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).
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 never instituted 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 Different 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 affiliated 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 emails 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 that data on the servers would be preserved and access given to it if necessary, 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.
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.
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 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, the opinions discussed above are interesting because they cite very little case law in support of their findings that parent companies have a duty to ensure that subsidiaries and affiliates preserve ESI. Presumably they are founded on legal theories similar to those used to determine whether corporate litigants must produce documents possessed by affiliates.
To determine whether such an obligation exists, courts usually consider the corporate structures of related companies, the affiliate’s relationship to the transactions at issue in the litigation, how closely the companies work together, and whether the affiliate is involved in the litigation or will benefit from its outcome. See, e.g., Steele Software Systems v. Dataquick Info. Systems, Case No. JFM 05-2017 (D. Md. October 3, 2006) and Mt. Hawley Ins. Co. v. Felman Prod., 03:09-cv-00481 (S.D. W. Va. August 19, 2010).