E-Discovery and Legal Process Outsourcing: ESIM Process Design and Choices between Outsourcing vs. Insourcing

December 21, 2009 by Bierce & Kenerson, P.C.

State and federal rules of civil procedure and emerging common law of the discovery process impose significant costs on businesses that are engaged in litigation. Pre-trial “discovery” serves to narrow the issues in dispute by forcing the disclosure of records, including electronically stored information (“ESI”) for judicial economy, to narrow the scope of disputed issues for adjudication (such as through motions for partial summary judgment, admissions and prior inconsistent statements), and to speed the actual trial process. E-discovery has become a daily challenge for the General Counsel, the CIO, the COO and the Risk Management Department. They face a choice of policies, procedures and technologies for insourcing (such as by using forensic software and employed staff) or outsourcing for electronic records discovery management. This article explores some of the differences between insourcing and outsourcing in terms of ESI records management, legal requirements for protection and production of electronic records, project management in forensic record examination, litigation readiness, knowledge management, risk management, ethics and legal compliance.

I. E-DISCOVERY AS A SUB-PROCESS OF RECORDS MANAGEMENT.

Record and Information Management (“RIM”) Policies and ESI Management (“ESIM”). The demands of e-discovery highlight the challenges of developing and managing effective governance policies and procedures for information of all kinds, including ESI, and the challenge of adopting and updating an ESI management (“ESIM”) plan for “business as usual.” The International Standards Organization has developed a records management standard (ISO 15489-1, at www.iso.org). ARMA International (www.arma.org) has identified eight standards for records and information management (“RIM”), namely, accountability, integrity, protection, policy compliance, retrievability/ availability, retention, disposition and transparency.

Memory-storage devices have proliferated, challenging the company’s records custodian. In addition to computers, there are cell phones, cameras (stand-alone or in cell phones), scanners, facsimile machines, USB “key” drives, backup hard drives and other storage devices. All pose a challenge for a fully compliant response to an e-discovery request.

Legal Requirements for Protection and Production of E-Records. Federal and state rules of civil procedure have evolved to include electronic records. See F.R.Civ. P. 26(b), 34 and 45 (subpoenas) and F. R. Evid. 901(a) (authenticity). State procedural rules have been adopted to implement the Uniform Rules Relating to Discovery of Electronically Stored Information issued by the National Conference of Commissioners on Uniform State Laws. [Copy available at http://www.law.upenn.edu/bll/archives/ulc/udoera/2007_final.htm]. Basic common law, statutory and civil procedure rules in e-discovery start with similar requirements:

Protection: preservation of ESI through a “litigation hold” to prevent inadvertent loss when a third party demand has been made, or it has become reasonably foreseeable that such a demand will be made, and ensuring that the in-house attorney’s instruction is actually implemented (for example, avoiding the inadvertent over-writing of storage and backup tapes).
Accountability: identifying the scope and “proportionality” of the e-discovery requirements in relation to the overall scope of the dispute.
Cost allocation: allocating costs that are reasonable to the producing party and costs that are unreasonable to the requesting party.
Cost management: using search terms and other cost-effective automated search technologies to get the reasonable or “agreed” coverage for the initial triage, fulfilling the approach that information technology can solve the problem of searching massive records databases using search technologies. See, e.g., Zubulake v. UBS Warburg, LLC, 2004 WL 1620866 (SDNY July 20, 2004, Judge Scheindlin) and other rulings in the same case, at 217 F.R.D. 309 (SDNY 2003), 216 FRD 280 (SDNY 2003) and 2003 WS 22410619 (SDNY Oct. 22, 2003).
Integrity (authenticity and identification of the e-record): identifying appropriate methods and procedures for ESI production, including the appropriate level and nature of legal supervision of forensic inspections, to ensure authentication under F.R.Evid. 901(b) by using circumstantial information such as the file access permissions, file ownership, dates when the file was created and when it was modified, other metadata and hash values for the record when copied to a forensic computer for analysis.
Accessibility: under the rules of evidence: identifying and managing risks of loss of evidentiary privileges by the mere use of electronic e-discovery tools and procedures.
Accountability for Non-Compliance: identifying the sanctions for culpable conduct, mainly, “spoliation” (intentional or negligent destruction of evidence) or negligent collection done by the record custodian rather than by an automated process, such as:

judicial issuance of an instruction to the jury that the jury may validly draw a “negative inference” (or “adverse inference”) from the fact that the offending party could not produce the normally available documents in support of its legal arguments, resulting in a conclusion that, if the “lost” or “destroyed” records had been introduced into evidence, they would have supported a negative conclusion as to disputed factual matters; and

judicial sanctions including an order to pay the reasonable expenses, including attorney’s fees, caused by the violation of discovery rules, where, for example, the adverse party incurred expenses to overcome the inability to access the “lost” or “destroyed” (spoliated) records.

