Court Rules on Sanctionable Behavior Related to Rule 11 Violations

In Super Pawn Jewelry & Loan, LLC. v. American Environmental Energy, Inc., No. 11-cv-08894, 2014 WL 4435454 (N.D. Ill. Sept. 9, 2014), the court found Super Pawn Jewelry & Loan, LLC (“Plaintiff”) jointly and severally liable for sanctions imposed upon one of its attorneys for violations of Rule 11 of the Federal Rules of Civil Procedure (“FRCP”).

Plaintiff originally filed suit against American Environmental Energy Inc. et al (the “Defendants”) alleging that the Defendants had intentionally and wrongfully failed to issue 1,000,000 shares of American Environmental as a result of a merger. Plaintiff asserted that the failure violated Section 10(b) of the Securities Exchange Act of 1934. The court ultimately dismissed the claim and declined to allow for leave to file a third amended complaint. Thereafter, defendants sought sanctions under Rule 11. 

The Private Securities Litigation Reform Act (“PSLRA”) requires that “in any private action arising under this chapter, upon final adjudication of the action, the court shall include in the record specific findings regarding compliance by each party and each attorney representing any party with each requirement of Rule 11(b) of the FRCP.” A violation of Rule 11(b) occurs when any responsive pleading is filed with a frivolous argument, for an improper purpose, or with a factual contention that lacks evidentiary support. To the extent the court finds a violation, the PSLRA creates a presumption that the opposing party must pay attorney’s fees and other expenses. 15 U.S.C. § 78u-4(c)(3)(A). The presumption may be rebutted upon a finding that imposing sanctions either creates an “unreasonable burden” upon the liable party that would be “unjust” and “failure to award the sanctions would not impose a greater burden on the competing party,” or that the “violation of Rule 11 was de minimis”. 

Defendants asserted that counsel for plaintiff violated Rule 11 by failing to adequately investigate claims before filing, and for filing the same, previously-dismissed claims without making a good faith attempt to plead around deficiencies of the first claims. The court determined that each lawyer was “uniquely situated” and analyzed the behavior of each.      

The initial lawyer involved in the case filed briefs in opposition to the Defendant’s motion to dismiss the first amended complaint, but his representation of Plaintiff lasted for only five weeks. As required by the PSLRA, the court assessed the pleading for any potential violation of Rule 11 to determine if sanctions were appropriate. The court found that because the lawyer filed the pleading based on his own belief of the facts, his behavior was not frivolous or sanctionable pursuant to Rule 11(b).

The court considered the actions of the second and third lawyers involved in the case. One asserted that “he played no substantive role in the case, merely serving as local counsel”. Although dismissing the defense, the court found that the record did not establish a failure to engage in a sufficient pre-filing investigation.  

Lastly, the court considered the behavior of Plaintiff’s final attorney. The lawyer filed the second amended complaint. The court found that the complaint “does include some changes, but most (and arguably all) of the fatal deficiencies of the first amended complaint are there.” The complaint reflected a “complete disregard for the Court's ruling on its securities fraud claims.” As the court reasoned:

• The Court's careful analysis of the first amended complaint, the Court's ruling on Defendants' motions to dismiss it, and the SAC that Plaintiff filed two months later — in the context of the long and troubling history of this case and in light of [counsel’s] own admissions in his brief — regrettably lead the Court to conclude that [counsel] offended Rule 11 in at least one, if not three, of the ways listed above. 

Plaintiff sought to avoid the sanctions imposed under Rule 11.  The court, however, disagreed. 

• Common sense forecloses Plaintiff's attempt to completely distance itself from its own lawsuit. Benjamin entered an appearance, of course, on Plaintiff's behalf, and — it can reasonably be inferred from timing alone — for the purpose of reviving its dismissed claims. In fact, in Benjamin's opposition brief, he makes clear that, upon returning to the case, he relied on his client's representations in filing the SAC. Plaintiff knew that the Court had just dismissed its claims, and, by authorizing its new attorney to refile them (and/or by hiring him to do so), Plaintiff subjected itself to certain ethical obligations — namely, to permit its attorney only to file claims brought for a proper purpose and grounded in fact based on a "reasonable inquiry under the circumstances."

The court, therefore, granted the motion for sanctions in part and directed defendants to submit a request for fees. 

The primary material for this case may be found on the DU Corporate Governance website.