Xyngular, Corp. v. Schenkel , 890 F.3d 868 ( 2018 )


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  •                                                                        FILED
    United States Court of Appeals
    PUBLISH                       Tenth Circuit
    UNITED STATES COURT OF APPEALS                  May 15, 2018
    Elisabeth A. Shumaker
    FOR THE TENTH CIRCUIT                      Clerk of Court
    _________________________________
    XYNGULAR, a Delaware corporation,
    Plaintiff Counter Defendant -
    Appellee,
    v.
    MARC SCHENKEL, an individual,
    Defendant Counterclaimant Third-
    Party Plaintiff - Appellant,                  No. 16-4193
    v.
    RUDY REVAK, an individual; MARY
    JULICH, an individual; STEVE KOLE,
    an individual; MARC WALKER, an
    individual; BRUCE JENSEN, an
    individual; DAN MURPHY, an
    individual; RUSSELL FLETCHER, an
    individual; JIM NORTHROP, an
    individual; ROBERT SPANGLER, an
    individual; SYMMETRY
    CORPORATION, a Delaware
    corporation; GLOBAL VENTURES
    MANAGEMENT SERVICES LLC, a
    Delaware limited liability company;
    ALYTIS, LLC; GLOBAL VENTURES
    PARTNERS,
    Third-Party Defendants - Appellees.
    _________________________________
    Appeal from the United States District Court
    for the District of Utah
    (D.C. No. 2:12-CV-00876-RJS-PMW)
    _________________________________
    Stephen Q. Wood (Mary Anne Q. Wood, with him on the briefs), Wood Balmforth LLC,
    Salt Lake City, Utah, for Defendant Counterclaimant Third-Party Plaintiff - Appellant.
    Mark F. James, Hatch, James & Dodge, P.C., Salt Lake City, Utah (Mitchell A. Stephens
    and Justin L. James, Hatch, James & Dodge, P.C., Salt Lake City, Utah, with him on the
    brief for Plaintiff Counter Defendant-Appellee, and Stephen E. W. Hale, Laura G.
    Kennedy, Matthew J. Ball, and Rita M. Cornish, Parr Brown Gee & Loveless, P.C., Salt
    Lake City, Utah, with him on the briefs, for Third-Party Defendants - Appellees), for
    Plaintiff Counter Defendant-Appellee.
    _________________________________
    Before BRISCOE, SEYMOUR, and LUCERO, Circuit Judges.
    _________________________________
    LUCERO, Circuit Judge.
    _________________________________
    Marc Schenkel appeals the dismissal by the district court of his claims against
    Xyngular Corporation and various third parties as a sanction for abuse of what he
    claims was pre-litigation discovery. Because we have not previously decided
    whether pre-litigation conduct that did not give rise to the substantive claims in a
    case is sanctionable by dismissal of a party’s claims, the issue remains an open
    question in our circuit. We conclude that termination sanctions are permissible when
    pre-litigation conduct is aimed at manipulating the judicial process and is unrelated
    to the conduct that gave rise to the substantive claims in a case. Because the district
    2
    court did not abuse its discretion in concluding that these conditions were met in the
    present case, we exercise jurisdiction under 
    28 U.S.C. § 12911
     and affirm.
    I
    Xyngular Corporation, a marketing company, was formed in 2009. Schenkel
    worked at Xyngular from the company’s inception, performing various services in
    exchange for an ownership interest. In 2010, the relationship between Schenkel and
    Xyngular’s directors soured. Schenkel believed the company was paying excessive
    amounts to Symmetry and Global Ventures Management Services (“GVMS”),2 two
    entities that were owned by the Xyngular directors and performed certain services for
    Xyngular. Believing that these activities amounted to illegal self-dealing, Schenkel
    sent Xyngular a demand letter on September 1, 2011, in which he asked the Board of
    Directors to investigate. He also requested that the Board pursue claims against
    certain Xyngular employees for misappropriation of corporate assets, corporate
    waste, self-dealing, and usurpation of corporate opportunities. Between mid-2010
    and mid-2011, Schenkel asked Ian Swan, who was a Xyngular shareholder and IT
    consultant at GVMS, to gather documentation regarding the suspected self-dealing
    and the number of shares to which Schenkel was entitled. In October 2011, Swan
    began to provide Schenkel with the requested documents.
    1
    Pursuant to Rule 54(b), the district court entered final judgment on
    Schenkel’s counterclaims and third-party claims, permitting Schenkel to appeal its
    interlocutory ruling and staying the remaining proceedings pending this appeal.
    2
    GVMS has since changed its name to Altyis.
