Penn, LLC v. Prosper Business Dev. Corp. , 773 F.3d 764 ( 2014 )

RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit I.O.P. 32.1(b)
File Name: 14a0290p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
_________________
PENN, LLC, et al., ┐
Plaintiffs, │
│
No. 14-3108
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AMELIA A. BOWER; ALVAND A. MOKHTARI; │
PLUNKETT & COONEY, P.C., >
│
Attorneys-Appellees, │
│
v. │
│
│
PROSPER BUSINESS DEVELOPMENT CORPORATION, et │
al., │
Defendants, │
│
│
JAMES E. ARNOLD & ASSOCIATES; JAMES E.
│
ARNOLD, │
Defendants-Appellants. │
┘
Appeal from the United States District Court
for the Southern District of Ohio at Columbus.
No. 2:10-cv-00993—Gregory L. Frost, District Judge.
Argued: October 9, 2014
Decided and Filed: December 12, 2014
Before: MOORE and COOK, Circuit Judges; STEEH, District Judge*
_________________
COUNSEL
ARGUED: James E. Arnold, JAMES E. ARNOLD & ASSOCIATES, LPA, Columbus, Ohio,
for Appellants. Josephine A. DeLorenzo, PLUNKETT COONEY, P.C., Bloomfield Hills,
Michigan, for Appellees. ON BRIEF: James E. Arnold, Damion M. Clifford, Gerhardt A.
*
The Honorable George Caram Steeh, United States District Judge for the Eastern District of Michigan,
sitting by designation.
1
No. 14-3108 Penn, LLC, et al. v. Prosper Bus. Dev., et al. Page 2
Gosnell II, JAMES E. ARNOLD & ASSOCIATES, LPA, Columbus, Ohio, for Appellants.
Josephine A. DeLorenzo, PLUNKETT COONEY, P.C., Bloomfield Hills, Michigan, for
Appellees.
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OPINION
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COOK, Circuit Judge. In this dispute over the management of a joint venture,
Defendants-Appellants James E. Arnold & Associates and the firm’s eponymous partner
(together the “Arnold Firm”) challenge the district court’s denial of their motion for Rule 11
sanctions against plaintiffs’ counsel, Attorneys-Appellees Amelia A. Bower, Alvand A.
Mokhtari, and Plunkett & Cooney, P.C. (collectively “P&C”). Although the district court found
the sanctions motion a “close call,” it ultimately rejected the Arnold Firm’s allegations that P&C
filed the plaintiffs’ complaint with an improper purpose and without a sufficient basis in law or
fact. We AFFIRM the district court’s denial of sanctions on the alternative ground that the
Arnold Firm’s failure to comply with Rule 11’s safe-harbor provision made sanctions
unavailable.
I.
P&C filed a complaint in federal court on behalf of Plaintiff Penn, LLC against
Defendant Prosper Business Development Corporation, Prosper’s owners, and the Arnold Firm.
The complaint alleged violations of the Racketeering Influenced and Corrupt Organizations Act,
fraud, conversion, unjust enrichment, and breach of fiduciary duty in connection with the
management of Penn and Prosper’s joint venture, Plaintiff BIGresearch, LLC.1 The complaint
represented the latest in a series of court and arbitral proceedings stretching back to 2004, but
Penn never before named the Arnold Firm—Prosper and BIGresearch’s counsel in the previous
disputes—as a defendant.
1
Although Penn named BIGresearch as a plaintiff, the company on whose behalf an investor sues typically
joins the derivative action as a nominal defendant. See Ross v. Bernhard, 396 U.S. 531, 538–39 (1970).
No. 14-3108 Penn, LLC, et al. v. Prosper Bus. Dev., et al. Page 3
On December 6, 2010, the Arnold Firm served P&C with a letter on behalf of both itself
and its clients and co-defendants. The letter purported to satisfy “the obligations of . . . Fed. R.
