Court of Chancery Finds Party in Contempt for Destruction of Evidence; Sanctions Include Heightened Burden of Proof, Waiver of Privilege and “Significant” Award of Attorneys’ Fees

A battle for control of Trans-Resources, Inc. (“TRI”) is interrupted by findings of contempt and spoliation of evidence resulting in severe sanctions. Unfortunately like many litigations in recent years, disputes on the merits can get overshadowed by e-discovery disputes. Prime examples include some of the most memorable e-discovery cases – Zubulake v. UBS Warburg, Qualcomm Inc. v. Broadcom Corp. and Coleman (Parent) Holdings, Inc. v. Morgan Stanley & Co. Inc., three cases where the Court, when faced with significant e-discovery problems, was forced to be creative is doling out sanctions. This case is another such example. 

Kevin Brady, a highly respected Delaware litigator, provided this synopsis.

TR Investors, LLC, et al. v. Genger, C.A. No. 3994-VCS, 2009 WL 4696062 (Del. Ch., Dec. 9, 2009), read opinion here, involves a dispute under 8 Del. C. §§ 220 and 225, where weeks after the case was settled, plaintiffs TR Investors, LLC, and others (collectively, the “Trump Group”) moved to reopen the matter and sought sanctions against defendant Arie Genger for intentionally causing computer “wiping” software to be installed and run on his desktop computer as well as TRI’s hard drives destroying a significant amount of information.

The Court of Chancery reopened the case and after a two-day hearing, found Genger in contempt because he had, through his agent, caused evidence that was on his computer as well as TRI’s computers (and which was subject to a status quo order) to be intentionally destroyed. In addition, the Court sanctioned Genger by, among other things, increasing his burden of proof, requiring him to provide corroborating evidence at trial (beyond just his own testimony), requiring him to produce certain documents to the plaintiffs that he had claimed were privileged, and awarding attorneys’ fees at a “suggested” level of $750,000.

Background

In 2008, Genger was the Chief Executive Officer of TRI and the Trump Group was a 47% owner of the outstanding stock of TRI. The Trump Group purchased an additional 19% bloc of TRI shares after which the Trump Group believed that it had voting control of TRI to remove the TRI board and install a new board. At a board of directors meeting held on August 25, 2008, the Trump Group delivered written consents of its shares and proposed to reconstitute TRI’s board. The practical effect of this proposal was to eliminate Genger’s control over TRI. Genger and two other directors rejected the proposal, believing that the Trump Group did not have the voting power to reconstitute the board.

Section 225 and 220 Actions and the Status Quo Order

On the same date as the Board meeting, TR Investors, LLC and others filed a Section 225 action asking the Court to, among other things: (a) declare that the Trump Group was the majority stockholder of TRI; (b) enjoin TRI from recognizing Genger as a director; (c) declare that the Trump Group, as the majority shareholder, was entitled to designate and elect two more of their designees to the TRI board, and to continue the terms of two directors; (d) declare that the TRI board was composed of their four designees; and (e) declare invalid any actions taken by a board not comprised of their designees from and after the delivery of their written consents.

The Trump Group also filed a Section 220 action asking the Court to, among other things, order TRI to permit the Trump Group to inspect and copy books and records from TRI. On August 28, 2008, the parties to the Section 225 action entered into a Standstill Agreement which provided that “no action will be taken to prosecute or defend any of the Litigations during the Term of this Agreement.” The next day, the parties submitted a stipulated status quo order which contained a provision that prohibited the parties from modifying or destroying any TRI-related information.

Preservation of TRI Information and Encryption of Genger’s Personal Information

In September 2008, in connection with the Section 225 action, TRI’s outside counsel worked with Genger to identify information on TRI’s computer system that was personal to Genger and not related to the business of TRI. Genger was concerned that if he lost control of TRI, the Trump Group would get access to his private information stored on TRI’s computers. Apparently, Genger had high level contacts within the Israeli government for whom he performed sensitive tasks relating to Israel’s national security and Genger used TRI’s computer system to create and receive documents related to these tasks.

TRI’s outside counsel collected electronic information from Genger’s TRI office and sent that information to the office of Genger’s personal counsel pending the outcome of the lawsuits. This was done not only to segregate the non-TRI documents and to protect Genger’s interest in keeping those documents confidential, but also to ensure that all of the documents related to TRI’s business were preserved for those managing the corporation and for possible use as evidence by the parties in the pending litigation. It was also done to identify Genger’s documents that were purely personal so that they could be encrypted in a manner that ensured that their confidentiality would be protected. As to non-personal documents, that information was preserved for use by TRI in its business and to ensure that it would be available if requested in the pending litigation.

Files Opened — Data Temporarily Stored in Unallocated Space

In reviewing TRI’s files, TRI’s attorneys opened documents and e-mails that were potential targets for encryption to review their contents. This is important because, as the Court discussed, in dealing with electronic information, if a document is opened long enough for the program’s autosave feature to function, the computer system will create a temporary copy of that file. These temporary copies are different than normal user-created files, such as word-processing documents, which are stored on the active, or allocated, space of a computer where such information is visible to a user. As long as the file is open, a temporary copy is in the active or allocated space. When the file is closed (or deleted by the user), the temporary copy is moved to the inactive, or unallocated, space of the computer until the computer needs that space to store other information at which time the original temporary copy is overwritten. While information in the unallocated space is hidden from the view of normal users, it can be recovered with the aid of technology consultants making a forensic copy.

