Litigation Hold Policy

Senior managers, in-house counsel and litigators take note: last month a new set of e-discovery guidelines emerged. Judge Shira Scheindlin, author of the definitive electronic discovery opinions in the Zubulake case six years ago, has issued another soon-to-be classic opinion in Pension Committee of the Univ. of Montreal Pension Plan, et al., v. Bank of America Securities, LLC, et al., 05 Civ. 9016 (SAS) (S.D.N.Y. Jan. 15, 2010) Amended Opinion and Order. Judge Scheindlin dubbed her decision in Pension Committee, “Zubulake Revisited: Six Years Later,” and in it, set out some examples of common mistakes companies make with respect to records management and e-discovery.

In Pension Committee, Judge Scheindlin enumerates specific conduct that she deems to be per se negligent, or worse. The harsh sanctions that accompany a finding of negligence with respect to electronic discovery is a warning to senior managers and in-house counsel that e-discovery can no longer be passed off to the IT department—the process must be closely managed by legal counsel at every step along the way.

Technically the opinion is only applicable to the federal courts in New York, but Judge Scheindlin’s status as a thought leader in the field of electronic discovery guarantees that the examples set out in this case will elicit serious discussions between senior management, legal departments, and IT groups throughout the country. Because Pension ­Committee is too lengthy for overview in a blog, I intend to highlight some of the key findings in a series of blogs that should get companies thinking about the way they handle electronic discovery and records management.

LESSON 1:

To avoid such a devastating sanction, companies should take the time now to review their litigation hold policy with experienced counsel. Taking Judge Scheindlin’s opinion as an example, in most cases litigation holds must be issued in advance of the filing of a suit. Because of the timeliness requirement, a litigation hold process must allow for swift and comprehensive implementation of the hold as disputes become apparent. Also, the mere issuance of a litigation hold is not enough to avoid devastating e-discovery sanctions. A timely issued hold that does not effectively protect potentially relevant data is meaningless. Companies must carefully outline not only litigation hold triggering events, but they should also review the technology used to implement the hold to ensure compliancethat potentially relevant data is being saved.

Next installment: Ensure there is sufficient legal oversight of your document review and production.

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Managed service providers (MSP) should carefully review their subscriber contracts to confirm the contracts do not weaken the MSP’s marketability if the MSP owner wants to sell the business.  A managed services agreement that allows the subscriber to cancel the agreement at any time and with no penalty will devalue the MSP because the MSP will not have a guaranteed revenue stream.  With no guaranteed revenue, potential buyers will be less interested in purchasing the MSP.

Managed services agreements that assign all intellectual property rights related to the service contract to the subscriber weaken the strength of the contract.  Rights to any software, processes, or marketing materials developed by the MSP under the agreement would belong to the subscriber.  The MSP will have forfeited a potentially substantial revenue stream from licensing agreements with licensors.

MSPs often want to retain the right to increase rates for new subscribers with whom the MSP is unfamiliar.  Flexible rates allow MSPs to ensure new subscribers understand the importance of keeping their account current.  A managed services agreement that does not allow the MSP to raise rates under certain conditions exposes the MSP to potential losses.

If you are selling an MSP, buying an MSP, or if you are an MSP enrolling new subscribers, you should consult counsel experienced in advising managed service providers.

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Although the proposed e-discovery legislation in New York State has yet to be implemented, a decision of the New York Supreme Court, New York County Commercial Division should cause all New York State Court practitioners to take note that e-discovery practice is already upon them. Justice Charles E. Ramos, in Einstein v. 357 LLC, 2009 N.Y. Slip Op. 3261 (N.Y. Cty. 2009), dispensed with the “we have produced what we could find” electronically stored information (ESI) defense by slapping the offending party with an adverse inference sanction. An adverse inference sanction allows the jury to presume that the lost evidence would have contradicted that party’s position at trial.  The effect of such an instruction is devastating.