Civ. P. 11” and threatened to seek sanctions “if the captioned matter [was] not dismissed before
the first answer date of December 20, 2010.” (R. 37-1, Ex. A, Arnold Aff. Ex. 2, Arnold Firm
Letter at 1.) The Arnold Firm complained that “virtually the entire complaint [was] frivolous”
and that “there [was] no reasonable basis in law or fact that [could] remotely support [it].” (Id. at
2 (emphasis in original).) The letter further alleged that P&C filed the complaint for the
“improper and abusive purpose” of disrupting the Arnold Firm’s attorney-client relationship with
Prosper and its owners. The firm also retained the right to seek sanctions on additional legal
grounds, stating in a footnote that the letter was “by no means intended to be an exhaustive
recitation of the Rule 11 . . . violations; it [was] merely illustrative.” (Id. at 2 n.3.)
Rather than withdraw the complaint, P&C responded with its own letter rejecting the
Arnold Firm’s allegations of impropriety.
On December 23, 2010, the Arnold Firm moved to dismiss all five causes of action
against it. And six months later, on May 27, 2011, the district court granted the motion and
dismissed the Arnold Firm from the action.
On June 8, 2011, the Arnold Firm, this time through its trial counsel, served P&C with a
proposed motion for Rule 11 sanctions. In an accompanying letter, the firm’s counsel threatened
to file the sanctions motion with the district court in twenty-one days unless P&C reimbursed the
Arnold Firm for the $36,788.14 incurred in obtaining dismissal of the complaint. P&C refused,
and the Arnold Firm filed its Rule 11 motion on June 30, 2011.
P&C opposed the motion not only on the merits but also on the procedural ground that
serving a copy of the motion post-dismissal failed to comply with Rule 11’s safe-harbor
provision which states:
A motion for sanctions must be made separately from any other motion and must
describe the specific conduct that allegedly violates Rule 11(b). The motion must
be served under Rule 5, but it must not be filed or be presented to the court if the
challenged paper, claim, defense, contention, or denial is withdrawn or
appropriately corrected within 21 days after service or within another time the
court sets.
No. 14-3108 Penn, LLC, et al. v. Prosper Bus. Dev., et al. Page 4
Fed. R. Civ. P. 11(c)(2).
The Arnold Firm countered that its December 6, 2010 letter satisfied the rule because it
put P&C on notice that its refusal to withdraw the complaint would result in a motion for
sanctions.
The district court bypassed the procedural issue, calling the question of whether a
warning letter satisfies Rule 11’s safe-harbor provision “somewhat unsettled.” (R. 72, Rule 11
Order at 5–6.) The court then denied the firm’s motion on the merits, finding P&C’s allegations
against the Arnold Firm “particularly deficient, [but] not so deficient as to necessitate sanctions
for their filing.” (Id. at 5.)
In January 2014, the district court entered final judgment in the underlying action
between Penn and Prosper. The Arnold Firm timely appealed, challenging the court’s denial of
sanctions.
II.
Although the district court denied the Arnold Firm’s Rule 11 motion on the merits, P&C
argues that the motion’s procedural shortcomings should decide the appeal, given that “we are
free to affirm the judgment on any basis supported by the record.” Angel v. Kentucky, 314 F.3d
262, 264 (6th Cir. 2002).
Three factors persuade us to affirm on the alternative ground that the Arnold Firm failed
to comply with Rule 11’s safe-harbor provision. First, the question “involves only application of
legal propositions to the undisputed facts in the record,” and the parties fully briefed and argued
the procedural issue in the district court and on appeal. Abercrombie & Fitch Stores, Inc. v. Am.
Eagle Outfitters, Inc., 280 F.3d 619, 629 (6th Cir. 2002); see also Blount-Hill v. Zelman,
636 F.3d 278, 284 (6th Cir. 2011). Second, the procedural issue precedes an inquiry on the
merits. Ridder v. City of Springfield, 109 F.3d 288, 296 (6th Cir. 1997) (“[T]he rule is
unquestionably explicit . . . that unless a movant has complied with the twenty-one day ‘safe
harbor’ service, the motion for sanctions ‘shall not be filed with or presented to the court.’”
(quoting former Fed. R. Civ. P. 11(c)(1)(A))). Finally, uncertainty over whether a warning letter
satisfies Rule 11’s safe-harbor provision persists in this circuit. See, e.g., First Bank of Marietta
No. 14-3108 Penn, LLC, et al. v. Prosper Bus. Dev., et al. Page 5
v. Hartford Underwriters Ins. Co., 307 F.3d 501, 527–28 (6th Cir. 2002) (discussing this court’s
apparently conflicting decisions); Tillman v. Apostolopoulos, No. 10-12253, 2010 WL 5088763,
at *2 & n.1 (E.D. Mich. Dec. 8, 2010) (noting the lack of controlling authority). We take this
opportunity to clarify the law.
