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AKH Co., Inc. v. Universal Underwriters Insurance Co.

United States District Court, D. Kansas

March 19, 2019

AKH COMPANY, INC., Plaintiff,



         Before the Court is Defendant/Counter-Claimant Universal Underwriters Insurance Co.'s (“UUIC”) most recent Motion for Sanctions (Doc. 601), which includes a request for dismissal. The motion is fully briefed and the Court is prepared to rule. As described more fully below, the Court grants in part the motion and awards UUIC fees and costs. The Court also grants UUIC's request that adverse inference instructions be read to the jury at trial. UUIC's request for case-terminating sanctions is denied.

         I. Standards

         UUIC brings this motion under Fed.R.Civ.P. 26, 33, 34, and 37.[1] UUIC's memorandum in support argues that sanctions should be awarded under Rule 37(b)(2). UUIC references and quotes Rule 37(b) and states “AKH's continuous discovery misconduct throughout this final stage of discovery . . . warrants sanctions.”[2] Rule 37(b) governs a party's failure to comply with a court order and lists several permissible sanctions for such violations:

(i) directing that the matters embraced in the order or other designated facts be taken as established for purposes of the action, as the prevailing party claims;
(ii) prohibiting the disobedient party from supporting or opposing designated claims or defenses, or from introducing designated matters in evidence;
(iii) striking pleadings in whole or in part;
(iv) staying further proceedings until the order is obeyed;
(v) dismissing the action or proceeding in whole or in part;
(vi) rendering a default judgment against the disobedient party; or
(vii) treating as contempt of court the failure to obey any order except an order to submit to a physical or mental examination.[3]

         But UUIC does not offer any evidence that AKH violated a court order. In fact, UUIC maintains that “a ninth motion to compel, though warranted, would be ineffective and could actually harm Universal by compelling it to engage in unending discovery.”[4]

         Since UUIC does not contend that AKH violated a court order, it must demonstrate that Rule 37(c), rather than Rule 37(b), applies. Rule 37(c) governs a party's “[f]ailure to disclose, to supplement an earlier response, or to [a]dmit.” Rule 37(c)(1) provides that “[i]f a party fails to provide information or identify a witness as required by Rule 26(a) or (e), ” then the party is not allowed to use the witness or information on a motion or at trial unless the failure was substantially justified or is harmless. In addition to or instead of this sanction, the court, on motion and after giving an opportunity to be heard:

(A) may order payment of the reasonable expenses, including attorney's fees, caused by the failure;
(B) may inform the jury of the party's failure; and
(C) may impose other appropriate sanctions, including any of the orders listed in Rule 37(b)(2)(A)(i)-(vi).[5]

         In the reply brief, UUIC suggests that the Court may impose sanctions under its inherent authority.[6] Because this ground for sanctions was raised for the first time in reply, the Court may not consider it without allowing AKH an opportunity to file a surreply.[7] Given the impending dispositive motion deadline, and the Court's previously-stated dedication to keeping this case on track for its November trial date, the Court declines to reopen briefing. The Court therefore confines its analysis to the original request for sanctions under Rule 37.

         II. Discussion

         UUIC argues that three discovery violations require imposition of sanctions: (1) the Counter-Defendants wrongfully withheld check registers and deposit lists from production until recently; (2) AKH recently attempted to change its long-standing response to a discovery in which it stated that it has no assets; and (3) AKH “dumped” more than 68, 000 documents from ex-employee Michael Schaeper's computer, including documents that appear to have been wrongfully withheld from earlier responses to UUIC's requests for production. The Court addresses each in turn.

