Antitrust Law Daily Wrap Up, RICO—7th Cir.: District court did not err in default sanction, damages award, against fraudsters, (Feb 6, 2014)

By Peter Reap, J.D., LL.M.

The federal district court in Chicago was within its discretion to impose harsh sanctions, including default, against Adam Swiech, Richard Swiech, and Derek Lewicki (collectively, the “defendants”), who had been sued by plaintiffs Jan Domanus and Andrew Kozlowski for engaging in a fraudulent scheme to loot a company in violation of RICO (Domanus v. Lewicki, February 4, 2014, Flaum, J.). In addition, the district court did not err in calculating a damages award of $413,000 against the defendants, declining to hold a damages hearing, and in denying the defendants’ motion to stay. Thus, the district court ruling was affirmed.

Background. Krakow Business Park sp. z o.o. (“KBP”) is a Polish entity that was formed to develop a business park near Krakow, Poland. Domanus and Kozlowski are shareholders in KBP, and the defendants are all either current or former shareholders.

The plaintiffs filed suit against the defendants, along with several other individuals and entities in 2008. Default judgment was not entered against the other parties and that litigation is still pending in the district court.

The plaintiffs alleged a fraudulent scheme to loot the company, and sought relief under the civil provisions of RICO, 18 U.S.C. §§ 1962(a)-(d). They also brought supplemental state claims including fraud and conversion. The plaintiffs contended that the defendants caused KBP to pay out millions of dollars to the defendants for services never performed, and that the defendants stole cash and property from the company. The defendants allegedly used some of this money to build subdivisions in suburban Chicago. They put other funds back into KBP as “capital contributions” in exchange for newly-issued stock to Adam Swiech. This new stock diluted the plaintiffs’ ownership shares and made Swiech the majority shareholder. Finally, the defendants allegedly sabotaged the sale of KBP’s shares to a real estate firm called Orco, and then tried to squeeze the plaintiffs out of the company.

Polish authorities investigated the Swiechs and Lewicki for crimes related to KBP and brought charges against them. Based on the record, that prosecution was seemingly ongoing at the time of default.

The defendants’ abuse of the discovery process resulted in several sanctions rulings by the magistrate. When the plaintiffs objected to the magistrate’s relatively lenient decisions, the district judge found the sanctions too light and imposed more onerous ones—including contempt and an order barring the defendants from using certain evidence.

On October 22, 2012, the plaintiffs moved for default judgment before the district judge. The defendants had not produced the documents that the contempt order required of them. They instead alleged that it was impossible for them to do so. The district judge was unpersuaded, concluding that the defendants had made hardly any effort, let alone extensive effort, to produce the documents they had been ordered to produce. The district judge granted default judgment against the Swiechs and Lewicki on January 11, 2013, denied their motion for a stay pending resolution of the case against the non-defaulting defendants, and entered final judgment awarding the damages on May 31.

The defendants appeal the district judge’s imposition of harsher discovery sanctions and her grant of default judgment. The defendants also appeal the district judge’s calculation of damages, her denial of their request for a damages hearing, and her denial of a stay pending resolution of the claims against the non-defaulting defendants.

Discovery Sanctions

The Bank Julius Baer account. Adam Swiech owned a Bank Julius Baer account in Switzerland. This account was flagged for the plaintiffs by Polish prosecutors, who provided documents showing money flowing into the account from KBP accounts. Through a subpoena, the plaintiffs obtained wire transfer records from American accounts held by Lewicki that showed additional transfers into the Julius Baer account.

Swiech did not turn over any records and refused to acknowledge he owned the account. By the end of 2011, Swiech had produced nothing, despite multiple discovery requests, and claimed the records were not within his control. The magistrate was unconvinced by Swiech’s story and ordered production of the records by January 6, 2012. Still, Swiech produced nothing. Finally, at the end of February, the plaintiffs moved for sanctions and sought to have Swiech held in contempt.

