“Lack of frankness in discovery can have unintended and sometimes damaging consequences.” So begins the decision in In re WRT Energy Securities Litigation, 2007 WL 2826624 (S.D.N.Y. 2007), where the Southern District of New York administered a stern lesson in the dangers that may arise for companies that allow the destruction of documents during litigation. The case is particularly important because the plaintiffs were actually hit with a spoliation sanction based on the destruction of documents that they did not have in their possession and did not themselves destroy.
The litigation involving WRT Energy, which began in 1995, arose out of an offering for the sale of senior notes as part of an effort by WRT to raise capital for its business of using advanced technologies to revitalize abandoned or shut-in oil and gas wells. The registration statement for the notes made a number of representations regarding the “success rate” WRT had experienced with respect to wells where it had implemented its technologies. After the notes offering, WRT’s financial condition deteriorated, the value of the notes fell significantly, and WRT ultimately filed for bankruptcy. The plaintiffs filed class action complaints alleging violations of the federal securities laws.
In the operative complaint, the plaintiffs alleged that the claims made by WRT with respect to its success in revitalizing failed wells were materially incorrect.
Discovery was suspended from 1999 through 2004 while various motions to dismiss were litigated. When discovery resumed, defendants repeatedly asked the plaintiffs through interrogatories to specify and identify the basis for their contention that the claims regarding well revitalization were incorrect. Plaintiffs responded that they had reviewed documents relating to 21 specific wells but reserved the right to supplement their responses. In the meantime, a document depository had been created to store the voluminous documents related to WRT’s business activities during the bankruptcy proceedings. After the bankruptcy was concluded, the depository was liquidated and the documents were returned to various parties, including WRT’s successor, Gulfport Energy. The bankruptcy court entered an order requiring the parties to preserve the documents until this proceeding was over.
Gulfport made the documents available for inspection, and the defense team identified and copied only the documents relating to the wells identified in plaintiffs’ interrogatory responses. In May of 2006, Gulfport’s general counsel informed the attorneys for both plaintiffs and the defendants of Gulfport’s intention to dispose of the WRT documents and gave the parties the opportunity to take possession of the documents. Counsel for the parties told Gulfport they had no further interest in the documents in Gulfport’s possession, and the documents were destroyed. Four months later, the parties exchanged expert reports, and plaintiffs’ expert identified an additional 75 wells that he characterized as failures. Defendants moved for sanctions, asking the court to preclude the plaintiffs from relying on their late-discovered theory of liability and the 75 wells on which it was based.
The court, in part, granted the motion for spoliation sanctions. In doing so, the court rejected plaintiffs’ argument that they could not be held responsible for breaching a duty to preserve evidence that they did not personally destroy. According to the court, the plaintiffs had functional control over the documents, since Gulfport gave them the opportunity to take custody of the documents, and plaintiffs therefore had an obligation to preserve them. As to culpability, plaintiffs had already seen a draft of the expert’s report that anticipated using more than the 21 wells in its analysis. The court concluded that “it was at least grossly negligent for plaintiffs’ counsel to permit the Gulfport documents to be destroyed without specifically warning [defendants] that their expert had analyzed all the wells and would likely present expert opinion regarding all of them.” The court did not allow the plaintiffs to rely on their having reserved the right to supplement their interrogatory responses, concluding that “the plaintiffs’ boilerplate reservation language does not trump the specific information that they provided concerning their theory.”
While the court agreed with plaintiffs that defendants had not established that documents relating to plaintiffs’ “cash flow model” analysis were relevant for purposes of spoliation, the court reached the opposite conclusion regarding documents containing reserve and related data. According to the court, “these documents are central to the [defendants’] argument” regarding how “success rate” was to be measured. The court stated that “any evidence of increased reserves would be favorable to the [defendants] given their broad definition of success.”
In crafting a remedy, the court rejected plaintiffs’ claims that spoliation sanctions should not be granted because the defendants had an opportunity to inspect the documents before they were destroyed. By “misleading” the defendants regarding their theory of the case, “the plaintiffs rendered the [defendants’] opportunity to review the Gulfport documents illusory . . ..” The court entered an order precluding the plaintiffs “from challenging the representativeness of the reserve information that the defendants ultimately rely upon . . . it will be conclusively presumed that similar results would have obtained for the remainder of the 97 wells if that information were available.” The court also allowed a jury instruction “explaining that this asymmetry is a consequence of a loss of evidence for which the plaintiffs were responsible.”
These devastating spoliation sanctions against the plaintiffs in WRT Energy are a reminder that a business involved in litigation should think twice before ever allowing the destruction of any documents that might be relevant.