    3
    On September 13, 2012, Xyngular filed suit against Schenkel, seeking a
    declaratory judgment that he was entitled to only two thousand shares and that his
    position as Master Distributor was terminated along with any accompanying rights.
    Xyngular also alleged that Schenkel committed corporate waste and misappropriated
    corporate resources. Schenkel responded by asserting a number of counter-claims
    and third-party claims. He argued that he was entitled to 2,600 shares, a permanent
    seat on Xyngular’s Board of Directors, and a non-terminable position in Xyngular’s
    distribution chain. He also alleged that Xyngular’s directors had engaged in self-
    dealing, concealed the presence of lead in the company’s products, and perpetuated
    sales tax fraud committed by Symmetry. Schenkel attached several documents he
    received from Swan as exhibits to his original answer, counter-claim, and third-party
    complaint.
    Schenkel subsequently sought a temporary restraining order (“TRO”) to
    restore his ownership interest, restore his seat on the Board of Directors, and prevent
    the Xyngular directors from looting the company. During a hearing on the TRO
    request, Xyngular’s counsel questioned the propriety of Schenkel’s receipt of
    documents from Swan. Xyngular later moved for terminating sanctions,3 alleging
    that Schenkel encouraged Swan to steal documents belonging to Xyngular,
    Symmetry, GVMS, and others. Xyngular argued that many of these documents were
    3
    Specifically, Xyngular asked the court to dismiss Schenkel’s claims with
    prejudice. We refer to such a remedy as a “terminating sanction.” See Conn. Gen.
    Life Ins. Co. v. New Images of Beverly Hills, 
    482 F.3d 1091
    , 1096 (9th Cir. 2007).
    4
    kept on GVMS servers, which made Schenkel’s use of them in seeking a TRO
    improper. Schenkel responded that Swan was authorized to access the documents,
    that Swan gave the documents to Schenkel voluntarily, and that Schenkel intended to
    use them to blow the whistle4 on Xyngular’s directors—not for the purpose of
    litigation. He further alleged that Xyngular had spoliated evidence and retaliated
    against him for whistleblowing. After the court allowed additional discovery, both
    parties filed cross-motions for terminating sanctions.
    The district court denied Schenkel’s motion. As to Xyngular’s motion, the
    court found that Schenkel encouraged Swan to remove documents from GVMS’s
    servers and then collected, reviewed, and used those documents in support of his
    claims. It further found that the documents belonged to Xyngular, GVMS,
    Symmetry, and various other companies. The court noted that although Swan had
    authorization to access the GVMS servers on which the documents were stored, there
    was no evidence that Swan had authority to remove the documents, possess them, or
    give them to third parties. Even though Schenkel’s conduct occurred before
    litigation officially began, the court determined he had obtained the documents in
    anticipation of litigation and used them to support his claims. It also held that, as a
    Xyngular shareholder, Schenkel was not entitled to receive the documents in the
    manner he did because he did not use the proper procedure to inspect the company’s
    4
    Schenkel reported what he believed to be the Xyngular directors’ illegal
    conduct to the FBI and handed over some of the documents to the agency.
    Additionally, Schenkel spoke with the IRS and Santa Clara County Tax Assessor
    about a tax fraud scheme the Xyngular directors were allegedly employing.
    5
    books and records. Finally, the court concluded that Xyngular had met its burden in
    showing that Schenkel acted willfully, in bad faith, and with fault. It dismissed
    Schenkel’s claims without entering default against Schenkel on Xyngular’s claims.
    Additionally, the court excluded the documents Schenkel obtained from Swan from
    evidence and awarded Xyngular and the third parties their costs and fees in bringing
    the sanctions motions. Schenkel timely appealed.
    II
    Schenkel first argues that the district court exceeded its inherent powers by
    imposing sanctions for pre-litigation conduct. He largely relies on our decision in
    Towerridge, Inc. v. T.A.O., Inc., 
    111 F.3d 758
     (10th Cir. 1997), for the proposition
    that a district court has inherent authority to sanction only: (1) “bad faith occurring
    during the course of litigation that is abusive of the judicial process” and (2) “bad
    faith in bringing an action or in causing an action to be brought.” 
    Id. at 768
    (quotation omitted).
    “We review a court’s imposition of sanctions under its inherent power for
    abuse of discretion.” LaFleur v. Teen Help, 
    342 F.3d 1145
    , 1149 (10th Cir. 2003)
    (quotation omitted). “An abuse of discretion occurs when the district court bases its
    ruling on an erroneous conclusion of law or relies on clearly erroneous fact findings.”
