Xyngular Corp. v. Schenkel (200 F. Supp. 3d 1273, 2016)

MEMORANDUM DECISION AND ORDER

ROBERT J! SHELBY, United States ' District Judge

This case arises out of a dispute between a corporation and' one of its shareholders over shares of stock. Plaintiff and Counterclaim Defendant Xyngular Corporation sued Defendant, Counterclaimant, and Third-Party Plaintiff Marc Schenkel for breach of contract. Schenkel then counterclaimed against Xyngular and brought third-party claims against several individuals and . entities associated with Xyngular. The case soon became mired in a quarrel over whether the parties engaged in sanc-tionable conduct. After engaging in lengthy discovery, on the issue, the parties filed cross-motions for dispositive sanctions. For the reasons stated below, the court grants in part the Xyngular Parties’ Motion for Dispositive Sanctions and-denies without prejudice Schenkel’s Motion for Dispositive Sanctions.

BACKGROUND

To provide necessary context for the cross-motions for dispositive sanctions, -the court details the events giving rise to this case as well as the procedural history that led to the current motions.

I. The Formation of Xyngular Corporation

Marc Schenkel met Rudy.Revak in summer 2009. The two became friends and had many discussions about their mutual interest in network marketing. Schenkel had been involved in the network marketing field for many years and at the time was a distributor for a multi-level marketing company called Xango. Revak was and is a founder and the majority owner of a multilevel marketing corporation called Symmetry.

Schenkel told Revak during their many discussions that he had learned of a new compensation concept that could revolutionize the network marketing arena. They agreed to form a new company that would use the concept. Revak offered for a fee to provide programming, product, and logistics support to the company through Symmetry. He also decided to include two of his Symmetry co-owners, Mary Julich and Steve Kole, in the venture to help manage the new company. The company they eventually created is Xyngular Corporation.

The four founders agreed that Revak and Symmetry would provide the necessary resources to launch Xyngular. They also used resources from Global Ventures Management Services (GVMS) to get the company off the ground. Revak, Julich, and Kole co-own GVMS, which began as a division of Symmetry in 2009 but later became a stand-alone entity in 2011. Like Symmetry, GVMS provides IT, consulting, and logistics services to Xyngular for a fee. GVMS also provides similar services to other entities, and it has since changed its name to Alytis.

In September 2009, Revak, Julich, and Kole incorporated Xyngular in Delaware. Xyngular’s Certificate of Incorporation shows that Revak, Julich, and Kole were designated as Xyngular’s Board of Directors. Revak became Chairman of the Board, while Julich became Vice President and Kole became Secretary and Treasurer.

Meanwhile, Schenkel declined to be Xyngular’s President because he was working on a separate business that required his attention. He instead agreed to recruit a President and a Master Distributor for Xyngular. As promised, Schenkel recruited Marc Walker to serve as Xyngu-lar’s President and Joe Slovenec to serve as its Master Distributor. Xyngular promised Slovenec a 3% ownership interest in Xyngular that would vest over time. Xyn-gular also hired Glen Oliver as the company’s Chief Operations Officer and Bart Graser as its Assistant Secretary and Treasurer.

The founders—Revak, Schenkel, Julich, and Kole—then agreed to an ownership structure whereby Revak would become Xyngular’s majority shareholder and the other three founders would become minority shareholders. They decided that Revak would receive a 51% ownership interest; that Schenkel, Julich, and Kole would each receive a 10% interest; that Walker would receive a 5% interest; and that Slovenec would receive a 2% interest. The founders also agreed that Ian Swan would receive a 2% ownership interest in the company. Swan is an IT consultant for GVMS who agreed to provide programming services to Xyngular and to create its infrastructure.

At its first meeting, held in October 2009, the Board of Directors issued Revak 5,100 shares, Julich 1,000 shares, Kole 1,000 shares, and Swan 200 shares. The Board did not issue Schenkel any shares at this meeting because his agreement with Xango prevented him from holding shares in Xyngular. But it was understood that Xyngular would issue Schenkel his 10% ownership interest once he was no longer obligated to Xango.

Later that month, Xyngular submitted to the Internal Revenue Service IRS Form 2553, titled “Election by a Small Business Corporation.” Kole signed the Form on behalf of Xyngular on October 23, 2009. Like the share distribution the Board approved at the October 2009 meeting, the Form shows that Revak is entitled to 5,100 shares, that Julich is entitled to 1,000 shares, that Kole is entitled to 1,000 shares, and that Swan is entitled to 200 shares.

The Board voted in January 2010 to double the number of outstanding shares. The Board doubled each of the current shareholders’ shares and issued Revak 10,-200 shares, Julich and Kole each 2,000 shares, and Swan 400 shares. Again, the Board did not issue Schenkel any shares due to his agreement with Xango. But shortly after the January 2010 meeting, Xango suspended Schenkel’s distributorship upon learning of his role within Xyn-gular.

Slovenec stepped down as Master Distributor in mid-2010. In doing so, he agreed to surrender his shares of-Xyngu-lar stock, including his 3% ownership interest—or 600 shares—that -had yet to vest.

II. Schenkel’s Role in Xyngular

Although Schenkel was unwilling to be Xyngular’s President, he was willing to use his relationships with major distributors from other leading multi-level marketing companies to help build the Xyngular distributor network. Believing that it could capitalize on those contacts, Xyngular gave Schenkel the top position on Xyngular’s distribution genealogy in addition to his 10% ownership interest in the company.

Schenkel also became Xyngular’s Interim Sales Director around the time when Slovenec resigned as Master Distributor, Xyngular paid Schenkel a monthly income while he served in that capacity, issued him a company credit card, and allowed him to attend exclusive company events. In turn, Schenkel held conference calls with distributors, traveled around the country to meet with distributors, and promoted Xyngular at meetings with distributors. The parties understood that Schenkel would temporarily hold the position until Xyngular hired a permanent Sales Director, which it did in about August 2011.

