United States District Court, S.D. New York
May 17, 2005.
KENNETH BYRNE, Plaintiff,
BUYTHISFAST NETWORK, INC., et. al., Defendants.
The opinion of the court was delivered by: HAROLD BAER, JR., District Judge[fn*] [fn*] Robert Zak, a spring 2005 intern in my Chambers, and currently a third-year law student at Fordham University School of Law, provided substantial assistance in the research and drafting of this Opinion.
OPINION & ORDER
On May 25, 2004, Plaintiff, Kenneth Byrne ("Byrne"), withdrew
all claims against Defendant, Richard Lusk ("Lusk"), in which he
alleged securities fraud, unpaid wages, and common law fraud.
(Dckt. 12.) Pursuant to Fed.R.Civ.P. 11 and 15 U.S.C. § 78u-4,
Lusk filed the instant motion for sanctions and alleged that the
lawsuit was frivolous and filed for the improper purpose of
intimidation and harassment. The motion was sub judice on
February 15, 2005. For the reasons set forth below, Lusk's motion
is GRANTED in-part and DENIED in-part.
A. Factual History
On December 17, 1999, Defendants Lusk and David Chester
("Chester") formed "BuyThisFast Network, Inc." ("Company"), to
develop distribution channels for major Internet merchants.
(Hunter Aff., Att'y for Def. ("Hunter"), Ex. I at 5). The
Company's first project was an "Online Convenience StoreTM,"
but implementation of the project was dependent upon the licensed
use of certain proprietary software. Id.
On or about April 5, 2000, Lusk and Chester hired Byrne as the
Company's Chief Operational Officer and Chief Technical Officer,
with an annual salary of $175,000. (Compl. at ¶ 12; Def's Mem.
Supp. Summ. J. at 3-4). Byrne's employment with the Company ended
no later than October 2000. (Hunter Aff. Ex. G, Resume of
Byrnes). By early-May 2000, Byrne had invested $90,000 of his
personal funds in the Company. (Dep. of Byrne at 103:5-7).
Approximately three months after he invested $90,000 of his
personal funds in the Company, Lusk informed Byrne that the Company "would not be
securing the [necessary] `proprietary technology' or
`patent-pending business models'" and, as a result, the Company
was unable to commence operations and Byrne lost the value of his
investment. (Compl. at ¶¶ 17-18.)
B. Procedural History
On March 21, 2003, approximately thirty-one months after he
discovered the alleged fraud, Byrne filed the instant action, and
sought damages for alleged: (1) violation of §§ 10(b), 20, and
Rule 10b-5 of the Securities Exchange Act of 1934; (2) violation
of 15 U.S.C. § 771; (3) common law fraud; and (4) unpaid wages.
(Compl. at ¶¶ 19-25.) In the Complaint, Byrne alleged that his
decision to invest in the Company was based on Lusk's materially
false and misleading oral representations. (Compl. at ¶ 14.)
On June 5, 2003, Lusk filed an Answer in which he denied any
liability and invoked the statute of limitations as an
affirmative defense. (Dckt. 4.) Throughout the duration of
discovery, Byrne never sought to depose Lusk, and indeed, made no
discovery demands. Lusk filed a motion for summary judgment on
April 2, 2004 and maintained, among other things, that Byrne's
securities fraud claims were barred by the applicable statute of
limitations. (Def's Mem. Supp. Summ. J. at 20). Subsequently, on
May 25, 2004, Byrne withdrew all claims against Lusk. (Dckt. 12.)
Lusk now moves for sanctions in an amount equal to the attorney's
fees and costs incurred to defend the allegedly frivolous
II. LEGAL STANDARD
Pursuant to Federal Rule of Civil Procedure 11 ("Rule 11"), an
attorney or party may be sanctioned if a pleading is presented
"for any improper purpose, such as to harass [another party]
. . .," or where the claims are not "warranted by existing law or
by a [non-frivolous] argument for the extension, modification, or
reversal of existing law or the establishment of new law. . . ."
The PSLRA altered the Rule 11 landscape in that a district
court is now required, upon final adjudication of any private
action for securities fraud, to make "specific findings regarding
compliance by each party and each attorney representing any party
with each requirement of Rule 11(b). . . ."
