Digging A Hole

Sue Reisinger

Corporate Counsel

09-01-2012

Litigation and anger can be a dangerous mix—like drinking and driving. Sometimes a company and its lawyers can become so outraged when a valued employee leaves, especially when executives believe that the employee took company secrets with him, that they lash out in court. That's what Eaton Corporation did when it sued six engineers who left for another company. Eight years later, Eaton is still dealing with the painful consequences of its actions.

Oh, what a tangled web Eaton wove. Its civil and criminal allegations, followed by the defendants' countersuits, have reached into four courts in Ohio, Mississippi, and North Carolina [see "Litigation Scorecard," page 64]. In one Mississippi county court alone, the original suit has gone through three judges and three special masters.

And Eaton's zealous legal tactics backfired big-time. Among the casualties so far are two terminated outside counsel, a tainted special master, and two fired in-house lawyers, including Eaton's litigation chief. The Cleveland-based Fortune 200 company has paid dearly as well. Its misconduct led to the dismissal of its suit, the assessment of $1.5 million in sanctions, and the infliction of serious damage to its reputation. The wrongdoing included paying off its star fact witness, lying about the payoff during discovery, hiring an outside counsel who influenced the judge through ex parte communications, and then withholding discovery documents that implicated its general counsel in those communications.

In a dramatic twist, Eaton entangled two civil rights heroes who were featured in a popular book and movie in its misdeeds. One was imprisoned, the other disbarred, for their actions in a different case. And it's not over yet.

Eaton denies any intentional wrongdoing. In a statement at the time, Eaton said that there was no proof that an outside counsel tried to sway the judge in its favor or that Eaton or its employees knew about the improper communications. Asked to comment, an Eaton spokesman wouldn't elaborate. The company has appealed the dismissal of its suit to the Mississippi Supreme Court.

Eaton general counsel Mark McGuire has mostly remained silent. The defendants accused him, court documents show, of at least being aware of some of the misconduct. McGuire declined to be interviewed for this article, but in June he visited the Cleveland Plain Dealer and said, "We're hopeful that we'll get our day in court to explain what happened."

But Eaton's time to explain is growing short—as is its credibility. In April its lawyers admitted to their second discovery violation. They had overlooked some emails involving the ex parte communications during discovery several years ago. When the withheld emails were revealed, the court went ballistic and ordered an inquiry.

As a result, at least two Eaton in-house counsel, including litigation chief Victor Leo, lost their jobs in May. Eaton's national outside counsel asked to withdraw, with Eaton's blessing. And now the defendants have asked the Mississippi Supreme Court to stay Eaton's appeal while they peruse the emails and thousands of other newly produced documents.

The month brought even more bad news for Eaton. Federal prosecutors decided to dismiss the criminal charges against the engineers. Worse, the defendants' civil counterclaim in Mississippi is still pending against the company, as is their antitrust suit in North Carolina that could cost Eaton treble damages if it's found liable.

Adding insult to injury, a nasty shareholder derivative suit pending in Cleveland accuses the company and its officers, including GC McGuire, of mismanaging the original suit and participating in illegal conduct that cost the company an estimated $1 billion in lost trade secrets.

How in the world could Eaton's case go so wrong?

The company has suggested that it's a victim of a perfect storm of bad breaks coupled with the defense's constant misdirection. But a review of court documents suggests another answer: layers of bad judgments, each followed by an attempt to compensate for or cover them. One court observer who didn't want to be named called it "an epic morality play" with a plot line reminiscent of a John Grisham novel.

We're no John Grisham. And with so much active litigation, almost no one wants to talk on the record. But based on news reports, interviews with several people close to the matter, and a review of more than 1,000 pages of court documents, here's a condensed version. There is an old adage that says that when you find yourself in a hole, stop digging. This is a story about lawyers who couldn't stop digging.

The tale begins in 2001, when six engineers decided to leave Eaton. The power management company is the dominant player in building and selling high-end hydraulic pumps and motors to the aerospace industry—especially to the U.S. government.