The parties dispute the remaining details of Schenkel’s role within Xyngular. The Xyngular Parties submit evidence that Schenkel assumed the responsibilities of Master Distributor in addition to his responsibilities as Interim Sales Director. Xyngular’s corporate representative testifies that Revak asked Schenkel to step in as the company’s Master Distributor when Slovenec resigned. Revak also declares that Schenkel orally agreed in early December 2010 to perform the duties of Master Distributor in exchange for additional compensation. Under the agreement, Schenkel would continue as the Interim Sales Director until Xyngular hired a permanent Sales Director. He would also receive an additional, irrevocable 3% ownership interest if Xyngular’s IPC sales reached $2. million per month while Schenkel performed as Master Distributor. And he would receive an additional 7% if Xyngular’s IPC sales reached $5 million per month while he performed as Master Distributor. Revak agreed to personally pay Schenkel the 7% of profits in the event sales hit the $5 million mark, and Schenkel agreed to pay the taxes on that amount.

As evidence of the agreement, the Xyn-gular Parties point to Revak’s handwritten notes from the December 2010 meeting. The notes state, “Give M.S. additional 3% ownership @ 2 mil and additional 7% @ 5 mil from Rudys dist. But M.S. to, pay taxes.” Julich declares that she later recorded the terms of the December 2010 agreement in a document titled “Xyngular Corporate Equity Agreement.” The document states:

Rudy Revak agrees to personally pay Marc Schenkel the equivalent of 7% of the total shareholder distribution paid from Xyngular Corporation.

Should the company be sold the equivalent of 7% of the net sale amount will be paid to Marc Schenkel by Mr. Rudy Revak.

Marc Schenkel agrees to pay any and all taxes due on this income.

This ' agreement will take effect any quarter that Xyngular Corporation averages a minimum of 5 million dollars in IPC sales per month. And [at] 2 millfion] per month IPC sales M.S. to receive 3% from Rudy Revak.

Revak and Schenkel signed the agreement on March 30, 2011,

As Master Distributor, Schenkel was required to recruit distributors and leadership. Although Schenkel recruited some people, the Xyngular Parties offer evidence that Schenkel failed to adequately perform these duties. For instance, Julich declares that by September 2011 Schenkel had substantially stopped participating in conference calls with and recruiting sales leaders, stopped traveling to conduct distributor meetings and trainings, and stopped training distributors generally. Julich also declares that Schenkel “had made unapproved and very expensive purchases at company events and thrown lavish parties that put the company at risk and negatively affected its image.” Walker likewise testifies that Schenkel made several unauthorized expenditures on the company’s credit card and threw parties that could - reflect poorly on Xyngular.

Meanwhile, Kole issued Schenkel his stock certificate in early 2011, but backdated the effective date of the shares to January 1, 2010. Revak and Kole signed the certificate. It shows that Xyngular issued Schenkel 2,600 shares. The Xyngular Parties contend that Kole erroneously issued Schenkel 2,600 shares—representing a 13% interest—instead of the allegedly agreed upon 2,000 shares—representing a 10% interest with the possibility of earning another 3% interest. The Xyngular Parties insist that the 2,600 shares figure was an error because Schenkel had not earned the additional 3%. Indeed, Xyngular did not hit its goal of $2 million IPC sales in one month until April 2012, after Schenkel allegedly quit performing as Master Distributor. And so, the Xyngular Parties maintain that Schenkel never became entitled to the additional 3% interest or 600 shares.

The Xyngular Parties also claim that Schenkel never sat on Xyngular’s Board of Directors. Though he may have attended some meetings, “Schenkel never attended any Board meetings as a member of the Board.” Julich declares that the shareholders did not elect Schenkel to sit on the Board. To be sure, Kole sent Schenkel a letter in August 2011 inviting him to become a Board member. And Schenkel even signed the letter later that month. But after Schenkel threatened litigation against the other founders, as explained below, the Board decided not to vote to add Schenkel to the Board. “As a consequence, Schenkel has never served on Xyngular’s Board or been one of its Directors.”

Schenkel offers contrary evidence showing that he never agreed to become Master Distributor, that he-nevertheless became entitled to 2,600 shares of Xyngular stock, and that he received a lifetime seat on. Xyngular’s Board of Directors. Schenk-el submits deposition testimony of Xyngu-lar’s corporate representative that Schenkel and Xyngular did not finalize an agreement that would have made him Xyngular’s Master Distributor, and that he worked hard while serving as Interim Sales Director. Schenkel also states in his sworn declaration that, while he served as the Interim Sales Director, he worked overtime, flew nearly 10,000 miles, and held meetings and events to recruit more distributors. He also “flew all over the country attending various public events and was featured in numerous Xyngular promotional videos that were distributed by the Company worldwide. [He] was routinely recognized as Xyngu-lar’s Founder and the face of the Company.” And for his efforts and success in that role, Xyngular rewarded him the “3 percent stock ownership, or 600 shares, which had once been reserved for Joe Slo-venec.” “[T]he transfer of these 600 shares was not a mistake or ... conditioned upon [his] continued performance as interim Salés Director.”

Schenkel also declares that Xyngular never hired another Master Distributor after Slovenec left the company, because Xyngular - eliminated the position when Schenkel became the Interim Sales Director. And “[p]rior to Xyngular’s formation, Mr. Revak promised [Schenkel] that [he] would have a permanent seat on Xyn-gular’s Board as one of the' founding shareholders. From the time Xyngular was launched in December 2009 until the Other Founders excluded [him] in September 2011, [he] attended Xyngular board meetings as a board member.”

Schenkel points to his stock certificate as evidence supporting his claim that he is entitled to 2,600 shares. He also submits an email that Graser, Xyngular’s Controller at the time, sent to Schenkel’s accountant in November 2011. Graser states in the email that Schenkel owns “13% of authorized shares.” Similarly, an email sent from Kole to Schenkel in March’ 2011 shows that 2,600 shares had vested in Schenkel’s name.

Schenkel further contends that the 600 shares he received for his efforts as Interim Sales Director is separate from the agreement memorialized in the Corporate Equity Agreement. While Revak’s agreement to pay Schenkel the equivalent of 3% or 7% from his personal funds was conditioned upon Xyngular reaching certain sales goals, Schenkel’s receipt of 600 shares was unconditional.

Finally, Schenkel offers an email that Kole sent to him in late April 2011. The email includes an attachment titled “Letter of Understanding.” In the body of the email, Kole states:

Attached is a Letter of Understanding. I don’t believe the word “Contract” or “Agreement” is the right word because since you got involved we have operated on the basis that you would become a shareholder and provide various services which you would be compensated for [as] the company progressed. This letter identifies all the various things that have been discussed with Rudy, Mary, and myself, what our understanding is, and what the intent of the company is. As such it’s just [ ] “an understanding” and therefore the legal wording should not distract from what the intents of the parties are.