    Ashby v. McKenna, 
    331 F.3d 1148
    , 1149 (10th Cir. 2003) (quotation omitted). In
    concluding that Schenkel’s conduct was sanctionable, the district court considered
    not only Schenkel’s misappropriation of Xyngular’s documents, but also his use of
    them in anticipation of litigation and during the litigation itself. We agree that under
    6
    Towerridge, a court may exercise its inherent powers to sanction bad-faith conduct
    that abuses the judicial process, including pre-litigation acts that directly affect a
    lawsuit.
    While not addressing pre-litigation conduct per se, the Supreme Court has held
    that “[a]s long as a party receives an appropriate hearing . . . the party may be
    sanctioned for abuses of process occurring beyond the courtroom.” Chambers v.
    NASCO, Inc., 
    501 U.S. 32
    , 57 (1991). Although we held in Towerridge that “an
    award of attorneys’ fees may not be premised solely on prelitigation conduct,” we
    observed that the bad faith at issue in that case “lay solely in [defendant]’s
    prelitigation acts which gave rise to [plaintiff]’s substantive claim.” Towerridge, 
    111 F.3d at 765, 768
    . By contrast, Schenkel’s misconduct was not the basis for
    Xyngular’s original suit, which stemmed from contractual disputes between the
    parties. Instead, the misconduct centered on his method of gathering evidence related
    to those substantive claims. Although it took place before litigation began,
    Schenkel’s misconduct was intended to improperly influence the judicial process.5
    Our sibling circuits have affirmed terminating sanctions where bad faith pre-
    litigation conduct extended into court proceedings. See, e.g., Eagle Hosp.
    Physicians, LLC v. SRG Consulting, Inc., 
    561 F.3d 1298
    , 1307 (11th Cir. 2009)
    (affirming a sanction of dismissal for a party whose “ongoing ability to intercept
    5
    At the time Swan provided Schenkel with the misappropriated documents,
    Schenkel was consulting with transactional counsel. In mid-2011, he retained and
    consulted with litigation counsel. And by the end of 2011, he had created a privilege
    log that withheld documents on the basis of “work product.”
    7
    confidential and privileged emails” both before and during litigation would make
    adjudication of his claims untenable); Jackson v. Microsoft Corp., 78 F. App’x 588,
    589 (9th Cir. 2003) (unpublished) (affirming a terminating sanction for a party’s pre-
    litigation receipt of privileged information because defendant “would be unfairly
    prejudiced were the case to go forward”).
    III
    Schenkel argues that the district court, when selecting a sanction, abused its
    discretion because it improperly applied the factors articulated in Ehrenhaus v.
    Reynolds, 
    965 F.2d 916
     (10th Cir. 1992), and the clear-and-convincing-evidence
    standard. “[O]utright dismissal of a lawsuit . . . is a particularly severe sanction, yet
    is within the court’s discretion.” Chambers, 
    501 U.S. at 45
    . In Ehrenhaus, we
    established five factors that district courts should consider before imposing dismissal
    as a sanction:
    (1) the degree of actual prejudice to the defendant; (2) the amount of
    interference with the judicial process; . . . (3) the culpability of the
    litigant, . . . ; (4) whether the court warned the party in advance that
    dismissal of the action would be a likely sanction for noncompliance,
    . . . ; and (5) the efficacy of lesser sanctions.
    Ehrenhaus, 
    965 F.2d at 921
     (quotation and citations omitted).
    We have additionally held that, “[b]ecause dismissal is such a harsh sanction,
    it is appropriate only in cases of willfulness, bad faith, or some fault.” Chavez v.
    City of Albuquerque, 
    402 F.3d 1039
    , 1044 (10th Cir. 2005) (quotation and brackets
    omitted). And although our circuit has no precedent precisely on point, persuasive
    authority from our sibling circuits indicates that a clear and convincing standard
    8
    applies. See Maynard v. Nygren, 
    372 F.3d 890
    , 891 (7th Cir. 2004); Shepherd v.
    Am. Broadcasting Cos., Inc., 
    62 F.3d 1469
    , 1472 (D.C. Cir. 1995); Aoude v. Mobil
    Oil Corp., 
    892 F.2d 1115
    , 1118 (1st Cir. 1989). We therefore apply the same
    standard to this case.
    Schenkel contends the record lacks clear and convincing evidence that any
    document he received was confidential, privileged, or contained trade secrets. This
    argument misapprehends the district court’s reasoning in imposing sanctions.
