Rule 11 — Actual Notice by Email Doesn’t Satisfy Safe Harbor Requirements — Finding of Meritless, Alone, Insufficient Basis for 1927 or Inherent Power Sanctions

Chong v. Chang, 2015 U.S. App. LEXIS 5381 (2d Cir. April 3, 2015):

Michael K. Chong appeals from the judgment of the United States District Court for the Southern District of New York (Forrest Click for Enhanced Coverage Linking Searches, J.), granting appellees' motion for attorney's fees and costs as a sanction for pursuing a baseless third-party complaint against appellees, Kwo Shin Chang and Steven Wong. We assume the parties' familiarity with the underlying facts, the procedural history, and the issues presented for review.

Chang, Wong, and others filed an action against Chong's client, Vihn Ly, asserting claims under the Fair Labor Standards Act ("FLSA") and New York Labor Law ("NYLL") in connection with the operation of [*2]  a restaurant, Neo Sushi. Ly's answer asserted counterclaims against Chang and Wong for fraud and breach of an alleged partnership agreement among Ly, Chang and Wong to purchase and own Neo Sushi. An amended complaint was filed in which Chang and Wong were no longer plaintiffs; Ly asserted the same claims against Chang and Wong, brought in the form of a third-party complaint.

After a trial, the district court entered judgment in favor of Chang and Wong, concluding "that there was a failure of proof as to essential elements of both claims." Special App. at 5. Chang and Wong sought sanctions in the form of fees and costs pursuant to Federal Rule of Civil Procedure 11, 28 U.S.C. § 1927, and the inherent power of the court. The court determined sanctions were "warranted under all three asserted grounds." Id. at 7.

We review a district court's award of sanctions, whether under Rule 11, § 1927, or its inherent power for abuse of discretion. See StreetEasy, Inc. v. Chertok, 752 F.3d 298, 306-07 (2d Cir. 2014) (discussing Rule 11 sanctions); Enmon v. Prospect Capital Corp., 675 F.3d 138, 143 (2d Cir. 2012) (discussing § 1927 and the court's inherent power).

Chong argues that the district court erred in imposing sanctions pursuant to Rule 11 because Chang and Wong failed to comply with the procedural requirements of the Rule's safe harbor provision. The district court found that "sufficient notice" was provided because opposing [*3]  counsel warned Chong by e-mail "about the possibility of attorneys' fees if he had to sit through trial." Special App. at 8. But the "safe-harbor provision is a strict procedural requirement" and "[a]n informal warning . . . without service of a separate Rule 11 motion is not sufficient." Star Mark Mgmt., Inc. v. Koon Chun Hing Kee Soy & Sauce Factory, Ltd., 682 F.3d 170, 175 (2d Cir. 2012) (per curiam). The e-mail sent to Chong in this case does not satisfy the requirements under the Rule.

Although the court set out the applicable standards for sanctions under Rule 11, § 1927, and the court's inherent authority, it did not engage in "separate consideration of the available sanctions machinery[, which] is not only warranted, but necessary for meaningful review." United States v. Int'l Bhd. of Teamsters, Chauffeurs, Warehousemen & Helpers of Am., 948 F.2d 1338, 1346 (2d Cir. 1991). A district court should "treat[] and determine[ each authority] separately" and the court's "resulting findings must appear with reasonable specificity in terms of the perceived misconduct and the sanctioning authority." MacDraw, Inc. v. CIT Grp. Equip. Fin., Inc., 73 F.3d 1253, 1262 (2d Cir. 1996) (internal quotation marks omitted).

The court's opinion lacks the specific findings required to support the imposition of sanctions under either its inherent authority or § 1927, and remand is therefore warranted. Schlaifer Nance & Co. v. Estate of Warhol, 194 F.3d 323, 338 (2d Cir. 1999). While it is true that "[b]ad faith can be inferred when the actions taken are so completely without merit as to require the conclusion that they [*4]  must have been undertaken for some improper purpose," id. (internal quotation marks omitted), the court's determination that "there was absolutely no merit to the claims asserted" is not sufficient. Special App. 3 n.3.

The standard requires "clear evidence that (1) the offending party's claims were entirely meritless and (2) the party acted for improper purposes." Revson v. Cinque & Cinque, PC, 221 F.3d 71, 79 (2d Cir. 2000) (internal quotation marks omitted). The court's only findings are that: "third-party plaintiffs failed to introduce evidence sufficient to support even a prima facie" claim; the "failure[] of proof [was] . . . powerful evidence of the fact that the complaint was meritless from the start;" and "[t]his obvious lack of merit gives rise to precisely the inference that . . . the third-party complaint was filed solely to pressure plaintiffs into withdrawing meritorious FLSA and NYLL claims." Special App. at 7-8. These findings collapse the relevant standard into a single requirement that the court find the claims baseless. But, as the district court recognized, "one of the ways this could [have] play[ed] out is with a wage and labor claim that there was a period of time during which the partnership operated where there were monies due and owing to the employees [*5]  and that [the] debt, if any, [was] owed by the partnership" as opposed to by Ly alone. Appellant App. at 71-72.

For the foregoing reasons, and finding no merit in Chang and Wong's other arguments, we hereby VACATE and REMAND the judgment of the district court.


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