Project Management in Forensic Record Examination. Within a holistic approach to ESIM, e-discovery tools and techniques can be identified along the continuum of “cradle-to-grave” (or more appropriately, “cradle to judge and jury”) progress. As a sub-process of electronic records management, an e-discovery process model can be used to identify the particular role or function of third-party software, in-house resources and an outsourcer’s resources. By looking holistically at the end-to-end chain of processes leading to satisfactory e-discovery compliance, under such a paradigm, the end-result, production and presentation of ESI, can be managed by effectively adopting either a total control at the “information management” level (when records are initially created and stored). The following is our own view of electronic discovery records management (“EDRM”) as a subset of an enterprise-wide holistic ESIM resource management paradigm for governance, risk management and compliance in e-discovery:

Litigation-Readiness: Converting “Business as Usual” IT into Information Management Operations for E-discovery. Information technology plays a strategic role in the enterprise’s ability to comply with e-discovery mandates. The enterprise’s legal department should team up with the IT department, the records management department and the line-of-business management to participate in the design – or re-design – of the enterprise’s information management operations and records management. E-discovery compliance features are now available through software that can troll the enterprise’s entire ESI, search for information according to a myriad of legal and business terms, technical parameters. In conjunction with the CIO and the records management department, the legal department can:

Gap Analysis: Conduct a “gap analysis” to identify which features are missing from those that are recommended or required under the applicable rules of civil procedure and common law, particularly those policies and procedures that involve data collection, classification, accessibility, storage, retention and destruction.
Strategic Access Plan: Develop a strategic access plan for the full life-cycle of “business as usual” and custody and control, including audit, of the company’s information and litigation-relevant information.
Process Design using an ESIM Paradigm: Apply the e-discovery records management sub-process of the enterprise’s holistic ESIM model to identify and segregate functions that will be performed by in-house or captive resources and those for outside legal counsel and outsourcing service providers.
Cross-Border Considerations: Integrate multinational and cross-border legal mandates into the design of the information technology and information management systems, at an early stage in the e-discovery process, to avoid breaches of foreign data protection and privacy laws when complying with U.S. judicial rules of procedure.
Integration of Internal and External Resources: Develop policies and procedures for use of outside litigation support services providers and an array of personnel and technology resources both domestically and internationally to fulfill e-discovery compliance mandates, without adversely impacting the ongoing business operations.

Litigation-readiness must be added to the selection criteria for new IT initiatives such as “cloud computing” (here, the “software as a service” model, not the “variable IT computing-power as a service” model), internal and external social networks, Twitter and internal and external collaboration platforms such as wikis, e-rooms and Google Wave.

Knowledge-Management Readiness: Managing and Protecting Corporate Knowledge. “Knowledge management” refers to policies, procedures and technology that enable an enterprise to capture, organize, identify, re-use and protect the confidentiality of its trade secrets. Knowledge management (“KM”) procedures must also enable the enterprise to distinguish among sources of confidential information that may be trade secrets, copyrights or patents of third parties (including “freeware” and “open source” software) as well. Accordingly, CIO’s must adopt KM planning strategies that, in conjunction with legal and compliance departments, also serve regulatory and legal requirements. The IT infrastructure needs to identify all such trade secrets during the e-discovery process so that, if disclosable, they are subject to non-disclosure and non-use under appropriate protective orders.

II. RISK MANAGEMENT

Risk of Spoliation by Employees and Contractors. According to one e-discovery service provider, a large majority of all corporate litigation is employment-related. If employees have access to change ESI, disgruntled or negligent employees pose a major risk of spoliation. Employees can unknowingly or intentionally destroy ESI evidence. Such actions can range from concealment (through downloading pirated software that deletes files on the employee’s web surfing history) to sabotage (actually deleting documents).

As a result, the legal department and the CIO need to develop IT-enabled solutions to prevent such acts. This article does not address this particular issue, but it highlights the need for appropriate design of the overall information management architecture as a preventive measure.

Risk Management. From the risk-management perspective, a proper defensive strategy will require an alliance between the company’s Legal Department, its Risk Management department and its IT department.

IT Role. The IT department needs to work with the Legal Department to ensure a proper chain of custody and proofs of authenticity.
Insurance. The Risk Management Department needs to help design and review the e-discovery process. Sanctions for spoliation have implications for coverages for directors and officers, employment practices, errors and omissions and general liability. The records manager needs to understand how the company’s Records Management (destruction) Policy meets e-discovery requirements.
Legal Department. The in-house Legal Department must not only manage the e-discovery process. It must design and manage effective records management policies, educate all employees about the e-discovery process and its role in management of risks, knowledge and records.

