Anyone who has served as a trustee in a chapter 7 or 11 bankruptcy case has encountered the business debtor whose records are “missing.” Usually, the debtor’s officers testify that they maintained the records, but just somehow won’t turn them over. The records just don’t show up. Or, the officers turn over computers or QuickBooks files and it is pretty obvious that the files are incomplete. These records are, of course, property of the bankruptcy estate under 11 U.S.C. §541(a). My standard protocol is to file a motion to compel turnover. Sometimes that works, and sometimes it does not. Concealment of the records is a criminal act under 28 U.S.C. §152, but, as a practical matter, referring a case to the U.S. Attorney’s Office for criminal prosecution does not always bear results – at least not ones that benefit the bankruptcy estate. This is especially true when the case, or the conduct involved, is relatively minor.
In Thyroff v. Nationwide Mutual Insurance Co., 8 N.Y.3d 283, 2007 WL 844860 (N.Y. 2007), the Court of Appeals of New York demonstrated an alternative remedy: a state law civil or criminal action for conversion. As a practical matter, such a claim will produce better results than a referral for federal prosecution. A trustee can bring a state law conversion claim seeking monetary damages for the value to the estate of the records. The civil case will be within the trustee’s control and the burden of proof is lower than with a criminal action. In most jurisdictions, a trustee can also initiate a state law criminal complaint, creating the immediate risk of criminal liability for the offending corporate officer. The trustee has more control over whether and when a state law criminal action proceeds than he would with a criminal referral to the U.S. Attorney. Also, the state law criminal complaint is more likely to lead to recovery of the data itself. The target of the complaint may well realize that correcting the offense is the best way of avoiding actual prosecution. This avenue is available to the target when the trustee has filed a state law criminal complaint, but the state authorities have not yet made a decision to prosecute.
But is a state law civil or criminal claim for conversion really an option when a corporate officer conceals or destroys corporate data? Is the taking of electronic information considered theft? The answer, apparently, is yes.
A number of courts have held that conversion of a computer disk or computer constitutes conversion of the information on that computer disk or computer. In American Federation of State, County and Municipal Employees, Local 2620 v. United Professionals, 2006 WL 4088322 (Cal. Sup. 2006), former union officers took information from a union membership database. The California Superior Court judge noted that it was well established under California law that a claim of conversion could be brought whenever a physical medium containing electronic information is taken. The taking of the physical medium (like a computer or a computer disk) allowed for a claim of conversion. The measure of damages would not be limited, however, to the value of the medium. The plaintiff would also be entitled to damages based on the value of the data contained in the physical medium. In that case, it was not clear from the decision how the former union officers took the data. However, the court did state that "the intangible interests are reflected in something tangible that was physically taken." The physical item could be de-minimus, such as a computer disk, without affecting the outcome. Thus, the court held the plaintiff was likely to prevail on its claim for conversion. This, rule, which other courts have also expressed, is known as the "merger doctrine." See Thyroff v. Nationwide Mutual Insurance Co., 8 N.Y.3d 283 (N.Y. 2007).
In Thyroff, the Court of Appeals of New York expanded on the merger doctrine in two ways. First, the decision applied the tort of conversion absent the conversion of an actual physical container. Second, the court applied the tort of conversion where the defendant denied the plaintiff access to electronic computer information, rather than taking the information.
Thyroff was an insurance agent working with the defendant, Nationwide Mutual Insurance Co. When Nationwide Mutual terminated its relationship with Thyroff, it allegedly denied Thyroff access to information he had maintained on Nationwide's computers. Thyroff sued Nationwide for conversion in federal court, and Nationwide filed a motion to dismiss. When the case reached the Second Circuit Court of Appeals, the court certified the following question to the New York Court of Appeals: "Is a claim for the conversion of electronic data cognizable under New York law?"
The state court said yes, and also said that a claim for conversion existed on the facts presented in Thyroff. Traditionally, a claim for conversion was for the “unauthorized assumption and exercise of the right of ownership over goods belonging to another to the exclusion of the owner’s rights.” State of New York v. Seventh Regiment Fund, 98 N.Y.2d 249, 259 (2002). New York courts had, in the past, refrained from applying the doctrine to intangible assets because there is no physical item to be taken, but the appeals court did not view the lack of physicality as a bar. With respect to electronic information, the court noted the value of electronic information in today’s age, and the importance of protecting that value from misappropriation. The court also noted that the form in which the information is kept changes neither its value nor the need to protect it. The information, if kept in paper files, could be converted, and the same rule should apply when the information is maintained in electronic form.
Thus, according to the highest court in New York, a claim for conversion neither requires a taking of a physical object, nor the transfer of the information. Now, let's turn back to the corporate officer who won’t provide the bankruptcy trustee with the debtor’s electronic information. Under the Thyroff rule, the officer has converted the data regardless of the form in which the information was stored or maintained. The trustee does not have to prove whether the data was on a computer or a disk. The trustee does not have to prove what happened to that disk or that computer. All the trustee has to prove is that the information existed and the officer has failed to provide it. With that proof, the corporate officer becomes liable for the damages caused by the loss of the data and the trustee now has a new tool in his toolkit.