Scott Garr Patricia Garr, on Behalf of Themselves and All Others Similarly Situated v. U.S. Healthcare, Inc., Leonard Abramson, Arnold Levin, Esquire, in His Own Right and Harris Sklar, Esquire, in His Own Right

Citation: 22 F.3d 1274Docket: 93-1754

Court: Court of Appeals for the Third Circuit; June 29, 1994; Federal Appellate Court

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An appeal was filed by Arnold Levin and Harris Sklar regarding sanctions imposed by the district court under Federal Rule of Civil Procedure 11. The appeal stems from orders dated February 5, 1993, and July 6, 1993, which concluded that the appellants violated Rule 11. The case emerged after a Wall Street Journal article on November 4, 1992, reported that U.S. Healthcare, Inc. insiders had sold stock prior to a significant decline in its price due to disappointing earnings. James R. Malone, from the law firm Greenfield, Chimicles, became interested in the article, which led him to seek potential plaintiffs for securities litigation. Notably, U.S. Healthcare accused Greenfield, Chimicles of maintaining a list of corporate stockholders for litigation purposes. Malone, without any clients expressing interest, initiated research on U.S. Healthcare to generate a lawsuit. He contacted Robert K. Greenfield, who owned stock in the company, to discuss the situation, resulting in Malone determining that a specific class of stockholders had a valid legal claim related to the insider stock sales.

On November 4, 1992, Malone filed a class action complaint on behalf of Greenfield under section 10(b) of the Securities Exchange Act of 1934, alleging that U.S. Healthcare and Abramson made false and misleading statements to the Securities and Exchange Commission, leading Greenfield and the class to purchase stock at inflated prices. The complaint included a claim of controlling person liability against Abramson under section 20 of the Act. Malone asserted that Greenfield could adequately represent the stockholder class, although he filed the complaint before Greenfield had seen it. On the following day, Malone filed a second class action for Allen Strunk with identical allegations, differing only in the plaintiff's name and share count, after being contacted by Strunk's New York attorney.

On the same day, Arnold Levin, who had a professional relationship with Greenfield, expressed interest in the case after reading a Wall Street Journal article. Levin discussed the merits of a section 10(b) action with Malone, who faxed him the Greenfield complaint. Levin believed the action had merit based on his review. Additionally, Harris J. Sklar, another attorney, also interested in the U.S. Healthcare situation, consulted with his client Scott Garr and received authorization to pursue a class action. Sklar sought co-counsel and contacted Levin, who shared details about Malone's case. After reviewing the Greenfield complaint, Sklar confirmed its merit and allowed Levin to file a new class action on behalf of Garr and his wife, which was completed on November 6, 1992, mirroring the previous complaints with changed plaintiff names and share counts.

On November 6, 1992, U.S. Healthcare and Abramson sought sanctions under Rule 11 in response to the Garr complaint filed by Levin and Sklar, submitting an extensive motion exceeding 100 pages. U.S. Healthcare's attorney, Alan J. Davis, revealed that he had anticipated additional complaints following the Greenfield complaint's filing, allowing him to prepare the sanctions motion in advance. They argued that the plaintiffs failed to conduct a thorough factual and legal investigation, resulting in complaints lacking any factual or legal basis, describing them as typical copycat lawsuits based on media reports.

On November 8, 1992, Robert K. Greenfield realized he had erred in bringing the complaint due to a conflict of interest, as he had significant business ties with U.S. Healthcare, and instructed Malone to withdraw it. Following this revelation, U.S. Healthcare supplemented their sanctions motion, claiming Malone did not adequately assess Greenfield's ability to represent the plaintiff class. Malone opposed the sanctions, leading to an evidentiary hearing on December 10, 1992, where Greenfield testified.

On December 15, 1992, the district court ordered Malone, Isquith, Levin, and Sklar to provide documentation proving a reasonable pre-filing inquiry into the facts and law. The court's subsequent opinion on February 4, 1993, concluded that while Malone's factual inquiry regarding the Greenfield complaint was reasonable, he violated Rule 11 regarding the adequacy of Greenfield’s representation of the class. Nevertheless, the court found no inadequate inquiry concerning Strunk's representation, resulting in no sanctions imposed for the Strunk action.