         A. Check Registers and Deposit Lists

         1. Background

         In November 2015, UUIC issued a Request for Production (“RFP”) to AKH for “all documents sufficient to show AKH's profits, losses, revenue, bank statements, and income for the last 5 years, including 2015.”[8] AKH objected that the request was overly broad, but produced corporate bank statements for the years 2011, 2012, and 2013.[9] By October 17, 2016, Magistrate Judge Gale found good cause to grant UUIC's request to designate a forensic accounting/damages expert after the deadline expired for expert designations, due to “Plaintiff's stonewalling tactics and failures to be forthcoming with discovery, ” on the topic of AKH's net worth.[10]

         In a January 30, 2017 letter from UUIC to AKH, UUIC's counsel requested on its expert's behalf financial documents that AKH would have provided to its tax preparer or accountant, showing losses, profits, revenues, and costs. Counsel referenced “AKH's previous position . . . that it possessed absolutely no accounting information other than its bank statements, ” but indicated that there was still missing a general ledger of AKH's transactions and copies of checks written from the bank accounts.[11] Counsel for AKH responded that “AKH does not maintain a general ledger program for its business any longer. All documents responsive to this request in its possession have been produced.”[12] AKH's counsel offered to contact the bank to obtain copies of the requested checks.

         In March 2017, UUIC deposed AKH's corporate representative, Hratch Andonian. Mr. Andonian did not know the answers to specific questions about AKH's finances, and “conceded . . . that [the] canceled checks would be the only way to identify how AKH spent its money.”[13]For example:

13 [Q.] If you look on that page, there's a section
14 titled “Checks Presented Conventionally.”
15 Do you see that?
16 A. Yes.
17 Q. And then there are all those checks listed
18 right below there?
19 A. Yes.
20 Q. How would we find out what all of these
21 checks were for or who they were paid to?
22 A. I suppose we could ask the bank to get us
23 the canceled checks.
24 Q. Okay.
25 A. Yeah.
. . . .
3 [Q.] But I'm wondering if AKH also used any
4 written documents to record its accounting materials
5 like, you know, a checkbook ledger where you would 6 have a printout of the check and a record of who
7 checks were paid to and from?
8 A. Frankly, I don't remember having anything
9 like that because the -- again, on the MaddenCo
10 system was connected to the point of sale and the
11 data was in the MaddenCo system. So the only thing
12 would be the checks and the vendor invoices. Parts
13 houses, tire supplies, those are the invoices would
14 be when -- and they would be entered in the system
15 and to be paid.
16 That's the process. I don't know if there
17 are any ledgers or -- I don't know that.[14]

         On June 9, 2017, UUIC moved for sanctions based in part on AKH's failure to produce the checks AKH requested after this testimony.[15] Judge Gale granted the motion on November 14, 2017, after finding that the checks were within the custody and control of AKH.[16]

         On April 30, 2018, this Court granted UUIC's motion to amend its counterclaim to add Andy and Hratch Andonian, 55 Inc., TireNetwork Group, Inc. (“TireNetwork”), and Andonian Enterprises, Inc. (“AEI”), and to add claims for fraudulent conveyance and alter ego liability.[17]Additional, limited discovery ensued. As part of that discovery, UUIC issued new RFPs to the Counter-Defendants, which included requests for net worth documents from 2011 to the present, and for documents sufficient to show the value or worth of any transfers between the Counter-Defendants.[18] In August 2018, UUIC noted in a letter to AKH that ledger and accounting software records were still missing. And during phone calls in September and November 2018, UUIC asked AKH for a proposal by which AKH could produce summary information that would not require UUIC to review bank statements and canceled checks. AKH produced over 7, 000 pages of check images alone for one bank account for the period of April 2012 to June 2015. Many of the check images include redacted payee information.

         In a letter from UUIC to AKH dated December 21, 2018, UUIC informed AKH that certain recently-produced documents contradicted AKH's longstanding claim that it did not have a ledger or accounting report that would allow UUIC to more easily determine check payees:

First, documents produced by AKH's accountant, Darrel Whitehead, include a tab labeled “MANUAL CHECK REGISTER LIST.” This chart appears to list the check number, date, payee, and amount for some checks written in 2015. A similar chart was produced that identifies the same information for at least some checks written in 2014. Second, correspondence produced by AKH suggests reports can be run to show checks written. (See AKH031135.) Finally, just this week Rene Peth, AKH's former CFO, testified that AKH can, or at least could, produce a report from the MaddenCo system that summarized checks written during a given date range, including check number, payee, and amount. Ms. Peth also noted that it was AKH policy to retain financial information for at least seven years. Please produce all manual check register lists or documents showing similar information, or, there are periods for which no such document was created or can now be created, please confirm the same in writing and explain why such summary materials are missing.[19]

         On January 9 and 18, 2019, AKH and the other Counter-Defendants produced for the first time check registers for 2011 to 2018, and deposit lists for 2013 to 2018. UUIC argues that this new production creates even more questions, and now that discovery is effectively closed, it is unable to resolve these questions through depositions or other follow-up discovery. UUIC identifies the following issues: (1) the ledgers do not consistently state the purpose of the transfer of money, so it is unclear whether payments listed relate to the alleged purchase of assets or loans among the entities; (2) the document entitled “2013 AKH Deposits” appears to be incomplete as the first chronological entry is in September 2013;[20] (3) Counter-Defendants 55 Inc., AEI, and TireNetwork produced check registers, but not deposit lists; (4) AEI's check register for 2013 is incomplete and shows only entries dated September 29, 2013;[21] (5) 55 Inc.'s check register for all years is completely unusable because of the manner in which it was produced-the payee information and corresponding amount seem to appear over 500 pages apart because the columns of the native document did not fit on one page of the .pdf document that 55 Inc. produced; and (6) the Counter-Defendants' newly-produced ledgers are inconsistent with each other, raising questions as to the overall reliability of the documents.[22]

         2. Ruling

         The Court agrees that AKH's delay in producing the check ledgers and deposit lists before January 2019 evidences a failure to produce and/or supplement documents responsive to an RFP that was originally served on AKH in 2015. The history of UUIC's goose chase for these documents reveals a waste of judicial time and resources, a waste of the parties' time and resources, and has resulted in substantial prejudice to UUIC. Discovery has closed; dispositive motions are due on March 27, 2019. UUIC no longer has the ability to resolve the many inconsistencies it has gleaned from the January 2019 production; inconsistencies that go to the heart of their claims of fraudulent transfer and alter-ego liability. AKH's many explanations in the briefs come too late.

         AKH and the Counter-Defendants respond that UUIC never specifically requested check registers or deposit lists in its RFPs. They concede that there were broad requests for financial information, but contend that since they objected that the requests were overly broad, they were not required to produce them. This argument ignores the many informal clarifying requests between 2015 and 2019 for these summary documents, the repeated representations by AKH that they did not exist, AKH's representations under oath by its corporate representative that such documents did not exist, its insistence that UUIC must pursue discovery of voluminous canceled checks and bank statements instead to determine net worth, and its decision to produce these documents only after being confronted by undeniable evidence that they existed after all. It is simply not credible to suggest that UUIC did not request these specific documents, or that they were not clearly responsive to net worth RFPs, including one directed at AKH in 2015, to which a duty to supplement under Rule 26(e) applies.

         Next, AKH and the Counter-Defendants complain that their more than 21, 000-page production regarding the flow of money between Counter-Defendants could not possibly be insufficient given its volume, and given that the documents were produced as they are kept in the ordinary course of business. But neither the volume of documents nor the fact that they were produced as they had been maintained disproves the fact that AKH and the Counter-Defendants' denied the existence of check registers and deposit lists until confronted by UUIC in January. The Counter-Defendants explain the different systems they used to maintain these lists over the years but fail to explain how these different systems explain the many issues identified by UUIC in its motion. For example, how does the fact that the entities maintained check registers in different software systems explain the wholesale failure to produce those check registers for certain years? As UUIC effectively sets forth in its briefing, this is but one of many questions raised by this late production, after years of AKH denying that such documents existed at all. Importantly, the biggest question raised by this production-the inconsistencies between the various Counter-Defendants' financial documents-is not addressed at all by the Counter-Defendants' response brief.

         The Court finds that Rule 37(c) applies here because AKH and the Counter-Defendants failed to provide information required by Rule 26(a) and (e) by withholding check registers and deposit lists until January 2019, even though they were responsive to multiple RFPs, and despite UUIC's repeated follow-up requests.

