Clientron Corp. v. Devon It, Inc., 070518 FED3, 16-3432

Docket Nº:16-3432
Attorney:John D. van Loben Sels [Argued] Fish IP Law Counsel for Appellant Gary M. Samms [Argued] Obermayer Rebmann Maxwell & Hippel LLP Centre Square West Counsel for Appellees
Judge Panel:Before: GREENAWAY, JR., KRAUSE, Circuit Judges, and JONES, District Judge.
Case Date:July 05, 2018
Court:United States Courts of Appeals, Court of Appeals for the Third Circuit




No. 16-3432

United States Court of Appeals, Third Circuit

July 5, 2018

Argued: January 23, 2018

On Appeal from the United States District Court for the Eastern District of Pennsylvania (E.D. Pa. No. 2-13-cv-05634) District Judge: Honorable Michael M. Baylson

John D. van Loben Sels [Argued] Fish IP Law Counsel for Appellant

Gary M. Samms [Argued] Obermayer Rebmann Maxwell & Hippel LLP Centre Square West Counsel for Appellees

Before: GREENAWAY, JR., KRAUSE, Circuit Judges, and JONES, District Judge. [*]



In this unusual case, Appellant Clientron Corp. is actually the prevailing party below and holds a judgment against Appellee Devon IT, Inc. worth over $7 million. Clientron claims, however, that it is unable to recover because Devon IT is insolvent. Before the District Court and now also on appeal, Clientron has argued that Devon IT's corporate veil should be pierced, and that the two shareholders who own Devon IT as tenants by the entirety, Appellees John Bennett and Nance DiRocco, should be held personally liable for the entire judgment. Although the District Court declined to disregard Devon IT's corporate form on the merits, it held Bennett-but not DiRocco-personally liable for a portion of the judgment as a sanction for egregious discovery misconduct. According to Clientron, this decision to sanction only Bennett was insufficient because he, like Devon IT, is judgment-proof. Clientron contends that it can recover only if DiRocco is held personally liable for the judgment as well.

As we will explain below, we hold that, irrespective of whether the imposed sanction was sufficient to cure the prejudice suffered by Clientron, the District Court committed legal error in piercing Devon IT's veil as a sanction to reach Bennett but not DiRocco, and in holding Bennett personally liable for only part of the judgment. We will therefore vacate the District Court's order sanctioning Bennett and remand so that the District Court may impose a new sanction.



The Parties' Contractual Relationship and This Litigation

Clientron is a Taiwanese manufacturer and distributor of computer components. Devon IT is a Pennsylvania corporation that sells computer hardware and software and whose sole shareholders are John Bennett and Nance DiRocco, a married couple that jointly owns one hundred percent of Devon IT's shares as tenants by the entirety. Devon IT is one of at least twenty-four business entities that Bennett and DiRocco have owned together using the tenancy by the entirety ownership form. Many of these entities bear similar names that somehow incorporate the word "Devon." Devon IT was incorporated in 1999 as an S corporation. At first, its primary function was to provide IT services to other Devon entities, but by 2005, it had begun to transition from performing internal work to providing services for other companies.

In 2010, Devon IT was awarded a contract from Dell to sell "thin client" computer products.[1] Devon IT in turn contracted with Clientron to manufacture the computers that Dell was to purchase. Under the arrangement, Clientron manufactured the goods and shipped them directly to Dell, and Dell paid Devon IT, who in turn paid Clientron. But Devon IT stopped paying Clientron entirely in March 2012. At the time, Devon IT owed Clientron over $6 million in unpaid invoices for products Clientron had provided. Sometime thereafter, Dell terminated its relationship with Devon IT and paid Devon IT $2 million, none of which ever made its way to Clientron.

Pursuant to the parties' agreement, Clientron submitted a request for arbitration to the Chinese Arbitration Association in Taiwan in September 2012, claiming that Devon IT had breached its obligations under the parties' agreement. The Taiwanese arbitrators ruled in Clientron's favor and awarded over $6.5 million in damages.

