Court Sanctions Defendants for Elaborate Spoliation, Declines to Sanction Misled Counsel Unaware of “What was Going on Behind the Scenes”

United Cent. Bank v. Kanan Fashions, Inc., No. 10 CV 331, 2011 WL 4396912 (N.D. Ill. Mar. 31, 2011); United Cent. Bank v. Kanan Fashions, Inc., No. 10 C 331, 2011 WL 4396856 (N.D. Ill. Sept. 21, 2011)

In this case, the magistrate judge recommended sanctions against defendants for their bad faith spoliation of a relevant server where the evidence strongly suggested that defendants arranged for the sale of the server to company in Dubai, which resulted in the unavailability of its admittedly relevant contents.  The magistrate judge declined to sanction defendants’ attorneys, however, where the evidence indicated that they made efforts to ensure preservation but were misled by their clients and unaware “of what was going on behind the scenes.”

Plaintiff alleged that defendants were in default on several loans and sought damages accordingly.  In the course of discovery, defense counsel repeatedly informed defendants of their obligation to preserve relevant information.  Despite their obligation to preserve and their assurances to counsel that all appropriate efforts were being undertaken, defendants took steps to ensure the unavailability of a relevant server which was maintained in one of defendants’ warehouses.  The details of defendants’ efforts are numerous and complex.  Summarizing broadly, when defendants experienced significant financial problems and defaulted on both the lease of the at-issue server and the loan related to the warehouse in which it was stored, Defendant Shah (who controlled the four corporate defendants) entered into an agreement for a “friendly foreclosure” on the warehouse and for the foreclosing bank to purchase the server’s lease (which was owned by a different bank and also in default) and to resell the server to Shah.  This agreement was reached after plaintiff’s complaint had been filed and after defendants had been informed of their duty to preserve.  Despite this, the arrangements for the bank’s purchase of the lease and resale of the server to Shah were not revealed to defense counsel.  Rather, defendants’ attorneys were assured that preservation was ongoing and repeated these assurances to the court and to the plaintiff, without correction or clarification from defendants.  When counsel eventually learned that the server had been left at the warehouse following defendants’ eviction and was in the possession of the bank, defendants assured counsel that access would not be a problem; such assurances continued for several months.

When it was finally revealed that the server had been left in the warehouse and had not been accessed (negotiations for the terms of the purchase and resale had been ongoing), the court ordered defendants to obtain the server or a forensic copy within a matter of weeks.  Several days later, defendants announced that the server was sold by the bank to a company in Dubai.  The details surrounding the sale were quite unusual, however, and led the magistrate judge to conclude that defendants had been involved (or had fabricated the sale).  Upon news of the sale, plaintiff moved for sanctions.

Following extensive analysis of the facts, the magistrate judge found that defendants were “at fault” for the spoliation and had acted “willfully and in bad faith.”  The magistrate judge also concluded that defendants deliberately withheld information from counsel and allowed them to make misrepresentations to the plaintiff and the court.

Plaintiff also sought sanctions against counsel, alleging that that they “failed to take an adequately active role in supervising their client’s discovery obligations.”  While the magistrate judge acknowledged that counsel could have done more and should not have accepted defendants’ assurances that they were upholding their discovery obligations, he concluded that their actions were not sanctionable.  In so holding, the magistrate judge reasoned that counsel had issued an initial litigation hold, had “continuously” reminded defendants of their discovery obligations, and had repeatedly instructed defendants to move the server to a more secure location.  Meanwhile, he pointed out, “Defendants were working against them with their own scheme to avoid producing the warehouse server.”  The analysis also included a discussion of Zubulake v. UBS Warburg LLC, 229 F.R.D. 422 (S.D.N.Y.2004) and Qualcomm, Inc. v. Broadcom Corp., No 05–cv–1958–B, 2010 WL 1336937 (S.D.Cal. Apr.2, 2010)—two cases in which counsels’ supervision of discovery was also at issue.

The magistrate judge recommended that the District Court order defendants to reimburse plaintiff for all expenses and fees related to the Motion for Sanctions and that defendants “be barred from introducing any evidence at trial regarding information on the server, and that the jury be instructed that Defendants’ failure to preserve the server may be considered evidence that the server contained information unfavorable to Defendants’ position.”

Upon review, the District Court adopted the recommendations of the magistrate judge, except to remand for a determination of whether the magistrate judge intended to sanction all six defendants, or only those most closely involved in the sanctionable behavior.

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