III. BUSINESS MODELS: INSOURCING, CAPTIVES AND OUTSOURCING

Business Models for Insourcing. Before comparing outsourcing and insourcing, it is helpful to consider the different business models in which an internal e-discovery operation can be financed. These models can be summarized:

Infrastructure Investment in a Complete e-discovery Toolkit. At the “high end,” the enterprise can make a capital investment in the essential tools of a fully “in-sourced” e-discovery operation. Such an investment will have significant payback for enterprises having a high volume of litigation with predictable volumes of e-discovery demands. Such enterprises will need to invest in all the people, process and technology necessary for the operation. If the operation is highly automated, it can be effectively managed onshore. If it requires substantial human review, part of the operation may be handled in offshore locations with remote access, security controls and other measures to prevent loss of confidentiality, competitive advantage and effectiveness. This leads to consider a captive e-discovery service delivery center. In this case, outsourcing can be a viable solution for that portion of the e-discovery process that requires supervised human review and analysis.
Pay-Per-Use Pricing. Where litigation is more volatile in terms of volume and timing, a “pay-per-use” pricing for insourced use of third-party technologies can prove cost-effective. This pricing model provides some benefits to enterprises that have very few litigations, but a large volume of ESI for assembly, analysis, protection and disclosure.
Consumption-Based Pricing. Consumption-based pricing reflects the volume of ESI being sorted and analyzed. This pricing model provides benefits for enterprises that want to allocate litigation costs to individual lines of business or affiliated companies, as a charge-back accounting principle that effectively rewards litigation-free business managers for staying away from the judicial system.

Relative Advantages of Insourcing.

Industries Affected by Persistent Litigation. Several software tools exist that allow in-house counsel and the CIO to conduct the full forensic discovery using staff employees. Internalization of the discovery process makes economic sense where the company is constantly involved in litigation. Such companies typically include insurance companies, banks, consumer products manufacturers, and can include food service chains and franchisees. Other companies that are subject to class action claims for torts or securities law violations can fall into this category as well, impacting virtually any publicly traded company that has a volatile stock price.
Control of Records Management; Cost Management. Software and IT services companies argue that insourcing can significantly reduce the costs of e-discovery. They argue that, by taking control of the forensic search, collection, analysis and processing of a company’s electronic records, companies have more flexibility and control over the manner in which these critical discovery processes are conducted. This control can translate into cost savings by enabling a closer supervision on-site by the internal lawyers.Cost savings must be compared to comparable external services.Cost savings that might arise from an easier ability to make small changes in the search criteria, for example, may result in a loss of the hard-wired “e-discovery plan” that serves as the basis of justifying to the court that the discovery disclosures comply with civil procedure to locate and disclose all relevant records.
Protection of Trade Secrets and Intellectual Property. Insourcing, or using captives, can provide a significant level of additional protection for knowledge management, trade secrets and intellectual capital. Such protection comes at the cost of maintaining internally controlled resources. Outsourcers will claim that their security levels are higher than those in many global enterprises. Outsourcers offer personal non-disclosure covenants by individual employees. But there is always a risk, whether through insourcing or outsourcing, that the personnel having access to trade secrets, for example, might abuse their positions of trust through tipping a securities investor, selling the ideas to a competitor of the enterprise or other tortious conduct. Even a non-disclosure agreement does not constitute a valid non-competition covenant, and even non-competition covenants are unenforceable as a matter of public policy unless strictly limited in time, territory and scope, and (in California and some other jurisdictions) they may require additional payments of consideration. In short, neither insourcing nor outsourcing appears to have a clear advantage in this field, except that e-discovery managers who are employed by the enterprise might offer an advantage by having ongoing knowledge of what is (and is not) a trade secret for faster, better, “cheaper” claims to a protective order.
Effectiveness of Coordination and Collection of ESI. The use of skilled internal people who know the company’s operations may be able to provide better collection and coordination of ESI. However, “professional” e-discovery service providers may have the advantage in skills at the beginning as the company’s internal personnel become familiar with the processes and technology of e-discovery. Hence, insourcing might follow outsourcing until the processes can be internalized.
Reduction of Risks of Noncompliance with e-discovery Rules. Well-trained, well-supported internal personnel might be able to reduce risks of non-compliance in the typical e-discovery process.

Relative Advantages of Outsourcing e-discovery. Outsourcing of e-discovery processes may be costly, but it may be the best solution for several reasons. This requires an analysis of the relative merits. This “gating analysis” should include appropriate considerations of staffing, quality, ethical risks and speed.