The district court evaluated the potential imposition of sanctions on Levin and Sklar, referencing the case Lewis v. Curtis, which stated that reliance on Wall Street Journal articles does not constitute an insubstantial investigation. However, the court clarified that Lewis, decided under Fed. R. Civ. P. 23.1, does not apply under Rule 11, which requires attorneys to conduct an independent analysis of the facts and law behind their pleadings. The court dismissed Levin's claim of reliance on Greenfield's investigation as insufficient, ruling that both Levin and Sklar acted prematurely and their inquiries were unreasonable, violating Rule 11. Sanctions were ordered, requiring Malone, Levin, and Sklar to pay the reasonable costs and attorney’s fees of U.S. Healthcare and Abramson, dismissing the Greenfield and Garr complaints without prejudice, and referring the matter to the Pennsylvania Disciplinary Board. U.S. Healthcare and Abramson's attorneys were instructed to provide affidavits detailing their costs. Although the Strunk action was not dismissed for Rule 11 violations, it was later dismissed by stipulation. The Rule 11 proceedings concluded on July 6, 1993, with the court imposing sanctions of $24,697.50 on Malone and $1,428.00 each on Levin and Sklar. Malone paid his sanction without appeal, while Levin and Sklar obtained stays and appealed the decision. Rule 11 mandates that an attorney’s signature certifies that they have read the document, believe it is well-grounded in fact and law, and is not filed for improper purposes.

A signer's signature on legal documents certifies that the signer has (1) read the document, (2) made a reasonable inquiry into its contents, concluding it is grounded in fact and law, and (3) has not acted in bad faith. The court evaluates the reasonableness of this inquiry using an objective standard, and the signer has a personal, nondelegable responsibility to comply with Rule 11. While a signer may rely on information from others, such as witnesses, the determination of a reasonable inquiry often considers whether the signer relied on counsel or other bar members. The assessment of compliance with Rule 11 is fact-specific and must avoid hindsight bias, evaluating what was reasonable at the time of submission. If the inquiry was adequate based on the circumstances at submission, subsequent developments do not expose the signer to sanctions. Conversely, inadequate inquiries will incur sanctions regardless of subsequent justifications. The reasonableness of the inquiry also involves a temporal aspect; the available time for investigation influences expectations of thoroughness. An attorney under tight deadlines may justifiably file based on less inquiry than one with ample time.

Reviewing a district court's Rule 11 determination employs an abuse of discretion standard, which may encompass other standards if the ruling is based on an erroneous legal view or a clearly erroneous evidence assessment. In this case, no factual disputes challenge the court's determination. Levin obtained information from competent securities law counsel, Malone, and supplemented it with knowledge from the Wall Street Journal and his own experience. Levin communicated this information to Sklar for certification. While recognizing the tension between personal Rule 11 obligations and reliance on others, this case presents no complications. Malone's thorough inquiry included a wide range of financial data about U.S. Healthcare and SEC filings, while Levin and Sklar relied solely on limited sources without reviewing Malone's comprehensive materials. They failed to justify this omission, with no constraints preventing them from accessing Malone's documents, which were publicly available. Additionally, there were no urgent time pressures to file the Garr complaint, as it was submitted shortly after the Wall Street Journal article's publication. Levin and Sklar did not argue a statute of limitations issue, and the recent nature of the events reported negated any such concerns.

Levin and Sklar failed to provide valid reasons for the necessity of filing the Garr complaint within two days of the article's publication, lacking claims for emergency relief or concerns about evading process or concealing assets. They relied excessively on Malone's investigation, which violated Rule 11, as they did not personally conduct a reasonable inquiry into the merits of the case. Their only modification to Malone's prepared complaint was changing the plaintiffs' names and share numbers. Although it could be argued that an inquiry was unnecessary since Malone had conducted one, Rule 11 mandates that attorneys must perform their own reasonable inquiries. The potential for differing conclusions from separate inquiries underscores this requirement. The clear violation of Rule 11 justifies the sanctions imposed on Levin and Sklar, which the district court's decision will be upheld under an abuse of discretion standard. Their reliance on Lewis v. Curtis is unhelpful, as it did not address Rule 11 and is irrelevant here; that case pertained to Rule 23.1 concerning derivative actions. Additionally, the Garr complaint's claim about false reports filed by U.S. Healthcare could not be substantiated by the Wall Street Journal article, which made no such allegations, and neither Levin nor Sklar claimed to have reviewed the relevant SEC filings before filing the complaint. Thus, their assertion of having conducted a reasonable inquiry is unfounded.

