MHC Investment Co. v. Racom Corp. , 323 F.3d 620 ( 2003 )

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
___________
No. 02-3162
___________
MHC Investment Co., *
*
Plaintiff, *
* Appeal from the United States
v. * District Court for the Southern
* District of Iowa.
Racom Corporation, *
*
Defendant, *
*
Shuttleworth & Ingersoll, *
*
Appellant. *
*
___________________ *
*
Racom Corporation, *
*
Third Party Plaintiff, *
*
v. *
*
Ronald W. Stepien, Dennis H. Melstad, *
David Sokol, *
*
Third Party Defendants. *
___________
Submitted: January 17, 2003
Filed: March 17, 2003
___________
Before MORRIS SHEPPARD ARNOLD, BRIGHT, and SMITH, Circuit Judges.
___________
BRIGHT, Circuit Judge.
MHC Investment Company (MHC), a subsidiary of MidAmerican Energy,
invested $10 million in Racom Corporation (Racom), a seller and servicer of two-way
radio equipment and systems. MHC filed suit against Racom alleging breach of
contract. Racom hired the law firm of Shuttleworth & Ingersoll (Shuttleworth).
Racom responded by pleading affirmative defenses of fraudulent inducement, lack
of authority on the part of Racom's Board of Directors (Board) to enter the agreement,
and lack of consideration. Racom also filed counterclaims against MHC for fraud,
slander per se, breach of fiduciary duty, and civil Racketeer Influenced and Corrupt
Organization Act (RICO) 18 U.S.C. §§ 1961-1968. MHC moved for summary
judgment on Racom's counterclaims. Racom moved to extend summary judgment
proceedings pursuant to Federal Rule of Civil Procedure 56(f), so that it could
conduct further discovery. The district court1 denied Racom's motion and its motion
to reconsider. Then, the district court granted MHC's motions for summary judgment.
The district court asked Shuttleworth to explain why the district court should
not sua sponte impose sanctions against Shuttleworth for pursuing frivolous defenses
and claims and attempting to delay payment of more than $10 million that Racom
owes MHC. After a show cause hearing, the court, in a written opinion, determined
that Shuttleworth violated Federal Rule of Civil Procedure 11. The court ordered
sanctions to be paid to the court in the amount of $25,000. Shuttleworth appeals,
arguing that the district court erred in imposing sanctions. We affirm.
1
The Honorable Robert W. Pratt, United States District Judge for the Southern
District of Iowa.
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I. BACKGROUND
On July 16, 1996, MHC (through its predecessor-in-interest MidAmerican
Capital Company) invested $10 million in Racom by purchasing preferred stock in
Racom.2 As part of the stock purchase agreement, MHC gained two of seven seats
on Racom's Board. Eventually, Dennis Melstad, MHC's president, and Ronald
Stepien held MHC's two seats on the Board. Stepien served as the vice president, and
later president, of MidAmerican Energy.
The stock purchase agreement also gave MHC a "put" on its preferred share,
by which MHC could tender the preferred share back to Racom for its original price,
in addition to any accrued or unpaid dividends, in the event that Racom did not meet
certain specified financial conditions by July 16, 2001. Under this provision, MHC
would have until September 16, 2001, to tender the put and then Racom was required
to meet the obligation with cash within ninety days of receiving MHC's notice of
exercising its right.
On June 29, 1998, MHC loaned Racom $9.75 million for one year to resolve
a dispute with another shareholder. After one year, MHC extended the loan at a
higher interest rate.
In January 1999, MHC accepted forty-five shares of Racom's common stock
in exchange for its forbearance of certain rights relating to payment of dividends due
but not paid. In addition, the common stock agreement also stated that Racom would
issue an additional 280 shares of common stock should MHC exercise its put right.
2
The Series A Preferred Stock had a cumulative dividend rate of eight percent
per annum with dividends payable semi-annually. Dividends were deferred for the
first two years.
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Beginning in mid-2001, Melstad, on behalf of MHC, began preparing for
MHC's exit from Racom. On September 12, 2001, MHC exercised its put right.
MHC estimated that Racom was obligated to pay $15,155,366.60 based on accrued
and unpaid dividends.3 After MHC exercised its put rights, Racom removed Melstad
and Stepien from Racom's Board.
This resulted in MHC filing two lawsuits in November 2001 against Racom in
Delaware, Racom's place of incorporation. In the first lawsuit, MHC and Melstad
sought inspection of certain corporate books and records of Racom. The second
lawsuit alleged that Racom illegally removed MHC's representatives from Racom's
Board. A different law firm represented Racom in the Delaware action.