But a new rival was emerging. In 2000 Frisby Aerospace (now Triumph Actuation Systems) in North Carolina and its parent company bought the aerospace hydraulic pump and motor business of Honeywell International Inc. for $29 million. About 42 Honeywell employees joined Frisby, but only two of them were engineers. Frisby needed more to compete.

So Frisby went on a recruiting binge. It hired one Eaton engineer, and others followed. But the legal fireworks didn't commence until 2004. That's when Frisby won a contract to supply the hydraulic system for The Boeing Company's new 787 Dreamliner. Eaton quickly filed a civil complaint against both Frisby and the engineers in Hinds County Circuit Court in Jackson, Mississippi—where Eaton operates one of the world's largest aerospace hydraulic pump manufacturing facilities—claiming that the ex-employees stole trade secrets.

The suit introduced Eaton's star witness, Milan Geor­geff, a terminated Frisby employee. Upset and unemployed, Georgeff contacted Eaton and said he had seen the company's documents floating around Frisby. In a fateful move that Eaton execs would come to regret, its general counsel at the time (now retired) negotiated a written consulting contract with Georgeff, who agreed to testify against Frisby. Court documents say that the contract was valued at some $380,000.

Frisby denied the theft charges. It said the so-called trade secrets involved drawings of parts, such as pistons, that had been common knowledge in the industry for years. And it accused Eaton of exaggerating Georgeff's minor allegations into overbroad claims of secrecy.

Frisby hit back with a claim of conspiracy: "Eaton and its coconspirators intended to destroy or cripple Frisby as a competitor . . . to obtain an undeserved large judgment or settlement . . . and to make an example of the engineers—through filing meritless or intentionally exaggerated civil litigation and encouraging criminal prosecution—for the purpose of discouraging any other Eaton employee who might prefer to leave Eaton to work for competitors."

But Eaton's aggressive legal strategy was paying off. When McGuire became general counsel in late 2005, he increased the pressure. Using Georgeff's allegations, Eaton convinced the U.S. attorney's office in Jackson to file criminal charges against five of the six engineers in 2006. A search warrant served on Frisby's plant turned up more than 300 items, including drawings and technical data taken from Eaton.

Eaton painted itself as a victim, and claimed that its businesses and employees had been damaged by dishonest engineers. Its rival, Frisby, was losing contracts while being tied up in the expensive civil litigation. And Frisby was still paying, though not able to use, the five engineers accused of crimes. Eaton was on a roll.

But not for long. Its powerful case was sitting atop a shaky foundation. While the company's chief executive, Alexander Cutler, exalted Eaton's ethics and cultural values on its website, its lawyers repeatedly crossed ethical boundaries.

The first misstep involved paying Georgeff. During discovery, Eaton and Georgeff both swore that he was not being compensated for his testimony. Meanwhile, Geor­geff filed his own suit against Frisby in North Carolina over his termination. During discovery in that suit, Frisby's lawyers asked the same basic questions about whether Geor­geff was being paid by Eaton. But this time Georgeff's North Carolina counsel answered truthfully—and turned over the compensation agreement.

Citing the payment, Frisby asked the Mississippi court to sanction Eaton and to dismiss the suit. Eaton insisted that it had done nothing wrong in hiring an unemployed engineer. Hinds County Circuit Judge Bobby DeLaughter assigned the matter to a special master to ascertain the truth.

In December 2006 the special master issued his report. It was not good news for Eaton. The master found that the plaintiffs' discovery answers were an "intentional effort to mislead." Frisby renewed its motion for sanctions and dismissal. Eaton was losing momentum.

But Frisby didn't know that Eaton was concealing a new gambit. Fearing a bad report from the special master, Eaton hired—behind the scenes, and without notifying the court—an outside counsel who had a long history with DeLaughter. For 32 years Ed Peters had been a legendary Hinds County district attorney, and DeLaughter had been his assistant D.A. for 12 of those years.

Peters and DeLaughter were heroic figures in Mississippi's checkered history. Against social and political pressures, they had brought the killer of civil rights leader Medgar Evers to justice in 1993, 30 years after the slaying. Their true efforts were immortalized in a book and then the movie, Ghosts of Mississippi, in which Craig T. Nelson portrayed D.A. Ed Peters and Alec Baldwin played the idealistic assistant D.A., Bobby DeLaughter, who prosecuted the case.