Staffing. One of the key benefits of outsourcing, and one of the key parameters in selecting the right outsourcing service provider, is the service provider’s staff. The best outsourcers have developed a methodology for human capital management in the specialized field of e-discovery and related disciplines. The outsourcer designs a service delivery platform, recruits, trains and tests its staff in generic functions (including project management, information technology and security) and then offers this staff for custom-training on the litigating company’s particular process and e-discovery requirements.Using a business company to provide litigation support can run afoul of ethics and disciplinary rules applicable to the litigating company’s (or its law firm’s) lawyers. Law society rule in England will be changed if and when a pending draft law is modified to permit competent non-lawyers to perform tasks that might be considered the practice of law. Under applicable ethics opinions of the American Bar Association and various city and state bar associations, the in-house lawyer or outside law firm cannot escape certain core ethical duties:

to supervise the work of the outside service provider;

to avoid assisting in the unauthorized practice of law (“UPL”)

to ensure the protection of client confidences;

to avoid waiving any rule permitting a claim of legal privilege (and to rectify innocent or mistaken disclosures, see e.g., Fed. R. Evid. 502);

to avoid conflicts of interest;

to protect against data loss, theft or other act or omission that might constitute sanctionable spoliation;

to comply with the rules of court relating to e-discovery and management of ESI at all stages.

Vendor selection involves finding the right fit for the particular litigating company’s legal, regulatory, compliance, privacy, legal ethics and security requirements.

Service Level Metrics and Quality Considerations. Few internal employees want to live by performance metrics. Outsourcers live by “guaranteeing” service metrics and other quality parameters.

Offshoring Issues. In considering an offshore captive or an offshore LPO outsourcing, the company’s lawyers must evaluate special cross-border legal issues.

Export Controls. By transferring any U.S. data abroad, the company may require a license from one or more branches of the U.S. government. While commercial information may be subject to a general export license that does not require any notification, filing or administration, some information (such as software or design information that may have dual civilian and military uses) may require a specific license. Similar issues arise where the company’s ESI includes trade secrets, pending patent applications and other information that is subject to a required export license.
Data Protection. Data protection rules under HIPAA and other legislation may apply to the data being processed. Foreign LPO service providers must ensure compliance.
Privacy. Privacy rights arise from many legal sources and different jurisdictions. Depending on the source of any personally identifiable information (“PII”), any transfer of company records to a foreign LPO service provider may violate applicable rules. This issue suggests a proactive approach in the design and implementation of the company’s overall information management systems.
Third-Party Consent. The information in a company’s database may include information that is licensed under restrictive disclosure conditions or where a third-party’s consent is required by an applicable law. Third-party consent may be required.
Client Consent. The information in a company’s data base may also require the client’s consent
Political Risk. Foreign service providers come with a suite of political risks that could impair service quality, timeliness of service, confidentiality and other custody and control issues for the ESI and the foreign nationals accessing such ESI.

IV. PROJECT MANAGEMENT

Most effective e-discovery procedures will require effective integration of internal and external resources. The design, planning, implementation, performance, intermediate re-balancing and supervision of all resources remain, of course, in the hands of the company, and, in particular, in-house attorneys. The Legal Department (which is ultimately responsible) may wish to consult with “outsourcing lawyers” not merely with litigation counsel on achieving a flexible, cost-effective, efficient design, vendor selection and supervision, review of compliance with ethics rules and project management.

Evaluation Process. Companies evaluating an LPO solution for e-discovery (or any other LPO) should therefore carefully explore all relevant implications, design the program for compliance and quality of service, address special issues involving any cross-border data flows and other commercial, judicial rules, legal and ethical requirements.

Project Management Roles. Each LPO project requires thoughtful and careful attention to ensuring that all responsibilities of the different parties are aligned with their roles. Within the outsourcing model, there is room for designing and allocating roles and responsibilities to give in-house attorneys control of the process so that they can manage the ethical responsibilities. The introduction of the LPO service provider raises new questions whether the cost-controlling measures will impair (or improve) the quality of the outcome. External lawyers could also manage the service providers.

V. BUSINESS MODELS

Business Models. Currently, most LPO e-discovery services are conducted under business models of insourcing (including contract attorneys), captives and outsourcing.
New Models. Over time, companies and their legal counsel will become more familiar with the tools, alternatives and strategies for effective LPO, including identifying and assessing risks and evaluating a risk-benefit matrix. With greater maturity in capabilities, new business models for identifying and managing e-discovery processes, tools and personnel may evolve. The impact of cloud computing, platform-as-a-service, software-as-a-service, virtualization of both servers and client computing and mobile computing will challenge enterprises and their technology and legal service providers to integrate a holistic and global ESIM process to incorporate the EDRM subset as “business as usual.”

