The Debtors Survival in the Digital Age
Overview of Digital Information Technology
Ten years ago, e-mail was the new kid on the block of information technology. Five years ago, it became clear that e-mail would play an important part in future litigation. Under the compulsory disclosure requirements to FRCP 26(a)(1), which became effective Dec. 1, 2000, parties must disclose the existence of electronic documents and other information when a lawsuit is started. Since then, companies and careers have tumbled because of the truth discovered in e-mail messages.
Enough was enough, and the Sarbanes-Oxley Act was added to 18 U.S.C. §1519. In December 2003, New Jersey adopted Local Civil Rule 26.1(d)(1). Now, New Jersey counsel must review with the client the client's "information management systems, including computer-based and other digital systems, in order to understand how information is stored and how it can be retrieved." Rule 26.1(d)(1) further requires counsel to determine and find active, backup or archival files and other digital evidence that may be used to support the client's claims or defenses. In addition, counsel needs to disclose this information to the opposing side as part of its Rule 26(a)(1) initial disclosure.
Cause and Effect
E-mail, a key part of the debtor's DIT, can potentially spell disaster for you and your clients. Would you take a guess at the number of e-mails you sent and received last year? Can you estimate the number for last week? Why do many attorneys trying to preserve the attorney/client privilege place language at the end of e-mail similar to: "This e-mail may contain confidential or privileged information. If you are not the intended recipient, please advise by return e-mail and delete immediately without reading or sending to others."? The answer, "they programmed the e-mail that way," will not do in the 21st Century. Does this mean that anyone can read the e-mail first and ask questions later? Can the recipient be held responsible to first go to the bottom of the e-mail to decide if the e-mail is confidential before reading it?
[F]ew things can cause conversion of the case any faster than the discovery that the debtor's e-data was altered or destroyed...by the DIP.
Perhaps you may need to consider rephrasing the e-mail disclaimer, because since e-mail was created, "delete" has never meant "erased" from the hard disk drive and media storage of the recipient. If e-mail, Internet, Intranet and other digital technologies used today and in the future for the exchange of confidential information are not treated as being important, then perhaps the courts will decide.
Digital Reality Check
It is nearly impossible for debtor's counsel to represent a business that does not own, lease or use computers, PDAs,3 digital devices4 and media storage. Every business bankruptcy has at its core the digital books and records5 and related information, known as "e-data."6
Did you know that just one hard disk drive found in almost any laptop today has the ability to store several million documents and spreadsheets? The committee may have some concerns that a second set of books exists. Now weigh the implications of business e-mail,7 because it has been estimated8 that 100 employees may amass and store as many as 7.5 million e-mails a year, and many of those will contain file attachments.
Often the debtor's success or failure in gaining confirmation of a plan can be measured by the degree of cooperation the debtor provides in obtaining its financial records—the e-data. Making the debtor's e-data available for examination by the digital forensic accounting technologist before the §341 meeting and before demand is made by the committee, examiner, chapter 11 trustee9 or the U.S. Trustee can be worthwhile and cost-effective.
Beware of Risks
Debtor's counsel will want to examine the reason behind proposed §365 motions, including the review of personal property under blanket lease, to be sure that no computers and digital devices are involved.10 Debtor's counsel should be aware that filing a motion to prevent spoilage11 of the digital information could become the linchpin to convert the case. Undoubtedly, quickly providing the committee access to the debtor's e-data will cost far less than an adversary proceeding.
Sometimes it is helpful for debtor's counsel to know what may happen if the debtor fails to cooperate. The committee may engage its own digital forensic accounting technologist. Often, when the opposing party does not cooperate, there is a reason behind it. This can become fertile territory for the creditors. It is not difficult for debtors, insiders, officers, employees and accountants to hide e-data from internal auditors, auditors, forensic accountants and examiners using only "conventional" means to uncover hidden assets and accounting and bankruptcy fraud.
Invisible digital attachments, known as alternative data streams, encryption and digital steganography,12 may become the target for examination13 in complex cases. The committee will look for information including names, addresses, passwords, bank accounts, taxpayer identification numbers, related parties, off-balance sheet accounts, insider transactions, financial statements, real estate ownership, stock option plans, beneficial owners, joint ventures, insurance coverage, contracts, spreadsheets, conveyances and transfers. Perhaps that second set of books will show its ugly head with other information that can be hiding behind legitimate files on the debtor's hard disk drives.14
Encrypted and hidden information may well be confidential information that the debtor and insiders are masking. Transparency of the numbers should never translate to the debtor and others trying to make the e-data become invisible.15 Spoliation of evidence and document retention policies are discussed below.