On December 10, 2001, Racom filed a declaratory action in Iowa state court,
seeking a determination of the validity of certain actions of Racom's Board and the
validity of the original stock purchase agreement. MHC removed the case to federal
court in Iowa.4
On December 12, 2001, MHC filed the instant action seeking repayment of the
loan and the issuance of additional common stock. Before Racom had an opportunity
to respond, MHC moved for summary judgment on January 2, 2002.
3
Around this time, Racom hired Shuttleworth to represent its interests. Racom
had other long time counsel. However, that counsel had a conflict of interest and
contacted Shuttleworth to take over representation of Racom.
4
According to Shuttleworth, the district court dismissed this action after the
parties finalized a settlement.
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Approximately three weeks later, Racom deposed Melstad, Stepien, Garry
Osborn,5 and Gregg Miller6 in the Delaware litigation. In addition, MHC produced
approximately 2500 pages of documents for the Delaware litigation, which included
a partially redacted MHC "Exit Strategy" memo. The parties had not conducted or
requested any discovery in the Iowa litigation.
On January 17, 2002, Shuttleworth filed an answer and counterclaim on behalf
of Racom to the Iowa federal claims. The pleadings asserted compulsory
counterclaims of fraud, RICO, slander per se, and breach of fiduciary duty.
Shuttleworth asserted defenses of fraudulent inducement, lack of corporate board
authority, and lack of consideration. Shuttleworth believed that MHC had committed
fraud in order to takeover Racom's business, that Melstad and Stepien did not act in
the best interest of Racom, that Melstad and Stepien had not been elected by Racom's
shareholders as provided for in Racom's charter, and that several agreements between
MHC and Racom were invalid.
On March 8, 2002, MHC filed a motion for summary judgment on Racom's
counterclaims in the Iowa case. Racom responded by filing for a continuance
pursuant to Federal Rule of Civil Procedure 56(f), requesting ninety days to conduct
discovery, including the opportunity to depose Stepien, Melstad, and David Sokol.7
After reviewing the Delaware depositions, including Stepien's and Melstad's
Delaware depositions, the district court denied Racom's motion, concluding that
further discovery was not "likely to uncover any information helpful to Racom in
defeating the motions for summary judgment." (App. at 161.) Racom then filed a
5
Osborn is vice president of financial services for MidAmerican.
6
Miller is the president of Racom.
7
Sokol was the chief executive officer of MidAmerican Energy Company.
Sokol had not been deposed in the Delaware litigation.
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motion for reconsideration, explaining the discovery conducted in the two Delaware
lawsuits was unrelated to its counterclaims. The district court also denied Racom's
motion for reconsideration.
As previously stated, the district court ordered a show cause hearing to allow
Shuttleworth an opportunity to explain why the district court should not impose
sanctions against it. At the hearing, Shuttleworth called five attorneys as witnesses.
Four of the witnesses were Shuttleworth attorneys: Kevin Collins, the partner
responsible for the case; Sarah Gayer, the associate who drafted the resistances to
MHC's summary judgment motions; Caroll Reasoner, a partner with the firm
specializing in corporate law who consulted with Collins and Gayer on the case; and
Bob Houghton, who testified to the prestige of the law firm and the accomplishments
of its attorneys. Finally, H. Richard "Dick" Smith, a long time Iowa practitioner,
testified that in his professional judgment Shuttleworth did not violate Rule 11
because they acted reasonably and in good faith. The court determined that
Shuttleworth and its attorneys violated Rule 11 by pursuing frivolous defenses and
claims with the purpose of delaying payment to MHC. The court sanctioned
Shuttleworth in the amount of $25,000. Shuttleworth timely appeals.
II. DISCUSSION
A. Rule 11 Standards
Rule 11 sanctions are imposed only in response to claims that are not
"warranted by existing law or by a nonfrivolous argument for the extension,
modification, or reversal of existing law." Fed. R. Civ. P. 11(b)(2). This standard is
applied with particular strictness where, as here, the sanctions are imposed on the
court's own motion. In that circumstance–unlike the situation in which an opposing
party moves for Rule 11 sanctions–there is no "safe harbor" in the Rule allowing
attorneys to correct or withdraw their challenged filings. See Fed. R. Civ. P.