Filed under: Newsletter Article, White Paper
Tagged: Accessibility, Accountability, Agreement, cloud computing, Cost allocation, Cost management, data protection, dispute resolution, e-discovery, ethics, Insourcing, integrity, Knowledge-Management, Memory-storage devices, outsourcing, Policies and ESI Management, privacy, Protection, Record and Information Management, risk management, sourcing

When is a Contractual Limitation of Liability Invalid and Unenforceable? American Public Policy Exceptions to Exculpatory Clauses in Telecommunications

December 21, 2009 by Bierce & Kenerson, P.C.

An essential element of risk management in any commercial contract for the sale of services or goods is the clause limiting the vendor’s liability.

In the sale of goods, the policy limitations are set forth in the Uniform Commercial Code, which invalidates clauses that deprive the customer of an “essential remedy” or the clause is part of an abuse of a consumer under a contract of adhesion, and under the federal Magnuson-Moss Warranty Act and similar state laws. In the sale of services, the policy limitations reflect common law, which may include a judicial analysis of regulations and the fundamental nature of the relationship between the service provider and the enterprise customer.

A decision by a New York State Supreme Court judge in November 2009 highlights the limits on exculpatory clauses under American jurisprudence under principles of gross negligence, willful misconduct, “special duty,” breach of the implied covenants of good faith and fair dealing and prima facie tort. In addition, other legal theories – such as fraud, intentional interference with business relationship, negligent misrepresentation, breach of the implied duty of good faith and fair dealing and prima facie tort – might not be available to enterprise customers for a simple failure by the service provider to deliver proper accounting information relating to its services. So the “special relationship” theory (described below) merits special attention.

This court decision is a stark reminder that the autonomy of contracting parties is always limited by public policy. Enforceability of contracts thus must include contract planning and negotiation, express limitations on remedies and conformity to public policy exclusions that invalidate certain exculpatory clauses. This interplay sets the framework for risk allocation, contract pricing, performance standards, dispute resolution and competitive strategy for the enterprise customer and the service provider.

I. The “Special Relationship” among Telecom Carriers

The Duty of Connected Telecommunications Carriers to Each Other. In this case, Empire One Telecommunications Inc. v. Verizon New York Inc. (__ N.Y.S.3d ____, Nov. 2, 2009 NYLJ, p. 21, cols. 3-4), Justice Carolyn E. Demarest ruled that one service provider cannot rely upon its exculpatory clause when it has a special duty due to a special relationship with its customer. The decision goes beyond a simple analysis of claims that include gross negligence and willful misconduct, which have long been judicially viewed as exceptions to the normal rule that contractual limitations of liability are enforceable.

Historical Monopoly, Regulated for Competition. The Empire case reflects special character of telecommunications services as a regulated utility. In the Empire One case, Verizon and Empire One were competitors. By virtue of the historical breakup of the prior monopoly held by AT&T over a decade before, Verizon controlled the transmission equipment and lines that carried the telecommunications for Empire’s customers. Under the Telecommunications Act of 1996, 47 U.S.C. 151 et seq.), Verizon had a statutory duty to provide certain telecommunications services to competitors like Empire. Empire was a reseller of Verizon services. Empire was allowed by federal law to interconnect its own network (and other networks) with the Verizon network.

Implied Duties. Under the Telecommunications Act of 1996, Empire was entitled to control the business relationship with the ultimate consumer because Empire enrolled them as its customers and Empire’s own equipment delivered the final connection to the customer. Verizon was carrying calls that were originated with other carriers (such as but not limited to Verizon) that terminated using Empire equipment. Under the Telecommunications Act of 1996, as terminating carrier, Empire is entitled to bill the customer for the service and make a profit by charging the interconnecting carriers that originated the calls for using Empire equipment to deliver the “last mile” termination services. All calls are logged into the billing system of Verizon, since it acts as traffic controller. Verizon equipment, as the glue of the telecom system, is capable of providing information on date, time, origination and destination and the duration of calls as well as codes (LATA identifiers, a valid settlement code, a valid originating local routing number and other validation codes used in billing) that enables interconnecting carriers to bill each other for services.

Failure to Provide Billing Records. Empire complained that Verizon had manipulated the call records that it delivered to Empire by stripping essential information needed for Empire to bill other carriers. Empire alleged that Verizon rendered the call records “useless for the very purpose for which they are intended”. Empire complained that such omissions prevented Empire from determining the originating jurisdiction or the types of telephone calls (mobile, land-line), thus depriving Empire of the ability to charge the originating carrier for the termination services by Empire.

Damages. Empire alleged its losses from 2004 to 2008 were approximately $2,500,000 in lost revenue plus approximately $160,000 in payments to Verizon for unusable billing records covering over 15 million telephone calls. The Empire court provided a refresher course in the liability that a breaching party is deemed to assume. A breaching party “is liable for those risks foreseen or which should have been foreseen at the time the contract was made.” Ashland Mgt. v. Janien, 82 NY2d 395, 403 (1993), quoted at Empire, page 22, col. 1.