15 U.S.C. § 78u-4(c)(1); see e.g., Rombach v. Chang, 355 F.3d 164, 178
(2d Cir. 2004). In accordance with the PSLRA, if the court finds
that a violation has occurred, the imposition of sanctions is
mandatory. 15 U.S.C. § 78u-4(c)(2). The PSLRA removed the judicial discretion of Rule 11 ("the court may . . . impose
sanctions") in favor of a rebuttal presumption:
[C]ourts shall adopt a presumption that the
appropriate sanction . . . for substantial failure
of any complaint to comply with any requirement of
Rule 11 . . . is an award to the opposing party of
the reasonable attorneys' fees and other expenses
incurred in the action.
15 U.S.C. § 78u-4(c)(3)(A)(ii) (emphasis added). There are two
ways to rebut the presumption:
 [U]pon proof by the party or attorney against
whom sanctions are to be imposed that . . . [such an
award] will impose an unreasonable burden on that
party or attorney and would be unjust, and the
failure to impose such an award would not impose a
greater burden on the party in whose favor sanctions
are to be imposed; or  the violation of Rule 11
. . . was de minimis.
15 U.S.C. § 78u-4(c)(3)(B). The PSLRA's stricter sanctions
procedure was designed to reduce the economic incentive to bring
abusive claims of securities fraud. Gurary v. Nu-Tech Biomed,
Inc., 303 F.3d 212
, 219-20 (2d Cir. 2002).
In Gurary, the Second Circuit articulated a three-step
sanction inquiry for district courts to follow in situations
where a plaintiff, like Byrne, has brought multiple claims. See
Gurary, 303 F.3d at 223. First, the court must determine whether
frivolous claims have been brought. Id. Second, if such claims
have been brought, the court shall determine whether
non-frivolous claims have also been joined. Id. Third, the
sanctions presumption may be rebutted if the court determines
that the violation was either de minimis or the party in
violation can show that full sanctions would constitute an
unreasonable burden. Id.
A. Frivolous Securities Fraud Claims
Lusk argues Byrne's securities fraud claims were clearly barred
by the applicable statute of limitations, and therefore, the
lawsuit was frivolous. (Dckt. 13.)
To bring a clearly time-barred complaint is a violation of Rule
11. See Norris v. Grosvenor Marketing Ltd., 803 F.2d 1281, 1288
(2d Cir. 1986); De La Fuente v. DCI Telecom. Inc.,
259 F. Supp. 2d 250, 263 (S.D.N.Y. 2003). In Norris, although the plaintiffs
had prevailed in an earlier arbitration proceeding, they pursued
identical claims against the defendants in district court after
the statute of limitations had expired, and the Second Circuit
concluded Rule 11 was violated. 803 F.2d at 1287.
An attorney has a responsibility to make a reasonable inquiry
into the relevant law to determine whether or not a cause of
action is warranted. See De La Fuente, 259 F. Supp. 2d at 274. For example, in Solloway v. Ellenbogen, 121 F.R.D. 29, 30
(S.D.N.Y. 1988), sanctions were awarded because the complaint
alleged diversity jurisdiction, when in fact, both plaintiffs and
defendants were citizens of New York. The Court held that "[t]he
utter frivolity of plaintiffs' filing, which on its face
demonstrates the absence of jurisdiction, is incapable of being
explained in a way that would satisfy Rule 11's requirement of
reasonable inquiry." Id. at 31 (internal citation omitted).
Here, Byrne made two separate securities fraud claims against
Lusk that were both clearly time-barred, and, as in Norris,
frivolous. The statute of limitations that governs Byrne's first
claim, pursuant to §§ 10(b), 20(a) and rule 10b-5 of the
Securities Exchange Act of 1934, is set forth in
28 U.S.C. § 1658, and provides:
[A] private right of action that involves a claim of
fraud, deceit, manipulation, or contrivance in
contravention of . . . the securities laws . . . may
be brought not later than the earlier of (1) 2
years after the discovery of the facts constituting
the violation; or (2) 5 years after such violation.
18 U.S.C. § 1658 (2005) (emphasis added). The statute of
limitations that governs Byrne's second claim that Lusk used
the means and instrumentalities of interstate commerce in
furtherance of securities fraud is set forth in
15 U.S.C. § 77m, and provides:
No action shall be maintained to enforce any
liability created under . . . § 771(a)(2) unless
brought within one year after the discovery of the
untrue statement. . . .
