United States: Bankruptcy Court Denies Creditor's Improper Discovery Request

Last Updated: September 26 2019
Article by Jane Rue Wittstein and Mark Douglas
Most Read Contributor in United States, September 2019

The scope of discovery available in a bankruptcy case concerning a debtor's conduct, property, financial condition, and related matters is so broad that it has sometimes been likened to a permissible "fishing expedition." However, a ruling recently handed down by the U.S. Bankruptcy Court for the Southern District of New York demonstrates that there are limits to the information that can be discovered in bankruptcy. In In re Cambridge Analytica LLC, 600 B.R. 750 (Bankr. S.D.N.Y. 2019), the court denied the motion of a creditor, who was a plaintiff in nonbankruptcy derivative litigation that did not involve the debtor, for an order under Rule 2004 of the Federal Rules of Bankruptcy Procedure (the "Bankruptcy Rules") directing the debtor to provide discovery regarding its assets. According to the court, the creditor, who had purchased a nominal claim against the debtor and had not participated meaningfully in the bankruptcy case, sought discovery for the "improper purpose" of obtaining discovery in the derivative suit. Allowing such discovery, the court reasoned, would "set a very bad precedent."

Bankruptcy Rule 2004

Bankruptcy Rule 2004 provides the basic discovery mechanism in bankruptcy outside the context of a specific litigated dispute. It provides that "[o]n motion of any party in interest, the court may order the examination of any entity." Such an examination "may relate only to the acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor's estate, or to the debtor's right to a discharge." In addition, in a nonrailroad "reorganization case under chapter 11" (in addition to certain other types of case), the examination "may also relate to the operation of any business and the desirability of its continuance, the source of any money or property acquired or to be acquired by the debtor for purposes of consummating a plan and the consideration given or offered therefor, and any other matter relevant to the case or to the formulation of a plan."

Discovery may also be sought in adversary proceedings or contested matters commenced during a bankruptcy case under Bankruptcy Rules 7026–7037 (with certain exceptions and additions in contested matters, as specified in Bankruptcy Rule 9014), which incorporate many of the discovery rules that apply to other kinds of litigation in the federal district courts. These rules include specific procedures governing disclosure, witnesses, depositions, interrogatories, document production, physical and mental examinations, requests for admission, and other discovery-related matters.

As the language quoted above indicates, the scope of discovery under Bankruptcy Rule 2004 is very broad. However, although the rule has historically been regarded as permitting a "fishing expedition," a bankruptcy court has the discretion to limit discovery in certain circumstances. See generally 9 Collier on Bankruptcy ¶ 2004.01 (16th ed. 2019). Courts may limit the scope of Bankruptcy Rule 2004 examinations to prevent abuse or harassment, or where discovery is sought concerning matters unrelated to the basic inquiry of the examination. See In re Mittco, Inc., 44 B.R. 35, 36 (Bankr. E.D. Wis. 1984). If the entity from which discovery is sought believes that the examination is beyond the scope allowed under Bankruptcy Rule 2004, it may move to quash the examination. See, e.g., In re Sanomedics, Inc., 583 B.R. 796 (Bankr. S.D. Fla. 2018); In re Rafsky, 300 B.R. 152 (Bankr. D. Conn. 2003).

An exception to the broad scope of discovery under Bankruptcy Rule 2004 is the "pending proceeding rule." If an adversary proceeding or a contested matter is pending in the bankruptcy case, parties to that proceeding or matter must seek discovery under Bankruptcy Rules 7026–7037 (with certain exceptions and additions specified in Bankruptcy Rule 9014) rather than the liberal provisions of Bankruptcy Rule 2004. See In re National Assessment, Inc., 547 B.R. 63, 65 (Bankr. W.D.N.Y. 2016); In re Bennett Funding, 203 B.R. 24, 28 (Bankr. N.D.N.Y. 1996).

Courts have also refused to sanction discovery under Bankruptcy Rule 2004 when the entity requesting the examination is attempting to benefit in pending nonbankruptcy litigation. See, e.g., Snyder v. Society Bank, 181 B.R. 40, 42 (S.D. Tex. 1994) (the bankruptcy court did not abuse its discretion in denying document production under Rule 2004 where the appellant's primary motivation was to use the requested materials in state court litigation against the examinee), aff'd, 52 F.3d 1067 (5th Cir. 1995); In re Bibhu LLC, 2019 WL 171550 (Bankr. S.D.N.Y. Jan. 10, 2019) (denying Rule 2004 discovery sought by a creditor that had sued two nondebtors in state court because the creditor was seeking to use the Rule 2004 discovery for the improper purpose of obtaining discovery in the state court litigation); accord In re Enron Corp., 281 B.R. 836 (Bankr. S.D.N.Y. 2002); In re Coffee Cupboard, Inc., 128 B.R. 509 (Bankr. E.D.N.Y. 1991). However, Bankruptcy Rule 2004 discovery may be appropriate if it seeks discovery of evidence unrelated to the pending litigation. See In re Washington Mut., Inc., 408 B.R. 45 (Bankr. D. Del. 2009).