Clientron then sued Devon IT, Bennett, and DiRocco in the Eastern District of Pennsylvania seeking to enforce the arbitration award. In a second suit that was later consolidated with the first, Clientron sought an additional $14.3 million in damages from the three Defendants for fraud and breach of contract stemming from Devon IT's refusal to pay for products in purchase orders that were not covered by the Taiwanese arbitration. Clientron further alleged that, under Pennsylvania law, Devon IT was the alter ego of its two sole shareholders, Bennett and DiRocco, and it asked the District Court to pierce Devon IT's corporate veil.[2]


The Appellees' Discovery Misconduct

During pretrial discovery, the Defendants continually failed to meet their obligations under the Federal Rules. In response to Clientron's requests for documents, they initially asserted frivolous general objections before eventually making either incomplete or non-responsive productions. At one point, they produced ninety-three boxes of irrelevant documents without sorting the documents into topics or categories. Moreover, despite being properly served with two deposition notices under Federal Rule of Civil Procedure 30(b)(6), which requires a corporation to designate a witness to testify on its behalf, Devon IT never designated such a witness at all, let alone regarding basic topics relevant to Clientron's alter ego claims, such as the administration of Devon IT's bank records, general ledger, and other corporate records. Defendants' counsel represented to the District Court that he overlooked the second Rule 30(b)(6) notice, but both the court and Clientron repeatedly reminded counsel and the Defendants themselves that they needed to designate a witness on the topics in the notice. Without any adequate explanation, however, the Defendants never produced a knowledgeable witness.

Meanwhile, Bennett, who was the chairman and sole member of Devon IT's board of directors, claimed to be unfamiliar with virtually all details of the case during his deposition. He maintained, for example, that he was unaware of whether Devon IT even maintained a general ledger. He further stated that he was unable to testify regarding any of Devon IT's defenses or counterclaims. Bennett also continued his practice of regularly deleting all of the sent and received emails from his personal account after he knew a dispute had arisen with Clientron, and even after Clientron had filed suit.

As a result of the Defendants' discovery practices, Clientron filed four separate motions to compel, as well as multiple letters to the District Court detailing their discovery issues. The District Court, for its part, entered four separate orders requiring the Defendants to provide discovery. After the Defendants failed to comply with those orders and Clientron filed a motion for sanctions, the court concluded that the Defendants' conduct was willful and in bad faith, and that the prejudice to Clientron was "obvious" because there was a "high probability that relevant information ha[d] not been provided." App. 14. Accordingly, in an August 28, 2015 order, the court issued a number of sanctions against Devon IT. First, it imposed a monetary sanction of $44, 320.50 corresponding to the extra costs incurred by Clientron. Second, it excluded Devon IT's evidence supporting its defense that the arbitration award should not be enforced because the arbitration clause in the parties' agreement did not cover the products that were at issue in the arbitration. And third, the District Court excluded any evidence supporting Devon IT's defenses to Clientron's non-arbitrated breach of contract claim that had not already been disclosed during pretrial proceedings.

Importantly, however, the District Court initially refrained from issuing any sanctions against Bennett individually because he had then recently filed for bankruptcy and was protected by an automatic stay. The court instead stated that it would reserve consideration of whether piercing the corporate veil would be an appropriate sanction to impose against him. DiRocco was not a party to Bennett's bankruptcy case, but the court nonetheless declined to sanction her individually because it concluded that she had not personally participated in any of the discovery misconduct.


The Enforcement of the Arbitration Award and the Jury Trial

On the same day that it issued discovery sanctions against Devon IT, the District Court granted Clientron's motion for summary judgment with respect to the arbitration award and enforced the roughly $6.5 million award against Devon IT plus interest and costs, equaling a total amount of $6, 943, 817.13. The court concluded that the award should be enforced as a matter of comity under governing Pennsylvania law. Clientron's non-arbitrated breach of contract and fraud claims then proceeded to a jury trial. The issue of whether Devon IT's corporate veil should be pierced also proceeded to trial, but the District Court ruled that the jury's verdict on that point would be advisory only.

Despite being provided with inadequate discovery, Clientron was nevertheless able to present a variety of evidence at trial in support of its contention that veil piercing was appropriate. Its accounting expert, Kyle Midkiff, testified that, based on the limited discovery provided, she was able to discern that, from 2010 to 2013, $24 million was siphoned from Devon IT to other Bennett and DiRocco-owned entities. And Midkiff saw that one of the Devon entities receiving the most money from Devon IT subsequently made payments into Bennett's personal account. Midkiff also explained that Devon IT's general ledger showed that Devon IT had made a $3.5 million loan to its shareholders, Bennett and DiRocco. The same loan...

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