Discovery Sanctions in the Second Circuit: Be Afraid, Be Very Afraid

Two of the most compelling discovery sanction cases of the past year are Klipsch Group., Inc. v. ePRO E-Commerce Ltd. and Ronnie Van Zant, Inc. v. Pyle, both decided in the Second Circuit. In the first, the court awarded $2.68 million in discovery sanctions in a case valued at a mere $20,000. In the second, the court issued an adverse inference when a defendant failed to preserve text messages held by a non-party. The implications of both decisions appear far-reaching and critically important for those involved in the discovery process.

Way back in August 2012, Klipsch Group brought a suit in the United States District Court for the Southern District of New York alleging that DealExtreme, part of the Chinese company ePRO, was selling counterfeit Klipsch headphones, causing Klipsch to lose sales and profits. Klipsch accused ePRO of selling at least $5 million in counterfeit headphones; ePRO countered that at most $8,000 in sales actually occurred – a claim that was initially supported by the fewer than 500 documents ePRO presented. As the case proceeded, however, it became apparent that ePRO had failed to preserve and produce documents that were highly relevant and potentially damaging.

During a deposition of ePRO’s CEO, it came to light that ePRO (1) failed to impose an adequate litigation hold on electronic data; and (2) failed to produce all relevant documents, including critical transactional sales documents. ePRO agreed to retain a discovery vendor and conduct a keyword search of ESI, which resulted in the production of an additional 40,000 documents including over 1,200 original sales documents (which ePRO had previously stated did not exist). Although this new production was voluminous, a close review of its contents made clear that there were likely additional relevant documents that had not been collected and/or produced.

During the motion for sanctions briefing, Magistrate Judge Dolinger authorized Klipsch, on its own dime with possible reimbursement later, to conduct a forensic examination of ePRO's computer system (see Klipsch Group, Inc. v. Big Box Store Ltd. et al., No. 12-6283 (VSB)(MHD), 2014 WL 9044595 (S.D.N.Y. March 4, 2014)). The investigation determined that custodians had manually deleted files, email and other potentially relevant data, used data-wiping software shortly before the forensic examination began, and updated operating systems during the litigation period (which deleted data). The investigation further determined that the sales data and documents in ePRO’s live sales databases (referred to as “structured ESI”) showed evidence of editing and omissions, and further, that ePRO’s own policies requiring backups of the sales database for disaster recovery purposes were not followed. As a result of this examination, in November 2015, the district court found five instances in which ePRO had willfully engaged in spoliation of ESI:

1. 4,596 relevant documents (including emails) had been manually deleted (most of these were able to be restored);
2. Seven employees used data-wiping programs shortly before the forensic examination, resulting in 31 permanently unrecoverable files;
3. Eighteen employees upgraded their operating systems...