Kole sent the Letter “to acknowledge and identify specific facts surrounding the acquisition of Marc Schenkel’s common shares of stock in Xyngular Corporation as well as other duties and responsibilities undertaken.” The Letter states, “Marc was offered 10% of the company as one of the original shareholders which equals 2,000 shares as of January 1st, 2011.” And “[a]s an original shareholder he was also promised a seat on the Board of Directors.” The company also provided Schenkel “a distributor position in the marketing plan immediately below the company with the understanding that he will continue to recruit sales leaders from the direct selling industry and be a ‘goodwill ambassador’ for the company.” But “per Marc’s request this position will not be known to the sales field.”

The Letter then explains that, after Slo-venec left his post as Master Distributor, Revak “requested that Marc Schenkel assume that role and become active in the company for a period of time until a Sales Manager could be hired by the company.” Schenkel’s role, “although no longer called a Master Distributor,” required him to (1) “participate in conference calls with the sales leaders and other distributors of the company”; (2) “[t]ravel to various cities and conduct distributor meetings”; ’(3) “[p]rovide training to distributors on how to improve recruiting and leadership development”; (4) “[d]iscuss with management concepts for sales promotions, contest criteria, and new product development”; and (5) “act [as] a liaison between the sales field and the company on current events and various day to day operational issues.” In exchange for the performance of those duties, Schenkel was to receive, among other things, “[a]n option to acquire the 600 shares of stock initially assigned to the Master Distributor responsibilities.”

With respect to Schenkel’s alleged Board of Directors seat, the Letter states that it is the Board’s intention “to treat Marc Schenkel in the same manner as the other three founding shareholders who are Rudy Revak, Mary Julich, and Steve Kole.” And “[t]he current Board shall consist of Marc Schenkel, Steve Kole, and Mary Julich, and Rudy Revak.” “The position for Marc Schenkel shall be [] permanent for as long as he is. living and maintains his stock interest providing he is of sound mind and body.”

At the end of the Letter, there is a line for Schenkel’s signature and another line for Kole’s, Both are unsigned..

III. Deterioration of the Relationship

Schenkel began to suspect in mid-2010 that Revak, Julich, and Kole were self-dealing, usurping corporate opportunities, and overall looting the company.

For example, Schenkel alleges that the other founders improperly gave bonuses to GYMS managers, including themselves, in February 2011. Schenkel also contends that the services; Symmetry provided to Xyngular were abysmal. Yet- the other founders unilaterally decided in April 2011—without a vote of disinterested board members—to increase the amount of fees Xyngular paid to Symmetry for its services. This allegedly occurred again when the other founders decided to increase the fees Xyngular paid to GVMS for its services. While this was happening, the other founders supposedly allowed Bruce Jensen, GVMS’s Vice President, to take control of Xyngular’s management. Schenkel claims that as part of his takeover, Jensen caused ' Xyngular to pay GVMS another $2.5 million for its substandard service.

Schenkel also maintains that the other founders secretly gave Xyngular stock to five Symmetry executives and shareholders for less than full consideration. And when he asked the other founders about it, they concealed the true nature of those transactions. For instance, Schenkel points to an email that Kole sent him in June 2011, in which Kole disclosed only three of the five Symmetry executives and shareholders that were given Xyngular stock.

Schenkel further claims that Revak, Ju-lich, and Kole misappropriated Xyngular’s premier product—an appetite suppressing, energy boosting tablet called Xyng—in October 2011 by putting another label on it and selling it through Symmetry as Sym-ply Magic.

IV. Schenkel’s Collection of Documents From Swan

Schenkel approached Swan at some point between mid-2010 and mid-2011 to see if he could confirm Schenkel’s suspicions that the other founders were engaging in illegal and otherwise unethical conduct. Schenkel also inquired if Swan had “any information pertaining to [Schenkel’s] situation and [his] shares at Xyngular.” Schenkel testifies that he asked Swan “if there was any information he could provide that would prove my point of how many shares I owned,” and if there “was anything that could support my claims when I found out that they were in my opinion looting the company.” Schenkel further “asked for any documentation that could substantiate not only my deal, but the fact that I wasn’t participating in any of these alleged acts.”

In response, Swan told Schenkel about numerous illegal activities in which the other founders allegedly engaged. For example, Swan told Schenkel that the other founders were making payments to themselves, other executives, and other individuals from offshore accounts to avoid taxes. Swan also shared his concern that Symmetiy was selling products containing lead. And he told Schenkel that Symmetry had engaged in a tax fraud scheme in which Symmetry collected over $2 million in sales tax from distributors nationwide and then failed to register or remit the sales tax to the proper authorities.

Swan learned about Symmetry’s alleged tax fraud before he met Schenkel and while he was working in Symmetry’s IT department. After he unsuccessfully tried to correct the issue internally, Swan began identifying and collecting, documents from the local area network on an ongoing basis to chronicle the other founders’ illegal conduct. Swan also collected documents for his own purposes, such as to confirm his ownership in Xyngular.

Schenkel discussed these and other issues with Swan for over a year. On several occasion, Swan showed Schenkel documents on his laptop that he had collected over time. According to Schenkel, the documents evidenced the other founders’ illegal conduct as well as confirmed his ownership in Xyngular. • It is unknown exactly what documents Schenkel viewed on Swan’s laptop.

In October 2011, Schenkel began collecting copies of documents from Swan “pursuant to [his] request to review the books and records of Xyngular.” As Schenkel put it, he asked Swan “for any information or documentation regarding not only, I believe, my shares, but the fact that I wasn’t participating in any of the alleged illegal acts.” Swan then proceeded to give Schenkel over three hundred documents on at least five “zip sticks.” For example, Swan gave Schenkel earnings distribution charts, Board meeting minutes, and “contracts that [Bevak] had signed showing his percent interest.” Swan also gave Schenkel balance sheets, budgets, financial projections, employment agreements, and documents containing settlement communications in a separate lawsuit, product ingredient information, and employees’ personal information.