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11(c)(1)(A). Here, the district court determined that Shuttleworth violated Rule
11(b)(1) and (b)(2). Federal Rule of Evidence 11 reads, in pertinent part:
(b) Representations to Court. By presenting to the court
(whether by signing, filing, submitting, or later advocating) a pleading,
written motion, or other paper, an attorney or unrepresented party is
certifying that to the best of the person's knowledge, information, and
belief, formed after an inquiry reasonable under the circumstances, –
(1) it is not being presented for any improper purpose, such
as to harass or to cause unnecessary delay or needless increase in
the cost of litigation;
(2) the claims, defenses, and other legal contentions therein
are warranted by existing law or by a nonfrivolous argument for
the extension, modification, or reversal of existing law or the
establishment of new law . . . .
Fed. R. Civ. P. 11.
We review the district court's imposition of sanctions under Rule 11 for the
abuse of discretion. See Black Hills Inst. of Geological Research v. South Dakota
Sch. of Mines & Tech., 12 F.3d 737, 745 (8th Cir. 1993). We will only reverse a
sanction when the district court based its decision "on an erroneous view of the law
or on a clearly erroneous assessment of the evidence." See Cooter & Gell v.
Hartmarx Corp, 496 U.S. 384, 405 (1990); see also Miller v. Bittner, 985 F.2d 935,
938 (8th Cir. 1993). We give "[d]eference to the determination of courts on the front
lines of litigation" because these courts are "best acquainted with the local bar's
litigation practices and thus best situated to determine when a sanction is warranted."
Cooter & Gell, 496 U.S. at 404. "Such deference will streamline the litigation
process by freeing appellate courts from the duty of reweighing evidence and
reconsidering facts already weighed and considered by the district court; it will also
discourage litigants from pursuing marginal appeals, thus reducing the amount of
satellite litigation." Id.-7-
Reviewing the district court's imposition of Rule 11 sanctions necessarily
requires an examination of the underlying factual and legal claims, as well as the
appropriateness of the sanction imposed. See Id. at 399.
B. Racom's Defenses and Counterclaims
As stated previously, Shuttleworth, on behalf of Racom, asserted several
defenses and counterclaims against MHC. We will address each individually.8 In its
written Rule 11 opinion, the court focused on fraud, fraudulent inducement and lack
of consideration.9 The court discussed the remaining claims in the summary
judgment opinion.
At the outset, the district court noted that Racom's claims lacked a specific
allegation of any representation that was false or a particular concealed fact.
See Rosen v. Bd. of Med. Exam'r of Iowa, 539 N.W.2d 345, 349 (Iowa 1995) (listing
elements of fraud and fraudulent inducement). Instead, Shuttleworth maintained that
8
Shuttleworth filed a counterclaim against MHC for civil RICO. Shuttleworth
did not resist MHC's motion for summary judgment on the RICO claim. Therefore,
it is not part of the sanction issue.
9
The court explained:
At the hearing, the Racom attorneys did not volunteer much
testimony on the substantive grounds for why they believed there was
a factual or legal basis for the claims and defenses they asserted;
however, the Court did have an opportunity to query them on some,
particularly their fraud defense, their fraud counterclaim, and their lack
of consideration defense. The Court had less time to explore other
claims; however, their lack of sufficiency was thoroughly covered in the
summary judgment order.
(App. at 413.)
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MHC fraudulently concealed their intent to defraud Racom and take over the
company. The court explained that the issue was "whether concealing the intent to
negotiate a series of transactions as advantageous to oneself as possible, without any
further misrepresentations or concealment, and without regard to the welfare of the
transaction partner, constitutes fraud." (App. at 415.) The court noted that Racom
initially did not give up control of its Board, with only two of the seven members on
the Racom Board represented by MHC. Further, the court noted that the other five
board members made the same informed decisions.
The district court also determined that Shuttleworth failed to show any
evidence of fraud. Shuttleworth responds that it could have produced evidence had
the district court provided it with an opportunity to conduct discovery. However,
Shuttleworth has failed to articulate what additional evidence it sought to support its
claims. Shuttleworth also fails to explain why it did not conduct any discovery after
MHC filed the Iowa lawsuit. The district court could properly determine that
Racom's claims of fraud and fraudulent inducement did not have any basis in fact, nor
did it rest on any legal grounds.
Second, the district court also examined Racom's affirmative defense of lack
of consideration. Shuttleworth, on behalf of Racom, presented the argument that
because MHC agreed to forebear on the dividend payments owed to them, the
forbearance was not adequate consideration to support the bargain. We determine
that the district court did not err in concluding that the argument lacked any legal
basis. See Federal Land Bank of Omaha v. Woods, 480 N.W.2d 61, 65 (Iowa 1992)
("'Consideration' is either a benefit given or to be given to the person who makes the
promise [or some other person] or a detriment experienced or to be experienced by
the person to whom the promise is made [or some other person].").
