A Florida state court recently imposed severe sanctions, including a partial default judgment, against a defendant for, inter alia, failing to comply with a court order requiring defendant to search backup tapes for relevant e-mails and produce such e-mails. The drastic sanctions imposed in this case, along with the growing list of sanctions imposed in other cases for electronic discovery failures, highlight the importance of taking electronic discovery obligations very seriously.

On March 23, 2005, a Florida state court imposed severe sanctions on a defendant for, inter alia, failing to search for and produce emails from backup tapes in violation of a court order. See Coleman (Parent) Holdings Inc. v. Morgan Stanley, Inc., No. CA 03-5045 AI, 2005 WL 674885 (Fla. Cir. Ct. Mar. 23, 2005). Those sanctions included, but were not limited to, the entry of a partial default judgment against defendant pursuant to which the jury will be instructed that numerous factual allegations in the complaint, including that the defendant participated in the "massive fraud" that allegedly caused plaintiff’s damages and helped conceal it, will be "deemed established for all purposes" in that action. Coleman, 2005 WL 674885, at *9. Moreover, the jury will be instructed that it may consider the defendant’s failure to comply with the court order "in determining whether [defendant] sought to conceal its offensive conduct" for purposes of awarding punitive damages. Id. at *10.

The Court Order Regarding Backup Tapes

In late 1997 and early 1998, the defendant served as financial advisor to Sunbeam Corporation (Sunbeam) in connection with Sunbeam’s acquisition of plaintiff’s interest in the Coleman Company, Inc. (Coleman), and lead underwriter for a $750,000,000 debenture offering that Sunbeam used to finance the cash portion of the acquisition. In February 1999, defendant instructed its investment bankers to preserve paper documents in their possession in connection with the Sunbeam transaction. Defendant continued, however, its practice of overwriting e-mails over 12 months old notwithstanding an SEC regulation (17 C.F.R. § 240.17a-4 (2005)) requiring that all communications, including e-mails, be retained in readily accessible form for 2 years.

On May 12, 2003, plaintiff, which had received Sunbeam stock as partial consideration for selling its interest in Coleman, filed a complaint alleging that defendant had made fraudulent and negligent misrepresentations to plaintiff concerning Sunbeam’s financial condition in connection with the acquisition, aided and abetted Sunbeam’s fraud, and conspired with Sunbeam to defraud plaintiff. That same day, defendant was served with plaintiff’s request for production of documents, which specifically requested all relevant electronically stored information. Concerned that it had received only a handful of e-mails, plaintiff moved to compel the production of e-mails, including those stored on magnetic tapes and hard drives. In opposition to the motion to compel, defendant argued that it would cost "at least hundreds of thousands of dollars and require several months" to complete the restoration of e-mails from its backup tapes and that, in any event, it would only be able to restore e-mail from backup tapes from January 2000—more than a year and a half after the events giving rise to plaintiff’s claims. Coleman, 2005 WL 674885, at *2.

The parties reached an accommodation on the e-mail issue, and on April 16, 2004 the court entered an order reflecting the parties’ agreement (Agreed Order). The Agreed Order required defendant to (1) search the oldest full backup tape for 36 of defendant’s employees involved in the Sunbeam transaction, (2) review e-mails dated from February 15, 1998 through April 15, 1998, and e-mails containing any of 29 specified search terms such as "Sunbeam" and "Coleman" regardless of their date, (3) produce by May 14, 2004 all responsive, non-privileged e-mails, (4) produce a privilege log, and (5) certify its full compliance with the Agreed Order. In response to the Agreed Order, defendant produced about 1,300 pages of e-mails on May 14, 2004, and certified its compliance with the Agreed Order on June 23, 2004.

Defendant’s Failure to Comply with the Agreed Order

On November 17, 2004 (three months before the trial date), defendant’s counsel advised plaintiff’s counsel that defendant "had discovered additional e-mail backup tapes …"; "[t]he data on some of [the] newly discovered tapes has been restored;" "we have re-run the searches described in [the Agreed Order]"; "some responsive e-mails have been located as a result of that process"; and [w]e will produce the responsive documents to you as soon as the production is finalized." Id. at *3. After an exchange of correspondence between counsel for each side in which the court later found that defendant’s counsel "stonewalled" plaintiff’s counsel regarding the "newly discovered" e-mail backup tapes and the completion of the restoration and production of responsive e-mails, plaintiff filed a motion seeking the imposition of an adverse inference jury instruction. Pursuant to the adverse inference instruction, the jury would be instructed that they could infer that the contents of the missing e-mails would be harmful to defendant’s defense (Adverse Inference Motion).

As a result of the Adverse Inference Motion, the court made the following findings: First, defendant had discovered 1,423 backup tapes no later than May 2004 and 738 eight-millimeter tapes in 2002 that, contrary to defendant’s assertions, were in locations where e-mail backups tapes customarily were stored and contained e-mails dating back at least to the late 1990s. None of these tapes had been searched for responsive e-mail at the time of the certification of compliance with the Agreed Order. Instead, those tapes were slowly being restored and were waiting to be uploaded into an e-mail archive system recently implemented by defendant before such tapes could be searched for relevant e-mails. Second, defendant discovered hundreds of additional backup tapes in January and February 2005. Third, defendant revealed at the hearing on the Adverse Inference Motion that a flaw in the software written by defendant had prevented it from locating all responsive e-mail attachments, and the date-range searches for certain types of e-mail users were flawed resulting in the discovery of at least 7,000 additional e-mail messages that were potentially relevant.

In granting the Adverse Inference Motion, the court stated that "[t]hroughout this entire process, [defendant] and its counsels’ lack of candor has frustrated the Court and opposing counsel’s ability to be fully and timely informed." Coleman (Parent) Holding, Inc. v. Morgan Stanley, Inc., No. 502003CA00504SXXO CAI, 2005 WL 679071, at *5 (Fla.Cir. Ct. Mar. 1, 2005). The court concluded that sanctions were justified because defendant overwrote e-mails "contrary to its legal obligation to maintain them in readily accessible form for two years and with knowledge that legal action was threatened", and defendant’s disobedience of the Agreed Order was "willful." Therefore, the court issued an order that "reversed the burden of proof on the aiding and abetting and conspiracy elements and included a statement of evidence of [defendant]’s efforts to hide its emails to be read to the jury, as relevant to both its consciousness of guilt and the appropriateness of punitive damages" (the Adverse Inference Order). Coleman, 2005 WL 674885, at *5. The court also ordered defendant to continue to use its best efforts to comply with the Agreed Order and attempt to locate additional responsive e-mails.

The Partial Default Judgment

Plaintiff thereafter filed a motion for entry of a default judgment against defendant (the Default Judgment Motion) on the ground that "it has since learned that the discovery abuses addressed in the Adverse Inference Motion and Order represent only a sampling of discovery abuses perpetrated by [defendant] and that the abuses have continued, unabated." Id. at *1. In deciding the Default Judgment Motion, the court stated that "[i]t is now clear why [defendant] was so unwilling to provide [plaintiff] with basic information about how and when the tapes were found or when production would be complete." Id. at *5. Defendant’s lack of forthrightness, according to the court, was motivated by the fact that (a) "candor would have required [defendant] to admit that it had not done a good faith search for the oldest full backup tapes, and that [defendant]’s certificate of compliance was false," (b) defendant "desperately wanted to hide an active SEC inquiry into its email retention practices," and (c) defendant "did not want to admit the existence of the historical email archive, which would expose the false representation it had made to the Court which it used to induce [plaintiff] to agree to entry of the Agreed Order." Id.

The court found that, since the hearing on the Adverse Inference Motion, numerous other problems with defendant’s search for e-mail from the backup tapes had been revealed, which defendant failed to disclose promptly and, in some instances, failed to disclose at all. For example, the scripts used by defendant to process e-mails into its archive caused the bodies of some messages to be truncated, which defendant learned on February 13, 2005, but failed to disclose to the court until March 14, 2005. Moreover, a software error caused blind carbon copies not to be captured in the archive process, which defendant told the SEC about on February 24, 2005, but never informed plaintiff or the court. And, defendant had found thousands of additional tapes that had not been searched. Based on these additional failures to comply with its discovery obligations, the court concluded that defendant "deliberately and contumaciously violated" discovery orders and "chose to hide information about its violations." Id. at *9.

The court added that the discovery abuses that it found "call into doubt all of [defendant]’s discovery responses", and concluded by stating that the "judicial system cannot function this way." (Emphasis in original). Coleman, 2005 WL 674885, at *9.

As noted earlier, the court entered a partial default judgment against defendant pursuant to which the jury will be instructed that numerous factual allegations in the complaint, including that the defendant participated in the "massive fraud" that allegedly caused plaintiff’s damages and helped conceal it, will be "deemed established for all purposes" in that action. As a result, plaintiff need only prove that it relied on defendant’s fraudulent statements and that such fraud caused plaintiff’s damages. Moreover, the jury will be instructed that it may consider the defendant’s failure to comply with the court order "in determining whether [defendant] sought to conceal its offensive conduct" for purposes of awarding punitive damages. Id. at *10.

Necessary Steps to Avoid Sanctions for E-Discovery Failures

The sanctions imposed in this case should serve as a reminder to litigants and their counsel that electronic discovery obligations must be taken seriously. It is essential to address these issues as soon as litigation is reasonably likely. Backup tapes are particularly problematic, and an agreement, or a court order, regarding the scope of a party’s obligations to preserve, restore, and search such media should be obtained as quickly as possible (at least until rules are enacted or case law is sufficiently developed to clarify parties’ obligations in this regard). Litigants and their knowledgeable counsel must be diligent in their efforts to locate possible sources of relevant electronically stored information. Expert advice should be sought where the process of restoration and retrieval is either complex or the company’s information technology personnel are not capable to perform such tasks. Finally, if problems restoring and retrieving such information are encountered, particularly where such problems make it impossible to comply with a court order, litigants and their counsel should disclose such problems to their adversary and the court as soon as the nature and scope of such problems are ascertained in order to avoid the types of drastic sanctions imposed in this case.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.