Litigating Spoliation Claims in Trade Secret Cases: Recent Trends Toward Terminating Sanctions

The Litigating Spoliation Claims in Trade Secrets Cases alert can be found here.

This article focuses specifically on the remedy of terminating sanctions, i.e. default judgment or dismissal, which courts recently have indicated an increasing willingness to impose. Indeed, there have been a number of examples since our last article of courts ordering terminating sanctions to remedy certain instances of intentional, bad faith spoliation. Some courts refer to this as the so called “death penalty sanction.” This article examines several of those cases, the circumstances in which courts are most likely to impose terminating sanctions, and the ways in which termination-worthy circumstances are established.

Courts are most likely to find circumstances warranting terminating sanctions where a party engaged in a multiple spoliative events. For example, repeated connection of external storage devices, use of deletion software, overwriting of files, manipulation of metadata, reformatting hard drives, physical destruction of devices, or concealment of relevant devices/online storage accounts are often persuasive evidence that spoliation was intentional, and not simply accidental. Retaining an expert to conduct a comprehensive forensic analysis is a key first step in establishing spoliation and obtaining terminating sanctions.

Also, courts appear more willing to order terminating sanctions in response to spoliation where a party repeatedly disregards the court’s authority. In several cases, the court emphasized discovery delay tactics, failure to comply with discovery orders, or outright false testimony. It is therefore important at the outset of a trade secret or restrictive covenant case to ensure the preservation of relevant information by sending offensive preservation letters or including preservation provisions in any temporary restraining, preliminary injunction, or other discovery orders, and to appropriately document and timely raise with the court all discovery disputes.

Key Cases

BalanceCXI, Inc. v. Int’l Consulting, No. 1:19-CV-0767-RP, 2020 WL 6886258 (W.D. Tex. Nov. 24, 2020) 

A software development company sued two former employees for theft of trade secrets and violation of non-competition and non-solicitation agreements, and filed a Motion for Rule 37(b) Discovery Sanctions for deleting electronically stored information (ESI). The court determined that defendants engaged in the following spoliation activity that warranted default judgment:

• Four months after the employees’ termination of employment, the company’s counsel issued the employees a letter that requested the return of their laptops and directed that they not copy or alter any of the data on their computers;
• Shortly following receipt of the letter, the employees connected external storage devices to their work-issued laptops before returning the laptops to the company;
• Forensic evidence showed that the employees perused the company’s confidential information on their work-issued laptops and created new folders on their desktops or on external storage devices with names referring to the company’s source code;
• Before turning over the external storage devices that they connected to their work-issued laptops, the employees used data-wiping software to permanently delete hundreds of files; and

• One employee physically destroyed the hard drives of two laptops that he connected to the external storage device containing the company’s information, reformatted one of the laptops twice, and deleted 100% of the data on the second laptop before reformatting it without a backup.

The court held that “[g]iven the seriousness of [Defendants’] actions, and the sheer number of devices they wiped, destroyed, or ‘lost,’ this is a case where it is readily apparent that the most serious sanction is warranted.” The court noted the duty to preserve which commenced at least as early as the letter from plaintiff’s counsel, and the fact that a substantial amount of the data at issue was unrecoverable. The court then further concluded that “the Defendants’ actions were intentional, repeated, concealed, and addressed to as many as ten separate devices,” and anything less than terminating sanctions would be insufficient because it was “hard to imagine a more pernicious pattern of evidence destruction.”
 
In recommending default judgment, the magistrate judge noted that any lesser sanction under Rule 37(e)(2)(A) and (B) would be insufficient to address the harm caused or to serve as a deterrent to other litigants. The court also awarded the company’s attorney’s fees and expenses incurred in filing and arguing the motion for sanctions and related motion to compel, to include the costs of the forensic expert. On subsequent motion, the court awarded nearly $300,000 in fees and costs.
 
