Automated Solutions Corp. v. Paragon Data Sys., Inc., No. 13-3025/3058, 2014 WL 2869286 (6th Cir. June 25, 2014)

The case arose from a contract involving the development of delivery- and subscription-tracking software for the Chicago Tribune. The relationship between the parties deteriorated, and the defendant Paragon terminated the contract. The plaintiff, Automated Solutions Corp. (ASC), then sued in state court and in federal court. In the federal lawsuit, ASC claimed Paragon copied its software to use in its own proprietary software, alleging copyright and trademark infringement.

During the course of the litigation before the federal district court, discovery disputes arose, and the court found that Paragon had “failed in its duty to preserve information.” ASC had asked Paragon to produce information regarding the development of the code for its software, and it failed to do so. Therefore, the court ordered a forensic investigation of Paragon’s systems to search for evidence that it copied ASC’s software.

ASC’s forensic examiner spoke to Paragon staff, searched the systems for information, and analyzed forensic images from the company’s e-mail server and two programmers’ hard drives. The forensic examiner’s ability to search for information was compromised in three primary ways:

  1. The hard drive of the programmer who designed Paragon’s software failed, and his files had not been transferred to his personal computer (which he used for work purposes).
  2. The personal computer of the Paragon programmer who worked on ASC’s software was not maintained after he left the company.
  3. Paragon failed to record information because it used faulty back-up tapes for at least a three-year period.

Paragon claimed that the two programmers’ hard drives may still have been in its possession; however, because it did not track them by serial number, it could not determine which drives were theirs, and the forensic examiner did not review them.

Based on its forensic vendor’s report, ASC asked for sanctions and attorneys’ fees for Paragon’s deliberate destruction of evidence. Meanwhile, Paragon moved for summary judgment on the substantive claims. The district judge delegated the motions to a magistrate, who granted both motions in part, finding that Paragon had no “systematic document retention policy” and that it failed to implement a litigation hold after ASC sued it, leading to the disposal of a server, the loss of the two programmers’ failed hard drives, and the late-disclosed work report from one of the programmers. The magistrate found the allegedly spoliated evidence largely irrelevant: there was no evidence that Paragon had used the server in question in developing its software, and the late-produced report did not relate to the claims at issue. However, the hard drive of the programmer who developed Paragon’s software was relevant, but because Paragon was negligent rather than malicious or willful in its failure to maintain the hard drives, the magistrate recommended that the district court take the “middle ground” and issue an adverse inference instruction at trial that the drive contained evidence showing that Paragon’s code was derived from ASC’s code. The district court adopted the magistrate’s ruling on summary judgment and extended it to ASC’s remaining claims, rendering the sanctions moot.

On appeal, ASC argued that the district court abused its discretion in denying the motion for sanctions. Instead, the district court should have terminated the case, entered judgment in its favor, awarded attorneys’ fees associated with bringing the motion, and sanctioned Paragon’s attorneys.

The Sixth Circuit agreed with the district court’s findings on all counts. ASC could not meet the required three-part test for establishing sanctions because it could not demonstrate the third prong, which requires that “the destroyed evidence was relevant to the party’s claim or defense such that a reasonable trier of fact could find that it would support the claim or defense.”

Further, the appellate court rebuffed ASC’s attempt to create a bright-line rule for sanctions following U.S. District Judge Shira Scheindlin’s 2010 opinion in the Pension Committee of University of Montreal Pension Plan v. Banc of America Securities case from the Southern District of New York, which was subsequently rejected by the Second Circuit in Chin v. Port Authority of New York and New Jersey. ASC argued that the district court abused its discretion by finding that “Paragon’s lack of any systematic document retention system” was more than “merely negligent” and arose to at least willful or gross negligence. Thus, ASC argued, the relevance of any spoliated evidence should be presumed, and the district court erred in failing to issue sanctions.

The appellate court rejected the bright-line rule of Pension Committee and noted that the Sixth Circuit takes a “case-by-case approach” to determining whether sanctions are appropriate and what form they should take. Therefore, its inquiry was limited to whether the district court “committed a ‘clear error of judgment,’” and the Sixth Circuit found ample support for the lower court’s conclusion.

However, the court did take the opportunity to roundly criticize Paragon’s conduct: “Paragon is an information-technology company, and thus could be expected to have a better-than-average understanding of electronic discovery and the necessity for functioning back-up tapes and the preservation of data.”

Takeaways

The Sixth Circuit clarified that in reviewing the propriety of discovery sanctions, it will undertake a painstaking, case-by-case analysis and defer heavily to the district court’s findings of fact rather than perform a de novo review. Therefore, parties should develop the factual record clearly and compellingly at the trial-court level.

Moreover, parties should take clear steps to inventory and preserve all potentially relevant data. Here, had ASC’s forensic examiner found relevant evidence been found during its examination, Paragon’s failure to have a comprehensive litigation hold program would likely have sabotaged its case.

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