Commercial Litigation and Arbitration

Rule 11 Sanctions — Falsely Claiming Personal Knowledge = Subjective Bad Faith — Dismissal Requires Willfulness, Bad Faith or Fault — Leave to Amend May Be Denied Based on Bad Faith

U.S. ex rel. Hayes v. Allstate Ins. Co., 2017 U.S. App. LEXIS 5756 (2d Cir. April 4, 2017):



Plaintiff-Appellant J. Michael Hayes, relator in this qui tam action, appeals from the February 8, 2016 order and February 9, 2016 judgment of the United States District Court of the Western District of New York (Skretny, J.) adopting the Report and Recommendation of the magistrate judge and dismissing Hayes's Amended Complaint with prejudice as to Hayes as a sanction pursuant to Federal Rule of Civil Procedure 11. We assume the parties' familiarity with the underlying facts, the [*5]  procedural history of the case, and the issues on appeal.1

1   We address a challenge to the district court's subject matter jurisdiction, mounted by several of the defendants, in an opinion filed simultaneously with this order.

Relator Hayes is an attorney. In this qui tam action, Hayes sued over sixty companies, primarily, but not exclusively, liability insurance companies, alleging that they have been systematically noncompliant with certain statutory obligations to reimburse Medicare. Hayes alleged that, through his law practice, he acquired "personal knowledge from conversations with defense counsel, insurance carrier representatives[,] and other attorneys[] of the Defendant insurance companies' company-wide and nationwide failure to notify Medicare of liability case resolutions . . . ." App. 150-51.

After the government declined to intervene and the complaint was unsealed, Hayes filed a motion for expedited discovery. In that motion, Hayes admitted that certain defendants might not have participated in the scheme alleged in the complaint and acknowledged that such defendants should be dismissed. After receiving this motion, the magistrate judge called a conference and observed that "repeatedly throughout the amended complaint, the allegation [wa]s that Mr. Hayes ha[d] personal knowledge of this nationwide scheme involving every single defendant." S. App. [*6]  21. The magistrate judge further noted that Hayes's motion for expedited discovery "admit[s] . . . that it's possible that some defendants weren't involved." S. App. 22. Due to this inconsistency, the magistrate judge ordered Hayes to show cause as to why he had not violated Federal Rule of Civil Procedure 11 and held several subsequent conferences to discuss the issue.

In the written Report and Recommendation on the Rule 11 violation issued on October 16, 2014, the magistrate judge returned to the allegations in Hayes's complaint, noting that:

   One of those allegations, repeated throughout the Amended Complaint, was that the Relator "has personal knowledge that this scheme [to defraud Medicare] was . . . employed generally and throughout the industry nationally, by all the Defendants herein." . . . However, the Relator's subsequent submissions demonstrate beyond question that he did not know whether all defendants had participated in the alleged scheme . . . . Relator's claim of personal knowledge that all defendants defrauded Medicare, and that they did so whenever they settled claims involving Medicare beneficiaries, fits the definition of subjective bad faith, because he knew that he had no such knowledge as to all defendants or [*7]  all settlements.

S. App. 111-13 (alterations in original). As a result, the magistrate judge recommended that Hayes's complaint against all defendants be dismissed with prejudice as to Hayes, but without prejudice as to the United States.

Hayes and the defendants submitted objections to the Report and Recommendation, but the district court adopted the magistrate judge's recommendation. The district court observed that "Hayes steadfastly adhered to his disproven allegations that he had personal knowledge that all defendants were engaged in a nationwide scheme to defraud the United States by failing to reimburse Medicare" when "[his] own submissions and statements before the court demonstrate that he does not possess such personal knowledge." S. App. 132. Hayes now appeals.