III.
Rule 11 imposes on attorneys a duty to reasonably investigate factual allegations and
legal contentions before presenting them to the court. Fed. R. Civ. P. 11(b). The threat of
sanctions encourages keen observance of this duty. See Ridder, 109 F.3d at 294 (“Rule 11’s
ultimate goal [is] deterrence, rather than compensation . . . .”). But, the drafters of Rule 11 also
included the safe-harbor provision to allow the nonmovant a reasonable period to reconsider the
legal and factual basis for his contentions and, if necessary, to withdraw the offending document.
See Fed. R. Civ. P. 11(c) Advisory Committee Notes (1993 Amendments). For similar reasons,
the party seeking sanctions must effectuate service at least twenty-one days “prior to the entry of
final judgment or judicial rejection of the offending contention.” Ridder, 109 F.3d at 297.
Failure to comply with the safe-harbor provision precludes imposing sanctions on the party’s
motion. Id.
Here, the Arnold Firm served P&C with a copy of its Rule 11 motion on June 8, 2011,
twelve days after the district court dismissed Penn’s claims against the firm. P&C contends that
this late service deprived it of the safe-harbor period’s protection and, therefore, foreclosed the
firm’s sanctions motion. Unable to rely on the June 8 letter under Ridder, the Arnold Firm
argues that its December 6, 2010 letter satisfied Rule 11’s safe-harbor provision because it
notified P&C of the firm’s intent to pursue sanctions approximately six months before the court
dismissed Penn’s complaint and eight before the Arnold Firm moved for sanctions. But “[i]t
would . . . wrench both the language and purpose of . . . the Rule to permit an informal warning
to substitute for service of a motion.” Barber v. Miller, 146 F.3d 707, 710 (9th Cir. 1998).
First and most important, the rule specifically requires formal service of a motion. The
safe-harbor provision states that “[t]he motion must be served under Rule 5” at least twenty-one
days before filing it with the court. Fed. R. Civ. P. 11(c)(2) (emphasis added). We have no
doubt that the word “motion” definitionally excludes warning letters, and our reading of the
No. 14-3108 Penn, LLC, et al. v. Prosper Bus. Dev., et al. Page 6
rule’s plain language finds support in the Advisory Committee’s Notes. In its gloss on the
1993 amendments, the Committee refers to letters as “informal notice” and recommends that
attorneys send a warning letter as a professional courtesy “before proceeding to prepare and
serve a Rule 11 motion.” Fed. R. Civ. P. 11 Advisory Committee Notes (1993 Amendments).
“In other words, the Advisory Committee’s Notes clearly suggest that warning letters . . . are
supplemental to, and cannot be deemed an adequate substitute for, the service of the motion
itself.” Roth v. Green, 466 F.3d 1179, 1192 (10th Cir. 2006); accord In re Pratt, 524 F.3d 580,
588 (5th Cir. 2008) (“We may not disregard the plain language of the [rule] and our prior
precedent without evidence of congressional intent to allow ‘substantial compliance’ through
informal service.”); Barber, 146 F.3d at 710 (“That requirement, too, was deliberately imposed,
with a recognition of the likelihood of other warnings.”).
Furthermore, important policy considerations counsel against the Arnold Firm’s more
permissive reading. We previously commented that “[t]he inclusion of a ‘safe harbor’ provision
is expected to reduce Rule 11’s volume, formalize appropriate due process considerations of
sanctions litigation, and diminish the rule’s chilling effect.” Ridder, 109 F.3d at 294. Similarly,
the Advisory Committee reasons that “the ‘safe harbor’ period begins to run only upon service of
the motion” in order “[t]o stress the seriousness of a motion for sanctions and to define precisely
the conduct claimed to violate the rule.” Fed. R. Civ. P. 11 Advisory Committee Notes (1993
Amendments).