Elements of a “Special Relationship.” The decision focused on the conditions that established a “special relationship” between one telecom carrier to another that used its telecom transport facilities (the equipment and the lines) for a fee. The decision focused on the statutory structure regulating public utilities for the public benefit, which, the court held, supports a finding of a “special relationship” between the service provider with a monopoly over the billing records and the service provider that needed the billing records to bill other carriers. “Public policy as reflected in the regulatory structure would also mitigate against enforcement” of the exculpatory clause. The concept of “special relationship” has precedents under prior New York judicial decisions where a public utility fails to perform its duty to furnish reliable service.

Unequal Bargaining Power. Verizon argued that there is no “special relationship,” and therefore the exculpatory clause is valid, where the service contract was negotiated by two sophisticated parties who negotiated in a commercial setting. Rejecting this argument, the court ruled there was clearly an inequality in bargaining power between the two public utilities since, in this case, the terms were not actually negotiated. To promote the public interest under the Telecommunications Act of 1996, the court said, Empire as customer should be afforded the “protection generally due a consumer when dealing with a utility with monopolistic control of the desired service.”

Published Tariff Filing. The general public policy against exculpation of gross negligence and willful misconduct was also written into the particular tariff that Verizon had filed with the public utilities commission.

Service Provider’s Termination of Service following Unresolved Billing Dispute. Other precedents under New York law dealing with Verizon’s wrongful refusal to provision telecom services have ruled that Verizon is liable for consequential damages to a reseller of telephone services over lines provided by Verizon where (i) Verizon had billed and actually been paid for a telephone feature that it had not actually provided (a “billing error”), (ii) the customer stopped paying for the feature allegedly not provided, and (iii) Verizon cut off the reseller from its network for non-payment. The court allowed the reseller to pursue lost profits as consequential tort damages for gross negligence or willful misconduct.

II. Other Classic Causes of Action when the Service Provider Fails to Perform Proper Accounting Services for its Services Performed

Gross Negligence. Under New York precedents, “gross negligence” must “smack of intentional wrongdoing.” Kalisch-Jarcho, Inc. v. Cit of New York, 58 NY2d 77, 385 (NY 1983). Gross negligence evinces a “reckless indifference to the rights of others.”

Fraud. Fraud involves (i) a false misrepresentation as to a material fact, (ii) an intention by the defendant to deceive the plaintiff by such false misrepresentation, (iii) justifiable reliance by the plaintiff on the misrepresentation, and (iv) damages caused by plaintiff’s reliance. Empire claimed each of these elements but the court dismissed the fraud claim since fraud claims cannot be used to duplicate the same elements of a breach of contract, where the fraud claim was “collateral to the contract” and not based on the same facts alleged as to the breach of contract. A fraud claim is insufficient if it merely alleges that a misrepresentation of an intention to perform services under the contract.

Implied Duty of Good Faith and Fair Dealing. Under common law, there is an implied duty of good faith and fair dealing in the performance of contractual obligations. Here, Empire’s claim that Verizon breached this duty was dismissed since it was equivalent to a claim for breach of contract.

Tortious Interference with Business Relations. In the Empire case, Empire as CLEC customer claimed that Verizon as service provider had interfered with Empire’s business relations by its failure to provide the call data needed to enable Empire to bill its interconnect customers. This legal theory requires the injured party to allege and prove (i) the existence of the actual or prospective business relationship with a third party, (ii) the defendant, having actual knowledge of that relationship, intentionally interfered with it; and (iii) the defendant either acted with the sole purpose of harming the plaintiff or used means that were dishonest, unfair or improper, and (iv) the defendant’s conduct thus injured the plaintiff’s business relationship.

In the Empire case, this legal theory was unsupported. Empire was unable to validly claim that Verizon’s failure to provide interconnect customer billing information was directed to harm Empire’s customers, not merely to harm Empire. The court noted that Empire merely alleged that it was unable to invoice interconnect carriers for transiting its network due to the invalid and inadequate call records that Verizon sells to it. “Empire’s inability to bill these third–party carriers, however, would not induce these carriers not to do business with Empire.” Hence, Empire was unable to sustain a claim of intentional interference with business relationship.

Negligent Misrepresentation. Empire also claimed that Verizon was liable for consequential damages due to Verizon’s negligent misrepresentation. Such a claim depends on alleging and proving three requirements: (i) the existence of a special relationship or privity-like relationship that imposes a duty on the defendant to impart correct information to the plaintiff, (ii) the fact that the information was incorrect, and (iii) the plaintiff reasonably relied on the information to its detriment. It is a question of fact whether there exists a “special relationship” sufficient to justify plaintiff’s legitimate expectation that the information would be true and accurate. In this case, the tariff and the contract were worded in a manner that denied this type of special relationship to Empire.

