Abandonment or Spoliation The Risks of Abandoning a Debtors Records
Businesses generate a tremendous volume of paper and electronic records. Poorly managed businesses without formal document retention policies may retain records for many years in various states of disarray. When such a business files a chapter 7 bankruptcy, the trustee is often faced with an economic problem: The trustee must decide whether to pay exorbitant storage fees to retain business records or to abandon them. For some trustees, conducting a full inventory of the records is cost-prohibitive, and the trustee may be forced to make this decision with limited information as to what may ultimately be at issue in the chapter 7 bankruptcy case.
Section 554 of the Bankruptcy Code permits a trustee to abandon estate property, including documents, after providing notice to creditors and other parties in interest. If the trustee provides notice and no one objects within 15 days, the trustee may abandon the designated property. See 11 U.S.C. §554; see also Bankruptcy Rule 6007. In some situations, it is not unusual for hundreds or even thousands of boxes of documents to be abandoned, even though the trustee does not have an understanding and appreciation of whether "hot" documents are being abandoned. Once abandoned, such documents located at storage facilities are generally destroyed quickly.
This abandonment and destruction, while seemingly cost-effective, can present serious problems in the context of litigation filed after documents have been destroyed. For example, while abandonment of records may occur early in a case, fraudulent-transfer litigation may be filed much later in the case, particularly if brought under state fraudulent conveyance statutes with longer statutes of limitations than those available under the Code. If a trustee sues a fraudulent transfer defendant after abandoning records, he or she may have destroyed critical business records without notice to the defendant. As a result, the trustee, may then face a claim of spoliation.
Spoliation is often defined as "the destruction, or the significant and meaningful alteration of a document or instrument." Andrade Garcia v. Columbia Med. Ctr., 996 F. Supp 605, 615 (E.D. Tex. 1998). In federal court, such conduct is sanctionable under federal law. King v. Ill. Cent. R.R., 337 F.3d 550, 556 (5th Cir. 2003). Discovery abuse sanctions may be levied to preserve the integrity of the justice system and to prevent a party from profiting by its own discovery abuses. Chambers v. NASCO Inc., 501 U.S. 32, 33 (1991) (In invoking their inherent power to punish conduct which abuses the judicial process, federal courts must exercise discretion in fashioning an appropriate sanction which may range from dismissal of a lawsuit to an assessment of attorney's fees).
To sanction a party who has destroyed evidence, the court must consider (1) the degree of fault of the party who altered or destroyed the evidence; (2) the degree of prejudice suffered by the opposing party; and (3) what degree of sanction is necessary to avoid substantial unfairness to the opposing party and to deter such conduct by others in the future. Schmid v. Milwaukee Elec. Tool Corp., 13 F.3d 76, 79 (3d Cir. 1994). The more egregious the conduct involved in spoliation, the more severe the sanction imposed by the court.
The Degree of Fault
Standards differ among federal courts in determining the "degree of fault" or level of intent necessary to warrant a spoliation-related sanction. The Fifth and Seventh Circuits permit an adverse inference against the destroyer of evidence only upon a showing of "bad faith" or "bad conduct." See King, 337 F.3d at 556; Brown & Williamson Tobacco Corp. v. Jacobson, 827 F.2d 1119, 1134-35 (7th Cir. 1987). In other circuits, the spoliation inference is available if the evidence was intentionally destroyed without bad faith. See, e.g., Brewer v. Quaker State Oil Ref. Corp., 72 F.3d 326, 334 (3d Cir. 1995). The Second Circuit has dismissed the intent requirement entirely, permitting a spoliation inference if the spoliator's conduct was reckless or grossly negligent. Reilly v. Natwest Mkts. Group Inc., 181 F.3d 253, 267-68 (2d Cir. 1999). The First and Ninth Circuits have relaxed the culpability requirement even more, requiring something less than "bad faith" such as "knowing disregard" to issue a spoliation inference instruction. See Glover v. BIC Corp., 6 F.3d 1318, 1329 (9th Cir. 1993); Nation-Wide Check Corp. v. Forest Hills Distribs. Inc., 692 F.2d 214, 219 (1st Cir. 1982). Moreover, even where some level of intent is required, generally the trier of fact may perceive the fact of the nonproduction or destruction of relevant, probative documents as circumstantial evidence that "the party which has prevented production did so out of the well-founded fear that the contents would harm him." Nation-Wide Check Corp., 692 F.2d at 217; see also Kronisch v. United States, 150 F.3d 112, 126 (2d Cir. 1998) (circumstantial evidence may suffice to support a reasonable probability of spoliation).
Although there are not yet reported decisions sanctioning a trustee for abandoning documents relevant to litigation, in Nation-Wide the First Circuit upheld an adverse instruction against an assignee for the benefit of creditors who "consciously abandoned" documents even though he was not "completely aware" of the significance of the records. 692 F.2d at 219 (where assignee proceeded to abandon records without making "further inquiry," he acted with "knowing disregard" and this "conscious abandonment" of potentially useful evidence was, at a minimum, an indication that the assignee believed that the records would not help his side of the case and might help his opponent).
