Klipsch Grp., Inc. v. ePRO E-Commerce Ltd., Nos. 16-3637-cv, 16-3726-cv (2d Cir. Jan. 25, 2018).

In this interlocutory appeal, the Second Circuit upheld the lower court’s imposition of a $2.7 million discovery sanction in a case with an estimated $25,000 value.

This case began with the plaintiff, Klipsch Group, Inc., challenging a subsidiary of ePRO E-Commerce for selling counterfeit Klipsch headphones. The parties have disagreed from the outset about the value of the infringing sales. Klipsch believes monetary damages should number in the millions, while ePRO counters that the case is worth less than $8,000.

During the litigation, the defendant ePRO consistently and systematically flouted its discovery obligations. First, it admitted that it had failed to place a legal hold on emails or other electronic data. Further, it did not disclose relevant sales documents. To “remedy those problems,” ePRO agreed to use a discovery vendor, which found 40,000 undisclosed discoverable documents. However, it turned out that ePRO had “limited [the vendor’s] investigation” without permission. And during a second round of court-ordered depositions, Klipsch determined that, “despite the magistrate judge’s clear directive,” ePRO still had not imposed an “adequate” legal hold.

Klipsch moved for discovery sanctions. While the magistrate denied that motion, “he authorized Klipsch to undertake an independent forensic examination” of ePRO’s data. The investigator found that ePRO’s “custodians had … manually delet[ed] thousands of files and emails, us[ed] data-wiping software … and updat[ed] their operating systems” to limit discovery. ePRO also refused to allow the investigator to examine numerous email and messaging accounts.

After a four-day evidentiary hearing, the district court found that ePRO had “willfully spoliated relevant” discoverable information. The court looked in part to “the various means of deleting data as cumulative proof that ePRO’s spoliation was willful.”

The district court ordered sanctions including adverse inference jury instructions and “reasonable” costs and attorneys’ fees. It ultimately awarded Klipsch $2.68 million “as compensation for the additional discovery efforts occasioned by ePRO’s misconduct.”

ePRO appealed, arguing that the lower court’s sanctions were “impermissibly punitive” because they were so “disproportionate to the likely value of the case.”

While the court found ePRO’s position “superficially sympathetic,” its argument “overlook[ed] the fact that ePRO caused Klipsch to accrue those costs by failing to comply with its discovery obligations.” The court noted that “the integrity of our civil litigation process requires” voluntary good-faith cooperation with discovery.

The appellate court held that the $2.7-million award “properly reflects the additional costs ePRO imposed on its opponent by refusing to comply with its discovery obligations.” Further, the court recognized that this sanction serves to “deter recalcitrant parties from the cavalier destruction or concealment” of discoverable materials.

The court was unmoved by ePRO’s challenge that the monetary sanction failed to comport with Federal Rule of Civil Procedure 37(e). First, the district court imposed sanctions under its “inherent power to manage its own affairs.” Additionally, “there is no special rule requiring parties to suffer an opponent’s open and notorious discovery misconduct in small value cases.” The district court also “carefully limited” its sanctions to those costs that Klipsch “incurred in direct response to ePRO’s misconduct.” Klipsch sought approval from the magistrate before each costly stage of investigation. The magistrate granted that approval in each case “only after ePRO had already squandered an opportunity to correct its own errors.”

The court roundly rejected ePRO’s proportionality argument for similar reasons. In short, it concluded that the relevant measure of proportionality is the relationship between the sanctions and “the costs ePRO inflicted on Klipsch” through its misconduct.

The Second Circuit affirmed the district court, concluding that the sanctions “properly compensated Klipsch for the corrective discovery efforts it undertook with court permission in response to ePRO’s misconduct.” In doing so, it “emphasize[d] that discovery sanctions should be commensurate with the costs unnecessarily created by the sanctionable behavior.”

Takeaways on proving misconduct and avoiding sanctions

Klipsch prevailed in part due to its own cautious course of action. The appeals court noted no “abusive conduct” on Klipsch’s part or any attempt to “burden [ePRO] with wasteful expenses.” Instead, Klipsch sought the magistrate’s approval before each costly investigation.

The Second Circuit also issued its own warning, noting that “ePRO did not have a software usage policy in place” to ensure the preservation of “professional communications sent through personal accounts.” That “was the company’s own error,” and it could not “complain because the resulting and wholly foreseeable deletion of material … gave rise to sanctions.”

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