Buyer Beware: The Bits and Bytes Could Get You

Section 363 of the Bankruptcy Code provides for a trustee or debtor-in-possession to sell property of the bankruptcy estate outside of the ordinary course of business. To facilitate such sales, § 363(f) of the Bankruptcy Code permits a trustee or debtor-in-possession to sell such property “free and clear of any interest in such property” under certain circumstances. Pursuant to § 363(f), bankruptcy courts throughout the country routinely enter orders approving sales of assets free and clear of interests, liens, claims and encumbrances. But buyer beware: There may be hidden discovery obligations that give rise to unexpected claims and potential liabilities and costs. One place to look for such hidden claims, liabilities and costs is in the electronic files, records and data a buyer may acquire out of a bankruptcy estate.

As with most discovery or investigative issues, cooperation and forward thinking can be fruitful in the bankruptcy context, especially when considering asset transfers. While it can be very difficult for a standard plaintiff and defendant to cooperate in discovery, it may be even harder in a bankruptcy proceeding, where the interests of debtors, trustees, creditors, affiliated entities, regulators and governmental entities and asset-purchasers vary significantly and where key facts and circumstances may be uncertain or unknown. Despite this, there are usually cooperative steps that can be taken regarding data that help move the bankruptcy to a close and facilitate management of ongoing and future discovery obligations and issues.

Consider two scenarios that may arise in connection with the acquisition of electronic files, records and data out of a bankruptcy estate. First, the trustee or the debtor-in-possession may be a party to pending litigation pursuant to which the trustee or the debtor-in-possession may be required to produce some or all of the electronic files, records and data in discovery. Second, litigation may arise in the future (whether anticipated or unanticipated) in which the electronic files, records and data acquired from the bankruptcy estate are relevant and may be the subject of discovery. In each instance, the buyer of the assets out of the bankruptcy estate may be drawn into the litigation as a target of third-party discovery or even as a party itself. For this reason, it is important for buyers of electronic systems, files, records and data to consider their obligations that exist or that could arise in connection with these scenarios and to consider how to minimize the resulting cost, disruption and potential liability. Also, parties with an interest in the data to be transferred pursuant to such a sale of assets should take steps to ensure that evidence needed for existing or future claims is preserved and not abandoned or allowed to decay.

Like anyone else, an asset-purchaser has an obligation to preserve data where that purchaser has reason to believe that the data in its possession, custody or control might be needed for future litigation to which it is or may be a party.[1] The law is less clear where the asset-purchaser may only be a third party to the anticipated litigation. However, the duty to preserve does arise, even for a third party, once it receives a subpoena,[2] and the third party may be subject to tort or statutory liability should it destroy the evidence necessary for a claim even absent a subpoena.[3]

Take the example of a true disinterested third party purchasing servers and other machines from a debtor-in-possession with the intent of repurposing that equipment or mining it for valuable data. The very next day, that purchaser could receive a letter or subpoena demanding the preservation of that data for litigation arising out of the bankruptcy case, unrelated litigation or even a government investigation. The purchaser may be responsible for costs associated with that discovery, especially if the purchaser wants to avoid surrender or isolation of the equipment pending the conclusion of the investigation or litigation. While delete-what-you-do-not-need is almost always the best practice, and a purchaser should always consider data deletion, the purchaser cannot just assume that such deletions are allowed. The arrival of a subpoena or a pre-existing relationship with the debtor could significantly change the preservation landscape.

Consider a related-party transaction in a bankruptcy where the value of the purchase is business continuity and the data itself. This could include customer contacts, proprietary databases, and research and development. Such a purchaser may not be a true third party, and preservation obligations may carry over. Creditors and other interested parties should take action to ensure that data-preservation and cost-effective access to such data post-transfer is possible and economical. An affiliated entity cannot avoid these obligations via the asset transfer.

In In re MF Global Ltd.,[4] the parties were faced with such a situation. In a sales agreement praised by the court, the trustee and interested parties created structures that allowed the transfer of significant amounts of assets, including data, to an affiliated party, and acknowledged the purchaser’s obligation to retain that data for potential claims. Also, the agreement allowed the debtor to retain appropriate resources to preserve data specific to the bankruptcy proceedings. At the same time, the sales agreement enabled the trustee to abandon certain data that the interested parties could agree was not needed.

Parties interested in an asset transfer could get very creative and even seek to set the scope of future discovery or identify acceptable search methodologies. This could include agreements on acceptable search terms or the use of Technology Assisted Review, like predictive coding. The asset-purchase agreement could provide for the creation of discovery databases with eDiscovery vendors and could require the funding of a reserve to maintain those databases for a reasonable period of time. Anything that bookends the potential liabilities of the purchaser is fair game and could help to turn the assets into funds that can potentially be used to pay creditors.

All of these examples assume that the buyer knows what it is getting. But what about information that is unknown (or maybe not even knowable) — so-called dark data? An asset-purchaser may have no interest at all in the systems or information that it is buying and no knowledge of what is there. There may be existing eDiscovery databases or other cloud storage solutions that have ongoing costs that must be funded. The acquired assets may include outdated data sources and no equipment, software or licenses to access them. Due diligence is key, and the asset-purchaser should take the time to understand these potential liabilities. This may require access to the data and the use of Technology Assisted Review to understand it.

As a takeaway, purchasers of assets out of a bankruptcy must be aware of the potential eDiscovery obligations that come with the assets they acquire. Such an awareness ultimately will shape strategy on due diligence related to the sale and on the ultimate documentation of the purchase agreement.