Third, Shuttleworth based Racom's breach of fiduciary duty on two incidents,
the 1999 Agreements and Melstad's participation in MHC's exit strategy from Racom.
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As to the 1999 agreements, Racom did not allege that the MHC board representatives
withheld any relevant information about their relationship to MHC or their
knowledge of the transaction from the Racom Board. Nor did Racom allege that the
MHC board representatives participated in any way in the negotiations to undermine
the arms-length nature of the valid agreements.
As to Melstad's participation in the exit strategy, the district court noted that
MHC's primary concern in the exit strategy was to minimize the loss of their
investment in Racom. "[I]t is clear from the memorandum that MHC's objective of
preserving its investment was entirely aligned with the best interests of Racom
because MHC could only protect its investment by maximizing Racom's value,
whether or not that involved taking control of Racom." (App. at 349.) In addition,
the court noted MHC had a right, as a preferred shareholder, to protect its interests.
See Odyssey Partners v. Fleming Co., 735 A.2d 386, 415 (Del. Ch. 1999) ("Thus one
who may be both a creditor and a fiduciary (e.g., a director or controlling shareholder)
does not by reason of that status alone have special limitations imposed upon the
exercise of his or her creditor rights."). As the district court concluded, Shuttleworth
failed to present facts supporting the breach of fiduciary duty claim.
Fourth, Shuttleworth asserted MHC and Melstad committed slander per se
based on the actions of Russ White.10 Racom asserts MHC directed White to call
various Racom customers about the Delaware lawsuits. Racom alleged that during
the calls White falsely stated that he was the vice president in charge of security, as
opposed to vice president of general services. Further, White explained to the
customers that MHC had asked Racom to make sure that the lawsuits would not affect
service.
10
White is an officer of MHC's corporate parent, MidAmerican Energy
Company.
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The district court determined that the alleged statements did not amount to
slander per se because the statements could not injure Racom's business. "The fact
that Mr. White might be in charge of security at Mid-American Energy or that MHC
requested that Racom not allow the lawsuit to affect service has no bearing on
Racom's ability to conduct business, which involves dealing with law enforcement
and emergency services." (App. at 351.)
Finally, Shuttleworth asserted that the agreements lacked the necessary quorum
of six Racom directors and that the directors violated their fiduciary duties in
approving the agreements. Shuttleworth argued that the court should not enforce
their agreement with MHC because when the initial 1996 agreement was made,
Racom's Board lacked authority to enter into those agreements. However, the district
court noted that Racom's corporate minutes reflected that at least six Racom board
members were present at all board meetings, therefore, the evidence did not support
this claim. We agree with the district court that the potential lack of the requisite
number of board members was immaterial. See Rodgers v. Baughman, 342 N.W.2d
801, 806 (Iowa 1983) ("[A] party may waive a condition precedent to his own
performance of a contractual duty, when such condition precedent exists for his sole
benefit and protection, and compel performance by the other party who has no interest
in the performance or nonperformance of the condition.").
In addition, the district court determined that Racom failed to demonstrate that
the directors' informed decisions were not made "in good faith and in the honest
belief that the action taken was in the best interests of the company." Aronson v.
Lewis, 473 A.2d 805, 812 (Del. 1984) (applying Delaware's business judgment rule).
Racom did not allege that any of the non-MHC directors who approved the
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transaction acted outside this standard.11 The court concluded that even under the
most stringent standards Racom's breach of fiduciary duty claims fail.
Shuttleworth makes much of the fact that it spent hundreds of hours with its
client and hundreds of hours in legal research. However, this case does not address
the failure to adequately research the claim or facts of the case. Instead, Shuttleworth
persisted in asserting claims and defenses which were not justifiable either in law or
in fact.
We determine that the district court did not abuse its discretion in finding that
the claims and defenses were not supported by fact and law. The district court also
did not err in deciding that Shuttleworth used the claims and defenses for the purpose
of delaying Racom's payment of money owed to MHC.
