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Seventh Circuit Vacates Damages Awarded to an Internet Marketing Firm Because Award Represented Revenues Rather than Profits

Thursday, September 22, 2011

e360 Insight, Inc. v. Spamhaus Project, Nos. 10-3538, -39, 2011 BL 226933 (7th Cir. Sept. 2, 2011) The U.S. Court of Appeals for the Seventh Circuit affirmed a district court's decision to strike the trial testimony of, and impose discovery sanctions against, a bulk e-mail marketing company that sued an organization that it claimed destroyed its business by placing the company on a list of businesses that transmit large quantities of unwanted commercial e-mail. The Seventh Circuit also reduced the district court's damages award in favor of the plaintiff from $27,002 to nominal damages of just $3.

Nonprofit Organization Identifies Plaintiff as a Spammer

As explained by the court, plaintiff e360 Insight, Inc. is "a now-defunct internet marketing company that was operated out of Wheeling, Illinois by co-plaintiff David Linhardt." Spamhaus at 2. Defendant Spamhaus Project is a nonprofit organization based in the United Kingdom that is dedicated to identifying spammers. Spamhaus maintains a list of Internet protocol ("IP") addresses of verified spam distributors and makes that list available on the Internet. Many Internet service providers ("ISPs") use Spamhaus's list to prevent their subscribers from receiving e-mails originating from those addresses. When Spamhaus added e360 to its list of known spammers, e360 and Linhardt sued Spamhaus for defamation, tortious interference with contractual relations, and tortious interference with prospective economic advantages. Spamhaus appeared in the litigation and asserted that the court could not properly exercise personal jurisdiction over it. Subsequently, however, Spamhaus decided not to participate in the litigation and withdrew its answer. The district court entered a default judgment against Spamhaus. Based on Linhardt's affidavit, the court awarded e360 $11,715,000 in damages. Spamhaus moved to set aside the default judgment, but the district court denied that motion. On appeal, the Seventh Circuit affirmed the default judgment, but held that the district court erred in accepting at face value Linhardt's "conclusory statement of the lost value of his business." See e360 Insight, Inc. v. Spamhaus Project, 500 F.3d 594, 603 (7th Cir. 2007). The Seventh Circuit remanded the action to the district court with instructions to conduct "a more extensive inquiry into the damages to which e360 is entitled." Id. On remand, the district court allowed the parties to conduct limited discovery on the question of damages and then conducted a bench trial. The district court awarded e360 a total of $27,002—$27,000 for its tortious interference with contractual relations claim and $1 in nominal damages for each of its claims of defamation and tortious interference with economic advantage. See e360 Insight, LLC v. Spamhaus Project, No. 06-CV-03958, 2010 BL 131145 (N.D. Ill. June 11, 2010); see also District Court Reduces Accused Spammer's $11 Million Damage Award to $27,000, Bloomberg Law Reports – Technology Law, Vol. 2, No. 13 (June 28, 2010).

Arguments on Second Appeal

Spamhaus appealed, arguing that the $27,000 award was improper because it represented an award of revenues rather than profits. The plaintiffs cross-appealed, arguing that the district court erred in imposing discovery sanctions that limited the amount of damages they could claim, in denying a motion by e360 to compel Spamhaus to respond to discovery, in striking one of e360's trial exhibits, and in striking or disregarding a large portion of Linhardt's trial testimony.

District Court's Discovery Sanctions

In 2008, prior to the damages trial, Spamhaus moved for sanctions against the plaintiffs, accusing them of "persistent discovery defaults." Spamhaus at 5. Those defaults included Linhardt's repeated failure to appear for his deposition and serving unresponsive answers to Spamhaus's interrogatories. On July 30, 2008, the district court granted Spamhaus's motion in part. Among other things, the court ordered e360 to respond to all outstanding interrogatories by August 13, 2008. The court also held that "[n]o new discovery may be propounded by either party." Id. The plaintiffs did not comply with the court's August 13 deadline, and Spamhaus moved to dismiss the action as a sanction pursuant to Rule 37(d)(2) of the Federal Rules of Civil Procedure. After Spamhaus filed its motion, the plaintiffs provided the delinquent interrogatory answers and opposed the dismissal motion. They blamed their noncompliance with the court's order on the departure of an attorney from the law firm representing the plaintiffs. The district court, however, observed that the plaintiffs' late answers identified 16 new witnesses to testify as to e360's costs, revenues, lost profits, and valuation. This represented a substantial change of position, as e360 had previously stated that only Linhardt would provide such testimony because he was the only person with knowledge of those matters. The late answers also increased the plaintiffs' damages estimate from $11.7 million to $135 million. The court further observed that on two occasions prior to Spamhaus's motion, it had been necessary to compel the plaintiffs to comply with their discovery obligations. In light of these facts, the district court denied Spamhaus's motion to dismiss the action but imposed sanctions against the plaintiffs. The court struck the plaintiffs' list of 16 new witnesses and struck their damages claims to the extent they exceeded the earlier $11.7 million estimate.