What happened:

Defendants were sued for deceptive practices in the marketing of New York City real estate. Soon after the litigation started defense counsel instructed the company’s IT director to put a litigation hold on relevant information.  Faced with allegations of incomplete production of ESI, defense counsel filed an affidavit and represented to the Court that the electronic information was centrally stored and all relevant documents had been produced.  At a subsequent hearing, it was discovered that the litigation hold was inadequate in that employees of the company could delete electronic documents in between the time that the company backed-up copies of its network. Furthermore, it was not until the fourth day of hearings that it became known that there were backup tapes available from which to cull data—a fact that had heretofore been affirmatively disclaimed.

According to the IT Director’s testimony, he never told counsel that there was a possibility, notwithstanding the litigation hold, that the Defendants could permanently delete documents without any means of recovery. He continued by testifying that no one asked him to ensure nothing could be deleted. Further testimony confirmed that the specific rules contained in the retention order were not even discussed with the IT Director, nor were examinations of the Defendants’ hard drives performed as ordered.

Lessons to be learned:

Communication between legal counsel and information technology managers is now more important than ever. Ensuring that litigants understand what is and is not possible with respect to information technology is of the utmost importance. Insufficient understanding of the technologies used to store ESI coupled with a lack of communication with the IT departments that are called on to execute e-discovery orders can turn a case in which you should win on the merits into one in which you lose due to discovery sanctions.

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For years, many businesses interested in renting computers running Microsoft software to third parties have faced a dilemma: either (1) commit to a complicated and potentially expensive Microsoft Services Provider License Agreement (SPLA), which until recently was the only license agreement under which Microsoft has allowed its software to be rented, (2) rent the computers outside a SPLA relationship and risk the exposure that such activity can entail in the form of an audit by Microsoft or by the Business Software Alliance (BSA), or (3) forego the revenue that might be realized from the rental business. Many other business owners have been unaware of the prohibition against renting in most Microsoft license agreements until discovering, in the context of a BSA audit, that the BSA typically treats a breached license as no license at all for the purpose of calculating the penalty to be paid to resolve a software audit. Worse, after paying that penalty to the BSA, affected businesses have been forced to enter into a SPLA in order to continue offering rental services, or else run the risk of losing the release from liability that they purchased with the settlement payment.

However, in a comparatively rare move toward licensing simplification, as of January 1, 2010, Microsoft is offering Rental Rights as an additive license for certain Windows operating system and Office productivity software licenses purchased under its Open and Select volume licensing programs. Now, instead of signing up for a SPLA, Microsoft’s compliance-minded volume licensing customers will be able to purchase rental rights along with other additive licenses (such as, for example, Software Assurance) when they purchase the underlying license for an eligible software product. The rental rights will be valid for the term of the underlying software license or for life of the system on which the software is installed.

More information on the new Rental Rights is available here:

https://partner.microsoft.com/40104043

The current pricing appears to be such that businesses with larger fleets of rental computers may want to stay with the more scalable SPLA licensing requirements. However, smaller businesses or those with a more limited number of rental systems should work with counsel or a licensing consultant to determine whether Rental Rights will be an appropriate mechanism to stay in compliance with licensing obligations.

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New York Assemblyman Mark Weprin has sponsored Assembly Bill A-06000, to implement e-discovery rules in Article 31 of the Civil Practice Laws and Rules that will apply in all civil cases. He predicts that, as was the situation when similar obligations were incorporated into the Federal Rules of Civil Procedure just a few years ago, there will be a sea-change as to the manner in which civil cases are litigated in the New York Courts.

Based on our consulting experience with general counsel and outside counsel concerning the risks and obligations regarding retention and production of electronically stored information (ESI) and in litigating spoliation motions, Mr. Weprin’s prediction is on point and the following three defenses will no longer suffice:

“We Have Produced What We Could Find”

The defense to a motion to compel that the party has produced what it could find will not suffice in many instances. The question that will invariably follow is whether reasonable steps were taken to preserve the information.  As litigators, we know that whenever a rule turns on the meaning of the term reasonable, a fight will ensue.

