Inherent Power Sanctions Properly Imposed on Non-Parties Responsible for the Violation but Sanctions May Not Include the Fees Incurred in the (Month-Long) Sanctions Proceeding

Orange Blossom LP v. So. Calif. Sunbelt Developers, Inc., 608 F.3d 456 (9th Cir. 2010):

Thirteen entities filed involuntary bankruptcy petitions against IBT International, Inc. (IBT) and Southern California Sunbelt Developers, Inc. (SCSD) under Chapter 11 of the Bankruptcy Code, 11 U.S.C. § 303. The [13] petitioning creditors are *** controlled by two individuals, Donald Grammer and David Tedder.

The bankruptcy court dismissed the involuntary petition against SCSD after finding that petitioners' claims were the subject of a bona fide dispute. See 11 U.S.C. § 303(b). The court subsequently dismissed the involuntary petition against IBT on a motion by petitioning creditors. In its response to that motion, IBT reserved its right to recover costs, attorney's fees and damages under § 303(i) in the event the motion was granted.

SCSD and IBT thereafter filed motions for costs, attorney's fees and punitive damages against petitioning creditors under § 303(i) [a fee-shifting provision]. They also sought sanctions against Grammer and Tedder under Bankruptcy Rule 9011 and the court's inherent power. ***

After a month-long evidentiary hearing on the motions, the bankruptcy court entered judgment against Grammer, Tedder and the petitioning creditors and in favor of SCSD and IBT as follows:

1. Under § 303(i)(1), the court held the 13 petitioning creditors jointly and severally liable for $745,318 in costs and attorney's fees incurred by SCSD and IBT, including costs and fees they incurred during the post-dismissal proceedings on the § 303(i) motions themselves.

2. Under § 303(i)(2)(B), the court found that the petitioning creditors filed the involuntary petitions in bad faith and held them jointly and severally liable for $130,000 in punitive damages — $ 5,000 per creditor per petition.

3. Finally, under its inherent power to impose sanctions, the court held Grammer and Tedder jointly and severally liable for the costs and attorney's fees awarded against the petitioning creditors.***

Finally, appellants Grammer and Tedder contend that the bankruptcy court improperly included the costs of litigating the motions for sanctions in the costs and fees the court ordered them to pay under its inherent power to impose sanctions. We agree.

In Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 406-07, 110 S. Ct. 2447, 110 L. Ed. 2d 359 (1990), the Supreme Court held that Federal Rule of Civil Procedure 11 did not authorize recovery of attorney's fees incurred to defend an award of Rule 11 sanctions on appeal. Relying on language in the version of Rule 11 in effect at that time, the Court reasoned that Rule 11 sanctions were limited to "those expenses directly caused" by the improper filing, which did not include costs of appeal…. [Ed. note: This result was reversed by the 1993 amendment to Fed.R.Civ.P. 11. See Fed.R.Civ.P. 11(c)(2).] We extended that principle in Lockary v. Kayfetz, 974 F.2d 1166 (9th Cir. 1992). In Lockary, the district court imposed sanctions against the plaintiffs' law firm under its inherent power rather than Rule 11. Id. at 1170. The sanctions included not only the costs incurred by the defendants to oppose the plaintiffs' improper filings, but also "the defendants' cost of preparing and supporting their motion for sanctions." *** The law firm appealed and, relying on Cooter & Gell, we reversed:

Cooter & Gell suggests that the trial court should limit sanctions to the opposing party's more "direct" costs, that is, the costs of opposing the offending pleading or motion. We thus find that the district court erred in including the defendants' attorneys' fees for preparing their motion for sanctions in the sanctions it imposed.

Id. at 1178.

[Footnote 6] We reject appellees' contention that Lockary has been overruled by Margolis v. Ryan, 140 F.3d 850 (9th Cir. 1998), with respect to sanctions imposed under the court's inherent power. In Margolis, the court interpreted Lockary as imposing a restriction on sanctions imposed under Rule 11. See Margolis, 140 F.3d at 854-55 ("Under Lockary, the attorneys' fees and costs associated with bringing a motion for sanctions under Fed. R. Civ. P. 11 should not be included in the award because they are not direct costs of opposing an offending pleading."). Therefore, although Margolisis binding circuit precedent, its conclusion that "[t]he rule in Lockary . . . is no longer good law" has no effect here because this is not a Rule 11 case.

As applied here, the bankruptcy court properly held Grammer and Tedder jointly and severally liable for the costs and attorney's fees incurred by SCSD and IBT to secure dismissal of the involuntary petitions. The bankruptcy court erred, however, by holding Grammer and Tedder liable for the costs and fees incurred by SCSD and IBT on the postdismissal motions themselves. We therefore affirm in part and reverse in part the judgments against Grammer and Tedder.

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