Discovery may be sought from both the debtor and third parties in a Bankruptcy Rule 2004 examination. However, if the nondebtor objects, the party seeking the examination must demonstrate "good cause." In re Wilcher, 56 B.R. 428, 434–35 (Bankr. N.D. Ill. 1985) (the examiner is required to show "some reasonable basis to examine the material sought to be discovered ... [such as that] the requested documents are necessary to establish the movant's claim or that denial of production would cause undue hardship or injustice"); accord In re Millennium Lab Holdings, LLC, 562 B.R. 614 (Bankr. D. Del. 2016); In re Davis, 452 B.R. 610 (Bankr. E.D. Mich. 2011). Courts generally apply a "totality of the circumstances" or balancing test to determine whether "good cause" exists. See In re AOG Enm't, Inc., 558 B.R. 98 (Bankr. S.D.N.Y. 2016); In re Countrywide Home Loans, Inc., 384 B.R. 373 (Bankr. W.D. Pa. 2008).

Cambridge Analytica

Political consulting firms Cambridge Analytica LLC and SCL USA Inc. (collectively, "Cambridge") were U.S. affiliates of UK-based Cambridge Analytica Ltd. Cambridge filed a chapter 7 petition in the Southern District of New York in May 2018 to liquidate its assets after its business dropped off precipitously in the wake of revelations that Cambridge and its affiliates improperly used the personal data of 87 million customers of Facebook, Inc. ("Facebook").

Facebook's officers and directors were then defendants in a derivative action (the "Derivative Action") filed in Delaware Chancery Court. Cambridge was not a named defendant in that litigation. However, both Facebook and Cambridge were defendants in putative class actions pending in the U.S. District Court for the District of Delaware (the "DB Litigation") in which the plaintiffs (the "DBL Plaintiffs") were seeking an award of damages arising from the data breach. Facebook and Cambridge were also defendants in litigation consolidated in the U.S. District Court for the Northern District of California (the "CP Litigation") in which the plaintiffs (the "CPL Plaintiffs") alleged violations of consumer privacy laws.

In June 2018, the DBL Plaintiffs filed a motion in the Cambridge bankruptcy case for an order under Bankruptcy Rule 2004 directing the production of documents and authorizing the examination of Cambridge regarding its property and financial condition "in light of the incomplete information provided by the Debtor in this bankruptcy case to date." In their motion, the DBL Plaintiffs represented that they were not seeking documents or information with respect to the DB Litigation and that, by separate motion, they were simultaneously seeking relief from the automatic stay to file a document preservation subpoena on Cambridge to ensure the preservation—not production—of any documents related to that litigation. The CPL Plaintiffs joined in the Bankruptcy Rule 2004 motion.

The chapter 7 trustee objected, arguing that, in light of the pendency of the DB Litigation, Bankruptcy Rule 2004 discovery should be denied under the pending proceeding rule. In addition, Facebook responded that any Facebook customer information in Cambridge's possession should remain confidential.

On January 8, 2019, the court entered an order directing the chapter 7 trustee to provide the requested documents to the movants and Facebook, with the caveat that the documents could be used only for litigation purposes in connection with Cambridge's chapter 7 case and/or the CP Litigation, and implementing safeguards to ensure that Facebook's customer information would remain confidential. The court deferred consideration of the movants' request that a representative be designated for Cambridge to be examined and to produce documents.

Karen Sbriglio ("Sbriglio"), a plaintiff in the Derivative Action, purchased a $650 claim against Cambridge on March 13, 2019. Eight days afterward, Sbriglio filed a motion seeking production of the same documents requested by the DBL Plaintiffs and authorizing an examination of Cambridge under Bankruptcy Rule 2004. The chapter 7 trustee objected.

The Bankruptcy Court's Ruling

The Bankruptcy Court denied the motion. Relying on Snyder, Bibhu, and similar cases, the court concluded that Sbriglio filed her Bankruptcy Rule 2004 request for the "improper purpose" of obtaining discovery for use in the Derivative Action—litigation in which Cambridge was not a defendant. That improper purpose was confirmed, the court explained, by the fact that Sbriglio was not actually a creditor of Cambridge on the bankruptcy petition date. According to the court, that circumstance made Sbriglio "markedly different" from the DBL Plaintiffs, who asserted claims against Cambridge in the DB Litigation even before the petition date and filed their Bankruptcy Rule 2004 motion "to further their interests as creditors." In addition, unlike Sbriglio, the DB Plaintiffs had been "regular and meaningful" participants in the bankruptcy case since its inception.

Allowing Sbriglio to proceed with discovery under Bankruptcy Rule 2004, the court wrote, "would set a very troubling precedent" because it would "incentivize parties to purchase nominal claims in bankruptcy cases solely to pursue their outside litigation agendas." The court refused to countenance this ploy.

Outlook

The broad discovery available under Bankruptcy Rule 2004 is an important tool designed to promote transparency, fairness, and maximization of the value of the estate in bankruptcy cases. However, Cambridge Analytica demonstrates that a bankruptcy court has the discretion to limit or deny such discovery if it is sought for an improper purpose. The brazenness of the creditor's conduct in acquiring a nominal claim for the purpose of obtaining discovery against nondebtor defendants in unrelated litigation made the court's decision a relatively easy call. Other cases calling upon the court to balance the competing considerations of broad disclosure and the pending proceeding rule may be more difficult.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions