The US Court of Appeals for the Second Circuit rejected a sanctioned party’s position that sanctions must be proportional to either the value of the evidence uncovered by remedial measures or the ultimate value of the case, and upheld discovery sanctions that amounted to greater than 100 times the district court’s appraisal of the likely damages in the case. Klipsch Group, Inc. v. ePRO E-Commerce Ltd., Case Nos. 16-3637; -3726 (2d Cir., Jan. 25, 2018) (Lynch, J). In doing so, the Court adopted a standard that “discovery sanctions should be commensurate with the costs unnecessarily created by the sanctionable behavior.”

At the district court, Klipsch, a manufacturer of sound equipment (including headphones), sued ePRO, alleging that ePRO sold counterfeit versions of its products. ePRO did not dispute that it sold some infringing products, but consistently presented evidence showing that the total infringing sales amounted to $8,000. Klipsch argued that the figure was closer to $5 million. Actual damages were subject to trebling.

During the course of discovery, ePRO engaged in a series of discovery abuses. ePRO initially failed to timely disclose the majority of responsive documents in its possession. Once this came to light, it agreed to retain a discovery vendor. Although the vendor discovered thousands of previously unproduced documents, there were indications that ePRO had artificially restricted the vendor’s access to electronic records. ePRO also failed to impose an adequate litigation hold, even after the court directed it to do so, and its custodians deleted thousands of documents, some permanently. As these and other abuses unfolded, the magistrate judge authorized various remedial measures, which included allowing Klipsch to take a second round of depositions and to undertake an independent forensic examination of ePRO’s computer systems.

Although the additional discovery failed to reveal any smoking gun, it confirmed that the infringing sales were unlikely to exceed the $8,000 figure posited by ePRO. The district court concluded that ePRO had engaged in willful spoliation, and granted Klipsch’s motions for (1) $2.7 million in sanctions to compensate for its corrective discovery efforts, (2) an asset restraint against ePRO in that amount, and (3) both permissive and mandatory jury instructions. The district court also found that ePRO represented a dissipation risk, and granted Klipsch’s request for a $2.3 million bond to preserve Klipsch’s ability to recover damages and fees at the end of the case. ePRO filed an interlocutory appeal challenging the district court’s evidentiary rulings and factual findings, contending that the sanctions were impermissibly punitive because the additional discovery did not support increased damages and the sanctions themselves were disproportionate to the likely value of the case.

The Second Circuit rejected ePRO’s argument, noting that at the time of the offending conduct, neither Klipsch nor the district court could have known what evidence the corrective measures would ultimately uncover. However, in light of ePRO’s conduct, it was reasonable for both to suspect that ePRO had concealed damaging evidence. The Court emphasized that the purpose of the sanctions was not to reward Klipsch for successful litigation but rather to compensate Klipsch for costs that it had reasonably incurred but should not, and otherwise would not, have had to bear.

Practice Note: ePRO’s experience presents a cautionary tale. Although damages in this matter were not likely to exceed $24,000, the Second Circuit approved restraints totaling $5 million. ePRO’ s conduct not only resulted in needless additional discovery and litigation, but damaged its credibility with the court and ultimately cost the company far more than it stood to lose in the underlying litigation.