The documents Schenkel obtained belong not only to Xyngular, but also to GVMS, Symmetry, and other companies that house their documents on GVMS’s servers. Aside from owning'shares in Xyn-gular, "Schenkel has never been an owner, officer, director, employee, or shareholder of any of these other companies. And though Swan—as an IT consultant for GVMS—had authorization and the necessary password to access the GVMS servers on which these documents and business records reside, there is no evidence that he had authorization to remove the documents, possess them, or give them to third parties. Nor is there any evidence that Schenkel himself had authorization or a password to access GVMS’s servers. To the contrary, he testified that he had neither a password nor access to GVMS’s local area network.

Schenkel collected documents from Swan “over a long period of time, perhaps over maybe a year.” But Swan testifies that he did not give Schenkel any documents after this litigation began in September 2012.

Around the time he began collecting documents from Swan, Schenkel contacted the FBI to report the other founders’ allegedly illegal conduct. He testifies that he contacted the FBI at least four times, and that he gave the FBI hard copies of the documents on the zip sticks. Schenk-el’s last visit with the FBI was on or about February 3, 2012. He acknowledges, however, that he received more documents from Swan after that last visit,.and that he did not give those documents to the FBI.

Schenkel also contacted the IRS and the Santa Clara County Tax Assessor to report the alleged tax fraud scheme. Schenkel spoke with the IRS at least three times, but did not provide the IRS any documents. He similarly talked with the Santa Clara County Tax Assessor several times between 2011 and late 2012, but did not give him any documents.

Schenkel never told Revak, Kole, or Ju-lich that he received documents from Swan, but he did tell Walker (Xyngular’s President) and Oliver (Xyngular’s COO). He also told Walker and Oliver that he had met with the FBI. But neither Schenkel nor Oliver could recall whether Schenkel disclosed which documents he had collected from Swan. And Walker testified that he never received any documents from Schenkel. The record before the court establishes that Schenkel’s disclosure to Walker and Oliver was incomplete, vague, and nonspecific.

In any event, Walker told Revak that Schenkel was receiving documents that apparently showed the other founders were engaging in misconduct. Walker also told Jensen that information was flowing from Swan to Schenkel. Jensen then shared this knowledge with Revak, Kole, and Ju-lich.

While he was reviewing and collecting documents from Swan, Schenkel made several of his concerns and complaints known to the other three founders. The Xyngular Parties maintain that the other founders took his concerns seriously and held meetings with him and his attorneys to discuss a resolution. Schenkel, however, testifies that they retaliated against him in response by excluding him from regular Xyngular meetings.

V. Schenkel’s Demand Letters

After Schenkel’s complaints went unheeded in his view, his current litigation counsel sent Xyngular a demand letter on September 1, 2011. Schenkel asked Xyn-gular’s Board of Directors to investigate and pursue claims against Revak, Julich, and Kole for “misappropriation of corporate assets, corporate waste, self-dealing, [and] usurpation of corporate opportunities.”

Schenkel alleged six forms of misconduct. First, the Board’s use of GVMS to provide IT services and other administrative support was improper because there was a conflict of interest and GVMS provided substandard service. Second, the other founders improperly authorized bonuses to GVMS employees, including themselves. Third, the other founders improperly created and operated a company named Nouvara that competed with Xyngular. Fourth, the other founders transferred “certain stock in Xyngular to shareholders of GVMS without apparent consideration.” Fifth, the other founders allowed Jensen, the Vice President of GVMS, to take control of Xyngular’s management without Board approval. And sixth, Jensen acted contrary to Xyngular’s interests by hiring GVMS to provide IT services, even though Jensen’s position at GVMS created a conflict of interest. Schenkel closed the letter by stating, “[i]f the board of directors refuses to pursue these claims, [he] will proceed with the appropriate derivative claims.”

Schenkel also had his California lawyers send Xyngular a similar demand letter on September 1, 2011. Schenkel demanded that the other founders “remedy the brazen self-dealing in which they -have engaged.” He closed the letter by stating that, although he had hoped to resolve the matter without resorting to legal action, “given that the company is on the brink of collapse, this no longer seems possible.” Schenkel admits that he “intended to initiate litigation” when he sent the two demand letters.

Schenkel personally sent Revak an email the next day. In it, Schenkel said, “I was surprised to receive a call today from Marc Walker informing me that Bruce Jensen had given him instructions that I was not to speak to any employees- of Xyngular and that I was not to attend the meetings .,. scheduled for next week.” Schenkel further stated that Jensen’s actions “illustrate the improper interference by GVMS employees in Xyngular’s business as well as retaliation against [him] for calling for ¡an investigation into the self-dealing, waste, mismanagement and other breaches of fiduciary duties which are threatening the very existance [sic] of Xyngular,” Schenkel then asked Revak “point blank” if Jensen’s instructions were accurate.

In response, Revak expressed his surprise to receive two letters threatening litigation, even after the other founders had listened to Schenkel’s concerns and had tried to reach a resolution. Revak then stated, “At this point, we recognize your role as a shareholder and a distributor.” And “[a]s a shareholder you are entitled to basic financials,and basic company information at a time mutually agreeable to the company and yourself.” Although “you are welcome to attend general distributor events or events that you are invited to,” “[i]t is not our intention to you have involved in the operations of the company at any level.”

Xyngular appointed three independent directors to its Board in late September 2011 to investigate Schenkel’s claims of misconduct. In , addition to reviewing the fees that GVMS charged and the services that it provided to Xyngular, the independent directors also reviewed the company’s relationship with Schenkel. As part of its review, the Board authorized Jensen to negotiate a resolution with Schenkel in spring 2012. The Board later authorized one of the independent directors to negotiate with Schenkel when Jensen was unsuccessful.

At the end of their investigation, the independent directors determined it would not be in Xyngular’s best interest to pursue claims against the other founders as Schenkel requested in his demand letters. The independent directors sent Schenkel a letter in early October 2012 notifying him of their decision. They explained that the bonuses paid to GVMS-employees were for important services and were in the best interest of the company to ensure continuation of the services; that the creation of Nouvara was meant to improve efficiency by using a centralized management company; that there was no transfer of Xyngular stock to members of GVMS other than the stock issued to Revak, Julich, and Kole when Xyngular was formed; that Jensen provides consulting and management services, but he “does not control Xyngular and has no authority to take action on Xyngular matters: other than as directed by the officers and Directors of Xyngular”; and that GVMS provides satisfactory IT services.