But there was nothing idealistic or heroic about their work in the Eaton case. Court records indicate that Eaton had agreed to pay Peters a contingency fee as high as $2 million, depending on the outcome of its suit. A later inquiry would find that another Eaton outside counsel, Michael Allred, had recommended hiring Peters to Eaton's chief litigation counsel, Vic Leo, when the lawyers were worried about the special master's probe.

Soon after Eaton hired Peters (by then a solo), he visited his old friend DeLaughter several times. Then, in April 2007, DeLaughter denied Frisby's motion to dismiss the case. He also rejected most of the special master's findings against Eaton, and sealed the report. The judge ruled that Allred, a private practitioner in Ridgeland, Mississippi, was solely responsible for the false discovery statements about Georgeff.

Eaton ended its relationship with Allred, who didn't return messages seeking comment.

Still, DeLaughter didn't completely exonerate Eaton. He held that the company, along with outside counsel Michael Schaalman of Quarles & Brady in Milwaukee, had knowledge of the discovery violations. The judge said that the defendants would be awarded sanctions in an amount to be determined against Eaton, Allred, and Schaalman (who also declined to comment for this story).

But DeLaughter never imposed the sanctions, and Ed Peters wasn't finished. In October 2007, at Peters's urging, DeLaughter removed the special master and replaced him with a new one whom Peters favored. As Peters would later tell the Federal Bureau of Investigation, he and DeLaughter had an almost father-son relationship, and DeLaughter "couldn't tell me no." The momentum seemed to have shifted back to Eaton.

But three months later, Peters's involvement exploded in Eaton's face—not because of what he did in this case, but because of what he and DeLaughter did in a matter that's now notorious. In January 2008 DeLaughter recused himself from the Eaton action because he was a target of a federal investigation in the case of Richard "Dickie" Scruggs.

Scruggs was the billionaire Mississippi trial lawyer and the so-called King of Torts. He had made a fortune bringing cases against asbestos and tobacco companies. Scruggs was sentenced to seven years in prison in 2008 and 2009 for trying to bribe one judge and for improperly influencing a second.

That second judge was DeLaughter. His former boss and longtime friend was the middleman. Peters received immunity from prosecution in exchange for his testimony against Scruggs and DeLaughter, and was later disbarred by the state supreme court. Delaughter was sentenced to 18 months in prison and was released last year.

At first the Scruggs matter seemed unrelated to Eaton. With DeLaughter off the case, Senior Circuit Judge W. Swan Yerger reassigned the Eaton case to himself. Then, ten days later, the facts surrounding the Scruggs case came out. The Frisby defendants asked Yerger to allow discovery about Peters's involvement, and to review DeLaughter's rulings.

Before Yerger could rule, another shoe fell. The second special master resigned, citing the possible appearance of impropriety due to ex parte communications with Peters. Peters had contacted him to ask if he would take the special master's job if DeLaughter offered it. That was enough for Yerger. He appointed yet a third special master, instructing this one to inquire into "any alleged attempt to influence any judicial officer" and to review DeLaughter's rulings.

When deposed, Peters took the Fifth. But during the Scruggs probe, he had admitted to the FBI that he was influencing the Eaton case through ex parte communications with DeLaughter. For its part, Eaton acknowledged that it had hired Peters—but as a consultant, it insisted, with no intention of trying to influence DeLaughter or the special master.

People used to say, "It all comes out in the wash." These days it all seems to come out in the emails. There were emailed discussions among the in-house and outside counsel of Peters's thoughts, of his description of DeLaughter as "supportive," of his predictions on how DeLaughter would rule.

One email from litigation chief Leo to general counsel McGuire said that Peters "intends to speak with the court administrator and the judge about the trial date. This may take some finessing." In another, Leo repeated for McGuire what Peters had said about the chance that DeLaughter would withhold a ruling on monetary sanctions until after the trial: "Ed said he believed that there was 'a 100 percent chance that would happen; maybe I am off a percent or two.' "

While the special master weighed this evidence, Yerger acted on the original sanctions motion that DeLaughter had sat on. In January 2010 the court awarded $1.5 million in sanctions to the defendants for the intentional discovery violations involving Georgeff. Eaton's appeal of the sanction to the state supreme court was denied.

