Monthly Archives: July 2014

Texas Supreme Court Issues New “Spoliation” Rules with Implications for Company Document-Retention Policies

Earlier this month, the Texas Supreme Court issued a key decision on a subject every business owner and executive should know about: the duty to preserve company documents and the consequences for failing to do so.  A court, in some circumstances, can hold a company that has destroyed or failed to preserve documents responsible for “spoliating” evidence.  When this occurs, the company may become subject to serious sanctions, which a court may craft to “even the playing field” to make up for the other party’s inability to use the destroyed evidence in presenting its case. Business owners must know when these circumstances arise and how to avoid a “spoliation” finding.

Texas courts over time have applied somewhat broad and inconsistent standards for “spoliation.” Litigants have seized on these decisions to attack opponents over alleged missing records, sometimes with unfair results.

In Brookshire Bros., Ltd. v. Aldridge, the Texas Supreme Court clarified the standards governing spoliation.[1]  A customer who had slipped and fallen at a grocery store sued the store.  The premises owner retained a relevant portion of the surveillance video footage covering the customer’s fall but allowed additional footage to be automatically erased.  Based on these facts, the trial court admitted evidence at trial of the premises owner’s alleged spoliation of the video footage and also submitted a jury instruction on spoliation.  The court of appeals affirmed, and the Texas Supreme Court granted review.

After examining the development of spoliation law in Texas and the balance of concerns associated with the issue of spoliation, the Texas Supreme Court made several pronouncements and clarifications about spoliation law in Texas that business owners, executives, and in-house counsel should be aware of:

  • Spoliation analysis involves a two-step process: first, the trial court must determine whether a party spoliated evidence; and second, the court must determine the appropriate remedy.
  •  To support a spoliation finding, the court must first find that (1) the party accused of spoliating evidence had a duty to reasonably preserve the evidence, and (2) the party intentionally or negligently breached that duty.  A duty to preserve evidence arises when a party knows or should know that there is a substantial chance of litigation and that there is relevant and important evidence in the party’s possession or control.
  •  Once a spoliation finding is made, the trial court has broad discretion to impose a remedy.
  • A remedy may even include a “spoliation instruction.” The judge can instruct the jury that it may draw negative inferences from the fact that the company spoliated evidence.  In other words, the jury can—and likely will—assume the missing evidence would have hurt the case of the party who destroyed it.
  • A spoliation instruction can devastate a party’s case.  Accordingly, it “is warranted only when the trial court finds that the spoliating party acted with the specific intent of concealing discoverable evidence, and that a less severe remedy would be insufficient to reduce the prejudice caused by the spoliation.”[2]
  • There is a caveat, however, to this specific-intent requirement: A negligent failure to preserve evidence may support a spoliation instruction “in the rare situation in which a nonspoliating party has been irreparably deprived of any meaningful ability to present a claim or defense.”[3]

Business owners and executives would be wise to make a careful analysis of Brookshire Bros. to ensure that their document-retention policies remain sound and to avoid the potentially harsh penalties that can result from accusations of spoliation.

Cantey Hanger attorneys regularly advise their business clients on document-retention policies and similar issues that can impact them in litigation. For more information about the Brookshire Bros. decision, contact associate attorney Derek Carson at 817-877-2850 or dcarson@canteyhanger.com

 

[1]Brookshire Bros., Ltd. v. Aldridge, — S.W.3d —, No. 10-0846, 2014 WL 2994435, at *1 (Tex. July 3, 2014).
[2]Id.
[3]Id.

Fifth Circuit Clarifies the “Active Participation” Exception to the Internal Revenue Code’s Farming-Syndicate Rules

Recently, the United States Court of Appeals for the Fifth Circuit handed down some good news for individual cattle ranchers and farmers wishing to take advantage of S corporations for tax purposes, yet seeking to avoid having their business operations classified by the IRS as an impermissible tax shelter.  In Burnett Ranches, Ltd. v. United States, — F.3d —, No. 13-10403, 2014 WL 2142112 (5th Cir. May 22, 2014), the Fifth Circuit examined the definition of “farming syndicate” set out in section 464 of the Internal Revenue Code and concluded that:

 “an otherwise qualified individual who has participated in management of the farming operations for not less than five years comes within the Active Participation Exception embodied in § 464(c)(2)(A), irrespective of the fact that the legal title of such individual’s attributable interest happens to be held in the name of her wholly owned S corp. rather than in her own name.”

Id. at *7.

To appreciate the significance of this holding, a brief overview and history of the farming-syndicate rules may prove helpful.  A farming syndicate, generally speaking, “is a tax-shelter arrangement whereby a farmer with tax losses sells a partnership interest in the farm to a high-income individual taxpayer who has no genuine interest in farming, with the purpose of providing the taxpayer loss deductions on his federal income-tax return.”  Burnett Ranches, Ltd. v. United States, No. 4:11-CV-562-Y, 2012 WL 10928475, at *3 (N.D. Tex. Oct. 24, 2012) (Means, J.) (citing Estate of Wallace v. C.I.R., 965 F.2d 1038, 1040–44 (11th Cir.1992)).  This is the “tax loophole that Congress sought to close in adopting § 464.”  Burnett Ranches, 2014 WL 2142112, at *3.

At the same time, however, Congress did not wish to prevent individuals, families, and entities that had “bona fide interests in agricultural endeavors” from enjoying the tax benefits that farmers had previously been able to enjoy, such as claiming deductions on their federal income-tax returns based on the cash-receipts-and-disbursements method of accounting.  Id.  Accordingly, Congress added subsection (c)(2) to identify and define certain classes of taxpayers whose interests in farming operations should be exempted from the treatment given to the interests of tax syndicates.  See id.

One such exemption, set out at subsection (c)(2)(A), attaches to “any interest” in a partnership or similar enterprise that is “attributable to” the active participation of an individual in the management of a farming business or trade for not less than 5 years.  See 26 U.S.C. § 464(c)(2)(A).  This is the exception that the individual taxpayer in Burnett Ranches was hoping to utilize.  The government had argued that the taxpayer’s interest did not fit within this “active participation” exception because the interest was not held directly by the individual tax payer but rather through an S corporation that the taxpayer wholly owned.

At the trial level, United States District Judge Terry R. Means rejected the government’s argument, observing that “the language of subsection 464(c)(2)(A) does not restrict application of the active-participation exception to indviduals. Rather, the statutory language indicates that the exception applies to any interest in a partnership that is attributable to an individual’s active participation in the management of a farming business for [five years or more].”  Burnett Ranches, 2012 WL 10928475, at *4.

On appeal, the Fifth Circuit affirmed and emphatically agreed with Judge Means’s conclusion that “[t]his interpretation of Section 464(c)(2)(A) maintains consistency with the purpose of the farming-syndicate rules without needlessly expanding their scope.”  Burnett Ranches, 2014 WL 2142112, at *3 (quoting Burnett Ranches, 2012 WL 10928475, at *5).  Congress, explained the Court, “did not intend to deprive genuine farmers or ranchers of their previously enjoyed tax benefits.”  Id.

In light of this recent decision, then, otherwise qualified cattle ranchers and farmers in Texas, Louisiana, and Mississippi who have participated in management of the farming operations for not less than five years may come within the active-participation exception set out in subsection 464(c)(2)(A) even though their attributable interest is held through a wholly owned S corporation rather than in their own names.