The Degree of Prejudice
In addition to proving destruction and some level of intent, even if circumstantially established, the spoliation claimant must also show that the destroyed records were relevant and probative to the litigation. See Stanojev v. Ebasco Services Inc., 643 F.2d 914, 923-24 (2d Cir. 1981) (to draw an adverse inference of spoliation requires some indication that the destroyed evidence would have been relevant to the contested issue). But in many courts, only "a minimum link of relevance" must be shown before the court has some discretion in determining how much weight to give the document destruction and what kind of sanction to impose. See Nation-Wide, 692 F.2d at 219. Although this can be difficult to prove, particularly where a trustee has not conducted an inventory of the abandoned documents, defendants may be able to uncover inventories kept by the debtor that show the relevance of the destroyed records. If such inventories are relatively easy to obtain, the trustee may encounter difficulty defending a wholesale abandonment without sufficient knowledge of the documents. Such an abandonment may be so negligent or reckless that it is tantamount to conduct supporting a spoliation remedy.
The Degree of Sanction
The trial court has broad discretion to impose sanctions on a party responsible for spoliation of evidence. Vick v. Texas Employment Commission, 514 F.2d 734, 737 (5th Cir. 1975). Sanctions for spoliation, including dismissal and an adverse inference instruction, are reviewed under an abuse of discretion standard. King, 337 F.3d at 56; see also Wilson v. Johns-Manville Sales Corp., 810 F.2d 1358, 1362-63 (5th Cir. 1987) (quoting Mayo v. Tri-Bell Indus. Inc., 787 F.2d 1007, 1012 (5th Cir. 1986) ("Control of discovery is committed to the sound discretion of the trial court, and its discovery rulings will be reversed only where they are arbitrary or clearly unreasonable").
Typical sanctions for discovery abuses range from monetary redress or an adverse inference to, in the most egregious cases, the "death penalty" sanction. King, 337 F.3d at 556; Nissho-Iwai American Corp. v. Klone, 845 F. 2d 1300, 1304-05 (5th Cir. 1988) (striking pleadings is an appropriate sanction for severe discovery abuses). If the destroying party is on notice of relevant evidence of potential liability, he or she has a duty to preserve such evidence. See Anderson, 2000 WL 492095 at *4 (citing Nation-Wide Check, 692 F.2d at 218). Severe sanctions are preferred when a party destroys evidence with knowledge that the documents are crucial to the lawsuit. Tandycrafts Inc. v. Bublitz, No. 3:97-CV-1074-I, 2002 WL 324290, at *2-3 (N.D. Tex. 2002) (unpublished) (finding that defendant "had to know" that the documents he destroyed were crucial to plaintiff's proof of damages and that plaintiff was substantially prejudiced by such destruction). Thus, knowing spoliation of evidence calls for severe sanctions to prevent a party from benefiting from his or her own misconduct. Id. at *3. Moreover, even when a finding of bad faith is not supported by the facts of the case, a court may still allow inadvertent destruction of evidence to be presented to a jury (without the added adverse inference) if such information is relevant to the credibility and reliability of the destroying party. See Caparotta v. Entegry Corp., 168 F.3d 754, 756-57 (5th Cir. 1999); Anderson, 2000 WL 492095 at *4.
In addition to the typical spoliation remedies, judges may craft whatever sanctions are appropriate to the case. See Daval Steel Prods. v. M/V Fakredine, 951 F.2d 1357, 1366 (2d Cir. 1991) (barring party from presenting evidence opposing claim); see also Konstantopoulos v. Westvaco Corp., 112 F.3d 710, 719-21 (3d Cir. 1997) (preventing spoliator's expert witness from testifying about spoliated evidence), cert. denied, 522 U.S. 1128, 118 S. Ct. 1079, 140 L. Ed. 2d 137 (1998); Dillon v. Nissan Motor Co., 986 F.2d 263, 267 (8th Cir. 1993) (same).
Given the risks of abandoning documents prior to the resolution of all litigation, trustees should exercise caution. At a minimum, trustees should provide notice of abandonment to all potential defendants, particularly if they are not creditors or parties who have filed notices of appearance. But even where a trustee files a notice of abandonment under §554 of the Code and serves it upon all potential defendants, trustees may not escape spoliation claims if they have not taken reasonable steps to inventory documents and ensure the irrelevance of the documents to any potential litigation prior to abandonment. Where fraudulent-transfer defendants find themselves in litigation with a trustee, they should question any proposed abandonment of documents if they receive notice of the proposed abandonment. To the extent that there has already been an abandonment of records, the defendants should determine whether potentially relevant documents were abandoned to destruction by the trustee and should conduct discovery on the diligence and level of inquiry exercised by the trustee prior to abandoning the records. Most importantly, neither trustees nor fraudulent-transfer defendants should assume that adherence to 11 U.S.C. §554 and Bankruptcy Rule 6007 will necessarily protect trustees from otherwise valid spoliation claims.