Prima Facie Tort. Empire unsuccessfully alleged that Verizon was liable for “prima facie” tort, a unique common law tort theory under New York law. The requirements for alleging and proving such a cause of action include (i) the intentional infliction of harm, (ii) which causes special damages, (iii) without any excuse or justification, (iv) by an act or series of acts that would otherwise be lawful, and (v) that the disinterested malevolence was the sole motivator for the defendant’s harm-causing conduct. Empire failed to allege the last point, which it probably could not prove since reaping unfair profits is not an act of malevolence but rather an act of greed.

III. Lessons for Everyone

The Empire One decision was framed in the area of telecommunications and invoicing. Separate from the area of regulated public utilities, it offers nonetheless several practical lessons for structuring an outsourcing agreement:

Exculpation is Limited. Public policy exceptions for gross negligence and willful misconduct are implied in every contract, whether or not included contractually.
Mutually Agreed “Special Relationship.” A “special relationship” may exist, and the service provider’s exculpation might not be valid or enforceable, where the enterprise customer depends on the service provider to provision the service,
Mutually Agreed Consequences. As a contracting matter, the parties should identify the consequences if the service provider suspends service while there is a dispute over adequacy of its provisioning of services, over billing for past services and for the customer’s inability to obtain alternative services in the spot market without consequential damages.
F&A Services: Special Negotiating and Drafting Issues. Legal theories of fraud, intentional interference with business relationship, negligent misrepresentation, breach of the implied duty of good faith and fair dealing and prima facie tort do not give any remedy to the enterprise customer that loses revenue from an inability to use the service provider’s billing records to invoice its own interconnect customers. For “finance and accounting” outsourcing, this lesson means that inaccurate or insufficient accounting services need to be identified as a breach, and the quantum and conditions of “damages” for “direct damages”.

Filed under: Case Study, Newsletter Article
Tagged: contracting, Contracts, dispute resolution, enterprise customer, Gross Negligence, management, risk management, Special Relationship, telecommunications

Courts of India as an Inconvenient Forum: Impact of Long Delays in Access to Court Procedure

October 9, 2009 by Bierce & Kenerson, P.C.

“Justice delayed is justice denied.” Enforcement of contract rights depends on a viable system that not only applies the rule of law, but does not delay the application of law to the aggrieved party’s petition for judicial redress. In one recent judicial decision in New York, the court addressed the question whether a possible ten year delay in adjudication in the courts of a foreign country was a sufficient balancing factor to justify retention of the case in New York rather than in the foreign forum. The foreign forum was India.

Forum Non Conveniens.

Under the basic principle of judicial jurisdiction, a court may exercise its competency to adjudicate disputes. Competency derives from the applicable constitutional delegation of authority to adjudicate, as well as the existence of a sufficient connection between the parties, the subject matter or the location of the events in dispute.

Under the common law system, courts have adopted the principle that they will not exercise their jurisdiction in all situations. They have adopted the principle of “forum non conveniens”, or “inconvenient forum,” to send the adjudication of the dispute to another forum that has a greater connection, a greater public interest or tighter connection with the subject matter and/or the parties.

Under New York law, the factors to be considered in a defendant’s motion to dismiss include:

the burden on the New York courts.

the potential hardship to the defendant.

the unavailability of an alternative forum in which the plaintiff may bring suit.

the fact that both parties are nonresidents of New York.

the fact that the transactions out of which the cause of action arose occurred primarily in foreign jurisdiction.

No one factor is decisive. Islamic Republic of Iran v. Pahlavi, 62 NY2d 474, 479 (cert. denied 469 U.S. 1108).

Delays in India as Basis for Denial of Motion to Dismiss.

In a dispute concerning the interpretation of a letter of credit, the New York Supreme Court, Appellate Division, ruled that a trial court must consider factors in addition to the fact that the courts of India are clogged for many years. The case involved a letter of credit issued in India to the Japanese seller of commercial goods.

The plaintiff, a Japanese corporation with principal offices in Japan, submitted an opinion of Bhupinder Nath Kirpal, a former Chief Justice of India, who expressed his conclusion that because of the huge backlog of existing cases, the fact that no preference is given to commercial cases or newly submitted cases and the shortage of judges in India, it would take the New Delhi High court at least ten years to decide this type of case.

In contrast, the defendant bank tendered an affidavit of Aziz Mushabber Ahmadi, another former Chief Justice of India, explaining that India provides an adequate alternative forum, and that the Indian Code of Civil Procedure had been amended in 1999 and 2002 in order to expedite the resolution of commercial matters. Former Justice Ahmadi expressed the view Indian courts could dispose of a commercial case within a year. Another reference suggests that the case could be disposed of within one to three years.