VI. The Lawsuit

Xyngular initiated ■ this lawsuit on September 13, 2012. In its Amended Complaint,- Xyngular asserts several claims against Schenkel.

Xyngular first seeks declaratory judgment that Schenkel is entitled to only 2,000 shares of Xyngular stock. While Kole may have caused Xyngular to issue 2,600 shares to Schenkel in early 2011, backdated to January 2010, Kole erred. And even though Xyngular originally claimed that Schenkel was entitled to only 1,623 shares—representing 10% of the 16,230 issued and outstanding shares—Xyngular now concedes that Schenkel is entitled to 2,000 shares, But Xyngular maintains that Schenkel is not entitled to the additional 3% interest—or .600 shares—to “which he would have been entitled had he properly discharged his duties and responsibilities” as Xyngular’s Master Distributor.

Xyngular also seeks a declaration that Schenkel’s position as Master Distributor and any rights he may have acquired with that position are terminated. Further, Xyngular claims that Schenkel breached his duties as Master Distributor by failing “to attend company meetings or make reasonable efforts to build the company”; by failing- “to train, motivate^] and recruit distributors”; and by disparaging Xyngular to distributors and other third parties. Xyngular likewise alleges that Schenkel “committed corporate waste and misappropriated Xyngular resources by making unauthorized expenditures on Xyngular’s corporate credit card, including in the form of expenditures for lavish parties and other expenditures that were not in Xyngular’s interest.” .

Schenkel responded to Xyngular’s allegations with a number of counter- and third-party claims against the Xyngular Parties in October 2012. For example, Schenkel alleges that he is entitled to 2,600 shares of Xyngular stock, that Xyngular promised him a permanent seat on Xyngu-lar’s Board of Directors, and that Xyngu-lar promised him a non-terminable position at the top of Xyngular’s distribution genealogy.

Schenkel further asserts that Revak, Ju-lich, Kole, and Jensen used a fraudulent scheme to loot Xyngular’s assets and enrich themselves. Schenkel alleges that Re-vak, Kole, Julich, and Jensen knew that Xyngular and Symmetry sold products containing lead in violation of California law, yet concealed that fact and refused to place the proper warnings on their products. And he likewise claims that Revak, Kole, Julich, and Jensen perpetuated sales tax fraud committed by Symmetry. Schenkel alleges that Symmetry represented to its distributors that it was collecting sales tax on their behalf, although Symmetry had not registered to collect sales tax in most states. Symmetry allegedly kept the money it collected as sales tax instead of properly remitting the money to state franchise tax boards.

In support of these assertions, Schenkel insists that “[a] number of brave Xyngular and Symmetry employees, including Ian Swan, acted as whistleblowers informing Mr. Schenkel of serious acts of misconduct and fraud that were being perpetuated by Mr. Revak, Ms. Julich, and Mr. Kole, among others.” Schenkel has since admitted, however, that “Ian Swan is the only individual who has claimed to be a whistleblower who provided him' documents regarding the Xyngular Parties.”

Schenkel attached several documents he received from Swan as exhibits to his original Answer, Counterclaim, and Third-Party Complaint. For instance, Schenkel attached a document detailing the fees Xyngular was to pay to Symmetry; a document summarizing Revak, Julich, and Kole’s allegedly self-interested loan transactions; and a 2010 document titled “Shareholder . K-l Information.” The court later sealed these exhibits because they contain Symmetry’s sensitive commercial information and Xyngular shareholders’ personal tax information.

A. Schenkel’s Motion for a Temporary Restraining Order

Schenkel filed a Motion for a Temporary Restraining Order on January 2,2013, asking the court to restore his 13% ownership interest in Xyngular, to restore his seat on Xyngular’s Board of Directors, and to enjoin the other founders from looting the company while litigation is pending.

Schenkel argued in his opening brief that unless the court enters a temporary restraining order, “he will not be able to maintain his claims [or] defend himself against the claims the other founders have brought against him.” He also asserted that the other founders gave him altered Board meeting minutes in response to his request in September 2012 after he spoke out' against their alleged self-dealing and other wrongdoing. In support, Schenkel attached as an exhibit to -his accompanying declaration draft Board meeting minutes from September 28, 2011, “which [he] was able to obtain” from Swan. A side-by-side comparison of the two versions of the minutes shows that the minutes Schenkel obtained from Swan contains information not included the'in the version the other founders provided to Schenkel. For example, the signed version of the minutes the other founders provided to Schenkel states:

10th order of business- Discussion by Steven Kole of the current capitalization of the company by its current shareholders.

But the unsigned version of the minutes Schenkel obtained through Swan includes the following additional text:

There currently are 20,000 shares authorized by the company with 17,200 shares issued and outstanding. There currently are 5 shareholders with Rudy Revak holding 10,200 shares comprising 59.302% of the outstanding shares.

Schenkel also attached as exhibits to his declaration other documents that he received from Swan, such as an unredacted document listing Symmetry’s members and officers. The document includes Re-vak’s, Julich’s, and Kole’s social security numbers, driver license numbers, birth dates, and home addresses. Schenkel also attached Schedule K-l Forms for 2010 and 2011. Both documents contain personal tax identifiers. The court later granted Schenkel’s ex parte- motion to seal the three exhibits.

In his reply brief in support of his Motion for a Temporary Restraining Order, Schenkel stated, “The Other Founders have now been confronted with documents they did not know Mr. Schenkel had.” Schenkel submitted with his second declaration twenty-eight documents that Swan took from GVMS’s servers and gave to him. Schenkel explained that the “documents are true and correct copies of Xyn-gular corporate records maintained on Xyngular’s servers. Each of the documents were [sic] provided to me by Ian Swan pursuant to my request to review the books and records of Xyngular.”

Swan explained in his supporting declaration, “I am a Xyngular shareholder and an IT Consultant at Global Ventures/Aly-tis. Prior to assuming my current responsibilities, I worked for Symmetry between April 1998 and June 2010 .... I was the systems architect and primary programmer for all Symmetry’s worldwide computer/IT infrastructure during that time.” Swan also stated, “Xyngular and Symmetry corporate records created by Steve Kole resided on Global Ventures [sic] servers and are not password protected or secured in any way. These documents are available to anyone. The following documents are true and correct copies of Xyn-gular corporate records.”

