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Xyngular v. Schenkel

United States Court of Appeals, Tenth Circuit

May 15, 2018

XYNGULAR, a Delaware corporation, Plaintiff Counter Defendant -Appellee,
v.
MARC SCHENKEL, an individual, Defendant Counterclaimant Third-Party Plaintiff - Appellant,
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 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. § 1291[1] 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.

         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 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 whistle[4] 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 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 Towerridge, a ...


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