(TMA International Headquarters)
Difficulties in complying with the duty to preserve
electronically stored information (ESI) have been chronicled in a rich body of
case law going back several years, including cases in which courts have severely
punished those found to have abrogated this
responsibility.
Recent changes to the Federal Rules of Civil Procedure (FRCP), which took
effect on December 1 and apply to many cases in U.S. Bankruptcy Courts, have
raised the ante. For organizations considering filing for bankruptcy or those
that have filed and are involved in related litigation, compliance with the duty
to preserve now can present even greater
challenges.
The timing and scope of the duty to preserve are not addressed explicitly
by the amendments to the FRCP. However, the amendments explicitly recognize the
primacy and the urgency of the preservation issue in today’s environment.
Because most information is stored electronically, a failure to take active and
timely measures to ensure preservation can result in the loss of significant
evidence.
Preservation is one of the electronic discovery issues specifically
identified in the rules as a required topic of discussion at the FRCP Rule 26(f)
conference. While this requirement is designed to head off problems resulting
from divergent opinions and expectations as to the scope of a preservation duty
later in the case, the likely effect may be to spark disputes about spoliation
at the beginning of many cases.
The duty to preserve generally arises when a legal proceeding is
“reasonably anticipated,” and the Rule 26(f) conference typically occurs months
after that triggering event. The implication is that implementation of
“litigation holds” on data to comply with preservation duties will be the
subject of increased focus, because these efforts or the lack of them are likely
to be scrutinized at the beginning of every federal court
case.
The new “safe harbor” from spoliation sanctions of Rule 37(f) applies
when information is lost due to the “routine, good faith” operation of
electronic information systems. The notes of the committee involved with
developing the new rules make it clear that taking shelter under 37(f) may
require suspension of routine in the face of a preservation duty, which once
again puts litigation hold implementation under the
microscope.
Finally, even in connection with rule changes that are not explicitly
about preservation duties, the committee notes focus heavily and in a cautionary
manner on preservation obligations. For example, in the notes to new Rule
26(b)(2)(B), which established a “two-tier” procedure for production of ESI
designated as “not reasonably accessible,” explicit warnings are issued that
this rule does not impact preservation duties with respect to such
information.
Thorny Issues
For
litigants in bankruptcy, the concern over such preservation efforts is magnified
by potential consequences under the Sarbanes-Oxley Act, which provides criminal
penalties for the destruction of evidence, with specific reference to bankruptcy
proceedings. Moreover, because of common characteristics of bankruptcy
situations, preservation of ESI presents some particularly thorny
issues.
Generally, when a debtor files for bankruptcy, litigation against the
debtor is stayed automatically. While this may protect a debtor at least
temporarily from the expense and exposure of proceeding with discovery, it does
not release it from the obligation to preserve potential evidence. This means
that even though the litigation is not proceeding, data that ordinarily would
have been collected and prepared for production must be
preserved.
If the data is not collected, it often is left in the hands of the
user-custodians, and a deliberate or inadvertent misstep by one or more of those
custodians that results in irretrievable data loss could trigger spoliation
consequences. An extended preservation period exacerbates thorny issues
involving preservation of information in continually updated and changing
databases. In addition, preserving potentially recoverable deleted files in
unallocated space on computer hard drives that may be overwritten with normal
use may become an issue.
Maintaining pre-filing financial information can be addressed by
preserving a copy of the general ledger and its feeder systems on the date of
the filing. This is a simple addition to the already required general ledger
modification that most companies employ at the time of the filing to designate
pre- and post-filing related transactions.
Preserving critical financial information held in ever changing “live”
financial and operational databases can be a very complicated issue. Addressing
which of the operational databases need to be preserved can be much trickier.
These systems can be voluminous, specialized, and very difficult to modify or
extract information from. To comply with the new rules and to understand what
information is potentially relevant, a full inventory of all databases should be
performed prior to a filing and reviewed with counsel to identify those that can
and should be preserved.
Preserving live data on an ongoing basis can be very costly to the estate
in the context of a liquidating entity. One tactic for addressing this issue is
to estimate the preservation costs for use in negotiations with the creditors
and litigants involved. It would not be uncommon for a mid-sized business in
liquidation to expend hundreds of thousands of dollars to preserve data — funds
that otherwise could be distributed to the litigants and creditors
involved.
Another potential problem area is preserving information that was handled
by employees who have left a company. Businesses that are headed toward
bankruptcy or that have filed typically are pressured to implement a variety of
cost-cutting measures, including employee layoffs. Preserving data associated
with or maintained by departed employees presents challenges because these
workers commonly were responsible for complying with preservation instructions
regarding their “local” data, which is information that resides on their
personal computers (PCs). When employees leave a company, it is common to erase
or reformat their PC hard drives and redeploy these devices to other
employees.
It also can be more difficult to track down and preserve data that might
have been non-centrally located. An example is data stored on file servers,
which typically are not well organized and not subject to any standard naming
conventions. The loss of information technology (IT) personnel also may
compromise the oversight and maintenance of the various systems that are sources
of ESI. Some of these professionals may carry specialized knowledge of how the
systems operate in their heads, expertise that is lost to the company when the
employee is laid off.
Drawing the Line
It can
be difficult under the best of circumstances to determine when a duty to
preserve has been triggered because doing so involves identifying the point in
time at which litigation becomes “reasonably anticipated.” Precisely where this
line should be drawn for companies considering filing for bankruptcy is murky.
At what point does the investigation of this option transmogrify into
“reasonable anticipation” of certain types of litigation? How is a potentially
bankrupt debtor supposed to evaluate the proper scope of this reasonably
anticipated litigation?
There are some very different and significant issues related to the new
federal rules related to the preservation of ESI in bankruptcy cases. These must
be considered prior to the time of filing and again prior to the time of
altering course to a liquidating Chapter 11 or Chapter 7. The costs can add up
rapidly and must be justified, not just to the company, but also to the
creditors, trustee, and judge.
_____________________________________________________________
The views expressed in the article are held by the authors and are
not necessarily representative of FTI Consulting, Inc.