Tuesday, January 16, 2007

Trustee Drop Kicks ESI Document Killer for $1.8 Million

A recent bankruptcy case from Delaware ought to firmly emblazon the idea in every bankruptcy lawyer's mind that ESI ("electronically stored information" for those unaware that the Federal Rules of Civil Procedure were recently amended) can become an issue at just about any point in a proceeding. In this particular instance, this hard-learned lesson enriched the estate to the tune of nearly $2 million Delaware dollars.

In the case Quintus Corporation v. Avaya, Inc., 353 B.R. 77 (Bankr. Del 2006), Avaya had purchased the assets of a Chapter 11 debtor the same day the case was commenced. In addition to the $30 million Delaware dollars Avaya agreed to pay at closing, Avaya also agreed to assume certain of the Debtor's liabilities, capped at $30 million. The sale was closed in April of 2001.

Kurt F. Gwynne was appointed as Chapter 11 trustee in January of 2002. As providence would design, the Trustee determined that Avaya failed to pay all of the assumed obligations as promised. After (I am guessing) some sand throwing and hair-pulling, the Trustee filed an adversary in March 2004, and asked to see some "books and records" of the Debtor. The Trustee even asked nicely. Then the Trustee asked not so nicely, and filed a motion to compel production which was partially granted in an October 2005 order.

When the smoke cleared from the discovery, here was the problem in summary format. The "books and records" (testimony of Debtor employees established that the books and records included a general ledger, accounts payable ledgers, other sub-ledgers, and records reflecting disputed and discounted invoices) of the Debtor, now the responsibility of Avaya, had been intentionally destroyed sometime in 2001 or 2002, apparently because Avaya needed the additional electronic storage space for its own books and records. The purchase agreement, outlining Avaya's obligations regarding the assumed debts, was not completely clear about certain debts, but did refer back to the Debtor's books and records as an identifying or limiting source of those obligations. The court did consider the bankruptcy schedules, as well as the proofs of claim, that were readily available to all parties.

An important preservation note: Avaya had a contractual obligation to pay all the assumed obligations based on the obligations reflected in the "books and records". That, at least, implies a duty to preserve those books and records. Since Avaya did not satisfy all of its obligations, it should have (according to the court) anticipated litigation and preserved the books and records. That the Trustee did not tee up the adversary until 2004 did nothing to save Avaya.

After the discovery period ended, Avaya did produce some of the books and records that it claimed supported its position that all assumed liabilities had been paid. Judge Walrath, while not discourteous, was clearly not impressed with Avaya's "too-little, too-late" production.

Finally, the court couched the Trustee's award in the terms of a sanction under Rule 37, and valued that award at the remaining amount of unpaid claims reflected in the schedules and the claims register. However, the court noted that the practical effect was the same as if the Trustee took a favorable judgment for breach of contract. Because the court was issuing such a harsh "sanction", the award of the Trustee's attorney's fees were not made. Assuming that the award in a breach of contract claim would have been at least $1.88 million, and assuming that Delaware law allows for the award of attorney's fees in a breach of contract case (as Texas does), the Court probably ought to have awarded attorney's fees to the Trustee as well. Otherwise, such an approach may entice parties to be "punished" by a spoliation inference, and avoid paying the other side's attorney fees. This is true especially (using my best Lewis Black voice here) where the offending party is being sanctioned for its behavior.

ESI issues are everywhere, and bankruptcy practitioners must be especially careful of all the potential implications. E-Everything, everywhere, every time!

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