Information in Unallocated Space Destroyed in Violation of Status Quo Order

Oren Ohana, who had served for years as a technology consultant for both TRI and Genger, was contacted by Genger about the collection from TRI computer system. During the preservation of Genger’s electronic files and e-mails, parts of TRI’s computer system were “imaged” which would show a “snapshot” of all information on the system as of that date. However, no image of the entire TRI hard drive was made, only an image of the active files on the TRI system (the information on the unallocated space had not been imaged or reviewed.) Ohana informed Genger that during the review process, non-encrypted copies of Genger’s personal files may have been created and left on the unallocated space of his computer and the TRI server. At Ohana’s suggestion and with Genger’s permission, Ohana ran a wiping software program on the hard drive of Genger’s computer as well as TRI’s server permanently overwriting and erasing the data on the unallocated space of a hard drive.

About a month later and just after the parties settled the litigation, the Trump Group discovered that “wiping” software had been used to erase information on TRI’s computer system. Within days of discovering the use of the “wiping” software, the Trump Group filed a motion to reopen the case and for an order to show cause as to why Genger should not be held in contempt. Eventually, the action was reopened but Genger’s destruction of documents created a question about the adequacy of the factual record and what, if any, consequences, should result from his conduct.

A great deal of discovery was taken to determine whether any evidence was lost because of Genger’s conduct. Because no image of the entire TRI hard drive was made during the review process (only an image of the active files on the TRI system), the Court noted that it would be impossible for the Trump Group to determine exactly what was erased. However, plaintiffs were able to prove that important information about the litigation that should have existed (because it was discovered in other sources) no longer existed.

Court Finds Genger Guilty of Civil Contempt

The Trump Group filed a motion for civil contempt against Genger as well as spoliation of evidence. The Court noted that to establish civil contempt, the petitioning party bears the burden initially to demonstrate by clear and convincing evidence that the contemnors violated a Court order “of which they had notice and by which they were bound.” The Court found that Genger acted in contempt of Court by directing his agent Ohana to delete company-related information. The Court also found that the Trump Group had shown that Genger consciously violated the Status Quo Order, which prohibited him from destroying any TRI-related files. Genger had been made aware of that order, because of the work Genger did with TRI’s outside lawyers.

Moreover, the Court found evidence that “relevant documents have been lost due to Genger’s misconduct…. [and] recently produced documents … show that Genger likely deleted several other documents relevant to the § 225 action from TRI’s hard drive. Copies of those documents would likely have been on the unallocated space if they had not been erased.”

Court Finds Spoliation of Evidence

The Court stated that “[d]ispositive sanctions, including dismissal of claims or imposition of an adverse inference, are only appropriate where a party acts to “intentionally or recklessly destroy evidence, when it knows that the item in question is relevant to a legal dispute or it was otherwise under a legal duty to preserve the item.” (emphasis in original). Here the Court found that Genger intentionally caused the destruction of information he knew was relevant to the litigation in violation of the Status Quo Order and thus subject to a legal duty to preserve. The Court also found that Genger acted recklessly by approving the use of the wiping software to wipe the unallocated space. Moreover, the Court found that the Trump Group identified specific documents that existed and would have supported its position but for Genger’s destructive actions.

Court Awards Multiple Sanctions

As part of the court’s inherent power to fashion a remedy for such violations and in determining what remedy to award for spoliation, the Court considered: (1) the culpability of the spoliating party; (2) the degree of prejudice suffered by the aggrieved party; and (3) the availability of lesser sanctions that could both avoid unfairness to the aggrieved party and serve as an adequate penalty to deter such future conduct.

Here, although the Court believed that Genger was improperly motivated and intended to limit the Trump Group’s ability to gather evidence in its disputes with him, the Court also found that part of his motivation was to protect his confidentiality interests in his personal information. In addition, the Trump Group did not suffer a high degree of prejudice because Genger’s misconduct only affected the unallocated space on his computer and TRI’s server, while the active files, which were not deleted, contained a good deal of relevant information.

As a result, the Court determined that: (1) because Genger destroyed evidence that otherwise would have been available to the Trump Group, the Court determined that Genger must produce certain relevant documents to which he had claimed privilege; (2) Genger’s burden of proof would be increased by “elevat[ing] by one level the burden of persuasion upon Genger to prevail on any affirmative defense or counter-claim” that he has raised; (3) Genger had to provide corroborating evidence to prove a material factual issue at trial, “his mere word will be insufficient to meet his burden of persuasion;” and (4) Genger should pay the plaintiffs’ attorneys’ fees and suggested “as reasonable” an amount of $750,000 because this was “an amount that strikes me as reasonable in light of what was at stake, and that is consistent with my impression that both sides have engaged in overkill.” 

Supplement: The Electronic Discovery Law blog has an overview of the case here.