Does a Parent Company Have Duty to Ensure Subsidiary Preserves Documents and ESI?

December 16, 2020

If a subsidiary business is embroiled in a legal dispute, must the parent company see to it that the subsidiary preserves materials relevant to the dispute? As with all great legal questions, the answer is . . . it depends.

If a parent company has sufficient control over a subsidiary, it may have a duty to ensure the subsidiary institutes litigation holds and properly preserves electronically stored information (ESI).

As explained by the Federal Court of Claims in Perfect Form Manufacturing v. United States, Case No. 18-52T (Fed. Cl. April 24, 2019), courts look at a few factors to figure out whether related companies must preserve and produce another’s documents and data. It often comes down to whether the information is in the parent company’s “possession, custody or control” under Federal Rule of Civil Procedure 34 (with the main focus on “control”).

The factors include:

actual control or inferred control, including any “complicity” in storing or withholding documents
commonality of ownership
exchange or intermingling of directors, officers or employees
exchange of documents between the companies in the ordinary course of business
any benefit or involvement by the non-party corporation in the transaction at issue
involvement of the non-party corporation in the litigation.

What follows are situations in which companies had a duty to preserve another’s ESI and documents, along with a couple cases in which courts found no duty to preserve.

Duty Found: Parent is Sole Shareholder

In Pegasus Aviation, Inc. v. Varig Logistica S.A., 118 A.D.3d 428 (N.Y. App. Div. 1st Dept. 2014), Pegasus sued both Varig and its parent company, MP Global Advisors for breach of aircraft leases. Varig did not institute a litigation hold, but at some point installed an information technology system that backed up Varig’s information. Despite the back-up system, Varig’s computer systems failed on multiple occasions and destroyed ESI relevant to the litigation. As a result, Pegasus successfully sought sanctions against both Varig and MP. Specifically, the trial court struck Varig’s answer and, finding that MP’s failure to ensure Varig instituted a litigation hold was negligent and agreed to instruct the jury that it could infer the lost ESI would support the alter ego claim against MP.

The court concluded MP had a duty to ensure Varig preserved ESI because it was Varig’s sole shareholder, selected Varig’s board of directors, and because MP closely monitored Varig’s business operations. The case ultimately ended up before New York’s highest court which agreed that MP possessed sufficient control over Varig obligating it to ensure the subsidiary preserved the electronic evidence. Pegasus Aviation Inc. v. Varig Logistica, 26 NY 3d 543 (2015).

Duty Found: Parent Company Puts Information On Subsidiary’s Servers

The sale of a subsidiary might also present parent companies with tricky ESI preservation issues. In ILWU-PMA Welfare Plan Bd. of Trs. v. Connecticut Gen. Life. Ins. Co., No. C 15-02965 WHA (N.D. Cal. Jan. 24, 2017), a union health plan sued a claims processing company and its parent for not seeking appropriate discounts on the health insurance claims the company processed.

During discovery, the parties figured out that email relevant to the case were on another subsidiary’s servers sold by the parent prior to the lawsuit. Despite an agreement between the parent company and the purchaser to preserve data, relevant ESI was lost.

The court determined that even with an agreement with the buyer to preserve the information, neither the subsidiary nor its parent took reasonable steps to preserve the information despite knowing a lawsuit was likely. The court further concluded that spoliation sanctions were likely appropriate.

Similarly, in Illumina Cambridge Ltd. v. Complete Genomics, Inc., Case No. 19-mc-80215-WHO (TSH) (N.D. Cal. Feb. 19, 2020), the court found related companies had a duty to preserve ESI because, among other reasons, they had shared access to network servers and databases.

Duty Found: One Corporation is the Alter Ego of Another Corporation

A company may be obligated to produce documents held by another company if the company in possession of the documents is the “alter ego” of the other (a company controlled by and set up as a front for another company).

In Almont Ambulatory Surgery Center v. Unitedhealth Group Inc., Case No. CV 14-03053 (C.D. Cal. March 2, 2018), UnitedHealth requested certain medical records and bills from medical providers that sued it because one of the issues in the case was whether the providers defrauded UnitedHealth into paying false medical claims.

The medical providers objected to producing the records arguing they had no control over them because the records were stored in software licensed to another company described as an “unrelated non-party entity.”

The court rejected the argument finding that the “non-party entity” was really the alter ego of the objecting medical providers. The court noted the transaction transferring the software license and records was not an “arm’s length” transaction. The companies had a “unity of ownership”, overlapping employees, shared attorneys and the same persons signing the license transfer agreement held positions with with both companies.

No Duty: Parent Had No “Practical Control” Over Subsidiary and its Documents

Not all courts conclude parent companies must preserve material possessed by a subsidiary.

For instance in Platinum Equity Advisors, LLC v. SDI, Inc., 2016 NY Slip Op 31079 (Sup. Court 2016), the court observed as a “general matter, sanctions for destruction of evidence are applied against the entity responsible for the destruction of the evidence” and refused to penalize a parent company for its subsidiary’s loss of ESI.

The court found no duty to preserve the ESI because the parent company did not have “practical control” over the subsidiary. The parent company was not a shareholder of the subsidiary, there was no evidence the parent was involved in formulating the subsidiary’s business strategy and no evidence that the parent could obtain the subsidiary’s documents on request.

Similarly in, Global Access Investment Advisor LLC v. Lopes, 2017 NY Slip Op 31173(U) (Sup. Ct. May 31, 2017), the court found no duty to preserve documents after divestiture of any interest in the company for which the records were sought.

Sedona Conference: Practical Ability Test Problematic for Parent Companies

Although, the court in Platinum Equity concluded the parent company in that case did not have “practical control” over its subsidiary’s documents, as detailed in a prior post, using “practical control” of documents as the benchmark could spell trouble some for parent companies.

The Sedona Conference, a “think tank” focused on complex litigation and other legal issues, faults the “Practical Ability” test because it may fail to recognize distinctions between sister companies:

[c]ourts have applied the Practical Ability Standard to obligate sister corporations to obtain documents from each other when each has ties to a common parent corporation, notwithstanding the fact that the entities may lack a sufficient relationship to warrant the imposition. Courts applying the Practical Ability Standard frequently bypass a thorough corporate veil analysis and order production of documents in the possession and custody of non-party sister entities.

Regardless of what test is used, companies and their in-house counsel must ensure they have proper document retention and legal hold processes in place so that relevant evidence is not lost when a legal dispute arises. For additional reading about legal holds, check out this article discussing when the duty to preserve documents and ESI arises and what must be done after legal hold notices are sent.

We can help tackle your legal hold process. Let us know if you want to talk about it!