Our decision requires sensitivity to two areas. First, Rule 11 embraces the idea
that on occasion attorneys engage in litigation tactics that are unjustifiable within the
broad bounds of our adversarial system, and that our system does not tolerate such
tactics. Cooter & Gell, 496 U.S. at 393. Second, our application of Rule 11 also
recognizes the adversarial nature of a system where attorneys zealously represent
their clients. However, the district court did not abuse its discretion in determining
that even those attorneys with the highest credentials can violate Rule 11 by pursuing
claims and defenses that do not have merit, and counsel should not put forth frivolous
claims before the court. The court concluded that "the behavior was not a single
incident, as this order and previous orders demonstrate, the Racom attorneys
established a pattern of persisting in these claims over the course of two separate
resistances to summary judgment motions, as well as two separate attempts to extend
11
The district court also noted that the MHC representatives did not constitute
a majority of the Racom Board, did not control or dominate the Board, and did not
withhold their interest in the 1999 Agreements with MHC.
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those proceedings without offering valid reasons to do so." (App. at 421.) After
reviewing the record, we cannot say that this conclusion amounts to an abuse of
discretion. Accordingly, we affirm the district court's decision to impose Rule 11
sanctions.
C. Amount of Sanctions
Finally, we address whether the amount of sanctions imposed is consistent with
the conduct in this case. Rule 11 states that sanctions "shall be limited to what is
sufficient to deter repetition of such conduct or comparable conduct by others
similarly situated." Fed. R. Civ. P. 11(c)(2).
Here, the district court determined that non-monetary sanctions such as issuing
an admonition, reprimand, or censure, or requiring participation in other educational
programs was inappropriate. In addressing monetary sanctions, the court noted that
since it initiated the Rule 11 proceeding, it was unable to direct monetary sanctions
toward MHC in order to remedy their expenditure of attorney fees. Fed. R. Civ. P.
11 advisory note ("a monetary sanction imposed after a court-initiated show cause
order be limited to a penalty payable to the court and that it be imposed only if the
show cause order is issued"). The court explained:
Given the sheer size of the judgment in a case of this type, the Court
could not possibly levy a sanction large enough to deter such behavior
in the parties themselves; however, the Court believes that a sanction
that outweighs the fees that an attorney might receive to wage such
claims might accomplish this goal. Moreover, the Court expects that a
person facing the loss of their business will seek the counsel of their
attorney and ask the attorney to do whatever they can to forestall the
undesirable result. On the other hand, attorneys are responsible for
limiting their advocacy to that permissible under Rule 11, as well as to
avoid the creation of unnecessary litigation costs to the parties and the
Court.
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(App. at 422-23.) The court imposed a sanction in the amount of $25,000 or
approximately three-fourths of fees and expenses of MHC's attorneys. This court
previously adopted the determination of a three-fourths of fees and expenses as an
appropriate sanction in Kirk Capital Corp. v. Bailey, 16 F.3d 1485, 1491 (8th Cir.
1994).12
While the award here may seem rather large, such an award is appropriate. The
Seventh Circuit in Vollmer v. Publishers Clearing House, 248 F.3d 698 (7th Cir.
2001), determined that the district court's imposition of a $50,000 sanction was
extremely large compared with other sua sponte sanctions. Id. at 710. The court
approvingly noted that such a sanction may be appropriate, but "when the district
court is cursory or unclear about its reasoning for imposing significant monetary
sanctions, we have required that a more detailed explanation be provided." Id. 711.
Here, the district court explained in great detail its reasons for imposing $25,000 in
12
Shuttleworth relies on Kirk Capital, however, it is distinguishable on several
grounds. First, Kirk Capital addressed the prior Rule 11. We noted that the
application of the current Rule 11 would have justified a different result. Kirk Capital,
16 F.3d at 1488. Second, Kirk Capital did not address sua sponte sanctions, instead
it awarded attorney fees to the opposing party. Here, the district court used attorney
fees as a guideline to determine the appropriate award of sanctions owed to the court.
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sanctions.13 In addition, the sanction imposed is less than one percent of the amount
Racom attempted to avoid paying MHC.
III. CONCLUSION
We affirm the district court's decision to impose Rule 11 sanctions in the
amount of $25,000 against Shuttleworth.
A true copy.
Attest:
CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.
13
The district court explained:
While the Rule 11 sanction is not intended to compensate MHC, and
cannot because the Court initiated this proceeding, the Court believes
$25,000 is appropriate in light of these costs that the Racom attorneys
forced MHC to incur. Moreover, the Court finds that given the large
amounts of money involved, a $25,000 sanction is the minimum amount
a Court can award in order to deter law firms from accepting fees in
order to wage frivolous claims and defenses in order to delay the
payment of large debts.
(App. at 423.)
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