Second Circuit Upholds $2.7 Million Sanctions Award over Discovery Violations

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Bankruptcy Law
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In affirming a $2.7 million sanctions award for spoliation of evidence, the Second Circuit is sending a clear message to federal court practitioners (and bankruptcy litigants alike) that their clients must adhere to litigation hold instructions and comply with the discovery rules or suffer the consequences.

In Klipsch Group, Inc. v. ePRO E-Commerce Ltd., 880 F.3d 620 (2018), the plaintiff, a manufacturer of sound equipment, including headphones, sued a subsidiary of ePRO, a Chinese corporation, in the Southern District of New York for allegedly selling counterfeit Klipsch headphones.  According to ePRO, any potential damages to the Plaintiff resulting from the sales of counterfeit products amounted to no more than $20,000.  Despite the allegedly small amount at stake, ePRO went to great lengths to destroy potentially damaging evidence, resulting in a sanctions award more than 100 times ePRO’s exposure.

During the course of discovery, ePRO produced fewer than 500 documents, insisting it did not have any original sales data, and instead producing spreadsheets created for purposes of the litigation.  But during a deposition of ePRO’s CEO, it became clear that ePRO had not put an effective litigation hold on a substantial portion of its electronic data, including emails and faxes.  After hiring its own discovery vendor, ePRO produced an additional 40,000 documents, including over 1,200 original sales documents.

Klipsch moved for discovery sanctions, arguing that large quantities of documents had been lost as a result of ePRO’s failure to initiate a proper litigation hold.  Rather than then sanctioning ePRO, the magistrate judge authorized Klipsch to undertake an independent forensic examination of ePRO’s computer systems at its own cost (subject to potential reimbursement by ePRO).

Klipsch’s independent forensic examination revealed:

  • 4,596 responsive files or emails were manually deleted (although all of these documents were ultimately recovered);
  • Seven (7) employees used data-wiping programs shortly before the forensic examination began;
  • Eighteen (18) employees ran operating system upgrades during the litigation hold period resulting in the loss of their program usage data;
  • ePRO failed to provide access to email accounts of approximately nineteen (19) current and former employees who were custodians of discoverable data; and
  • Thirty-two (32) of thirty-six (36) custodians of discoverable data, including the CFO, refused to permit access to their accounts on a private messaging system.

As a result of ePRO’s spoliation of evidence, the District Court awarded Klipsch $2.68 million as compensation for the additional discovery efforts occasioned by ePRO’s misconduct.

On appeal, the Second Circuit affirmed the award, rejecting ePRO’s arguments that the award: (i) was so out of proportion to the value of the case or the evidence uncovered as to be impermissibly punitive and a violation of due process; (ii) failed to adhere to the limitations of Federal Rule of Civil Procedure 37(e); and (iii) lacked proportionality.

As to the sanctions amount, the Second Circuit pointed out that ePRO caused Klipsch to accrue the discovery costs by failing to comply with its own discovery obligations.  It stated, “[s]uch compliance is not optional or negotiable; rather, the integrity of our civil litigation process requires that the parties before us, although adversarial to one another, carry out their duties to maintain and disclose the relevant information in their possession in good faith.”

The Court went on to state, “[t]he extremely broad discovery permitted by the Federal Rules depends on the parties’ voluntary participation. The system functions because, in the vast majority of cases, we can rely on each side to preserve evidence and to disclose relevant information when asked (and sometimes even before then) without being forced to proceed at the point of a court order.”

This decision, while exceptional given the egregious conduct involved, is a cautionary tale to parties engaged in discovery battles.  All must adhere to their discovery obligations under the Federal Rules of Civil Procedure or risk severe sanctions for non-compliance.

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