. The documents referenced by Schenkel and Swan in their declarations—and attached as exhibits to the declarations— include draft Board meeting minutes from Xyngular’s September 2011, December 2011, and April 2012 Board meetings. They also include, other corporate documents, such as documents concerning Xyngular’s shareholder distributions; taxable income; and earnings distributions, one of which is dated May 1,2012.

B. The January 23, 2013 Hearing

The court held an evidentiary hearing on the Motion for a Temporary Restraining Order on January 23, 2013. During preliminary statements, counsel for the Xyngular Parties argued:

The next issue, before I get to the elements for a preliminary—for a temporary restraining order, is those who come to you must come to you seeking equity, must come to you having done equity.

You can imagine if you. were practicing as a lawyer sitting where I was at 8:00 o’clock on Tuesday night—or Monday night, when I get two declarations, one from Mr. Swan and a second one from Mr. Schenkel. And it was interesting just before this hearing Ms. Wood asked me the question when am I going to tell them where is the location of these documents. And what had happened was they got access to the server of Xyngu-lar, and they took documents.

They say that Mr. Schenkel has said I don’t have access to any of the documents of board meetings. He submitted in his first declaration—we’ll be asking him some questions about where he got those documents from. He had documents that show metadata, and those were not authorized, your honor, that those documents be given to Mr. Schenkel, or that Mr. Swan give them to Mr. Schenkel.

It’s no different than if I had gone to Ms. Wood’s office, if it were unlocked, and I took a document and I—and I then submitted it to this court without anybody knowing about it. And that kind of wild west cowboy discovery tactic is wrong, and let me tell you why. Because if you go. look at the exhibits attached to Mr. Swan’s and Mr. Schenkel’s declarations, there are board minutes, and there are a bunch of iterations of those board minutes. There’s advice of their counsel in those minutes, and that’s exactly why courts should not sanction that kind of cowboy discovery where they go out and reach out and take discovery and explain, well, the reason I don’t—I can do this is because you didn’t have a password.

They shouldn’t be performing that kind of discovery. We should be able to protect attorney-client privileged communications with a client. They’ve taken those documents on their own, taken the law into their own hands. They have not done equity. And when they come to this court with unclean hands, this court should not give them equity.

Schenkel’s counsel and the court then had the following discussion:

Ms. Wood: The plaintiffs and third-party defendants have produced not a single document in this case. They produced not a single document in their initial disclosures.

We have produced every single document in our possession, every single minute, every single everything. We have never hidden a single thing from them.

Furthermore, we never asked Mr. Swan to get us documents. It was not a discovery trick. Mr. Swan is himself a whistleblower, as is Mr. Schenkel, and they are protected under both federal and state law. Mr. Swan’s declaration said that he reported his concerns to the F.B.I., and they jointly talked to the F.B.I. about—

The court: You know, I’ll listen to [any] argument you’d like to make about this. It’s not going to affect my analysis of the T.R.O. I fully expect that— well, fully expect. I will not be the slightest bit surprised if there’s some motion practice about all this. I anticipate there very likely will be. We’re not going to resolve those issues today.

Ms. Wood: Your honor, but my integrity has been impugned, and I think I have a chance to respond to it. The doc—both Mr. Swan and Mr. Schenk-el are shareholders of Xyngular. The ■ argument that is being made by Mr. Hale is they are entitled to filter the information that goes to the shareholders.

But the shareholders are entitled, when they make a demand, to the minutes of the board meeting, and you don’t get to keep sets of minutes for people you like and sets of minutes for people you don’t like. And both pursuant to demand, and as shareholders, Mr. Schenkel made the demand as members of the board. He was entitled to those.

Now, I had nothing to do with their access, and I did not direct anybody to get those documents, neither did anybody else from our offices. But for them to produce not a single document in their initial disclosures, and for us to produce absolutely everything we have, including anything that Mr. Schenkel got from Mr. Swan, and for them to say that somehow we were trying to hide something, that we had breached some duty, that is not the law:

The court: They’re separate issues in my mind. I’m reticent to' get into it because it seems to me that the parties are undoubtedly going to conduct some discovery on this, and if it’s important to the parties and there have been violations either of rule 26 or rule 37 or the shareholders, it will be briefed by the parties and I’ll decide it then.-It seems to me separate questions about a party’s obligation to produce documents and describe documents in their initial disclosures and somebody accessing a server, pulling documents without—with or without authorization. I’m not making any findings today—separate questions. Concerning to the court in whatever instance, but we’ll resolve it when we get to it. It’s not going to affect the outcome of the T.R.O. today.

The court went on to receive testimony from Schenkel, Julich, and Swan. Shortly after Swan .began testifying, and in response to a line of questions about the source of documents he, provided to Schenkel, the court advised Swan of his Fifth Amendment constitutional right to be free from self-incrimination. And after a brief exchange between the court and Swan, Swan left the courtroom. He did not return.

Later in the hearing, counsel for the Xyngular Parties again argued:

We have a man who has, without the knowledge or authority of the management of the company, taken documents, confidential documents, from the server of a company. That’s not how you get documents. I don’t care, your honor, whether you’re a whistleblower, whether you’re an attorney, it doesn’t matter, you cannot , act illegally to obtain documents.

When they produced to us a disk that has an enormous amount of documents that clearly came from the company, and we don’t know how they got them, how in the world these got into the—apparently into the public forum, as you can guess that is an enormous concern. And until we received the declaration of Mr. Swan, we didn’t know how that happened.

Mr. Swan stole documents unauthorized from the company, he gave them to Mr. Schenkel, who is now using them in this proceeding. And as you know, injunctive relief is an equitable proceeding. If you want relief from the court, you come with clean hands. And if you don’t come with clean hands, you’re not entitled to equitable relief. And it is not clean hands to come into a court and produce documents that you know were taken unauthorized from a source and use them in the proceeding, and that’s what we believe the testimony is.

In response, Schenkel’s counsel argued: Mr. Schenkel and Mr. Swan are owners of [Xyngular]. They did not take any documents and bring them outside the realm of the company, except for to testify in this proceeding as a witness. So this is not the situation, as Mr. Hale suggested, as perhaps we going to his office and stealing documents from him. The better analogy, your honor, is that somebody at his office discovers that the company is involved with illegal conduct and takes documents and goes to the Federal Bureau of Investigation to report the illegal conduct.