Calsep, Inc. v. Intelligent Petroleum Software Sols., LLC, No. 4:19-CV-1118, 2021 WL 1729169 (S.D. Tex. Apr. 29, 2021)

In Calsep, Calsep, Inc. alleged that a former employee downloaded trade secrets to external storage devices and used the information to develop competing software. The parties agreed to a preliminary injunction, and the court noted that “despite the order to which the Defendants agreed, Defendants have delayed discovery, manipulated electronic data, and permanently deleted a significant amount of electronic data.” In ordering default judgment and awarding attorney’s fees to Calsep, the court found multiple instances of bad faith, demonstrated by repeated spoliation activity and violation of discovery orders. Specifically, the court found that the defendants:

• Filed multiple false affidavits to thwart discovery and mislead the court about the events resulting in the lawsuit;
• Sought to delay and limit discovery to prevent Calsep from reviewing the source code control system that would show whether there was misappropriation and the extent of that misappropriation;
• Manipulated data, irretrievably deleted data two days after the court entered a preliminary injunction, and used advance knowledge and techniques to destroy records of deletion activity; and
• Violated six different court orders, including orders granting motions to compel.

Based on this misconduct, the court held that “Defendants’ actions reveal[ed] a pattern of behavior that raise[d] the inference of bad faith and intent to deprive the Plaintiffs of the information on the Defendants’ source code control system in this litigation.” The court further noted that “Rule 37 death penalty sanctions are ‘justified only in the most egregious cases, such as … intentionally destroying evidence by burning, shredding or wiping out computer hard drives.’”  In a subsequent ruling, the court awarded Calsep over $800,000 in expert fees and expenses and reasonable attorney’s fees incurred in investigating the former employees’ spoliation of evidence, and in preparing, filing, and prosecuting their motion for sanctions, including briefing and court appearances.
 
Carmichael v. Separators, Inc., 148 N.E.3d 1048 (Ind. Ct. App.), transfer denied, 157 N.E.3d 521 (Ind. 2020)

In Carmichael, the Indiana court of appeals affirmed the entry of default judgment in a trade secret case brought by an employer, Separators, Inc., against two former employees. The court found that:

• One former employee began deleting documents within minutes after receiving service of the complaint;
• A second former employee deleted over 1,000 files shortly after being served;
• They later deleted 1,000 files in the days prior to turning their devices over to a forensic expert;
• They overwrote 3,000 images the day before they were to be produced;
• They concealed the existence of multiple devices and internet-based storage accounts containing discoverable information; and
• Their conduct violated multiple discovery orders, including a temporary restraining order, preliminary injunction, order to preserve electronic evidence, and agreed inspection order.

“[T]he substance, timing, [and] multiplicity” of discovery issues compelled a finding of intentional spoliation, noting that “[t]his degree of spoliation represents the apex of the spoliation culpability continuum and has been strongly condemned by our supreme court.” The court further emphasized that the former employees’ “conduct was egregious and demonstrated a flagrant disregard for the trial court’s discovery orders and the judicial process.” “This is precisely the type of discovery misconduct that should be sanctioned by default so as to discourage other litigants from attempting it.”
 
HealthPlan Servs., Inc. v. Dixit, No. 8:18-CV-2608-T-23AAS, 2020 WL 12048884 (M.D. Fla. July 29, 2020)

In HealthPlan, HealthPlan Services Inc., a provider of software applications to insurance and managed care industries, accused a former employee of using his software company to market HealthPlan’s software platform as his own. HealthPlan argued that the former employee failed to comply with discovery orders under Rule 37(b) and failed to preserve ESI under rule 37(e). In recommending default judgment, the magistrate judge noted:

• The former employee, in violation of discovery orders, accessed, manipulated, and upgraded another former employee’s laptop, failed to produce the original hard drive of said employee’s laptop, and produced the laptop, but refused and/or was unable to provide passwords so that HealthPlan’s expert could access encrypted files;
• The former employee testified that he had previously backed up the other employee’s laptop, when forensic review revealed that he created the back up three days after that testimony;
• After being ordered multiple times to amend written discovery responses, the former employee served “amended” responses that were identical or nearly identical to initial responses; and
• The former employee, who was appearing pro se after cycling through five lawyers, undermined prior counsel’s ability to comply with discovery orders and prevent delays, and then terminated prior counsel because he did not want to comply with discovery orders.

The court concluded that the employee’s “discovery antics warrant[ed] the most severe sanction of default judgment.” The court also ordered him to pay HealthPlan’s reasonable expenses and attorney’s fees.
 