Levin and Sklar argue against sanctions by referencing rulings in prior cases that suggest Rule 11 should only apply in "exceptional circumstances" or for documents deemed "patently unmeritorious or frivolous." However, the court clarifies that sanctions in this case are not based on the Garr complaint's merit but rather on Levin and Sklar's failure to conduct a reasonable inquiry as required by Rule 11 before signing the complaint. The court notes that the rationale for using Rule 11 solely in exceptional cases is to prevent sanctions from being applied merely due to disagreements over litigation outcomes. Levin and Sklar's claim that the district court abused its discretion in imposing a $1,428 monetary sanction is dismissed as frivolous, with the court emphasizing that this amount reflects judicial restraint.

In a dissenting opinion, Judge Roth acknowledges that while Levin and Sklar's conduct was subpar, he disagrees with the imposition of sanctions. He argues that if a court finds a complaint to be meritorious, it should not further investigate the attorney's pre-filing inquiry. Roth points out that the Garr complaint was essentially identical to another valid complaint that was not dismissed, implying that the district court viewed the Garr complaint as meritorious. Roth critiques the majority's reliance on a statement from a district court in another circuit regarding sanctions, arguing that it does not support their position and overlooks contrary legal principles from other circuits. He emphasizes the need for a nuanced analysis of Rule 11's enforcement and its implications for legal practice.

Rule 11 sanctions are deemed inappropriate in the Second Circuit when a claim has some basis, even if an attorney did not conduct a sufficient pre-filing investigation. The court's focus should be on whether an objectively reasonable basis for a claim was established during pretrial or trial proceedings, as illustrated in cases like Calloway v. Marvel Entertainment Group. Sanctions are warranted only when a claim is "patently clear" to have no chance of success, as established in Eastway Const. Corp. v. City of New York. The overarching principle is that sanctions are reserved for exceptional circumstances where a claim is clearly unmeritorious. The Supreme Court emphasizes that Rule 11's central goal is to deter baseless filings while balancing concerns that it may lead to excessive litigation and inhibit vigorous advocacy. The Advisory Committee also notes that Rule 11 aims to reduce frivolous claims and streamline the litigation process. A standard that permits claims with merit, despite inadequate attorney investigation, would better serve the goals of deterrence and efficient court functioning. The likelihood of sanctions should not discourage lawyers from pursuing legitimate claims, as the absence of frivolous claims is the best evidence of a thorough investigation. Encouraging courts to investigate an attorney's research adequacy could lead to inefficiencies and unnecessary speculation, ultimately hindering judicial efficiency.

The majority seeks to impose sanctions on counsel to deter the filing of frivolous lawsuits, though it is argued that this approach could paradoxically promote the filing of motions for sanctions instead. The specific case exemplifies this issue, as the motion for sanctions was prepared prior to the defendants reviewing the Garr complaint, indicating a preemptive and possibly indiscriminate use of sanctions. It is suggested that if the court rules that complaints, while facially meritorious, can be filed without thorough investigation, defendants may be less inclined to pursue sanctions. Instead, they could face sanctions themselves for filing unwarranted motions without proper inquiry into the merits of the complaint. The author critiques the majority's reasoning for potentially undermining the objectives of Rule 11, advocating for the reversal of the sanctions imposed against attorneys Levin and Sklar. The petition for rehearing submitted by Levin and Sklar was denied, despite some judges advocating for a rehearing en banc. Additionally, details regarding ownership of shares by various parties and the procedural aspects of attorney-client relationships are mentioned, with a note that amendments to Rule 11 effective December 1, 1993, are not relevant to this case.