It was not just this—the ownership, your honor, Mr. Schenkel was very clear. They also discussed tax fraud and tax evasion. That was the primary purpose of going to the F.B.I. was that these two individuals saw that there was tax fraud and tax evasion being committed, and they did not want to be personally involved in that.

The hearing continued, and the parties eventually finished examining the witnesses. The court ultimately denied Schenkel’s request for a temporary restraining order because he failed to show that he would suffer irreparable harm in the absence of injunctive relief.

C. The Xyngular Parties’ First Motion for Dispositive Sanctions

A little over two months later, the Xyn-gular Parties filed their first motion for terminating sanctions. The Xyngular Parties alleged that (1) Schenkel improperly encouragéd Swan to steal documents belonging to Xyngular, Symmetry, GVMS, and other companies that were kept on GVMS’s servers; (2) Schenkel knowingly and improperly received the documents from Swan and shared them with his counsel in this case; (3) Schenkel failed to return the documents, including privileged, confidential, and sensitive documents to their owners; and (4) Schenkel improperly used the stolen documents to support his Motion for a Temporary Restraining Order.

Schenkel denied the allegations against him. He argued in his opposition to the Xyngular Parties’ motion that Swan was authorized to access all the documents on GVMS’s servers, and that Swan voluntarily gave documents to Schenkel confirming Schenkel’s ownership interest in Xyngular and showing allegedly illegal conduct by the Xyngular Parties. Schenkel maintained that he did not obtain the documents from Swan for use in this litigation, but instead to blow the whistle on the Xyngular Parties before litigation.

Schenkel also made a number of allegations of wrongdoing against the Xyngular Parties in his opposition brief. Most notably, he alleged that the Xyngular Parties retaliated against him and Swan for blowing the whistle on their illegal activities, and that they spoliated evidence. For instance, Schenkel stated that the Xyngular Parties scrubbed his name from an October 2009 IRS Form 2553, which lists the name of each Xyngular shareholder. He further asserted that the Xyngular Parties altered Board meeting minutes and untruthfully claimed that other minutes no longer existed. And he claimed that Julich and her assistant “spent several days shredding documents,” and that- Julich’s husband wiped Kole’s desktop computer “down to the metal.”

Schenkel also alleged that “[n]umerous witnesses stand ready to provide documents and testimony supporting Mr. Schenkel’s claims of fraud and illegal conduct. ... [Witnesses also stand ready to testify regarding Ms. Julich’s and Mr. Kole’s spoliation of documents.” But these “[potential witnesses are understandably concerned that they could be terminated or retaliated against for providing truthful testimon/’ because the Xyngular Parties allegedly retaliated against Swan.

Finally, Schenkel stated that “[he] and his counsel watched together [on September 7, 2011,] as e-mails between Mr. Schenkel and the Other Founders were being remotely deleted from Mr. Schenk-el’s email account. He was powerless to stop it.” “Something similar appears to have been done to counsel’s computer system. A folder of relevant e-mails on counsel’s computer system has been mysteriously emptied.”

Schenkel later alleged that “Rudy Re-vak, Steven Kole[,] and Mary Julich, as well as other Xyngular, GVMS, or Symmetry employees may have knowledge of the deletion of emails from Mr. Schenkel’s email account.” Schenkel eventually backtracked from these allegations and conceded that he does not contend that the Xyngular Parties were responsible for the hacking of his email account.

D. The May 20, 2014 Hearing

The court held a hearing on the Xyngú-lar Parties’ motion for terminating sanctions on May 20, 2014. The court expressed at the outset concern about the gravity of each party’s allegations and the integrity of the judicial proceedings. The court then stayed the case so the parties could conduct discovery on the allegations of misconduct and file sanctions motions, if any, based on a more complete record. The court explained:

Based on the allegations and the evidence presented both in the Plaintiffs moving papers and in the opposition filed by Mr. Schenkel, I have grave concerns that I think we’re required to address before we reach the merits of any claims in this case.

I think I have an obligation to ensure the integrity of these proceedings, to ensure the authenticity of the evidence that we’re receiving and considering in connection with the merits, and, moreover, I think an obligation to ensure that the parties who are here availing themselves of this Court belong here and they’re entitled to seek the relief that they’re asking of the Court.

My view is we have to get to the bottom of that before we reach any of the claims on the merits in this case, and we’re going to. So I have come today prepared with some thoughts , to share with all of you and a proposal for a plan. •

This is what I propose. I think the record before me is incomplete to make a complete determination about the relief that Xyngular and the Third-Party Defendants are seeking. I think I don’t have all the information I need to make a ruling.

Similarly, the opposition filed by Mr. Schenkel raises grave concerns in -my mind about the conduct of Xyngular and some of the Third-Party Defendants. I think we need a complete record about that. If there’s going to be a motion, and there may not be one forthcoming—we’ll talk about a schedule in a moment. All of those issues I think should be resolved together after an opportunity for discovery limited on these issues. I am going to stay the case, everything in the case, save for those issues relating to the motion for terminating sanctions and any motion Mr. Schenkel may wish to file relating to any sanctionable conduct that you think may have occurred concerning document destruction, whatever discovery abuses or issues you think there are, doctoring documents, fabricating evidence, whatever it is, there’s a whole host of general allegations in your opposition.

Let me share a few additional thoughts with you that you can share with your clients. I take these allegations in these papers extremely seriously. I think this record potentially supports terminating sanctions against one or more parties in this case. It’s not perfectly clear to me, but based on general allegations in these papers, there may be obligations that arise that require me to make referrals to the U.S. Attorney’s Office or the Office of Professional Conduct. I don’t know how those cards are going to fall, but we’re going to understand all of the evidence in this case and see where it takes us.

Later in the hearing, Schenkel’s counsel orally moved for the undersigned’s disqualification. Schenkel’s counsel argued that the undersigned delayed the proceedings to Schenkel’s disadvantage and made comments exhibiting bias during the hearing on Schenkel’s Motion for a Temporary Restraining Order.

