Court Of Appeals Reverses Order Granting Rule 11 Sanctions In A 2-1 Split

The Court of Appeals split yesterday on whether a Plaintiff and his lawyers who continued with a lawsuit after they should have determined that it was not well grounded in fact or law could be hit with non-monetary sanctions.  The majority reversed, saying that the trial court should not have considered events occurring after the filing of the Complaint in awarding sanctions.

The case decided by the Court of Appeals is Egelhof v. Szulik.  The case arose in the Business Court, and was a shareholder derivative action against the technology company Red Hat.  Judge Tennille dismissed the case in 2006 due to Plaintiff's failure to make a proper demand under Delaware law. 

After that, Defendants moved for sanctions and attorneys fees.  In the 2008 decision appealed from, Judge Tennille sanctioned Plaintiff and his lawyers by barring Plaintiff from serving as a representative plaintiff for five years and by barring the lawyers from being admitted pro hac in North Carolina for a like period.  Judge Tennille refused to award monetary sanctions.

Plaintiff appealed, arguing that there was no basis for Rule 11 sanctions because there had been no finding by the Business Court that their Complaint was "neither well grounded in fact nor warranted by existing law" at the time it was filed.  They were right, as the Business Court had expressly stated that the Complaint, standing alone, did not warrant Rule 11 sanctions.  Defendants appealed too, arguing that they were entitled to monetary sanctions.

The Business Court's sanctions ruling was based on post-filing events which it said should have led the Plaintiff to conclude that it should no longer pursue its action, including the dismissal of another case (Pozen) brought in the Business Court by the same lawyers, for the same reason that the Egelhof case was dismissed a few months later: failure to make a demand under Delaware law. 

The Court of Appeals majority concluded that a Court cannot consider matters outside the face of the Complaint in determining whether the Complaint lacked factual or legal support so as to warrant Rule 11 sanctions.  It relied on Bryson v. Sullivan, 330 N.C. 644, 412 S.E.2d 327 (1992), in which the Supreme Court held that "in determining whether a pleading was warranted by existing law at the time it was signed the court must look at the face of the pleading and must not read it in conjunction with responsive pleadings."

Judge Calabria dissented, holding that "sanctions are not limited when later filings reveal the case has become meritless.  The trial court may look beyond the face of the pleading when considering whether litigation was continued for an improper purpose."  Judge Calabria found that sanctions were appropriate not only under Rule 11, but also under the inherent power of the Court.

And Judge Calabria took it one step further, holding that the trial court had erred by not giving proper consideration to an award of monetary sanctions under N.C. Gen. Stat. §6-21.5.  Relying on Sunamerica Financial Corp. v. Bonham, 328 N.C. 254, 400 S.E.2d 435 (1991), she held that a "trial court is required to evaluate whether the losing party persisted in litigating the case after a point where he should reasonably have become aware that the pleading he filed no longer contained a justiciable issue."

The Supreme Court will sort out this disagreement if the case goes forward, but there are two other Rule 11 tidbits in this opinion on which the majority and majority agreed:

The Court held that Rule 11 permits sanctions to be imposed against a party and his attorney attorney even though they didn't sign the Complaint.  (Here, out-of-state counsel had never signed the Complaint, but were sanctioned by the trial court.) 

The Court of Appeals also held that due process does not require that a party against whom sanctions are sought be put on notice of the specific type of sanctions which may be ordered, rejecting a due process challenge by the Plaintiff.  All that is required is notice of the bases of the sanctions and an opportunity to be heard.

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