The scope of discovery available in a bankruptcy case concerning a debtor's conduct, property, financial condition, and related matters is so broad that it has sometimes been likened to a permissible "fishing expedition." However, a ruling recently handed down by the U.S. Bankruptcy Court for the Southern District of New York demonstrates that there are limits to the information that can be discovered in bankruptcy. In In re Cambridge Analytica LLC, 600 B.R. 750 (Bankr. S.D.N.Y. 2019), the court denied the motion of a creditor, who was a plaintiff in nonbankruptcy derivative litigation that did not involve the debtor, for an order under Rule 2004 of the Federal Rules of Bankruptcy Procedure (the "Bankruptcy Rules") directing the debtor to provide discovery regarding its assets. According to the court, the creditor, who had purchased a nominal claim against the debtor and had not participated meaningfully in the bankruptcy case, sought discovery for the "improper purpose" of obtaining discovery in the derivative suit. Allowing such discovery, the court reasoned, would "set a very bad precedent."
Bankruptcy Rule 2004
Bankruptcy Rule 2004 provides the basic discovery mechanism in bankruptcy outside the context of a specific litigated dispute. It provides that "[o]n motion of any party in interest, the court may order the examination of any entity." Such an examination "may relate only to the acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor's estate, or to the debtor's right to a discharge." In addition, in a nonrailroad "reorganization case under chapter 11" (in addition to certain other types of case), the examination "may also relate to the operation of any business and the desirability of its continuance, the source of any money or property acquired or to be acquired by the debtor for purposes of consummating a plan and the consideration given or offered therefor, and any other matter relevant to the case or to the formulation of a plan."
Discovery may also be sought in adversary proceedings or contested matters commenced during a bankruptcy case under Bankruptcy Rules 7026–7037 (with certain exceptions and additions in contested matters, as specified in Bankruptcy Rule 9014), which incorporate many of the discovery rules that apply to other kinds of litigation in the federal district courts. These rules include specific procedures governing disclosure, witnesses, depositions, interrogatories, document production, physical and mental examinations, requests for admission, and other discovery-related matters.
As the language quoted above indicates, the scope of discovery under Bankruptcy Rule 2004 is very broad. However, although the rule has historically been regarded as permitting a "fishing expedition," a bankruptcy court has the discretion to limit discovery in certain circumstances. See generally 9 Collier on Bankruptcy ¶ 2004.01 (16th ed. 2019). Courts may limit the scope of Bankruptcy Rule 2004 examinations to prevent abuse or harassment, or where discovery is sought concerning matters unrelated to the basic inquiry of the examination. See In re Mittco, Inc., 44 B.R. 35, 36 (Bankr. E.D. Wis. 1984). If the entity from which discovery is sought believes that the examination is beyond the scope allowed under Bankruptcy Rule 2004, it may move to quash the examination. See, e.g., In re Sanomedics, Inc., 583 B.R. 796 (Bankr. S.D. Fla. 2018); In re Rafsky, 300 B.R. 152 (Bankr. D. Conn. 2003).
An exception to the broad scope of discovery under Bankruptcy Rule 2004 is the "pending proceeding rule." If an adversary proceeding or a contested matter is pending in the bankruptcy case, parties to that proceeding or matter must seek discovery under Bankruptcy Rules 7026–7037 (with certain exceptions and additions specified in Bankruptcy Rule 9014) rather than the liberal provisions of Bankruptcy Rule 2004. See In re National Assessment, Inc., 547 B.R. 63, 65 (Bankr. W.D.N.Y. 2016); In re Bennett Funding, 203 B.R. 24, 28 (Bankr. N.D.N.Y. 1996).
Courts have also refused to sanction discovery under Bankruptcy Rule 2004 when the entity requesting the examination is attempting to benefit in pending nonbankruptcy litigation. See, e.g., Snyder v. Society Bank, 181 B.R. 40, 42 (S.D. Tex. 1994) (the bankruptcy court did not abuse its discretion in denying document production under Rule 2004 where the appellant's primary motivation was to use the requested materials in state court litigation against the examinee), aff'd, 52 F.3d 1067 (5th Cir. 1995); In re Bibhu LLC, 2019 WL 171550 (Bankr. S.D.N.Y. Jan. 10, 2019) (denying Rule 2004 discovery sought by a creditor that had sued two nondebtors in state court because the creditor was seeking to use the Rule 2004 discovery for the improper purpose of obtaining discovery in the state court litigation); accord In re Enron Corp., 281 B.R. 836 (Bankr. S.D.N.Y. 2002); In re Coffee Cupboard, Inc., 128 B.R. 509 (Bankr. E.D.N.Y. 1991). However, Bankruptcy Rule 2004 discovery may be appropriate if it seeks discovery of evidence unrelated to the pending litigation. See In re Washington Mut., Inc., 408 B.R. 45 (Bankr. D. Del. 2009).