E. Schenkel’s Motion to Disqualify

Schenkel filed a written motion to disqualify two weeks later. He argued that the undersigned’s comments and actions created an appearance of partiality and bias against him that “threatened] [his] due process rights to a fair trial.” For example, Schenkel claimed that the court expressed opinions and conclusions without evidentiary support that raise a reasonable question of partiality, inappropriátely drove' Swan—Schenkel’s primary witness—off the stand, improperly fashioned an ad hoc summary proceeding to determine criminal liability, and ordered Schenkel to file a motion for sanctions to create an illusion of evenhandedness.

The court denied Schenkel’s motion to disqualify. The court explained that its opinions and observations were insufficient to require disqualification, that the court’s warnings to Swan were not inappropriate, that the court ordered the parties to conduct discovery on the serious allegations of misconduct made by both parties so it could get to the bottom of the allegations, and that the court invited—but did not order—Schenkel to file a motion for sanctions if he and his counsel were able to substantiate his allegations of misconduct.

The court then denied the Xyngular Parties’ motion for sanctions without prejudice at a later status conference.

VII. The Current Motions for Terminating Sanctions

The parties engaged in additional discovery and filed cross-motions for terminating sanctions. These are the motions now before the court.

Schenkel contends in his Motion for Sanctions that terminating sanctions against the Xyngular Parties are appropriate because the Xyngular Parties have habitually violated their duty of candor to the court and spoliated evidence. He maintains that the Xyngular Parties committed misconduct in four ways.

First, Schenkel argues that the Xyngu-lar Parties filed this lawsuit in bad faith, and that their Amended Complaint rests upon allegations they now admit are false or lacking in evidentiary support. Schenkel asserts that Xyngular alleged in bad faith that he accepted and held the position of Master Distributor. Schenkel submits the deposition testimony of Xyngular’s corporate representative admitting that Schenk-el and Xyngular did not finalize an agreement that would have made him Master Distributor. Schenkel also maintains that Xyngular alleged in bad faith that he breached his obligations to the company. He again points to the deposition testimony of Xyngular’s corporate representative that he worked hard during his time as the Interim Sales Director and that he helped the company grow. He contends that Xyngular has presented no evidence to the contrary. Schenkel further argues that Xyngular alleged in bad faith and without any documentary evidence that he wasted corporate resources. Schenkel presents the testimony of Xyngular’s Vice President of Finance, Graser, who testifies that he could not recall Schenkel making any improper expenditure. Schenkel also asserts that Xyngular did not mistakenly issue him 2,600 shares, and that Xyngular alleged in bad faith that he is entitled to fewer shares.

Second, Schenkel contends that the Xyn-gular Parties committed perjury in their discovery responses. Schenkel argues that the Xyngular Parties committed perjury when they denied selling expired products by fraudulently relabeling products with new expiration dates. He also claims that the Xyngular Parties committed perjury when Symmetry stated in response to an interrogatory that “it is not aware of any foreign state, federal, state, or local taxes that have not been paid.” Symmetry also denied committing “acts of perjury, fraud, tax fraud, tax evasions, failure to pay tax, ... and the failure to disclose the existence [of] lead or other toxic substances (as defined by California state law) in Symmetry’s products,” and it denied making any agreements to keep those acts confidential. Xyngular similarly denied that any of its “officers, employees and/or board members were aware of Symmetry’s failure to pay foreign, federal, state and /or local taxes.” Yet, as Schenkel notes, Kole testified that “there was a period early in [Symmetry] where there were amounts designated as sales tax on orders to the distributor that were charged to the distributor that registrations to several states, many states, were not undertaken and, therefore, not paid.” The money that was collected but not paid was “retained in the company for corporate uses.”

Schenkel also asserts that the Xyngular Parties committed perjury when they denied selling any products containing impermissible amounts of lead. Schenkel alleged in his Second Amended Counterclaim and Third-Party Complaint that he was

informed that Symmetry had been notified that numerous products it was selling, including a multivitamin for children, were unsafe because they contained lead and were potentially harmful to the public. Symmetry, however, concealed this fact from their customers and distributors and was continuing to sell the products without any warning.

The Xyngular Parties denied this allegation in their Answer “for lack of information,” and “expressly den[ied] that Symmetry is or was selling unsafe products or products that are potentially harmful to the public.” Symmetry, however, was sued in late 2010 for distributing products containing lead without warnings required by California law. Symmetry settled that lawsuit by entering into, a Consent Judgment and agreeing to pay thousands of dollars in fines. Symmetry admitted to this after the Xyngular Parties filed their Answer and in response to an interrogatory:

[A] lawsuit was brought against it ... regarding the alleged lead content of its products. Some of Symmetry’s products were determined to contain ingredients containing a lead content beyond California’s legal limits. Symmetry settled this lawsuit with a small monetary payment and by providing a warning to California residents who purchase such products.

Third, Schenkel argues that the Xyngu-lar Parties made numerous false statements to the court during motion practice. Schenkel claims that the Xyngular Parties misrepresented that he and Swan were neither Xyngular employees nor whistle-blowers. He also contends that the Xyngu-lar Parties misrepresented that he never told Xyngular’s management that he was getting documents from Swan, and misrepresented that they did not know Swan was giving documents to Schenkel.

Fourth, Schenkel argues that the Xyn-gular Parties altered and spoliated documents before and after this litigation started, and then denied doing so in response to his requests for admission. For example, Xyngular denied that (1) it destroyed, altered, or spoliated documents after Schenkel sent his demand letter in September 2011; (2) it produced altered board meeting minutes to Schenkel in September 2012; and (3) it was aware of any persons who were involved in any destruction, alteration, or spoliation of documents.

But, Schenkel insists, the Xyngular Parties gave him altered Board meeting minutes in September 2012 after he requested to review Xyngular’s books' and 'records. He argues that the minutes Swan gave him contain information that Kole deleted from the finalized, signed minutes that Xyngular gave him. Schenkel further claims that the Xyngular Parties spoliated evidence when Kole instructed Graser to delete any reference to stock appreciation rights from a financial report that Graser was preparing for Schenkel in response to his demand letter. Schenkel also presents Swan’s deposition testimony that Julich had Mali Sonnier, an employee working under Julich’s direction, shred “a lot” of documents over the course of about two days around the time this litigation began. And he contends that Sonnier deleted an electronic document relating to Swan’s employment status, and that Ju-lich’s husband wiped and reformatted Kole’s computer. Lastly, Schenkel asserts that the Xyngular Parties erased his name from an October' 2009 IRS Form 2553, which lists the