In our last article, we discussed the fact that e-discovery preservation duties apply equally to transactional attorneys and litigators, despite the lack of any real guidelines provided to the former. In this article, we pose five practical questions to transactional attorneys that may help their clients avoid claims of spoliation if the deal turns sour.
1. First things first, what does your data retention policy require?
Too often, counsel expend much effort to design and draft document/data retention policies, only to have them filed away and not regularly referenced, applied or audited for compliance. We have litigated multiple cases in which the opposition openly admitted to facts that evidenced conduct that clearly violated their own data retention policies. If there is any doubt as to whether your document/data retention policy requires you to preserve documents (electronic or otherwise) that you created, used or received during the course of your transaction, you should resolve that doubt immediately. One pointer that we often give to our transactional colleagues is that they should consult the client’s document/data retention policy in advance of negotiations and remind all involved of the duties that policy imposes. Violating your own policy, especially as in-house counsel, will be embarrassing and could force you to resolve a dispute over a failed deal from a position of weakness.
2. Did the other side threaten litigation during negotiations, or did you consult a litigation colleague about any perceived threats?
In one piece of litigation we handled resulting from a deal gone bad, the transactional lawyer on the other side testified during his deposition (with some degree of apparent pride) about the number of times he had to consult his litigation colleagues as a result of extremely adversarial circumstances or heated exchanges during the negotiations. Apparently the witness thought that this made our client appear litigious or unreasonable. The same witness readily agreed that he was not merely seeking updates on pending litigation for a due diligence checklist. Instead, he was going to his colleagues for advice as to how to respond to threats during the negotiations. Toward the end of the deposition, this same witness was much more reserved when asked when he began to preserve electronic documents in relation to his frequent visits to his litigation colleagues. He was wise to seek their counsel, but he was foolish to not preserve documents at the same time he sought their advice.
As the litigation proceeded, his client argued that anything that the transactional lawyer might have had but not preserved would have been shielded from production by the attorney-client privilege or the attorney work-product doctrine. That was a logical argument and might even be true in some circumstances. However, adverse-inference case law and resulting jury instructions do not provide an exception for spoliated documents that were likely privileged simply based on the fact that the author or recipient is a lawyer. Instead, the law requires you to preserve the documents when you reasonably anticipate litigation and, if privileged, include them on a privilege log to prevent their production to the other side. The takeaway here: It is much better to have a paralegal create a lengthy privilege log based on the documents you have preserved than to run the risk of an adverse-inference instruction to the jury.
3. Maintain situational awareness: What led to the negotiations and proposed deal?
Often clients find themselves at the negotiating table after receiving or sending a cease-and-desist letter threatening litigation unless one side hands over the world to the other. In these situations, litigation is not only reasonably foreseeable, but it has actually been threatened. But too often, we learn of clients who turned off their preservation efforts the minute the parties began to make serious efforts to resolve the dispute. In these situations, you should make every effort to ensure that all key custodians are continuing to preserve documents while the parties work to resolve the dispute.
4. Has anyone proposed a break-up provision, a fee shift or liquidated damages to be paid in case of bad faith?
Sometimes your counterpart on the transaction might not be so direct as to threaten litigation or mention that she has been consulting with litigation counsel. But that does not mean that everything is rosy. In many transactions that have become the topic of litigation, we have seen the seeds of the dispute being planted when one side proposes break-up fees, fee-shift provisions or liquidated damages tied to a finding of bad faith. These are signposts that a court might later interpret to be triggers for a duty to preserve.
5. Does the deal involve an earn-out agreement?
Earn-out agreements are agreements that include the possibility of the seller paying additional purchase price compensation based on the performance of the sold entity after the closing. Earn-out agreements sometimes can bridge the gap between the seller’s valuation of her company and the buyer’s valuation of it. The devil is always in the details, and in earn-out agreements, trouble typically arises if the parties do not fully understand or appreciate how to measure the post-closing financial performance of the entity being sold. As a result, earn-out agreements often end up in litigation with the seller asserting that she is entitled to additional earn-out compensation or the buyer asserting that he overpaid for the company and should not have to pay any earn-out compensation. Based on the track record of earn-out agreements, a court could very well interpret the parties’ inability to agree upon a firm valuation for the company at closing as circumstances that may indicate a reasonable anticipation of subsequent litigation.
In short, these are five practical questions that may help you to determine whether the circumstances in your deal have triggered a duty to preserve.