce the evidence stored in the server that the SRC Defendants took with them from Carnegie Hall Towers. Mound Cotton affirms that it engaged in dialogue with the defendants on the need to locate and gather paper and electronic documents. Indeed, when repeatedly questioned at oral argument on what inquiries it had made to discover electronic evidence, Mound Cotton reiterated that it had asked the defendants for all electronic and hard copy documents. But counsel’s obligation is not confined to a request for documents; the duty is to search for sources of information.

It appears that Mound Cotton never undertook the more methodical survey of the SRC Defendants’ sources of information that Judge Scheindlin outlined in Zubulake V. Mound Cotton simply accepted the defendants’ representation that, because SRC was no longer in operation, there were no computers or electronic collections to search. Had Mound Cotton been diligent, it might have asked – as it should have – what had happened to the computers SRC used at Carnegie Hall Towers. This question alone would have alerted Mound Cotton to the existence of the server that the defendants had taken with them from their former office. Further, Mound Cotton’s obligation under Zubulake V extends to an inquiry as to whether information was stored on that server and, had the defendants been unable to answer that question, directing that a technician examine the server. In the case of a defunct organization such as SRC, this forensic effort would be no more than the equivalent of questioning the information technology personnel of a live enterprise about how information is stored on the organization’s computer system.

I emphasize that the duty in such cases is not to retrieve information from a difficult-to-access source, such as the server here, but rather to ascertain whether any information is stored there. In reaching this determination, I am guided by the proposed amendments to Federal Rule of Civil Procedure 26, which become effective in December of this year. Proposed Rule 26(a) requires parties to disclose “a description by category and location of … electronically stored information.” Pending Rules Amendments, http://www.uscourts.gov/rules/newrules6.html. at 28. Proposed Rule 26(b)(2) reinforces the concept that a party must identify even those sources that are “not reasonably accessible,” but exempts the party from having to provide discovery from such sources unless its adversary moves to compel discovery. Id. at 43-44. The proposed amendments essentially codify the teaching of Zubulake IV & V, of which Mound Cotton should have been well aware. I find Mound Cotton’s deficiencies here to constitute gross negligence. Cf. Hous. Rights Ctr. v. Sterling, No. 03 Civ. 859, 2005 WL 3320739, at **3, 7 (C.D. Cal. March 2, 2005) (finding that counsel’s failure to verify with client whether there was an e-mail backup system “cannot be countenanced,” and that failure to search back-up tapes owing to “honest miscommunication” between client and counsel as to whether such tapes existed “was at least grossly negligent”). For their part, the SRC Defendants were at the least negligent in carelessly representing to counsel that “there were no computers . . . to search” when they knew that they still possessed, and were actually using at least one of, the servers from Carnegie Hall Towers.

However, the court declined to issue an adverse inference instruction. The court concluded that the gross negligence of the SRC Defendants in abandoning the computers was an insufficient basis on its own, and that Phoenix had failed to offer any that the abandoned evidence would have supported its claims or defenses. As for the late production, it found that the severe sanction was not warranted because SRC had come forward with the evidence, even if after the close of discovery. The court further noted that, to the extent Phoenix suffered prejudice by having to review the documents in a compressed time frame, “[Phoenix] has brought this ill on itself by eschewing the cure of adjourning the trial.”

The court went on to reject the other sanctions requested, with the exception of Phoenix’s request for monetary sanctions. Phoenix had requested: (i) costs, including attorneys’ fees, associated with bringing this motion; (ii) $200,000 in costs for converting the recently discovered documents into a searchable format and for the burden of reviewing these documents late in the game; and (iii) $25,000 each for re-deposing Schack, Van Pelt, and Hopkins.

The court observed: “The discovery delinquencies of the SRC Defendants and their counsel had resulted in the late production of 200-300 boxes of documents – at least four times as much as the fifty boxes originally produced – which has severely disrupted the progress of this litigation in the last two months before trial, a trial date, by the way, to which all parties agreed at the pre-trial conference.” The court found that monetary sanctions would most appropriately serve the prophylactic, punitive, and remedial purposes of discovery sanctions. Accordingly, it ordered the SRC Defendants and Mound Cotton to reimburse Phoenix equally for any statutory costs and attorneys’ fees associated with bringing the motion, and to pay $10,000 each for the re-depositions of Schack, Van Pelt, and Hopkins for the limited purpose of inquiring into issues raised by the documents recovered from the server. The court directed that the sanctions were to be borne by the SRC Defendants and Mound Cotton equally, and were not to be covered by the Defendants’ insurance carriers.

The court determined that Phoenix was not entitled to reimbursement for converting the documents into a searchable format, since it chose to receive the documents in hard copy instead of the searchable “Case Vault” format offered by Mound Cotton, and because it chose to review the documents under time constraints instead of requesting an adjournment of the trial.