Permitting litigants to substitute warning letters, or other types of informal notice, for a
motion timely served pursuant to Rule 5 undermines these goals. Whereas a properly served
motion unambiguously alerts the recipient that he must withdraw his contention within twenty-
one days or defend it against the arguments raised in that motion, a letter prompts the recipient to
guess at his opponent’s seriousness. See Radcliffe v. Rainbow Constr. Co., 254 F.3d 772, 789
(9th Cir. 2001). Thus, not only Rule 11’s text, but also “[p]ragmatic realities require such strict
adherence to the rule’s outlined procedure.” Ridder, 109 F.3d at 297.
This case bears out these concerns. Although the Arnold Firm argues that its
December 6, 2010 warning letter satisfied Rule 11, the letter expressly reserved the firm’s right
to assert additional grounds for sanctions in its actual motion. Tellingly, trial counsel implicitly
No. 14-3108 Penn, LLC, et al. v. Prosper Bus. Dev., et al. Page 7
recognized the formality and seriousness required by Rule 11 when it attached the proposed
sanctions motion to its June 8, 2011 warning letter.
The majority of our sister circuits to address this issue adopt the same position. See Star
Mark Mgmt., Inc. v. Koon Chun Hing Kee Soy & Sauce Factory, Ltd., 682 F.3d 170, 175–76 (2d
Cir. 2012) (“An informal warning in the form of a letter without service of a separate Rule 11
motion is not sufficient to trigger the 21-day safe harbor period.”); Pratt, 524 F.3d at 586–88
(holding that Rule 9011 of the Federal Rules of Bankruptcy Procedure requires formal service of
a proposed sanctions motion based on Fifth Circuit precedent analyzing Rule 11); Roth, 466 F.3d
at 1192–93 (“[N]othing in subsection (c)(1)[] suggests that a letter addressed to the alleged
offending party will suffice to satisfy the safe harbor requirements.”); Gordon v. Unifund CCR
Partners, 345 F.3d 1028, 1030 (8th Cir. 2003) (reversing a sanctions award, in part, because
“Unifund did not serve a prepared motion on Appellant prior to making any request to the
court”); Barber, 146 F.3d at 710 (“Those warnings were not motions, however, and the Rule
requires service of a motion.”); cf. In re Miller, 730 F.3d 198, 204 n.5 (3d Cir. 2013)
(questioning an earlier, unpublished decision that upheld informal notice by warning letter);
Brickwood Contractors, Inc. v. Datanet Eng’g, Inc., 369 F.3d 385, 396 (4th Cir. 2004) (“[W]e
conclude that the safe-harbor provisions of Rule 11 are inflexible claim-processing rules . . . .”).
Only the Seventh Circuit has espoused the opposite stance in a published opinion. See
Nisenbaum v. Milwaukee Cnty., 333 F.3d 804, 808 (7th Cir. 2003). But its decision declines to
address any of the textual or policy concerns outlined above, and other circuits roundly criticize
the decision’s cursory reasoning. See Pratt, 524 F.3d at 587–88; Roth, 466 F.3d at 1193.
Finally, invoking stare decisis, the Arnold Firm contends that three of this court’s
unpublished decisions establish that a warning letter satisfies Rule 11’s safe-harbor provision.
See Baker v. Chevron U.S.A. Inc., 533 F. App’x 509, 528 (6th Cir. 2013) (upholding a sanctions
award where the defendant sent a “safe-harbor letter,” and the plaintiff never challenged its
procedural compliance with Rule 11); Barker v. Bank One, Lexington, N.A., No. 97-5787, 1998
WL 466437, at *2 (6th Cir. July 30, 1998) (order) (holding that the movant substantially
complied with Rule 11’s safe-harbor provision by sending a warning letter); Hadden v. Letzgus,
No. 96-2250, 1997 WL 434413, at *1 (6th Cir. July 31, 1997) (order) (holding harmless the
No. 14-3108 Penn, LLC, et al. v. Prosper Bus. Dev., et al. Page 8
defendant’s failure to serve an opponent with informal notice or a motion because the plaintiffs
had “ample opportunity to dismiss [the] meritless cause of action voluntarily”). But these
unpublished decisions neither bind us nor persuade us to forsake the benefit to bench and bar
afforded by requiring strict compliance with Rule 11’s clear text.
IV.
We AFFIRM the district court’s denial of sanctions given the Arnold Firm’s failure to
observe the mandatory procedures of Rule 11.