January 1, 2013

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Drowning in Paper

How Long to Keep Business Records

Gretta Spendlove

January 1, 2013

When Mike Lewy returned from deer hunting and unloaded his M700 rifle, the gun discharged and sent a bullet ripping through the ceiling and into his mother’s leg. The Lewys sued Remington Arms, the gun manufacturer, for liability based on design defects and failure to warn. In this 1988 products liability case, the jury awarded Mrs. Lewy $20,000 in compensatory damages and $400,000 in punitive damages.

As the Remington Arms lawsuit proceeded, Remington refused to turn over evidence of complaints from other customers about the M700 on the basis that the complaints had been destroyed under Remington’s record retention policy. That policy required customer complaints to be retained for only three years. The trial court instructed the jury that it could infer that all the evidence that Remington failed to produce was unfavorable to it because Remington’s records policies were unreasonable.

The appeals court listed questions to ask in determining whether records retention policies are adequate: 1) whether they are reasonable considering all facts and circumstances (“A three year retention policy may be sufficient for documents such as appointment books or telephone messages, but inadequate for documents such as customer complaints”); 2) whether they were instituted in bad faith; and 3) whether lawsuits concerning the complaint have been filed.

Basic Rules for Records Retention
Businesses should comply with specific timelines for records retention set by the IRS, state and federal statutes of limitation, and laws and regulations governing specific businesses. Since calculating timelines from the IRS regulations and state and federal statutes of limitation can be so complicated, businesses may prefer to rely on summaries of timelines distributed by their lawyers or CPAs. They must remain aware, however, of special guidelines applicable to their type of business.

In addition, businesses should follow general principles suggested by the Remington Arms court—timelines must be reasonable given all facts and circumstances, and timelines cannot be instituted in bad faith. Once a lawsuit is filed, businesses cannot destroy records related to the lawsuit, even as part of a routine records destruction process.

IRS Regulations
IRS Code Section 6001 requires anyone liable for federal tax or its collection to keep records and to comply with applicable rules and regulations. The IRS website includes a framework for analyzing how long specific records must be kept. That framework is based on keeping records for at least the IRS “limitations periods,” or the periods within which the IRS can enforce its rights.

For instance, since the IRS can audit tax returns for three years after they are filed, documents on which the tax return was based should be kept for at least three years. Since analyzing limitations periods is complicated, businesses may prefer to rely on retention schedules compiled by their lawyers and accountants.

State and Federal Statutes of Limitations
Claims under either state or federal law must be made within certain limitations periods, also set by law. In general, claims based on written contracts can be brought under Utah law within six years of execution of the contract, claims on oral contracts can be brought within four years and claims for negligence can be brought within four years of the negligent action. Documents to defend against a claim or to assert a claim should be kept at least as long as the limitations period. Thus, written contracts should be kept for the term of the contract and at least six years more.

Laws and Regulations Governing Specific Businesses
In addition to the broad rules that apply to all businesses, regulators of specific types of businesses often set record retention schedules. For instance, Utah nursing care facilities must retain medical records for seven years after the last date of patient care. Limited liability companies must permanently retain basic records such as their articles of organization.

Reasonableness, Good Faith, and Litigation Tests
In 2001, the SEC issued a subpoena to Arthur Anderson, a national accounting firm, for records relating to its audits of Enron. In 2002, Arthur Anderson disclosed that the company had destroyed records related to Enron audits. Officials claimed the records were destroyed in conformity with records retention schedules, before the SEC investigation began. Federal prosecutors claimed Arthur Anderson destroyed the audit records after the SEC investigation began and that Arthur Andersen officials were fully aware that the company would be asked to produce the records. The company was charged and convicted of obstruction of justice, and its clients fled.

In the wake of the Enron scandal, the Sarbanes-Oxley legislation was enacted. It mandates retention of all documents relevant to possible government investigation and requires that audit work papers be retained for at least seven years.

Bottom Line
Companies cannot use records retention schedules as pretexts to destroy potentially damaging materials on an expedited basis. They cannot destroy relevant documents when an investigation or litigation is pending. They must know and comply with records retention schedules managed by the IRS Code and other laws and regulations.

Gretta Spendlove is a lawyer at Durham Jones & Pinegar.

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