The magistrate found Swiech’s behavior sanctionable, but declined to hold him in contempt. Instead, she sanctioned Swiech with a potential adverse jury instruction: if Swiech failed to produce the records by the close of discovery, the jury would be instructed that the records would have been adverse to him.

Swiech argued on appeal that the magistrate judge did not clearly err and that it was therefore an abuse of discretion for the district court to hold him in contempt. The appellate court disagreed. Swiech’s efforts to comply with the magistrate’s production orders were minimal, at best. He did not disclose the account’s existence and then denied owning it. Once he requested records, he sent patently inadequate letters to Julius Baer that did not comply with the magistrate judge’s orders. Indeed, both judges agreed that Swiech had disobeyed several explicit production orders, the court observed.

Given that, the district judge’s decision to stiffen the penalty was sensible, according to the appellate court. She noted that the records at issue were central to the case and that an adverse jury instruction was insufficient impetus for Swiech to comply. District courts must support a contempt finding with clear and convincing evidence that the court’s clear order has been violated. Swiech’s overtly noncompliant behavior in response to the magistrate’s production orders certainly qualified. Thus, the district judge’s decision to hold Swiech in contempt was not an abuse of discretion.

The HSBC account. The second controversial account was a Polish HSBC account belonging to Lewicki. Lewicki first claimed the account was irrelevant to the dispute. Ultimately, Lewicki produced only an online transaction log for the account, which contained no details about the wire transfers the plaintiffs had requested.

Nonetheless, the magistrate judge declined to hold Lewicki in contempt or impose sanctions. Subsequently, the district judge found Lewicki incredible and the court held him in contempt as well.

The district judge’s decision to hold Lewicki in contempt was based largely on her finding that Lewicki was not credible. This finding, in turn, was informed by Lewicki’s pattern of discovery violations and recalcitrance. The appellate court did not question the court’s credibility finding—especially where the lower court’s determination appeared reasonable, the court said.

Once the district judge found Lewicki’s testimony incredible, it followed that the magistrate judge had clearly erred by not imposing sanctions. It also meant that there was clear and convincing evidence to support a contempt finding, because what remained was Lewicki’s unexcused failure to produce documents after multiple production orders. Thus, the district court’s imposition of harsher sanctions was no abuse of discretion, the court ruled.

The hard drive. On May 20, 2011, then-counsel for the defendants sent the plaintiffs over 1,800 pages of documents taken from a computer hard drive belonging to Richard Swiech. The plaintiffs reviewed the files and suspected that the production was incomplete, as the documents contained suspiciously few emails between the defendants. The defendants initially denied under-producing, but eventually admitted that there were additional documents on the hard drive. The magistrate gave the defendants 60 days to review and produce the rest of the documents. None were forthcoming.

The magistrate judge found that the defendants had violated their duty to preserve evidence, and noted that “much of the Defendants’ explanation for discarding the hard drive is incredible.” But the magistrate limited sanctions to a jury instruction on spoliation: she found the defendants’ behavior was grossly negligent, but not in bad faith.

The district judge reached the “inescapable conclusion that Defendants destroyed evidence and lied about it.” As such, she reasoned that a spoliation instruction was insufficiently harsh. Instead, the district judge forbade the defendants’ use of any of the documents taken from the hard drive and ordered the defendants to obtain emails from their email service providers.

The district judge’s bad faith finding was reasonable, the appellate court held. The defendants’ stories regarding the destruction of the computer were far from consistent—both the district judge and the magistrate judge agreed on that point. Once the district court concluded that bad faith had driven the defendants’ failure to produce the hard drive, it was permissible to infer that the missing evidence would in fact have been harmful to the defendants. Given that, it was no abuse of discretion to grant a harsher sanction barring the use of any documents from the hard drive and ordering Richard Swiech and Lewicki to seek all of their emails from their email providers. Such a sanction appropriately mitigated the harm to the plaintiffs as a result of the defendants’ wrongdoing.

The Default Judgment

The discovery abuse led the district judge to default the defendants, the appellate court noted. Default judgment is strong medicine for discovery abuse. It is appropriate only where there is a clear record of delay or contumacious conduct.

