Where Sanctions Sought under Rule 37, Due Process Violated by Sanctioning under Inherent Power (Circuit Split (Second vs. Third)) — $6,400 Fine Is Likely “Substantial” and Thus Likely Requires Criminal Contempt Protections

Eastcott v. Hasselblad USA, Inc., 2014 U.S. App. LEXIS 10362 (Fed. Cir. June 4, 2014):

This patent appeal involves camera lens technology and the district court's imposition of sanctions for a "sham" invoice requesting expert fees. In 2011, Appellant John Eastcott filed a complaint in the United States District Court for the Southern District of New York against Appellees Hasselblad A/S, Hasselblad USA Inc., and B&H Photo & Electronics Corp. alleging infringement of U.S. Patent No. 5,592,331 ("the '331 patent"). Specifically, Eastcott asserted that the Hasselblad HTS 1.5 adapter infringed claims 1, 6, and 26 of the '331 patent. Appellees counterclaimed for declaratory judgment of non-infringement and invalidity.

During discovery, Appellees moved  [*2] for sanctions, alleging that Eastcott and his counsel fabricated an invoice for expert witness fees. After a hearing, the district court imposed sanctions against Eastcott and his counsel under its inherent power in the amount of double the attorneys' fees and costs for bringing the motion, with half payable to Appellees and the other half payable to the district court. In a subsequent decision, the district court granted summary judgment of non-infringement of claim 26 and invalidity of claims 1 and 6.

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On May 11, 2012, Appellees filed a motion seeking an order that Eastcott  [*6] must pay (1) $18,770.53 for Appellees' expert fees from the two depositions, now including travel time; (2) attorneys' fees and costs for filing the motion, and (3) sanctions for "fabricating the charges on the [Eastcott/Momatiuk] invoice." See Memorandum and Order at 2, Eastcott v. Hasselblad USA Inc., 892 F. Supp. 2d 587 (S.D.N.Y. 2012), ECF No. 36 (internal quotation marks omitted). On September 25, 2012, the district court granted Appellees' motion, and imposed sanctions upon Eastcott and his counsel, jointly and severally, in the amount of $12,815.70, for creating, submitting, and continuing to rely on the "sham invoice." Id. The district court reached this number by doubling the attorneys' fees and costs of $6,407.85 the Appellees incurred in bringing the motion. The court ordered half of the sanction payable to Appellees and half payable to the court. The court expressly grounded the sanctions upon its inherent authority.

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B. Sanctions

Turning to the district court's sanctions, Eastcott and his counsel assert that they did not receive notice of the authority underlying the contemplated sanctions or the applicable standard according to which they might be imposed. We agree. Under Second Circuit law, "'due process requires that courts provide notice and opportunity to be heard before imposing any kind of sanctions.'" Ted Lapidus, S.A. v. Vann, 112 F.3d 91 (2d Cir. 1997) (quoting In re Ames Dept. Stores, Inc., 76 F.3d 66, 70 (2d Cir. 1996) (emphasis in original)). "An attorney whom the court proposes to sanction must receive specific notice of the conduct alleged to be sanctionable and the standard by which that conduct will be assessed, and an opportunity to be heard on that matter, and must be forewarned of the authority under which sanctions are being considered, and given a chance to defend himself against specific charges."2 Sakon v. Andreo, 119 F.3d 109, 114 (2d Cir. 1997) (internal quotation marks and citations omitted); see Schlaifer Nance & Co. v. Estate of Warhol, 194 F.3d 323, 334 (2d Cir. 1999) ("At a minimum, the notice requirement mandates that the  [*16] subject of a sanctions motion be informed of: (1) the source of authority for the sanctions being considered; and (2) the specific conduct or omission for which the sanctions are being considered so that the subject of the sanctions motion can prepare a defense."); Lapidus, 112 F.3d at 97 ("We believe that a sanctioned attorney must receive specific notice of the conduct alleged to be sanctionable and the standard by which that conduct will be assessed, and an opportunity to be heard on that matter.").

2   While Appellees assert that a district court can properly impose sanctions under its inherent power without specific notice of the grounds for sanctions, they cite no Second Circuit authority to support this position, relying instead on non-binding Third Circuit precedent. Although the Third Circuit's approach has much to commend it, we see no case law in the Second Circuit to date to indicate that the Second Circuit would adopt a similar exception to its otherwise strict notice requirements.

Before the district court imposed sanctions, Eastcott and his counsel were unaware that the court might sanction them under its inherent powers. Appellees' initial letter-motion requested simply  [*17] that the district court "sanction [Eastcott] and its counsel for fabricating the charges on the 'invoice.'" J.A. 1190. This letter-motion did not cite any specific authority. Eastcott and his counsel responded by arguing that the letter-motion seeks "unspecified sanctions" and that "Rule 11 does not provide for sanctions for discovery disputes such as this and in no way has [Eastcott] abused discovery or made unreasonable demands on [Appellees'] experts." J.A. 1205-07. In their reply, Appellees explicitly stated that they believed that "[s]anctions are awardable under Rule 37." J.A. 1268. This mention of Rule 37 was the only specific authority cited by the Appellees.