Debtor's Counsel Strikes First
The ideal situation is for debtor's counsel to arrange for the digital forensic accounting technologist to immediately view the computers and digital devices in place on-site at the start of the case. Most, if not all, of the hesitation about turning over the debtor's digital books and records and related digital documents is on the part of insiders, officers, directors, employees and others. After all, they can hardly ignore reading about the endless accounting scandals. Be aware that any hesitation could be a sign that the debtor's e-data is in jeopardy. The committee is obviously aware that computers, PDAs, digital devices and media backup contain the critical information necessary to gain money for creditors.
Debtor's counsel would do well to consider making available the following information to the committee before the §341 meeting:
- An inventory of computers of every kind, servers, PDAs, media storage equipment and other digital devices owned, leased, rented or used by the debtor, including the present location and individual having control over these items.
- A list of officers, directors, employees and contract employees involved in accounting, finance and computer operations and services including their titles, dates of hire and all e-mail addresses.
- A list of officers, directors, employees and contract employees who left or terminated during the last 12 months that were involved in accounting, finance and computer operations and services, including their titles, original dates of hire, dates of termination and all e-mail addresses.
- An inventory of computer software by applications used, including name, title, version and whether that software is included in any personal property lease.
- The debtor's document retention policies, including all changes and modifications.
- A list of outside computer hardware and software service providers currently or previously used (during the last three years), including each provider's name, address, phone number, e-mail address and description of contract services provided.
- An inventory of storage media backup of every type, such as active, backup or archival files and other digital evidence, including detailed logs and location of all backup media.
- An organization chart and DIT flowchart.
- A list of application service providers currently or previously used (during the last three years), including the name of each ASP, address, phone number, e-mail address and description of services from ASP.
- A list of any "outsourced" services currently or previously provided to the debtor and directly or indirectly relating to workouts, turnarounds, appraisals, business valuations, mergers, acquisitions, tax planning, auditing, accounting, finance, internal audit, computer services and related areas, including the company name, partner/contact person, address, phone number, e-mail addresses and description of services provided.
- An inventory of computers of every kind, servers, PDAs, media storage equipment and other digital devices previously leased, rented or used by the debtor during the past three years that are no longer in service, including the names and addresses of the lessors, e-mail addresses, date of termination of lease, rental or use, and present location (if known) and individual having control over property (if known).
- An inventory of computers of every kind—servers, PDAs, media storage equipment and other digital devices sold or disposed of during the past three years, including the name and address of the buyer and any past or present affiliation with the debtor.
- A list of reported complaints from present and former employees under SOA "whistle-blower" provisions, including names, addresses, phone numbers and e-mail addresses.
- A list of all web site addresses owned or licensed to or by the debtor.
Document Retention Policies and Spoiling of Evidence
Bankruptcy is not the time to begin document retention policies (DRP). Few things can cause conversion of the case any faster than the discovery that the debtor's e-data was altered or destroyed (or attempted to be) by the DIP. The digital books and records and related documents may not be pretty, but why lose whatever chance exists to have a plan confirmed?
More and more bankruptcy cases will see the truth as it exists only in digital form. Debtor's counsel must take an active role and responsibility for preserving e-data for the DIP. Counsel should be cautious when advising the debtor, insiders, officers, directors, employees and others about the DRP.
The committee and others do not want to produce or receive millions of pages of irrelevant information from the debtor. Much can be done to reduce the cost of retrieving e-data, and to allow both the committee and the debtor the opportunity to informally develop e-facts in an efficient and cost-effective manner if the parties initially work toward that end. As is often the case, the digital evidence becomes compelling on its face, and when the parties understand the digital evidence, many parties will want to settle the dispute before it reaches court.
Debtor's counsel should take care and consider the needs of the committee to obtain a confirmed plan and control costs. It is possible the committee may object to using the debtor's digital forensic accounting technologist. However, substantial benefits can be gained for the debtor by having the ability early in the case to view the existing digital information technology and media backup. In addition, aiding the debtor with the DIT will provide valuable results and improve the likelihood that the plan is confirmed.
When dealing with the technical aspects of DIT, each case needs to be tailored to the facts and circumstances related to the information technologies used on a case-by-case basis. To receive a non-exhaustive list of the best practices for the debtor's digital information technology within the bankruptcy context, please contact the author.
The Case Converts
If a case converts, as it sometimes does, debtor's counsel will want to exercise the same degree of openness in dealing with the panel trustee. As debtor's counsel already knows, under §521(4) it is the duty of the debtor to "surrender to the trustee all property of the estate and any recorded information, including books, documents, records and papers relating to property of the estate, whether or not immunity is granted under §344 of this title."
Debtor's counsel needs to embrace digital information technology and take advantage of the benefits available early in the case. The digital forensic accounting technologist provides specialized skills and experience to conduct the investigation into the digital records that can benefit both debtor and creditors. Presenting digital financial information suitable to the situation understandably and concisely, and when necessary for final judicial determination, is the primary benefit to the debtor.
1 Jack Seward has, for many years, specialized in litigation support, bankruptcy, insolvency and the discovery, recovery and analysis of digital forensic accounting information for attorneys, corporations, creditors, trustees, stockholders and other interested parties. The author is a consultant and digital forensic accounting technologist and has an association with a New York area forensic accounting firm. Return to article
2 See the following on this subject: Seward, J., "The Debtor's Digital Autopsy, or Where's the Money!" NABTalk, Journal of the National Association of Bankruptcy Trustees, Summer 2003; Seward, J. "The Debtor's Digital Reckonings," International Journal of Digital Evidence, Fall 2003 (http://www.ijde.org/docs/03_fall_seward.pdf). Issues related to potential fiduciary liability or claims against insiders, officers, directors and others are incongruent with protecting the business debtor initially and are not addressed in this article. Return to article
3 PDA is an acronym for Personal Digital Assistant that includes, but is not limited to, Palm, Handspring Treo, iPaq, Jornada, Cassiopeia, Clie, Visor or Windows CE and/or Pocket PC devices. Return to article
4 Digital devices include, but are not limited to: numerous hand-held devices, CD, DVD, Microdrive, CompactFlash, SmartMedia, SecureDigital, Memory Stick and MultiMediaCard, optical devices, floppy disks, USB devices, FireWire devices, PCMCIA hard disk drives, Zip disks, Jazz Disks, internal and external hard disk drives, and tape backup systems. Return to article
5 Accounting applications include, but are not limited to: Great Plains, Sage, Best, MAS 90/200, Solomon, DacEasy, J.D. Edwards, Peachtree, SAP, Lawson, Simply Accounting, Business Works, Net Ledger, Oracle, Platinum, e Epicor, Pro Series, PeopleSoft, ACCPAC, Ross Systems, Intentia, Cougar Mountain, M.Y.O.B., Agresso, Macola, Navison, Siebel, Easy Accounting and specific applications such as FRx, Timberline, Forefront, Keystroke Point of Sale, Supply Chain, CRM and Electronic Data Interchange (EDI) automated programs. Return to article
7 The Federal Energy Regulatory Commission gathered e-data from Enron in its investigation of energy-market manipulation and in March 2003 released more than 1.6 million pieces of e-mail and other documents (http://www.ferc.gov/industries/electronic/indus-act/03/26/03-release.asp). Return to article
8 Ken Withers, a research associate at the Federal Judicial Center in Washington, D.C., estimates that a company of 100 employees may generate 7.5 million e-mails per year. Withers, Ken, "Digital Discovery Starts to Work," National Law Journal, Nov. 4, 2002. Return to article
9 In re David Shick and Venture Mortgage Corp., 215 BRA (S.D.N.Y. 1997) (court granted chapter 11 trustee's motion for turnover of debtor's computer and information as property of the estate). Return to article
11 Motion under Rule 16 (c) (12) and (16) of the Federal Rules of Civil Procedure. The Antioch Co. v. Scrapebook Borders Inc., 210 F.R.D. 645 (D. Minn. 2002) (motion for order to preserve records granted). Return to article
13 See Seward, Jack, "Digital Stealth Secrets and the [Sarbanes-Oxley] Act," LJN's The Corporate Compliance & Regulatory Newsletter, Law Journal Newsletters, March 2004 (http://www.ljnonline.com). Return to article
15 In re NextCard Inc., filed 11/14/2002, Delaware, case no. 02-13376. "NextCard Fraud Case Dawns Digital Bankruptcy Enforcement," Bankruptcy Law & Litigation Report, December 2003, p. 86. Return to article