Eaton was sinking fast. Next came the third special master's report regarding the Peters/DeLaughter affair. He didn't believe Eaton's in-house or outside lawyers when they said they didn't know Peters was involved in ex parte communications with DeLaughter. "I find it incredible that no one on the Eaton team was aware of the impact Peters was having on the rulings that Eaton was receiving. There were numerous 'red flags,' " he wrote, citing several emails that should have been questioned by in-house counsel.

Finally, in December 2010, the judge dismissed Eaton's case, citing the company's misconduct. In a scathing 26-page order, Yerger wrote of a "fraud upon the court." He said Eaton's counsel's "selective memories and continuous story-changing point to only one explanation: Eaton and its counsel knew of the serious improprieties occurring on its behalf between Peters and DeLaughter, and stood by with blind eyes." He found in the Eaton emails "clear and convincing evidence of misconduct by Peters on behalf of Eaton and Eaton's knowledge and/or negligence and ­inaction in investigating." At press time Eaton's appeal of the dismissal was pending in the Mississippi Supreme Court.

Eaton asked Yerger to dismiss Frisby's counterclaim, and he refused. Frisby's civil suit against Eaton in North Carolina was moving forward. And Yerger's final act before retiring from the bench at the end of 2010 was to unseal most of the records in the Eaton case, which meant that Frisby could use them in the other litigation. In January 2011 Judge Jeffrey Weill took over the suit.

A month later came more bad news for Eaton. The company's shareholders filed suit against it and its officers in Cuyahoga County Common Pleas Court in Cleveland. The suit alleges that Eaton's lawyers and CEO bungled the Frisby case.

By this April, with no more shoes left to drop, let's just say that Eaton's misdeeds were transparent. Outside lawyers preparing Eaton's defense against the shareholder suit found other emails and documents that should have been turned over to Frisby years ago. Especially critical were emails about the Peters scandal, further implicating Eaton's in-house lawyers and outside counsel Schaalman.

Eaton voluntarily brought the documents to the attention of Judge Weill. It asked James Brandt, managing partner of Latham & Watkins's New York office, to conduct an internal investigation. Brandt's report concluded, "Our review . . . did not reveal any deliberate attempts by Eaton lawyers to conceal" the emails.

But Brandt did find something else. It seems that Leo allegedly told Eaton's tech department not to search the hard drive for emails because the lawyers would manually search their own computers. Some were overlooked. A manual check "was not a reliable method for identifying all responsive emails," Brandt wrote.

McGuire admitted to the court that the original search for emails was "inadequate." He also fired Leo as well as Sharon O'Flaherty, an in-house senior lawyer directly involved in discovery. The Peters emails were found on O'Flaherty's computer. She told the court that she had accidentally missed them, and that she believed the tech department was searching as well. Schaalman, of Quarles & Brady, was also history.

Perhaps it was all too much for the U.S. attorney's office. In June prosecutors dropped all criminal charges against the five former Eaton engineers. They offered no reason.

Beyond its appeal, Eaton has one more chance. It has filed a counterclaim in Frisby's North Carolina suit. The claim basically repeats its original trade secrets suit against Frisby, and contends that Judge Yerger never gave Eaton its due process in Hinds County. But Frisby has asked the North Carolina court to dismiss the counterclaim based on res judicata—that Yerger already decided those issues in Frisby's favor.

We're not sure what John Grisham would say, but this case speaks volumes about Eaton's lawyers. Filled with moral outrage, they attacked again and again in ways that came back to haunt them. The lessons from this matter could fill a litigation casebook—or an ethics seminar.

As Judge Yerger concluded: "Contrary to Eaton's claim of being victimized by Peters's allegedly 'unauthorized' misconduct, Eaton is not the true victim. Instead the true victim is the justice system and its integrity."