         3. Sanctions

         Under Rule 37(c)(1), AKH and the Counter-Defendants may not use wrongfully withheld information as evidence on a motion or at trial unless the failure to produce was “substantially justified or is harmless.” The Court considers the following factors when making this inquiry: “(1) the prejudice or surprise to the party against whom the [evidence] is offered; (2) the ability of the party to cure the prejudice; (3) the extent to which introducing such [evidence] would disrupt the trial; and (4) the moving party's bad faith or willfulness.”[23]

         A rote application of these factors clearly weighs in favor of UUIC. The prejudice to UUIC is high because of the amount of time and money spent deciphering bank statements and canceled checks based on AKH's repeated representations that such was the only way to determine its net worth, or the flow of money between AKH and the other Counter-Defendants. UUIC was required to file a motion to compel when those canceled checks were not forthcoming, and hired a forensic accountant to try to decipher the net-worth documents, without the assistance of any summary documents like a general ledger, check register, or deposit list. Many depositions were taken, including AKH's Rule 30(b)(6) depositions, without these documents, meaning that UUIC was never given the opportunity to clarify or follow-up on the many issues that the documents now present. Given this posture, not only is the prejudice high, but AKH cannot cure the prejudice without completely derailing the case's schedule again-six years after it was originally filed. As described throughout this section, the Court also finds AKH and the Counter-Defendants acted in bad faith. There is simply no other credible way to explain the failure to produce these documents sooner.

         Nonetheless, the Court is not inclined to prohibit introduction of these documents as evidence at trial, largely because UUIC should be able to point to the many inconsistencies in the record that it has documented in its motion. Instead, the Court will “inform the jury of the party's failure” to timely produce this information under Rule 37(c)(1)(B). UUIC also requests an adverse-inference instruction that any ambiguity or inconsistency in the check registers and deposit lists should be resolved in UUIC's favor. An adverse-inference instruction is permissible in federal court when, as here, “there exists an ‘unexplained failure or refusal of a party . . . to produce evidence that would tend to throw light on the issues.'”[24] The Tenth Circuit has followed the Eighth Circuit's lead in considering whether the following factors are present to trigger the adverse-inference rule:

(1) it appears that the documentary evidence exists or existed; (2) the suppressing party has possession or control of the evidence; (3) the evidence is available to the suppressing party, but not to the party seeking production; (4) it appears that there has been actual suppression or withholding of evidence.[25]

         As documented above, all these factors are present here. The check registers and deposit lists for AKH existed at the time UUIC first requested AKH's net worth documents and at the time Mr. Andonian testified that UUIC would need to look at the bank statements and canceled checks to determine AKH's net worth and asset transfers. AKH had control of those documents and withheld them from production. AKH was given multiple opportunities after the initial RFP was issued in 2015 to produce the evidence or correct the record that summary documents did in fact exist, but it did not. Instead, it allowed UUIC to litigate these issues and hire an expert to make sense of the thousands of bank statements and canceled checks it produced to demonstrate AKH's net worth. By the time the summary documents were finally produced, it was too late for UUIC to conduct follow-up discovery to resolve issues and inconsistencies. An adverse inference instruction is thus warranted that when determining punitive damages, fraudulent conveyance, and alter ego liability, any inconsistencies in the check registers and deposit lists may be resolved in UUIC's favor.

         Therefore, in accordance with the rule, instead of prohibiting the use of this evidence on a motion or at trial, the Court orders as follows: (1) payment of reasonable attorneys' fees and costs in litigating this motion, and the reasonable fees UUIC incurred retaining an expert to evaluate the bank statements and canceled checks, under Fed.R.Civ.P. 37(c)(1)(A); and (2) adverse-inference instructions shall be read to the jury regarding the Counter-Defendants' failure to timely produce these records under Fed.R.Civ.P. 37(c)(1)(B), and allowing them to resolve inconsistencies in favor of UUIC. The Court finds that these sanctions appropriately and proportionally address the Counter-Defendants' failure to timely produce these financial summary documents. They compensate UUIC for its expensive efforts in deciphering massive quantities of documents associated with bank statements and canceled checks, after repeated efforts to obtain summary documentation about AKH and the Counter-Defendants' many transfers of assets during the course of this lawsuit.

         B. ...

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