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By MARYBETH WILKINSON, a partner in the Chicago office at Lovells with more than a decade of experience in cross-border ADR and arbitration; and JONATHAN GLUSMAN, an associate in the Commercial Litigation and Insurance and Reinsurance practices

Technological change and the growth of electronic discovery have forced companies to reconsider how they preserve documents for actual or threatened litigation. Companies have not paid as much attention to whether and how they should preserve documents held by third parties, however.

EXPANSION OF ELECTRONIC DISCOVERY

Once a lawsuit becomes reasonably foreseeable, anyone likely to be a party must preserve relevant documents. If litigation ensues, parties must produce nonprivileged documents if requested by the other side.

Not fulfilling these obligations can have severe repercussions, including costly and intrusive backup tape searches and computer forensics. If it appears that critical documents have been lost, courts and arbitrators can make adverse inferences or otherwise sanction those responsible.

Electronic discovery has forced courts and litigants to revisit customary standards for preserving and producing documents for litigation. Companies keep more documents today than ever. A company might once have kept one copy of a document but now keeps many, often in multiple versions. Electronic information is so easy to search and retrieve that users keep documents in a jumble instead of segregating them into files. Thus, a litigation hold might have to cover an entire e-mail account or hard drive, or even the company's entire set of backup tapes.

Indiscriminate document retention is risky for a number of reasons. It increases the chances an opponent will see harmful documents the company was not required to keep but kept anyway. Also, from a practical standpoint, it can multiply the costs of litigation because collecting, reviewing, and producing electronically stored information is expensive.

THIRD-PARTY OBLIGATIONS

Companies generally are responsible for their own documents but do not need to preserve or produce documents from a third party. The third party can be subpoenaed to produce documents that might reveal useful evidence. Third parties enjoy greater protections, however, and courts often narrow or refuse to enforce broad third party subpoenas. In arbitration, a third party might have to comply with a subpoena only once the hearing is held, or not at all.

Under some circumstances, though, a litigant is responsible for a third party's documents as if they were in the party's own files. If the third party's documents are within the litigant's "control," they can be subject to the same, higher, standards applicable to the parties themselves.

When does a party control documents it does not possess? A common test is whether the company has the right or practical ability to obtain the documents upon request. For example, in the recent case of Goodman v. Praxair Services Inc., the plaintiff sought sanctions after discovering the defendant's consultants had deleted key documents. The court refused, saying the company did not control the consultant's files because there was no evidence it had the "practical ability" to get them upon request.

The "control" and "practical ability" tests are important for insurers because their relationships with third-party administrators, agents and adjusters usually include the right to inspect or copy documents relating to their business.

Under such a clause, an insurer might have to preserve and potentially produce any relevant documents that its administrator possesses. For example, in Youell v. Grimes, a party was ordered to search for responsive documents in the files of Lloyd's syndicates, intermediaries and third-party administrators.

A right to access records clause does not automatically open the third party's files to unrestricted discovery. Instead, courts look at the relationship between the companies, as well as the connection between the documents and the parties' relationship. In Gerling International Insurance, Co. v. Commissioner of Internal Revenue, for example, the court refused to order a reinsurer to give the IRS a list of shareholders held by its lone cedent, despite a broad access to records clause.

The court's holding rested on two grounds. First, it found that the inspection clause was intended to allow the reinsurer to verify it had received its share of gains and losses from the business, and not to facilitate an audit on foreign soil by a government agency. Second, although the two companies were under common ownership, they were not so closely connected that one company was the alter ego of the other.

POSSIBLE SOLUTIONS

Insurers are unlikely either to stop relying on outside companies, or to forego their right to access records relating to their own business. They can, however, take steps to mitigate the risk associated with those relationships.

Insurers should consider drafting their contracts to require third parties to follow best practices for document retention and to comply with litigation holds. The contract also might require the third party to indemnify the insurer if it fails to do so. These steps could make it more likely documents will be retained and, if not, reduce the chances the insurer will later be sanctioned.

If litigation does arise, the insurer should immediately issue a "litigation hold" communication to third parties whose documents could be deemed under the insurer's control. The insurer should also follow up regularly to ensure the hold is implemented. Later, if document production becomes necessary, the insurer should collect the third party's relevant documents and produce them.

Access to records clauses also can be drafted to cover only records relating to the subject business and to allow the third party to object or intervene if those documents come into play in litigation. This may limit the range of documents subject to retention and production, address the third party's concerns about being dragged into litigation, and raise obstacles for opponents seeking broad discovery of the third party's documents.

The expansion of electronic discovery has raised the stakes for all companies with respect to document retention. Insurers in particular need to consider whether they need to proactively ensure that the third parties through whom they do business live up to the standards that they themselves must follow.

April 1, 2010

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