Lightspeed Media Corp. v. Smith

Citations: 830 F.3d 500; 2016 U.S. App. LEXIS 13195; 2016 WL 3905605Docket: Nos. 15-2440 & 15-2682

Court: Court of Appeals for the Seventh Circuit; July 19, 2016; Federal Appellate Court

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John Steele and Paul Hansmeier are facing contempt sanctions for engaging in deceptive practices to evade prior sanctions imposed by a district court. Despite earlier advice from the court to cease such actions, they allegedly misled the court and obstructed discovery efforts. This prompted Anthony Smith, a defendant in the underlying litigation, to seek further sanctions against Steele, Hansmeier, and Paul Duffy (now deceased). Initially, the court denied Smith's request but later reversed its decision upon reconsideration. The court found Steele and Hansmeier in contempt and sanctioned them for discovery misconduct.

Steele's sanction for discovery misconduct was upheld, while his contempt sanction was vacated. Hansmeier's appeal was dismissed. The case stems from a series of lawsuits filed by Steele, Hansmeier, and Duffy, collectively termed a 'pornotrolling collective,' representing Lightspeed Media in actions under the Computer Fraud and Abuse Act. Their strategy involved obtaining personal information from ISPs through subpoenas to pursue settlements from alleged copyright violators. However, ISPs resisted compliance, and the lawsuits began to fall apart, leading to sanctions against the Attorneys for frivolous litigation. After failing to pay the imposed sanctions, Smith and other defendants moved for contempt, while the Attorneys claimed insolvency and failed to respond to discovery requests.

On January 30, attorneys moved to quash Smith’s subpoenas to financial institutions. Steele faxed the motion to JPMorgan without disclosing its court status. When JPMorgan asked for a court-stamped copy, Steele did not respond. At a February 13 hearing, the attorneys claimed inability to pay sanctions, leading to a court order for them to submit financial statements, which they did in camera. The court denied Steele's motion to quash on February 19. On March 3, JPMorgan again requested a stamped copy of the motion, which Duffy provided, omitting its denial. Following this, on March 20, Smith filed a renewed contempt motion based on the attorneys' financial statements and alleged discovery interference. The court held the attorneys in contempt on March 24, imposing sanctions of $26,102.58. Smith then issued eight new subpoenas to the attorneys' financial institutions. A stay on the contempt order was issued on April 4 pending appeal. Steele falsely informed Smith’s counsel that the subpoenas were withdrawn due to the stay. Despite the stay not applying to the subpoenas, Steele misrepresented the situation to Sabadell United Bank on April 16. Smith sought sanctions against Duffy and Steele for obstructing discovery, while Hansmeier moved to quash Smith’s subpoenas on April 21. Financial institutions continued to withhold documents. On July 31, 2014, the court upheld sanctions and contempt orders against the attorneys. Subsequent hearings and motions occurred, with Smith uncovering evidence of substantial withdrawals by Steele and control over assets by Hansmeier, contradicting their claims of insolvency. The district court granted Smith’s motion for reconsideration on June 5, 2015, awarding him discovery costs and contempt sanctions totaling $65,263.00, to be paid by July 15, 2015. Smith itemized $94,343.51 in discovery costs, which were to be split between Steele and Duffy. Both attorneys filed notices of appeal regarding the sanctions in July and August 2015, with further developments occurring thereafter.

On July 13, 2015, Hansmeier filed for bankruptcy in Minnesota. The district court had ordered Steele and Duffy to pay discovery costs by August 10, 2015. On that date, Steele sent $47,171.75 for his share of the discovery sanction and $65,000.00 for the contempt sanction to the court; Duffy's payment was not made as he died that same day. Hansmeier’s bankruptcy was later converted to Chapter 7 on December 3, 2015. The district court's decisions in this context are subject to abuse of discretion review, while legal conclusions are reviewed de novo and factual findings for clear error.

With Hansmeier's bankruptcy proceedings under Chapter 7, only the trustee has the standing to pursue claims belonging to the estate, resulting in the dismissal of Hansmeier's appeal. Steele's appeal remains unaffected. He argues that the district court abused its discretion by granting a motion to reconsider. The court is allowed to revisit its rulings during litigation to address issues and prevent unnecessary appeals, particularly if no final judgment has been made. Sanctions against nonparties are considered final and thus immediately appealable.