Univ. of Mississippi Med. Ctr. v. Sullivan, No. 3:19-CV-459-CWR-LGI, 2021 WL 4713242 (S.D. Miss. Oct. 8, 2021)

The University of Mississippi Medical Center sued a physician for misappropriation of trade secrets, alleging that the physician stole confidential patient information and the hospital’s financial information to help start his own practice. The court granted the hospital’s motion for default judgment, based on the following facts:

• The physician committed perjury and deliberately concealed evidence from the court when he repeatedly claimed that he did not possess an external hard drive with the hospital’s confidential information, when in fact he had two such devices;
• The physician’s practice (also named in the suit) likewise denied the existence of the hard drives and failed to correct its misrepresentations to the court; and

• The physician destroyed a spreadsheet in which he (and co-conspirator staff of the hospital) compiled confidential patient information.

The court concluded that the physician’s “destruction and concealment of documents and hard drives — evidence central to [Plaintiff’s] federal claims — appear[ed] motivated by a desire to evade investigation,” “undermined [Plaintiff’s] discovery process,” and “stymied the administration of justice.” The court further held that the “coordinated pattern of deception involving perjury, spoliation, and concealment of evidence” warranted default judgment as the record supports “sufficient inferences to conclude that Defendants’ conduct amounted to bad faith and willful abuse of judicial administration.”

WeRide Corp. v. Kun Huang, No. 5:18-CV-07233-EJD, 2020 WL 1967209 (N.D. Cal. Apr. 24, 2020)

WeRide sued its former CEO, Jing Wang, former Head of Hardware Technology, Kun Huang, and a new competitor company, AllRide, alleging that they misappropriated WeRide’s trade secret source code in violation of the Federal Defend Trade Secrets Act and California’s Uniform Trade Secrets Act. The court concluded that Wang, Huang, and AllRide’s spoliation conduct warranted default judgment under Rule 37 based on the following:

• AllRide (1) failed to disable its automatic email deletion settings for emails 90-days and older, (2) repeatedly destroyed and re-created email accounts belonging to the individual defendants and other key individuals after the complaint was filed and the preliminary injunction issued, and (3) wiped the laptops of key individuals after the complaint was filed;
• Wang controlled AllRide. His protestations that he had no knowledge of AllRide’s practices were “at best inaccurate” given that (1) AllRide deleted Wang’s email account shortly after the original complaint was filed, then created and destroyed two additional accounts for him, one that used a fake name, (2) AllRide deleted Wang’s wife’s email account and created a new one for her using an alias, and (3) Wang introduced to AllRide DingTalk, a messaging system that immediately deletes messages; and
• Huang (1) wiped two WeRide laptops after he was terminated but before returning them, (2) re-formatted an AllRide MacBook, preventing WeRide from recovering any source code data, (3) returned the AllRide MacBook to the Apple store on the same day WeRide sent the cease and desist letter, and (4) after the preliminary injunction was issued, modified over 1000 source code files on an AllRide computer in the two days before he was ordered to turn it over to WeRide.

The court concluded that spoliation was intentional based on AllRide’s “disturbing pattern of destroying discoverable material that began with the company’s founding and continued not only through the commencement of this litigation but past the preliminary injunction as well.” And with respect to Huang, the court noted that “[e]ach instance of spoliation [was] directly tied to an event leading to, or occurring in this litigation.” The court also ordered payment of WeRide’s reasonable fees and costs incurred in filing the motion for sanctions, discovery of spoliation activity, and related motions practice.

Takeaways

The above cases reinforce that, to obtain terminating sanctions for spoliation, a party must show egregious circumstances, such as bad faith and intentional spoliation. In addition, emphasizing a party’s disregard of the court’s authority, particularly with respect to discovery orders, will strengthen a request for default judgment.
The following litigation strategies are key in obtaining terminating sanctions:

• Retaining a forensic expert who can identify, investigate, and present instances of spoliation activity in an understandable manner;
• Marshalling the facts, and in particular the timing of spoliative activity, to highlight suspicious cover-ups, patterns of behavior, delay tactics, and other red flags;
• Emphasizing efforts to conceal information, including intentionally failing to comply with discovery, refusing to disclose relevant information, or providing inconsistent testimony; and
• Paying attention to opposing counsel’s behavior, including counsel’s withdrawing from the case and a defendant’s termination of counsel.