These are cross-appeals from a judgment of the United States District Court for the Southern District of New York (Carter, J.). Defendant-appellant contends on appeal that the district court erred in holding it liable for consulting fees owed appellee; on its cross-appeal, plaintiff-appellee urges that Rule 11 sanctions should have been imposed against appellant for asserting baseless claims in the district court. Affirmed in part, reversed in part, and remanded.
This case involves cross-appeals from a judgment of the United States District Court for the Southern District of New York (Carter, J.). As part of what was apparently a complex tax shelter, appellant Everett Allied Company ("EAC") sold a garage to Goodwalk Associates ("Goodwalk"), a limited partnership, in return for notes secured by a mortgage.*fn1 Under a sale-leaseback arrangement, Goodwalk made payments on its debt to EAC, and EAC paid Goodwalk rent for use of the property. At the same time, EAC entered into a "consulting" agreement with appellee Cross & Cross Properties, Ltd. ("Cross"), under which Cross was to receive annual "consulting" fees through 1988 if it ensured that Goodwalk (with which it was closely affiliated) made its annual payments to EAC. EAC subsequently brought a foreclosure action against Goodwalk, which Goodwalk settled in mid-1986 by reconveying the property to EAC. Cross then brought this action against EAC for its consulting fees for 1985-1988. After EAC counterclaimed for fees it had earlier paid to Cross, Cross moved for Rule 11 sanctions against EAC.
For the reasons stated below, we reverse the district court's judgment insofar as it required EAC to pay Cross fees for 1986-1988. Further, we reverse and remand for findings as to whether EAC violated Rule 11 by asserting a counterclaim for fees that had been the subject of an earlier settlement with Cross.
In the spring of 1978, Ira Smith, the President of Cross, entered into negotiations with EAC regarding a four-story garage In the State of Washington. EAC agreed to sell the garage to Smith's nominee, Goodwalk Associates, a limited partnership which was headed by Barry Smith, Ira's brother, and which was formed specifically for this transaction. Goodwalk, in turn, agreed to lease the property back to EAC.
Under the arrangement, on July 1, 1978, EAC transferred title in the garage to Goodwalk in exchange for two notes for a total of $2.26 million; the notes were secured by a mortgage on the property. The agreement stipulated that Goodwalk was to make annual payments of principal and interest (the "debt service payments") of $198,000 to EAC; this included a substantial lump-sum payment which was due every year on July 1 (the "July payment"), and the balance of the annual payments were to be made in equal monthly installments. In return, EAC was to make annual rental payments of $154,000 to Goodwalk.
The net difference between Goodwalk's debt service payments and EAC's rental payments -- $44,000 -- was to be met by annual capital contributions from Goodwalk's limited partners. The transaction was structured so that part of each $44,000 contribution was allocated to the July lump-sum payment, which was to be EAC's annual profit. The balance of the $44,000 was to be paid by Goodwalk to EAC as part of its debt service payments, and then EAC would pay consulting fees due to Cross.
Cross' fees were set under a collateral "consultancy agreement" between EAC and Cross, The agreement provided that Cross was to receive annual consulting fees until 1988. In return, the agreement required Cross to afford EAC certain nominal consulting services and -- more importantly -- provided that EAC was not to be liable for Cross' annual fees unless EAC received its full annual debt service payments from Goodwalk. Thus, the overall arrangement was structured so that if Goodwalk made its full annual debt service payments to EAC, EAC was, according to Cross, to forward a portion of those payments to Cross in the form of consulting fees.
Relations between the parties soured over the first few years of the arrangement, in part because both sides were habitually late in making payments to each other. In April 1982 EAC sent Cross a letter of termination, announcing that EAC would no longer pay Cross its annual consulting fees because Goodwalk had failed to make full and timely payments on its debt, and demanding that Cross return all fees already paid by EAC. Then, on August 3, 1983, EAC sued Goodwalk in a foreclosure action in Washington state court on the ground that Goodwalk had defaulted on its obligations to EAC; EAC sought to accelerate the full amount due, approximately $2.252 million, and to foreclose on the mortgage. That foreclosure action was stayed in 1984 when Goodwalk filed for bankruptcy in the Southern District of New York, but Goodwalk nevertheless continued to make full payments on its debt to EAC through mid-1986. In April 1984, EAC commenced an action in New York state court against Cross, seeking return of all fees it had paid to Cross before April 1982; the status of that suit is not known to this court at this time.
These various disputes between the parties were largely settled in 1985 and 1986. In January 1985, EAC and Cross entered into a stipulation in the Washington foreclosure action which settled all claims between them, as of December 31, 1984, specifically leaving unresolved any claims for consulting fees due after that date. In August 1986, after Goodwalk had made all payments which were due to EAC through July 1986 -- including the lump -- sum July payment for 1986 -- EAC and Goodwalk agreed to settle all their claims, and Goodwalk reconveyed the property to EAC. Thus, this separate action originally stemmed from Cross' claims for fees owed by EAC for the years after 1984, i.e., from 1985 to 1988.
Cross first brought this action against EAC in January 1986 in New York state court, claiming that EAC owed Cross consulting fees for 1985, and had wrongly repudiated its obligation to pay fees to Cross for 1986-1988. Cross alleged that EAC therefore owed Cross a total of $49,047 for the four years' fees, plus interest.
On EAC's petition, the suit by Cross was removed to federal court on grounds of diversity. Following removal, EAC entered its answer, and counterclaimed for the fees paid to Cross before April 1982. EAC also moved to have the action dismissed for lack of personal jurisdiction or, in the alternative, for a change of venue. EAC further moved for disqualification of Cross' counsel because the law firm representing Cross had assisted EAC during the original negotiations. Cross thereafter cross-moved for dismissal of EAC's counterclaim, pointing out that the January 1985 Washington state court settlement between Cross and EAC barred EAC's counterclaim for fees paid before December 31, 1984. In an order dated March 12, 1986, the district court herein denied EAC's various motions, and, in light of the Washington settlement, granted Cross' motion to dismiss EAC's counterclaim for fees paid before April 1982.
The case proceeded towards trial, and the parties filed their joint pretrial order on December 4, 1987. As part of its contentions for trial, Cross urged the district court to sanction EAC under Rule 11 of the Federal Rules of Civil Procedure for filing its unsuccessful motions and counterclaim.
On May 10, 1988 -- three days before EAC was notified that the case was on Judge Carter's ready trial calendar, and over five months after the pretrial order was filed -- EAC moved to amend its answer to add the affirmative defenses of failure of consideration, fraud, breach of duty of good faith, and illegality of contract. The ...