No Abuse of Discretion in Imposing Discovery Sanctions

Fed. R. Civ. P. 37(b)(2)(A) grants district courts authority to impose sanctions for violations of discovery orders. Under the applicable abuse of discretion standard, an appellate court will not set aside sanctions that are "reasonable under the circumstances." Spamhaus at 7. The Seventh Circuit held that the district court did not abuse its discretion in imposing sanctions on the plaintiffs. Although the plaintiffs argued that they did not act willfully or in bad faith, the court pointed out that a district court may impose discovery sanctions short of dismissal when the sanctioned party has been guilty of mere negligence. "e360's failure to comply with the district court's July order" was at least negligent, the court held, and thus "was a sufficient basis to impose sanctions under Rule 37(b)(2)(A)." Id. at 8. Moreover, the court reasoned that it was appropriate to consider the reasonableness of the sanction in light of the plaintiffs' prior discovery behavior. In particular, the court concluded that several facts—including Linhardt's repeated failure to appear for his deposition, the district court's entry of two earlier orders compelling the plaintiffs to comply with discovery, and the fact that the plaintiffs' delinquent interrogatory answers introduced 16 new witnesses and increased their damage estimate more than tenfold—"provided powerful evidence that e360 was not engaging in the discovery process in good faith." Id. at 10. Under these circumstances, the Seventh Circuit concluded that the district court could properly have dismissed the plaintiffs' claims as a sanction, and in imposing lesser sanctions, the district court "exercised its discretion with considerable restraint." Id. at 12.

No Abuse of Discretion in Denying Plaintiff's Motion to Compel

The Seventh Circuit also found no abuse of discretion in the district court's denial of an October 2008 motion by the plaintiffs to compel Spamhaus to provide information about the location of certain data, as well as the identities of Spamhaus employees, their job functions, and their compensation. By the time the plaintiffs filed their motion, the district court had already ruled that the only remaining discovery would be the depositions of Linhardt and Spamhaus's corporate representative. Moreover, most of the information sought in the plaintiffs' motion—such as the compensation of Spamhaus's employees and the location of data—was irrelevant to the question of damages. The plaintiffs argued, however, that some of the information they sought was relevant because it might help identify third parties who used Spamhaus's list of spammers and blocked e-mail from e360 in reliance on that list. In rejecting this argument, the Seventh Circuit observed that Spamhaus did not collect information regarding who viewed its list; moreover, there was only a speculative possibility that any useful information could have been obtained if the plaintiffs' motion had been granted. Accordingly, the plaintiffs suffered no actual and substantial prejudice such as would warrant reversal of the district court's ruling.

No Abuse of Discretion in Excluding Plaintiffs' Trial Exhibit or Striking Plaintiff's Testimony

The Seventh Circuit affirmed the trial court's exclusion of one of the plaintiffs' trial exhibits—a spreadsheet purporting to show the diminution in e360's value as a result of Spamhaus's inclusion of e360 on its spammer list. The plaintiffs had previously produced a version of the spreadsheet which estimated the diminution in value to be $135,173,577. The week before the trial, the plaintiffs revised the spreadsheet and placed the estimate at $122,271,346. Spamhaus moved to strike the exhibit, and although the district court allowed the plaintiffs to present the spreadsheet at trial, the court subsequently granted Spamhaus's motion. The Seventh Circuit found no abuse of discretion in this decision because the plaintiffs provided the document after the discovery cutoff date and because Linhardt, who had prepared the spreadsheet, lacked the expertise necessary to establish the foundation for its admission into evidence. The Seventh Circuit noted that the plaintiffs' attempt to introduce the document "was clearly an attempt to evade the district court's proper discovery sanction limiting the damages e360 could seek." Spamhaus at 16. The Seventh Circuit also affirmed the district court's exclusion of much of Linhardt's damages testimony. Linhardt testified that he had estimated e360's damages by calculating the average amount of revenue it would have received for each e-mail it sent and multiplying that amount by the number of e-mails he believed had been blocked as a result of e360's appearance on the spammer list. Because the plaintiffs' prior estimates of their damages had fluctuated dramatically, the court found that the district court was justified in giving "Linhardt's testimony no weight because he was not credible." Id. at 18.

Vacatur of Damages Award

The district court's award to the plaintiffs of $27,000 in damages was based on evidence that three of e360's customers had collectively paid e360 a total of $27,000 per month, and as a result of Spamhaus's actions, e360 lost its contracts with those customers. The plaintiffs acknowledged that long-term contracts were not the norm in their industry, and the district court found no reason to believe that e360's contracts would be different from others. However, the district court concluded that the three customers in question would have continued their relationship with e360 for an additional month absent Spamhaus's actions. Spamhaus argued on appeal that the district court's damages award was excessive because it was based on e360's gross revenues rather than its profits. The Seventh Circuit agreed. In Taylor v. Meirick, 712 F.2d 1112, 1121 (7th Cir. 1983), it observed, the court had rejected as improbable a plaintiff's claim "that lost sales revenue would have been all profit." In the instant case, the Seventh Circuit found the same conclusion to be justified because e360 would have incurred costs, including royalties payable whenever its e-mails generated revenue, that would have to be deducted from gross revenues to produce profits. Because the plaintiffs "failed to offer any evidence that would have allowed the district court to determine what portion of its $27,000 lost gross revenue would have been profit," the Seventh Circuit concluded that the district court erred in awarding the gross revenue figure to the plaintiffs. Spamhaus at 22. The lack of such evidence also precluded the Seventh Circuit from imposing a remittitur of damages. Accordingly, the Seventh Circuit vacated the $27,000 damages award and substituted in its place a nominal damages award of $3 for each of plaintiffs' claims. Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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