Recent ESI changes on discovery and privilege may broadly affect tax controversies.

• Author: Blair, David B.
• Position: Electronically stored information

Introduction

Recent developments in the courts' approach to discovery of electronically stored information (ESI) and the inadvertent waiver of privilege have important implications for taxpayers in litigation with the Internal Revenue Service and potentially in the context of administrative proceedings before the Examination Division (Exam) and Appeals. In recent years, courts and practitioners have recognized the unique challenges that ESI presents in the context of discovery in civil litigation. This recognition led to the development of guidance by a group known as the Sedona Conference, with the publication of the first version of The Sedona Principles Addressing Electronic Document Production in January 2004. In 2006, amendments to the Federal Rules of Civil Procedure addressed some of the practical problems associated with ESI, and in 2007, the Court of Federal Claims promulgated a set of conforming amendments to its rules. Currently, there are several proposed ESI-related amendments to the Rules of the Tax Court. This article summarizes the recent rules changes related to ESI and considers the implications for taxpayer controversies with the IRS.

Problems Presented by ESI

Historically, ESI presented difficulties in the formal discovery context because of significant differences from more "traditional," paper records for which early procedural rules were designed. Compounding these difficulties is that, over the last 20 years or so, businesses of all types have gone from slowly embracing the personal computer to near-complete reliance on PCs, word processing software, electronic spreadsheets, database programs, email, and digital storage of information. It is estimated that more than 90 percent of all information used by businesses is now created and stored electronically. (1)

There are many differences between ESI and paper documents that can affect document production and discovery. Some are obvious and some are subtle. For starters, the volume of ESI tends to be much greater than traditional paper documents and records. This is so for a number of reasons, including that electronic communication has in many instances replaced face-to-face or telephonic communication. Today a company can generate, receive, and accumulate literally millions of emails and electronic files of various sorts in a single day, the vast majority of which are never printed. Add to that the ever-increasing capacity of systems to store such information on archival tapes, hard drives, and portable media such as "jump" drives, and the accumulation of ESI can become overwhelming for a company in the position of having to identify information responsive to discovery requests and review the mass of information for privilege before producing copies for the other side in a litigation.

Aside from its sheer volume (and to a great extent contributing to that volume) is that ESI is so easy to duplicate, both by individual users and automatically. For example, email is often sent to multiple recipients, with copies being made on a number of servers simultaneously. Responses to emails more often than not contain copies of the original. Systems are backed-up and archived automatically on a periodic basis. Web pages are often saved as many different cache files over time. Electronic documents are edited, saved as different versions, and then circulated and re-circulated via email and shared electronic environments such as centralized document management systems. Because of the ease of duplication, ESI can be dispersed to many different systems and saved on various kinds of media.

This can lead to difficulties in determining the origins and authorship of information, as well as the "chain of custody," since many versions of a document or email chain may be edited and shared by multiple users. The myriad ways in which ESI can proliferate may lead to serious difficulties in terms of locating all potentially relevant versions of a document and other pertinent information. Compounding these difficulties, ESI tends to be much harder to dispose of than traditional paper documents. When ESI is "deleted," in most cases it remains on the digital storage medium, with only its index reference having been removed. Until the actual file is overwritten, it can be recovered. Accordingly, the accumulation of ESI can persist well beyond its intended lifespan, which raises a host of issues about the duty to preserve and search for such information.

Much ESI, unlike its hardcopy counterparts, is designed to be updated automatically. For example, many websites are updated with information from applications that continually run in the background. Many systems feature automatically updated filing information and automatic archiving of certain data. Moreover, much ESI can be changed in ways that are not easily detectable, and sometimes this occurs as a result of the routine operation of a system (e.g., movement of a file from one server to another). ESI documents in most instances contain metadata, which is information about the circumstances and history of a document that is not necessarily readable or evident in its native format. In some cases, metadata for a particular document may be relevant to the issues in a litigation, and for the reasons identified above, this metadata might differ significantly from version to version of the same document.

Adding to all of these complexities is the common and relatively frequent migration of ESI to different software and system platforms as businesses evolve. Often legacy data is retained, but in a form not readily accessible by a company's current systems. In many instances, the technical know-how, equipment, and software necessary to easily access historical ESI may no longer be in a company's possession, which can raise the costs of recovery to unworkable levels. In short, ESI can pose a unique set of practical problems in discovery, where litigants and courts must determine the rights and obligations of the parties with respect to information that may be quite difficult and expensive to identify and recover, but nonetheless may be of great importance to resolution of the dispute.

Recent and Proposed Changes to Court Rules to Address ESI Problems

1. Background

   Because of the explosive growth of ESI, for years courts have wrestled with application of the discovery rules to ESI. Before the Federal Rules of Civil Procedure (Federal Rules) were amended in 2006 to address ESI specifically, the courts had in the main recognized that computer-based information was discoverable under the rules as then written. (2) Nonetheless, the old Federal Rules were not written with a view to dealing with the problems posed by ESI. Consequently, a group of distinguished practitioners, judges, and academics began to meet with the aim of developing guidelines and rules of thumb to help courts and litigants navigate the new ESI environment. This group came to be called the Sedona Conference, (3) and it was largely responsible for the foundational thinking that led to amendment of the Federal Rules in 2006, as well as the currently pending slate of proposed amendments to the Tax Court Rules. (4)

2. Rules Now Explicitly Address ESI

   There are a number of recent, important rule changes that embody a practical, somewhat flexible approach to discovery of ESI. Fed. R. Civ. P. 34 now provides that a party may request "any designated documents or electronically stored information," explicitly identifying ESI as a separate category of information that may be obtained pursuant to requests for production. Similarly, Rule 26, which imposes initial disclosure obligations for litigants, now requires a party to disclose ESI "that the disclosing party has in its possession, custody, or control and may use to support its claims or defenses ...." (6) The Advisory Committee Notes (7) to Rule 34 explain that, although "document" had been interpreted to include certain kinds of information stored in an electronic format, it became necessary to expand the scope of Rule 34 to include ESI that might not fit within the traditional notion of a "document." (8) Importantly, the Rules do not provide a precise definition of "electronically stored information." The Advisory Committee Notes merely state "Rule 34(a)(1) is expansive and includes any type of information that is stored electronically."

   Under Rule 34(b)(1)(C), the requesting party "may specify the form or forms in which electronically stored information is to be produced." Rule 34(b)(2)(E) provides that "[i]f a request does not specify a form for producing electronically stored information, a party must produce it in a form or forms in which it is ordinarily maintained or in a reasonably usable form or forms; and [a] party need not produce the same electronically stored information in more than one form." (9) Significantly, the Rules do not take a position on whether metadata must be produced along with basic data. (10) Rule 33, which governs the use of interrogatories, now includes "electronically stored information" within the ambit of "business records," giving interrogatory respondents the option of producing electronically stored business records in lieu of deriving an answer to the interrogatory, if the burden of deriving the answer would be substantially the same for either party. (11)

3. The Proportionality Rule: Limitations on the Production of ESI

   In what is commonly referred to as the "proportionality rule," Rule 26(b)(2)(C) generally requires a court to limit discovery where, among other things, the burden and expense of production outweighs the likely benefit. Applying the proportionality concept to ESI, Rule 26(b)(2)(B) now provides that a party need not produce electronically stored information where the information is "not reasonably accessible because of undue burden or cost." (12) On a motion to compel, the party requesting the information may still be able to obtain discovery of such...