Federal Rule of Civil Procedure 11(b)(3) provides that "[b]y presenting to the court a pleading, . . . an attorney . . . certifies that to the best of [his] knowledge, information, and belief, . . . the factual contentions have evidentiary support." A court may, sua sponte, "order an attorney . . . to show cause why conduct specifically described in the order has not violated Rule 11(b)." Fed R. Civ. P. 11(c)(3). "If, after notice and a reasonable opportunity to respond, the court determines [*8]  that Rule 11(b) has been violated, the court may impose an appropriate sanction." Fed. R. Civ. P. 11(c)(1). A district court must make a finding of bad faith before issuing sanctions sua sponte. See Muhammad v. Walmart Stores E., L.P., 732 F.3d 104, 108 (2d Cir. 2013) (per curiam) (citing In re Pennie & Edmonds LLP, 323 F.3d 86, 91 (2d Cir. 2003)). Similarly, the district court must make a finding of "willfulness, bad faith, or fault" before dismissing a complaint as a sanction. West v. Goodyear Tire & Rubber Co., 167 F.3d 776, 779 (2d Cir. 1999).

Hayes now concedes that his claim to have personal knowledge of the involvement of "all" the defendants in the alleged scheme was "incorrect," but contends that this error was not the result of bad faith and thus did not merit the sanction of dismissal. Br. at 22, 24. Whether a litigant "acted . . . in bad faith [is a] question[] of fact, and we review the [d]istrict [c]ourt's determination[]" on that question "for clear error." Agiwal v. Mid Island Mortg. Corp., 555 F.3d 298, 302 (2d Cir. 2009) (per curiam). Ordinarily, we review a district court's imposition of Rule 11 sanctions for abuse of discretion. See Star Mark Mgmt., Inc. v. Koon Chun Hing Kee Soy & Sauce Factory, Ltd., 682 F.3d 170, 175 (2d Cir. 2012). "We must bear in mind, however, that when the district court is accuser, fact finder and sentencing judge all in one, our review is more exacting than under the ordinary abuse-of-discretion standard." ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 579 F.3d 143, 150 (2d Cir. 2009) (citation and internal quotation marks omitted).

The magistrate judge concluded, and the district court adopted the conclusion, that Hayes's "claim [*9]  of personal knowledge that all defendants defrauded Medicare . . . fits the definition of subjective bad faith[] because he knew that he had no such knowledge as to all defendants." S. App. 112-13, 132. Hayes's primary argument to the contrary, that he was confused by "corporate complexities," Br. at 25, is different from the explanations for his behavior that he offered to the magistrate judge below. Even if we were to credit Hayes's explanation, confusion about corporate complexities would not justify falsely purporting to have personal knowledge as to more than sixty defendants' involvement in wrongdoing. Cf. DiRose v. PK Mgmt. Corp., 691 F.2d 628, 632 (2d Cir. 1982). In light of the foregoing, the finding of bad faith made by the magistrate judge and district court is not clearly erroneous, even under our "more exacting" standard of review. Shaar Fund, 579 F.3d at 150.

Hayes also argues that he should have been granted leave to amend his complaint. "The court should freely give leave [to amend] when justice so requires." Fed. R. Civ. P. 15(a)(2). However, leave to amend may be denied based on bad faith. See Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Sec., LLC, 797 F.3d 160, 190 (2d Cir. 2015). "We review the district court's denial of leave to amend the complaint for abuse of discretion." Id. at 169. The magistrate judge concluded Hayes "should not now be allowed to simply walk away [*10]  from his earlier misrepresentations," and the district court adopted this conclusion. S. App. 118, 132. And insofar as Hayes concedes that some of the defendants may not be proper parties to the case, his proposed Second Amended Complaint does not solve that problem; in fact, the proposed Second Amended Complaint would add 38 new defendants. The district court's denial of leave to amend for bad faith based on the foregoing does not constitute an abuse of discretion.

We have considered all of Hayes's remaining arguments and find them without merit. For the reasons given here, as well as those given in the opinion on the district court's subject matter jurisdiction issued simultaneously with this order, we AFFIRM the judgment of the district court.

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