Robert A. Mark, Judge, United States Bankruptcy Court.
Creditors normally have a right to conduct Rule 2004 examinations of third parties who possess documents and information relevant to the administration of a bankruptcy case. In this opinion, the Court finds an exception to this general right where the party seeking discovery bought a small unsecured claim to become a creditor and is unquestionably seeking discovery solely in support of non-bankruptcy litigation and not for any legitimate bankruptcy purpose.
Four petitioning creditors filed an involuntary chapter 11 petition against Sanomedics, Inc. (the "Debtor") on August 24, 2016. The Court entered an Order for Relief on October 5, 2016 [DE # 6], and at the request of the U.S. Trustee and the petitioning creditors, converted this case to chapter 7 by Order dated October 28, 2016 [DE # 16].
More than a year later, on December 31, 2017, KIPU Systems, LLC ("KIPU") filed a complaint (the "Complaint") in the U.S. District Court for the Southern District of Florida against ZenCharts, LLC ("ZenCharts"), and other entities and individuals, including the Debtor's CEO and President, Keith Houlihan, case number 1:17-cv-24733-KMW (the "District Court Case"). The Debtor is not named as a defendant but is described in the Complaint as a participant in the bad acts alleged in the Complaint.
On January 9, 2018, shortly after KIPU filed the District Court Case, Tilius, LLC ("Tilius") acquired a $12,524.43 unsecured claim (the "Claim") against the Debtor from KCSA Strategic Communications [DE #78]. KIPU's counsel in the District Court Case represents both KIPU and Tilius in this bankruptcy case and counsel admitted that Tilius is affiliated with KIPU at a hearing on March 22, 2018.
After cancelling the originally scheduled examination of ZenCharts, the Trustee renoticed the examination in the January 24, 2018 Notice of Rule 2004 Examination Duces Tecum of ZenCharts, LLC (the Trustee's Re-Noticed 2004 Examination") [DE # 85]. On January 25, 2018, Tilius cross-noticed the Trustee's Re-Noticed 2004 Examination (the "Tilius Cross-Notice") [DE # 86]. Most significantly, for purposes of this opinion, in conjunction with its cross-notice, Tilius separately issued its own subpoena duces tecum to ZenCharts (the "Tilius Subpoena") [DE# 87]. The scope of the documents requested in the Tilius Subpoena is far broader than the documents requested by the Trustee, spanning 9 pages and containing 85 paragraphs of requests. The Tilius Subpoena and Tilius Cross-Notice will be referred to as the "Tilius Discovery Requests."
On January 31, 2018, ZenCharts filed ZenCharts, LLC's Motion for Protective Order Against Tilius, LLC's Rule 2004 Examination and Quashing Subpoena (the "Motion for Protective Order") [DE#89]. Tilius filed an objection to the Motion for Protective Order [DE# 96], and the Court conducted an initial hearing on February 28, 2018. Following the initial hearing, the Court entered its February 21, 2018 Order Reserving Ruling and Granting Interim Relief on Motion for Protective Order, and Setting Filing Deadlines (the "Interim Relief Order") [DE# 102].
The Interim Relief Order noted that in filing the Trustee's Cross-Notice of Subpoena Duces Tecum of ZenCharts, LLC [DE# 92], the Trustee expanded her document request to include all of the documents requested in the Tilius Subpoena. The Interim Relief Order also noted that ZenCharts was willing to produce documents to the Trustee with the scope of production to be agreed to or determined by the Court.
Both ZenCharts and Tilius filed supplemental memoranda [DE # 105, 106], and the Court conducted a further hearing on March 22, 2018. Having reviewed the supplemental memoranda, and having considered the arguments of counsel at the March 22, 2018 hearing, the Court finds substantial cause to grant ZenCharts' Motion for Protective Order.
The crux of this discovery dispute involves Tilius' interest in seeking to obtain extensive discovery from ZenCharts, a non-debtor, under Fed. R. Bankr. P. 2004 ("Rule 2004"). ZenCharts argues that Tilius is affiliated with KIPU and that the subject matter of the documents requested by Tilius relate to the causes of action central to KIPU's District Court Case, namely KIPU's claims against ZenCharts for alleged misappropriation of intellectual property and trade secrets, and for trademark infringement. Based on these facts, ZenCharts argues Tilius is barred from taking Rule 2004 discovery under the "pending proceeding rule." ZenCharts also argues that the Tilius Discovery Requests seek discovery broader than KIPU would be entitled to in the District Court Case.
Despite substantial briefing by both ZenCharts and Tilius on the pending proceeding rule, the Court does not find the pending proceeding cases to be on point. Rather, the issue here is simply whether Tilius should be allowed to conduct Rule 2004 discovery of ZenCharts at all or be allowed to review documents ZenCharts produces to the Trustee. The facts strongly support the Court's conclusion that it may not.
Tilius argues that, "[a]s a creditor, Tilius has standing to examine ZenCharts, and certainly to inquire about the Debtor's business, and ZenCharts'[s] involvement with the Debtor" [DE # 96, p.6]. While that general proposition may be true, the basic purpose of Rule 2004 discovery is not served where, as here, the "creditor" propounding the Rule 2004 discovery became a creditor of the Debtor only because of a post-petition purchase of a de minimis claim against the Debtor, the value of which is grossly eclipsed by the amount expended by the new "creditor" in seeking to conduct broad discovery under Rule 2004. Under these circumstances, the Court can and should exercise its authority under 11 U.S.C. § 105(a) "to prevent an abuse of process."
This case is a chapter 7 liquidation of a corporate debtor. The only possible motivation a small unsecured creditor would have for participating in this case would be to maximize any distribution it might receive on account of its claim against the Debtor. As assignee and holder of one such small claim, Tilius is clearly not acting to maximize its distribution.
Tilius has already incurred far more in attorney's fees pursuing discovery than the amount of its unsecured claim. In addition to the time spent drafting the lengthy Tilius subpoena, Tilius filed a twenty-six-page Objection [DE # 96] to the Motion for Protective Order in which it acknowledges it "has incurred significant fees and
The inescapable conclusion is that the effort of Tilius to take extensive discovery of ZenCharts is for the improper purpose of assisting its affiliate, KIPU, in the District Court Case, not to maximize recovery on its small unsecured claim in this bankruptcy case. Because the Tilius Discovery Requests are not being pursued for any legitimate bankruptcy purpose, there is cause to grant ZenChart's Motion for Protective Order.
Therefore, it is —
1. ZenCharts's Motion for Protective Order is granted.
2. Tilius' Objection [DE # 96] is overruled, and its request for an award of attorney's fees and costs [DE # 97] is denied.
3. The Tilius Discovery Requests are quashed, and Tilius may not propound any discovery on ZenCharts or have access to the discovery responses made by ZenCharts to the Trustee.