Nor did the district court warn Eastcott and his counsel of potential sanctions under the court's inherent powers at the motions hearing. After listening to arguments from both parties, the district court stated that it would "take this matter under advisement." J.A. 1330. The district court then turned its attention on Eastcott's counsel to consider "whether the conduct of counsel in what the Court may determine is a patently fraudulent invoice prepared with fraudulent intent warrants referral to the grievance committee  [*18] of the Southern District of New York of counsel for their facilitation and participation in what may or may not be . . . a gross fraud." J.A. 1330-31. The district court then provided each party ample opportunity to raise any additional support for their positions. Throughout the entire hearing, the district court did not mention the possibility of sanctions under its inherent powers. See J.A. 1325-38. Nor did Appellees request sanctions under the district court's inherent powers at the hearing. Not until the district court imposed the sanctions in its Memorandum Order was there any indication of the court's inherent powers as a basis for sanctions.

Under Second Circuit standards, the notice the district court and Appellees' counsel provided Eastcott and his counsel was insufficient to satisfy due process. As noted above, "[a]t a minimum, the notice requirement mandates that the subject of a sanctions motion be informed of: (1) the source of authority for the sanctions being considered; and (2) the specific conduct or omission for which the sanctions are being considered so that the subject of the sanctions motion can prepare a defense." Schlaifer, 194 F.3d at 334. Consistent with these  [*19] requirements, in L.B. Foster Co. v. America Piles, Inc., the Second Circuit found that the district court failed to provide procedural safeguards to a sanctioned party when it imposed sanctions under 28 U.S.C. § 1927, though the party only received notice that sanctions were sought under Rule 11. 138 F.3d 81, 89 (2d Cir. 1998); cf. Schlaifer, 194 F.3d at 334 (finding sufficient notice when the sanctions motion invoked and set forth the standards for sanctions under the court's inherent power and § 1927, even though the motion focused on Rule 11). Although Eastcott surely had an opportunity to be heard and argue that sanctions were not warranted, we find that Eastcott and his counsel did not receive notice of the standard and authority under which sanctions were being considered before the district court imposed sanctions. Because the Second Circuit requires greater notice before it will find that a sanctioned party received all process due to him or her prior to the imposition of sanctions, we vacate the district court's order imposing sanctions and remand for further proceedings.

On remand, the district court must also reconsider any sanctions which are punitive rather than merely  [*20] compensatory in nature. When imposing punitive sanctions, such as the portion of the sanction here made payable to the court, additional procedures are required. "A troublesome aspect of a trial court's power to impose sanctions . . . is that the trial court may act as accuser, fact finder and sentencing judge, not subject to restrictions of any procedural code and at times not limited by any rule of law governing the severity of sanctions that may be imposed." Mackler Prods., Inc. v. Cohen, 146 F.3d 126, 128-29 (2d Cir. 1998) (Mackler I) (citation omitted) (finding that a $10,000.00 sanction, payable to the court, imposed under its inherent authority was a punitive sanction, and consequently, required the protections of criminal procedure). Given this concern, "in certain sanctions proceedings, the person facing imposition of sanctions should have the benefit of the procedural protections available to a person charged with a crime." Id. at 128. "Criminal protections are generally thought to include, in addition to notice and the opportunity to be heard, the right to a public trial, assistance of counsel, presumption of innocence, the privilege against self-incrimination, and the requirement  [*21] of proof beyond a reasonable doubt." Id. (citations omitted).

In Mackler I, the Second Circuit found that a $10,000.00 sanction payable to the district court imposed under its inherent authority was a punitive sanction, and consequently, required the protections available to criminal defendants. Id. at 129. In reaching this conclusion, the court considered the following factors: (1) whether the sanction was intended to be compensatory or punitive; (2) whether the imposition was retrospective, rather than to coerce future compliance; (3) whether the sanction was payable to the court, rather than the injured party; and (4) whether the size of the sanction was substantial. Id. In finding that the sanction imposed there required greater procedural protections, the court explained that it had all of the features of a criminal sanction outlined above. Id. Similarly, here, we conclude that at least a portion of the sanction imposed was punitive, retrospective with no opportunity to purge, payable to the court, and substantial.3 It is undisputed that Eastcott and his counsel did not receive the benefit of all of the procedural safeguards which are prerequisites to imposition of a criminal penalty.  [*22] Because we find that the imposition of the sanction payable to the court in the amount of $6,407.85 on Eastcott and his counsel, jointly and severally, required that the district court afford them criminal procedural protections, we also vacate and remand the district court's order imposing the portion of the "punitive" sanction payable to the court on this basis.

3   In a subsequent appeal, the Second Circuit held that the district court's reduction of its sanction from $10,000.00 to $2,000.00 did not alter the criminal character of the sanction where all of the factors indicative of a criminal sanction remained. Mackler Productions, Inc. v. Cohen, 225 F.3d 136, 142-43 (2d Cir. 2000) (Mackler II). In Mackler II, the court emphasized that the gravamen of its analysis focused on "whether or not the sanction at issue was criminal or civil in character." Mackler II, 225 F.3d at 142 (emphasis in original); see also Buffington v. Baltimore Cnty., Md., 913 F.2d 113, 132-35 (4th Cir. 1990) (finding $6,785.37 punitive sanction to require criminal procedural protections). Noting that only the amount of the sanction had changed, the court found that all of the other factors still supported the conclusion  [*23] that the sanction at issue was criminal in nature, despite the reduction in the size of the sanction. Mackler II, 225 F.3d at 142.

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