“The Evidence Was Not Lost on Purpose”

If the Federal approach in New York is any predictor, it will not be a valid defense to a sanctions motion that the litigant lost the evidence through carelessness as opposed to having done so intentionally to try to get an advantage in the case.  The Second Circuit Court of Appeals has held that the degree of fault necessary to impose the full range of sanctions in a Federal civil case is only that of negligence or carelessness.

“The Lost Evidence Was Not That Important”

Courts ordinarily decide cases on the merits based upon its assessment of the importance of conflicting evidence.  When evidence cannot be produced, the Court’s inability to assess the significance of the evidence-whether a “smoking gun” or merely a collateral point-works to the detriment of the party who failed to preserve it.  Such an approach promises a sea-change because in all other contexts the significance of the evidence to the outcome depends on the Court’s assessment of the evidence.  Here, the Court is empowered to presume that the lost evidence was very significant.

If you have any thoughts, comments or questions about this article, please contact Jonathan Scott at (214) 999-0080.

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As an attorney who represents businesses with regard to document retention and electronic discovery, and who has obtained discovery sanctions in a Federal RICO case against the adverse party, I followed with great interest recent events where allegations by a former in house counsel involved in an employment dispute spawned the filing of RICO cases against Toyota and certain of its officers and employees that were thereafter voluntarily discontinued.

The assertions made by a former managing counsel for Toyota, Dimitrios Biller, sounded more like a story for a movie. While at Toyota, Biller was responsible for its defense of personal injury claims involving its vehicles. After he resigned and was in an employment related dispute with Toyota and still subject to attorney-client confidentiality obligations, he made public statements claiming that Toyota had deliberately withheld unfavorable crash test evidence and delivered to the US District Courthouse in Marshall, Texas, four boxes of documents that allegedly contained this “smoking gun” evidence.  This Court was the venue for a number of personal injury cases against Toyota.

Pursuant to a Court order, the evidence was sealed and placed on a secure server.

In response to Biller’s assertions, the Dallas firm that represented the plaintiffs in the underlying lawsuits, filed fifteen lawsuits on September 25, 2009, including Lopez v. Toyota Motor Corporation et al., 2:09 CV-00292-TJW alleging that Toyota and its officials had operated a racketeering enterprise designed to obstruct justice. The claims were brought under the Federal RICO statute, which Congress enacted to target organized crime but that has been used and sometimes misused to cast a traditional business dispute into a Federal case. The remedies available where a civil RICO claim has been proven are powerful and include treble damages, attorney’s fees, and injunctive relief. In an extreme case, the Court is authorized to appoint a Federal monitor over the enterprise.

As it turns out, there was a big problem with these RICO cases against Toyota and the problem was that the evidence of misconduct that Mr. Biller asserted he delivered to the Court was not in the materials the Court received.

After the materials were secured, Plaintiff’s counsel was given electronic access to a mirror image copy of the evidence deposited with the Court and after reviewing the documents and finding no evidence to substantiate that Toyota had engaged in any discovery misconduct, counsel voluntarily dismissed the lawsuits.

These events illustrate some important points. Allegations are merely that and must be distinguished from evidence. It is fortunate that the documents were available to disprove the allegations. Allegations of non-disclosure of evidence, if proven, not only threaten to undermine the outcome in litigation but can also trigger an avalanche of ancillary lawsuits.

Jonathan and his team consult nationally with business executives and attorneys to help manage the risks involved in e-discovery and helps companies defend allegations of wrongdoing in complex litigation matters.

If you have any questions or comments about this topic, Jonathan may be reached (214) 999-0080.