    Although the district court concluded that the documents comprised internal files
    such as board meeting minutes and employees’ personal information, the inquiry that
    was essential to the imposition of sanctions was not whether the documents were
    confidential, privileged, or trade secrets—but rather, whether Schenkel acted
    willfully, in bad faith, and with fault in a way that abused the judicial process in
    collecting them. In concluding that he did so, the district court noted that Schenkel
    did not attempt to use the proper procedures for a shareholder to inspect corporate
    records, that he did so anticipating litigation, and that he gathered documents that
    belonged not only to Xyngular but also to his other potential opponents in this
    litigation. We hold that the district court did not err in concluding that this amounted
    to clear and convincing evidence of Schenkel’s bad faith. See Archibeque v.
    Atchison, Topeka & Santa Fe Ry. Co., 
    70 F.3d 1172
    , 1174 (10th Cir. 1995)
    (concluding that a litigant exhibited bad faith warranting dismissal of her claims by
    deliberately “fail[ing] to cooperate in the discovery process”).
    9
    We further hold that the district court permissibly applied the Ehrenhaus
    factors in determining that terminating sanctions were appropriate. First, in
    measuring “the degree of actual prejudice to the opposing party,” LaFleur, 
    342 F.3d at 1151
    , the court noted that Schenkel collected over three hundred documents, that
    Xyngular and the other parties could not identify the documents that he collected, and
    that some of the documents contained personal information about Xyngular
    employees. Although some of the documents may have been subject to discovery,
    the district court noted that Schenkel’s actions amounted to a circumvention of the
    discovery process and its built-in protections for parties’ interests. The district court
    did not conclude that any of the documents were privileged, but it did note that
    Schenkel’s actions deprived the parties of the right to argue that they were before
    disclosing them in the course of litigation. It also observed that Schenkel’s actions
    led the parties to expend significant time and resources resolving the issue of the
    misappropriated documents.
    Second, Schenkel’s actions amounted to a substantial “interference with the
    judicial process,” LaFleur, 
    342 F.3d at 1151
    , because he had, in anticipation of
    pursuing legal remedies, opted out of the proper discovery procedures. Schenkel
    bypassed the judicial process while nevertheless seeking to take advantage of it. As
    for the third factor—the question of Schenkel’s culpability—the district court
    repeated its conclusion that he had acted with willfulness, bad faith, and fault, and
    that he “made a calculated decision to obtain the documents for strategic use in
    litigation.”
    10
    The fourth factor asks “whether the litigant was warned in advance that
    dismissal was a likely sanction.” LaFleur, 
    342 F.3d at 1151
    . The district court
    observed that it did not have an opportunity to warn Schenkel before he received the
    documents, but observed that this factor was not dispositive. See Rogers v. Andrus
    Transp. Servs., 
    502 F.3d 1147
    , 1152 (10th Cir. 2007) (noting that a warning under
    the fourth Ehrenhaus factor “is not a sine qua non for dismissal” (italics omitted)).
    Schenkel now argues that the district court erred in dismissing his claims without
    prior warning. He contends that, although some courts have imposed terminating
    sanctions without a warning, those cases did not involve pre-litigation misconduct.
    Schenkel does not, however, cite any authority holding that terminating sanctions in a
    case like this one necessarily require prior warning. We decline to hold that
    Ehrenhaus dictates such a result.
    Finally, the district court addressed the question of whether lesser sanctions
    would be effective. In its analysis, the court reiterated the prejudice to the parties
    that resulted from Schenkel’s circumvention of the discovery process, and noted that
    any sanction short of dismissal would incentivize future litigants to similarly
    misappropriate documents in anticipation of litigation. It concluded that dismissal
    was the least severe sanction that would effectively cure the prejudice, deter future
    misconduct, and punish Schenkel’s wrongdoing. Schenkel argues that the district
    court erred in declining to impose a lesser sanction, describing the sanction he
    received as unprecedented. But Schenkel never argued before the district court that
    lesser alternative sanctions would be appropriate; he instead insisted that his conduct
    11
    was not improper at all and therefore warranted no sanction. “Absent extraordinary
    circumstances, we will not consider arguments raised for the first time on appeal.”
    Turner v. Pub. Serv. Co. of Colo., 
    563 F.3d 1136
    , 1143 (10th Cir. 2009).
    The imposition of sanctions is one of many matters within a trial court’s broad
    discretion, and we reverse only when that discretion has been abused. LaFleur, 
    342 F.3d at 1149
    . In this case, the district court carefully analyzed the evidence and the
    parties’ arguments. We do not discern any abuse of discretion in the district court’s
    analysis.
    IV
    AFFIRMED.
    12