Discovery may be sought from both the debtor and third parties in a Bankruptcy Rule 2004 examination. However, if the nondebtor objects, the party seeking the examination must demonstrate "good cause." In re Wilcher, 56 B.R. 428, 434–35 (Bankr. N.D. Ill. 1985) (the examiner is required to show "some reasonable basis to examine the material sought to be discovered … [such as that] the requested documents are necessary to establish the movant's claim or that denial of production would cause undue hardship or injustice"); accord In re Millennium Lab Holdings, LLC, 562 B.R. 614 (Bankr. D. Del. 2016); In re Davis, 452 B.R. 610 (Bankr. E.D. Mich. 2011). Courts generally apply a "totality of the circumstances" or balancing test to determine whether "good cause" exists. See In re AOG Enm't, Inc., 558 B.R. 98 (Bankr. S.D.N.Y. 2016); In re Countrywide Home Loans, Inc., 384 B.R. 373 (Bankr. W.D. Pa. 2008).
Political consulting firms Cambridge Analytica LLC and SCL USA Inc. (collectively, "Cambridge") were U.S. affiliates of UK-based Cambridge Analytica Ltd. Cambridge filed a chapter 7 petition in the Southern District of New York in May 2018 to liquidate its assets after its business dropped off precipitously in the wake of revelations that Cambridge and its affiliates improperly used the personal data of 87 million customers of Facebook, Inc. ("Facebook").
Facebook's officers and directors were then defendants in a derivative action (the "Derivative Action") filed in Delaware Chancery Court. Cambridge was not a named defendant in that litigation. However, both Facebook and Cambridge were defendants in putative class actions pending in the U.S. District Court for the District of Delaware (the "DB Litigation") in which the plaintiffs (the "DBL Plaintiffs") were seeking an award of damages arising from the data breach. Facebook and Cambridge were also defendants in litigation consolidated in the U.S. District Court for the Northern District of California (the "CP Litigation") in which the plaintiffs (the "CPL Plaintiffs") alleged violations of consumer privacy laws.
In June 2018, the DBL Plaintiffs filed a motion in the Cambridge bankruptcy case for an order under Bankruptcy Rule 2004 directing the production of documents and authorizing the examination of Cambridge regarding its property and financial condition "in light of the incomplete information provided by the Debtor in this bankruptcy case to date." In their motion, the DBL Plaintiffs represented that they were not seeking documents or information with respect to the DB Litigation and that, by separate motion, they were simultaneously seeking relief from the automatic stay to file a document preservation subpoena on Cambridge to ensure the preservation—not production—of any documents related to that litigation. The CPL Plaintiffs joined in the Bankruptcy Rule 2004 motion.
The chapter 7 trustee objected, arguing that, in light of the pendency of the DB Litigation, Bankruptcy Rule 2004 discovery should be denied under the pending proceeding rule. In addition, Facebook responded that any Facebook customer information in Cambridge's possession should remain confidential.
On January 8, 2019, the court entered an order directing the chapter 7 trustee to provide the requested documents to the movants and Facebook, with the caveat that the documents could be used only for litigation purposes in connection with Cambridge's chapter 7 case and/or the CP Litigation, and implementing safeguards to ensure that Facebook's customer information would remain confidential. The court deferred consideration of the movants' request that a representative be designated for Cambridge to be examined and to produce documents.
Karen Sbriglio ("Sbriglio"), a plaintiff in the Derivative Action, purchased a $650 claim against Cambridge on March 13, 2019. Eight days afterward, Sbriglio filed a motion seeking production of the same documents requested by the DBL Plaintiffs and authorizing an examination of Cambridge under Bankruptcy Rule 2004. The chapter 7 trustee objected.
The Bankruptcy Court's Ruling
The Bankruptcy Court denied the motion. Relying on Snyder, Bibhu, and similar cases, the court concluded that Sbriglio filed her Bankruptcy Rule 2004 request for the "improper purpose" of obtaining discovery for use in the Derivative Action—litigation in which Cambridge was not a defendant. That improper purpose was confirmed, the court explained, by the fact that Sbriglio was not actually a creditor of Cambridge on the bankruptcy petition date. According to the court, that circumstance made Sbriglio "markedly different" from the DBL Plaintiffs, who asserted claims against Cambridge in the DB Litigation even before the petition date and filed their Bankruptcy Rule 2004 motion "to further their interests as creditors." In addition, unlike Sbriglio, the DB Plaintiffs had been "regular and meaningful" participants in the bankruptcy case since its inception.
Allowing Sbriglio to proceed with discovery under Bankruptcy Rule 2004, the court wrote, "would set a very troubling precedent" because it would "incentivize parties to purchase nominal claims in bankruptcy cases solely to pursue their outside litigation agendas." The court refused to countenance this ploy.
The broad discovery available under Bankruptcy Rule 2004 is an important tool designed to promote transparency, fairness, and maximization of the value of the estate in bankruptcy cases. However, Cambridge Analytica demonstrates that a bankruptcy court has the discretion to limit or deny such discovery if it is sought for an improper purpose. The brazenness of the creditor's conduct in acquiring a nominal claim for the purpose of obtaining discovery against nondebtor defendants in unrelated litigation made the court's decision a relatively easy call. Other cases calling upon the court to balance the competing considerations of broad disclosure and the pending proceeding rule may be more difficult.