The defendants correctly argued that they could not be sanctioned for failure to comply with discovery orders if compliance was impossible. They claim that the district judge held them to too high a standard for demonstrating impossibility.

However, there was no evidence that the district court was applying a more rigorous standard than it should have, the appellate court explained. The district judge’s conclusion that the defendants’ efforts were neither extensive nor in good faith was entirely reasonable. The defendants made, at most, token efforts to comply with the August 13 contempt order. In the case of Lewicki, there was no effort at all. Their other behavior during discovery bolstered the case for default. For one, Adam Swiech’s failure to sit for, or even schedule, his deposition smacked of discovery-dodging.

Taken together, these discovery abuses formed a mosaic that convincingly showed both a clear record of delay or contumacious conduct, and willfulness, bad faith, or fault. Moreover, the district judge was clear that her list of abuses was not exhaustive. Thus, the district judge’s decision to grant the default judgment was warranted and not an abuse of discretion.

The Damages Calculation.

After the judgment was entered, the plaintiffs proposed a three-step method for calculating their damages, and offered expert testimony in favor of their theory. The expert first measured the portion of KBP ownership lost as a result of the defendants’ diluting the plaintiffs’ stake in the company. The expert then multiplied this figure by the price a real-estate firm called Orco had offered to purchase all of KBP’s shares to yield the plaintiffs’ gross damages. Finally, the expert subtracted the actual value of the plaintiffs’ KBP shares to calculate their net damages.

Fixing KBP’s present value (from which the plaintiffs’ share value was derived) was tricky, because the defendants did not turn over some of the relevant company documents. Thus, the plaintiffs’ expert relied on the 2009 offer of another business—Apollo-Rida Poland sp. z o.o.—to buy all of KBP’s shares. Finally, because the default judgment had established liability under RICO, the damages were trebled, for a total of just over $413,000,000.

The district judge acknowledged that the plaintiffs’ theory was perhaps speculative, but adopted it anyway, both because the defendants’ had put forth no alternative and because she found it was their obstructionist behavior that made business records hard to obtain.

The defendants raised a multitude of arguments attacking the damages award on appeal: the damages were not sufficiently certain for the district court to calculate them without holding a hearing. The defendants challenged the certainty of the “adjusted ownership percentages,” the accuracy and certainty of the Orco offer used to calculate the gross loss amount, and the reliability of using the Apollo offer to calculate KBP’s present value.

Because the defendants did not challenge the plaintiffs’ adjusted ownership computations in the district court, they have forfeited their right to do so on appeal. The defendants did raise complaints about the Orco offer below, but there was nothing to suggest that the district court erred on this front. Thus, the plaintiffs properly proved their gross losses from the Orco deal.

As for the Apollo offer, the documents needed to perform the preferred analysis were unavailable and the expert thought that the Apollo offer was a sensible alternative. The district judge reasonably found this methodology permissible, especially because the defendants had withheld documents that might have aided in a more accurate valuation. There was no abuse of discretion in adopting any of the inputs in the plaintiffs’ damages formula, the court held.

Nor did the district court abuse its discretion in denying the defendants a damages hearing. The defendants did not submit a damages expert or put forth an alternative damages theory of their own, though they presumably possessed sufficient information to construct one. The district court had figures in hand and it was no abuse of discretion to decline to hold a damages hearing in these circumstances.

The Denial of the Motion to Stay

There were no inconsistent awards in this case. The plaintiffs committed—both in open court and in their briefs—to dismiss all claims against the non-defaulting defendants if the judgment against the Swiechs and Lewicki was affirmed. It was therefore no abuse of discretion for the district court to deny the defendants’ motion for a stay.

The case is No. 13-2435.

Attorneys: Robert S. Michaels (Robinson, Curley & Clayton, PC) for Jan Domanus. Thomas D. Carroll (Fuksa Khorshid, LLC) for Derek Lewicki.

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