The trial court in New York relied on the delays in India and the fact that the Indian defendant has an office in New York. Consequently, the trial court retained jurisdiction, denying the Indian defendant’s motion to dismiss for inconvenient forum.

Other Factors.

On appeal, the Appellate Division overruled the lower court for not considering any other factors.

Interpretation of Foreign Law; Need for Expert Testimony.
The New York appellate court considered that the need to interpret foreign law outweighed the risk of a lengthy delay in the foreign court system.

…[The motion court failed to consider the burden of having to interpret Indian banking law. The applicability of foreign law is an important consideration in determining a forum non conveniens motion [citation] and weighs in favor of dismissal [citation], given that expert testimony is essential. NYLJ, May 24, 2004, p. 31, at cols. 3-4 (1st Dept. May 18, 2004).

Comity and Interest of Foreign Courts.
The New York appellate court also underscored the importance of the principle of judicial restraint in respect of the public interest of foreign courts and foreign legal systems. This principle of restraint, adopted early in U.S. judicial history with Marbury v. Madison, serves to enhance the respect of foreign courts for judicial decisions of New York courts reciprocally under the principle of comity. Thus, in considering a motion to dismiss for forum non conveniens, New York courts should:

defer to India’s interest in resolving its own affairs. New York courts have recognized that where a foreign forum has a substantial interest in adjudicating an action, such interest is a factor weighing in favor of dismissal. [Citation.] As the affidavit of former Chief Justice Ahmadi noted, Indian courts are keenly interested in governing the affairs of its financial institutions to insure uniformity and consistency in the processing of financial transactions and in the interpretation of Indian banking statutes and laws.

In conclusion, the appellate court ruled that the lower court erred in concluding that India was not an adequate forum because of the delays in its court system. The lower court had relied on an earlier decision finding that delays in Indian courts were from 15 to 20 years. That earlier decision had been decided before the Indian judicial procedure reforms in 1999 and 2002.

Lessons in Outsourcing.

This decision highlights the critical importance of properly drafting dispute resolution clauses in outsourcing contracts.

Foreign Governmental Interest.
While the dispute related to letters of credit, the appellate court noted the critical interest of Indian courts in adjudicating matters relating to “processing of financial transactions.” The same interest could be said to exist for virtually any IT-enabled transaction processing in India. This covers all business process outsourcing.
Choice of Law.
This decision relates to interpretation of foreign law. Parties to international commercial contracts in outsourcing should understand the applicable law and its role in the decision-making process under the principle of forum non conveniens.
Choice of Forum.
This case underscores the need for the parties to choose the relevant forum. The New York decision did not have any discussion of the terms of the Indian bank’s letter of credit. This litigation might have been avoided if the letter of credit had not only identified the mutually chosen applicable law, but also a mutually agreed exclusive forum for resolution of the disputes. Perhaps the issuing bank chose not to include that choice of forum in its letter of credit terms, possibly due to the pre-reform decisions that had adjudicated that Indian courts were not a viable solution to dispute resolution.
Guarantees.
A guarantee is a contractual obligation to pay money or perform certain acts under pre-defined conditions. In this situation, the dispute related to a bank guarantee in the form of a letter of credit. In outsourcing, enterprise customers should consider the availability and suitability of possible guarantees of performance. In view of the recent infamous bankruptcies of Enron and WorldCom, service providers may also take note of the possible value of guarantees of payment by the customer, or alternative contractual provisions assuring the service provider of its own rights of enforcement or alternatives to judicial enforcement.
Role of Arbitration.
An arbitration clause may overcome issues of forum non conveniens. But arbitration still retains the risk (albeit small) of non-enforcement under the rules governing recognition and enforcement of foreign arbitral awards.
Role of Offshore Judicial Reform in Offshore Outsourcing.
This case is a beacon and warning for foreign governments that have byzantine, poorly administered, politically influence or backlogged judicial systems. If your government wishes to promote exports of services, you should offer a judicial system that is accessible and viable as an alternative forum under the principle of forum non conveniens. In the absence of a credible judicial system, your service providers will be forced into courts such as those of New York, and the customary international financial and practical guarantee structures in offshore outsourcing transactions might serve as barriers to entry for new service providers. Development of a credible judicial system does not occur overnight, but failure to make steps in that direction may retard economic development.

Decision:

Shin-Etsu Chemical Co., Ltd. v. ICICI Bank Limited, __ N.Y.S.2d __, NYLJ May 24, 2004, p. 18, cols. 1-6, p. 31, cols. 1-6 (1st Dept. May 18, 2004), by Sullivan, J. (Docket No. 3033).

Published: May 26, 2004

Filed under: White Paper
Tagged: arbitration, dispute resolution, enterprise customers, foreign law, India, IT-enabled transaction, service providers