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Many businesses understandably want to prevent their employees from leaving their jobs and seeking employment with competitors. The reasons may vary, but the desire typically stems from concern regarding company secrets falling into the hands of those who could use them to do the most damage to the bottom line.  It is therefore common to see employment contracts that prohibit an employee either from competing directly with his or her former employer or from joining a competing company.

Courts always carefully construe these provisions. State laws are essentially unanimous in requiring that the provisions be reasonably limited, with their duration and scope – geographic and otherwise – narrowly tailored to protect the employer’s legitimate interests. Any ambiguity in such provisions almost always is construed against the employer, so employers must exercise considerable care in drafting them. In some states, however, non-compete clauses are even more particularly disfavored. For example, California law affirmatively prohibits “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind.” (Cal. Bus. & Prof. Code § 16600) In addition, courts construing the California law have made it clear that the statute applies not only to “traditional” non-compete clauses that expressly restrain an employee from engaging in competitive activities following termination, but also to differently structured provisions that have substantially the same effect as an express prohibition.

A recent example is found in the opinion of the U.S. District Court in the Northern District of California in the case of Applied Materials, Inc. v. Advanced Micro-Fabrication Equipment (Shanghai) Co. (May 20, 2009). There, the employer, Applied Materials, had attempted to enforce the following patent assignment clause against former employees and their new employer:

In case any invention is described in a patent application or is disclosed to third parties by me within one (1) year after terminating my employment with APPLIED, it is to be presumed that the invention was conceived or made during the period of my employment for APPLIED, and the invention will be assigned to APPLIED as provided by this Agreement, provided it relates to my work with APPLIED or any of its subsidiaries.

In defending the clause, Applied Materials argued that the clause merely created a presumption that a former employee would have the opportunity to rebut in order to avoid an assignment. However, the court disagreed, noting that the provision “does not state that an employee may rebut this presumption, nor does it state how an employee would do so.” The court further held that because the clause “touches post-employment inventions, regardless of when they were conceived or whether they were based on Applied's confidential information, [it] necessarily operates as a restriction on employee mobility.” As a result, the court determined the clause to be unlawful and void under California law and incapable of reformation.

Cases such as Applied Materials emphasize the point that, regardless of the jurisdictions in which they are located, companies need to look to various kinds of measures to protect their trade secrets and should not rely solely or even substantially on non-compete clauses. California businesses have a special burden to overcome, but even businesses in states that allow non-compete clauses must be wary of the scrutiny to which such provisions are subject. It is important to consult with counsel to identify and implement a holistic and diverse regime of trade secret protections.

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It is a fundamental tenet of American capitalism that businesses seek to grow and corner a market in an industry. However, there is a fine line between successfully dominating a trade and running afoul of the Sherman Act, which prohibits attempts to monopolize trade or commerce among the states.

A recent case that helps define the scope of the Sherman Act is Xerox Corporation v. Media Sciences, Inc., in the United States District Court in the Southern District of New York. In that case, Media Sciences claimed Xerox is monopolizing the after-market manufacturing of ink sticks for printers, is engaging in anti-competitive behavior, and is fixing prices to exploit consumers. In ruling on a motion for summary judgment filed by Xerox, the court analyzed monopolization based on several criteria, including whether Xerox has the power to control prices and exclude competition, whether it engaged in predatory or anticompetitive conduct, and whether it has a specific intent to monopolize or a dangerous probability of achieving a monopoly. The court noted that an after-market analysis further requires a court to consider whether consumers who have already purchased a defendant’s product are locked in by the high costs and whether the company is exploiting customers.

The court determined that Xerox did not take advantage of its consumers by fixing the price at a supracompetitive rate, and it dismissed the anti-trust action. The court’s analysis shed light on the importance of pricing of products in which there are few, if any, alternatives in the market. Companies with a significant market share in an industry should consult regularly with counsel to ensure their business model and practices do not conflict with existing anti-trust law.