The district court's decision to reconsider was assumed to be under the constraints of Federal Rule of Civil Procedure 59(e), which requires showing a manifest error of law or fact or presenting new evidence. Smith provided newly discovered documents revealing Steele and Duffy's misleading communications with JPMorgan and Sabadell, including evidence that Steele withdrew over $300,000 shortly before and after a show-cause hearing. The court assessed these documents alongside evidence that Steele had lied about his ability to pay the sanctions. 

Steele's argument against Smith's late submission of evidence was dismissed, as it was Steele and Hansmeier's conduct that obstructed Smith’s access to necessary documents prior to the hearing. Steele had previously claimed that Smith possessed all relevant documents, which delayed the production of financial evidence from Sabadell until after the hearing had concluded.

Hansmeier's second motion to quash and incomplete document production delayed Smith's access to relevant documents until February 2015. Steele argued that Smith should have discovered the documents sooner, claiming Monyet's existence was public record since 2010 and relevant documents were available from a Minnesota bankruptcy case in mid-2014. However, Smith had no knowledge of Monyet or Hansmeier's control over it, nor was he a party to the bankruptcy case. The district court did not err in granting Smith's reconsideration motion, finding that Duffy and Steele obstructed discovery through misleading communications with financial institutions. 

Steele denied any misconduct and claimed the sanctions were excessive. He had issued subpoenas and requests for production in January 2014, which the Attorneys moved to quash. Steele misled JPMorgan by faxing a motion without a file-stamp, making it difficult for JPMorgan to ascertain the motion's status. Even after the motion was denied, Steele failed to inform JPMorgan. Duffy sent a court-stamped copy without revealing the motion's denial, further misleading JPMorgan regarding its obligations. 

On April 16, 2014, Steele misled Sabadell by sending a stay order that only applied to original sanctions, not discovery obligations. The district court found Steele's actions obstructive and supported this conclusion with evidence. Steele argued that costs incurred prior to his January 30 communication were unjustified, but the court noted these were due to the Attorneys' refusal to comply with sanctions. Sanctions under Section 1927 cover only excess costs from vexatious behavior, not total litigation costs, and must be reviewed in the context of the entire case history. The court emphasized that all obstructive actions throughout the lawsuit contributed to the sanctions imposed.

Rule 37(a) stipulates that sanctions should cover all expenses that would not have arisen had the opposing party acted appropriately, as established in Tamari v. Bache, Co. Lebanon. The district court has the authority to assess the entire pattern of a party's vexatious conduct when determining sanctions, which were granted on October 30, 2014. By November 13, 2014, the Attorneys had submitted itemized fees and were aware that the remaining defendants' costs would be substantial. The district court formally imposed $261,025.11 in sanctions on November 27, 2013, during a time when Steele and Hansmeier were transferring large amounts from their accounts, indicating egregious disregard for the court's order. 

Smith's litigation regarding their ability to pay the sanctions was necessary, with compensable expenses traced back to third-party subpoenas issued on January 16, 2014. Steele contends that the contempt sanction was criminal rather than civil, arguing that this violates the Fifth Amendment due process clause and that the court should have adhered to Federal Rule of Criminal Procedure 42. The distinction between civil and criminal contempt lies in the nature of the proceedings and the purpose of the relief sought. Civil contempt aims to compel compliance or compensate for losses, while criminal contempt serves to punish and uphold the court's authority. A contempt fine is remedial if paid to the complainant and punitive if paid to the court. Conditional penalties are coercive and thus deemed civil contempt, whereas fines intended to punish or deter are classified as criminal contempt.

A 'flat, unconditional fine' for criminal contempt, as established in Hicks, 485 U.S. at 633, is not intended to compensate for actual harm. In evaluating Steele’s fine of $65,268.00, it is determined to be punitive rather than compensatory, as it was based solely on the attorneys’ contemptuous behavior, representing a percentage of an earlier sanction rather than any actual costs incurred. The court's intent was to punish past misconduct and deter future violations, with no connection to specific damages experienced by Smith or the district court. Unlike in Lightspeed I, where a fine was linked to attorneys' fees related to litigation, the fine in this case lacked any remedial purpose. The Ninth Circuit's ruling in Ingenuity 13, also involving a punitive sanction, is distinguished as it aimed to compensate for the complainant's losses, which was not the case here. Consequently, the contempt order is vacated, and the matter is remanded for further proceedings without commenting on potential future contempt actions. Hansmeier's appeal is dismissed due to his bankruptcy status, while Steele's contempt sanction is vacated for lack of due process under the Fifth Amendment. The district court's discovery sanction against Steele is affirmed. Smith's Motion for Damages, Attorneys’ Fees, and Costs is denied, with each party bearing its own appeal costs.