Because there can be at least a two-year lag between a bankruptcy filing and a preference demand made pursuant to 11 U.S.C. §547, a consistent, proactive approach to gathering defense data is critical. Modern legal practice requires a nonintuitive, technical and peculiarly factual approach to defending preferences and preserving the electronically stored information (ESI) relevant to defending preferences. The creditor will need to supply the facts upon which its defense is based. Thus, trade creditors must work with counsel to properly preserve ESI so it can be used to defend the preference.
A consistent approach to dealing with data gathering can be beneficial to both the actual defense and to managing the cost of discovery in the ESI world. This article reviews the types of information that a trade creditor should gather and then outlines the legal considerations arising from electronic discovery practices under the Federal Rules of Civil Procedure.
Information Gathered to Defend a Preference
In general, the following checklist of what to gather and preserve is a good starting point.
- An electronic download of all data maintained concerning the payments from the debtor to you during the 90-day preference period and approximately one year prior (more if it is maintained pursuant to your company’s document-retention policies). Vendors in seasonal business may need multiple years to establish a cyclical nature relationship. See Chart 1 for an example file layout.
- An electronic download of all data concerning unpaid invoices due from the debtor as of the bankruptcy petition date. See Chart 1 for an example file layout.
- If your invoice date does not equal the date that your goods were shipped or your services were provided, then data will be needed to identify the new value given after the earliest alleged preference payment.
- Any judgments, contracts, notes or agreements with the debtor.
- Any correspondence (including e-mail) with the debtor prior to the bankruptcy date that pertains to collections, credit limits or arrangements, payment terms, and any notes or contemporaneous records of discussions regarding same.
- If any payments were COD or prepayments, provide documentation sufficient to support this fact.
- Your standard industry classification (SIC) code.
- Your company’s document retention policy.
- Actual invoices from you to the debtor.
Preserve Data
The vast majority of the information needed today to defend a preference will be ESI, which covers virtually every kind of electronically information. ESI includes anything created on a computer (i.e., documents in Word or PDF formats, spreadsheets and, of course, e-mail and attachments). There are other less obvious types of ESI, such as voicemail, text messages, video or other recordings.
Federal courts have generally required an attorney to advise its client to implement a “litigation hold” policy to preserve documents and ESI once litigation is reasonably anticipated. [1] Query whether the listing of one’s client as a recipient of transfers within 90 days of the petition date in a debtor’s SOFA means litigation is reasonably anticipated and a hold is required?
Nonetheless, once one decides that a need exists to preserve data to defend a potential preference claim, one element of that preservation must be to suspend routine document retention/destruction policies until data can be preserved in native format with all relevant metadata intact so as to avoid spoliation accusations at a later date. [2] Care must be taken to identifying the types of potential ESI and who might have it. [3] Counsel and the client must also identify where all of the ESI may be located, including servers, laptops and cell phones, just to name a few of the places that must be considered. [4]
Rule 26(b)(2)(B) specifies that a party need not provide discovery of ESI from sources that the party identifies as not reasonably accessible because of undue burden or cost. Thus, when gathering preference-defense materials, the ability to preserve and produce ESI must be considered and counsel must be prepared to address this issue in a response to a discovery request or motion for protective order. [5]
Production of ESI is governed by Federal Rule of Civil Procedure 34, and the request may specify the form in which ESI is to be produced. In the response to the request, the respondent may object to the form in which ESI is to be produced. If the form of production is not specified in the request, the respondent must produce the information in the forms in which it is ordinarily maintained or in forms that are reasonably usable. A consistent policy as to the type, method and manner for gathering and preserving ESI will beneficial in responding to discovery as a party need not produce the same ESI in more than one form. [6]
Click here to view the above chart on a separate page.
Conclusion
This article provided an overview of what and how creditors and their counsel should set about preserving ESI to defend preferences. Armed with a procedure of what should be gathered and a consistent practice for gathering the data, creditors can cost effectively prepare for the dreaded demand letter in an ESI world.
1. See, e.g., Kronish v. United States, 150 F.3d 112, 126 (3d Cir. 1998).
2. See, e.g. Pension Comm. of Univ. of Montreal Pension Plan v. Bank of Am. Sec., 685 F.Supp.2d 456, 465 (S.D.N.Y. 2010) (failure to issue written litigation hold constitutes gross negligence because it likely to result in destruction of relevant information).
3. Id. (failure to collect all ESI from all employees may be negligence).
4. See Fed. R. Civ. P. 26(a) (initial disclosures must include copy of or description by category and location of all ESI).
5. Fed. R. Civ. P. 26(b)(2)(B) (burden of proof concerning undue burden or cost is on responding party).
6. See Fed. R. Civ. P. 34(b)(iii).