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The Supreme Court of Kansas, in the recent decision Landmark National Bank v. Kesler, (--- P.3d ----, 2009 WL 2633640), has called into question the validity of MERS, the mortgage tracking system that currently services an estimated 60 million loans.  MERS, (Mortgage Electronic Registration System), was established by Fannie Mae, Freddie Mac, and the mortgage industry in 1997 to record loan assignments electronically. The stated purpose of MERS is to reduce the costs associated with the mortgage banking industry by avoiding the costly statutory requirements of recording each mortgage note transaction in the county land record. It purports to do this by registering MERS as the nominee of the lender and servicer in the county land records, thereby allowing the note to be traded behind the scenes without the need to register each transaction.

The Kansas case involves Boyd Kesler, a borrower who, in 2004, secured a loan from Landmark National Bank (Landmark) with a mortgage on the property in Ford County, Kansas that Landmark subsequently registered with the Ford County Clerk. In March of 2005, Mr. Kesler took out a second mortgage on the same property from Millennia Mortgage Corp (Millennia). The mortgage document on this second loan listed MERS as the mortgagee, acting “solely as a nominee for Lender, as hereinafter defined, and Lender’s successors and assigns.” The document identified Millennia as the “Lender.” Sometime later, Millennia assigned the second mortgage to Sovereign Bank (Sovereign). Relying on the framework of MERS for protection, Sovereign chose not to record the transaction in the Ford County register.

In 2006 Mr. Kesler filed for bankruptcy, prompting Landmark to file a petition to foreclose on its mortgage. Landmark, relying on the Ford County records, served both Kesler and the original note holder on the second mortgage, Millennia, in the foreclosure action. Neither Kesler nor Millennia answered the petition, and the trial court issued a default judgment. As a result, Landmark received the full amount owed on the first mortgage, Kesler received the balance from the foreclosure sale with nothing left to Sovereign.

Upon learning of the default judgment, MERS, as the mortgagee of record, filed a motion to vacate but was confronted with an unsympathetic trial court. The court found that MERS was not a real party in interest and that Landmark was not required to name it as a party to the foreclosure. Applying an abuse of discretion standard, the Kansas Supreme Court analyzed the content of the mortgage document along with other opinions on related matters to conclude that MERS is functionally a straw man with no stake in the outcome of the foreclosure.

It is the Court’s ruling that MERS has no interest in the underlying loan transaction that could prove problematic to the mortgage industry. If MERS is deemed not to have any ownership interest in loans recorded in their name, lien priority issues arise for those mortgages that subsequently were sold in the mortgage instrument market. The practical effect of this decision is that second mortgage holders utilizing the MERS system will have to scramble to re-record their mortgages in order to protect themselves from suffering the same fate as Sovereign.

Given the trend of the nation’s courts to closely scrutinize the transactions underlying the foreclosures plaguing the country as a result of unscrupulous lending practices, it is possible that the Kesler case may prove to be a harbinger of more decisions hostile to MERS in the future. Mortgage lenders and purchasers should keep the decision in mind when drafting or revising their policies regarding recordation and perfection of their interests.

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For the first time in 29 years, the Federal Trade Commission is amending its guidelines to crack down on false reviews of products posted online, otherwise known as “astroturfing.”  This type of marketing includes false reviews, testimonials and comments about products in exchange for some form of payment to the reviewer. Microsoft is one of many companies believed to engage in astroturfing as a tool to promote its products.

The FTC now will require full disclosure of all payments to bloggers and consumer reviewers, including distribution of free products.  Thus, someone on a company’s payroll must disclose that information when posting an online review, comment, or testimonial.

The proposed guidelines have a broad reach, and may include blogs by an average consumer.  Bloggers will be required to disclose any free samples they may receive, and the FTC will require proof to support claims about a product.  Once the guidelines are in place, software companies will need to work with counsel to revise marketing strategies in order to ensure compliance or to fully disclose payments to reviewers.

The guidelines are expected to be effective by the end of the year.

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