15 U.S.C. § 77m (2005).
According to the Complaint, Byrne discovered the alleged fraud
on August 10, 2000. (Compl. at ¶ 18.) Therefore, any claim under
the securities laws must have been brought no later than August
10, 2002. Byrne filed his complaint on March 21, 2003 7 months
too late. Moreover, Byrne's failed to set forth any argument
claiming that the statute of limitations may have been tolled
after August 10, 2000. Indeed, both Lusk and Chester explicitly
raised the statute of limitations issue as an affirmative defense
in their Answers. Lusk's attorney also maintains that he
repeatedly discussed the time-barred aspect of the case with
Byrne's attorney a contention that Byrne's attorney did not
dispute, though he had the opportunity to do so. (Mem. Supp.
Def's Mot. Sanct. at 18). Byrne pursued the matter for more than
a year and forced Lusk to incur the legal expenses necessary to
defend the lawsuit through discovery (conducted only by the
Defendants) and summary judgment. B. Non-Frivolous Claims
Since Byrne's securities fraud claims were violative of Rule
11, the PSLRA requires the Court to make an inquiry as to whether
the PSLRA's presumption of full attorneys' fees and expenses is
applicable. See e.g., Gurary, 303 F.3d at 223.
1. Unpaid Wages Claim
There is insufficient information in the record to indicate
that Byrne's unpaid wages claim was frivolous. Under New York
law, there is a six year statute of limitations for employee
claims of unpaid wages and, therefore, the claim was timely. N.Y.
Lab. Law § 198.3 (McKinney Supp. 1999). However, Byrne claimed to
have $37,000 in unpaid wages a small fraction of the $1,000,000
the Plaintiff's sought in damages. Therefore, Byrne's unpaid
wages claim, though not sanctionable, is too insignificant to
save the Complaint from being viewed as an abusive securities
2. Common Law Fraud Claim
Byrne's common law fraud claim was also brought within the
relevant six-year statute of limitations. See N.Y.C.P.L.R. §
213 (2005). Application of Rule 11 requires the court to
determine whether the attorney's conduct was reasonable at the
time the complaint was signed. See Rotter v. Leahy,
93 F. Supp. 2d 487, 502 (S.D.N.Y. 2000). Under New York law, a claim for
common law fraud requires the plaintiff to demonstrate that the
defendant: (1) made a false representation of a material fact;
(2) with scienter; (3) upon which the plaintiff justifiably
relied; (4) that caused damage to the plaintiff. See
HealthExtras, Inc. v. SG Cowen Sec. Corp., No. 02 Civ. 9613,
2004 WL 97699, at *3 (S.D.N.Y. Jan. 20, 2004).
Byrne sufficiently alleged that Lusk made false statements that
caused him to suffer damages. As to the scienter requirement,
"whether [it] exists is generally a question of fact, so much so
that the Second Circuit has been lenient in allowing scienter
issues to withstand summary judgment based on fairly tenuous
inferences." Id. at *4. In HealthExtras, the Court held that
it was sufficient for the Complaint to allege that the defendants
had intentionally committed acts of fraud against the plaintiff.
Id. Likewise, Byrne's Complaint included the allegation that
Lusk was aware that he made false and misleading statements to
encourage Byrne's investment in the Company. (Compl. at ¶¶ 14
15.) Byrne's Complaint also included a sufficient allegation of
reliance. (Id. at ¶ 15.) Therefore, at the time Byrne's
attorney signed the Complaint, a colorable claim of fraud
existed, and accordingly, Byrne's common law fraud claim was not frivolous.
3. Statutory Presumption Not Applicable
Byrne's Complaint contains both frivolous and non-frivolous
claims. In Gurary, the Second Circuit was faced with an almost
identical situation the plaintiff had made four claims; two of
which were frivolous. 303 F.3d at 218. In its analysis, the
Second Circuit stated:
[F]rivolous claims [may be] joined with non-frivolous
claims in a wide variety of ways, including the
combination of frivolous claims with (1) valid,
winning claims; (2) claims lost before a jury but
which are meritorious enough to survive summary
dismissal; (3) claims that, though properly dismissed
at summary judgment because capable of resolution as
a matter of law, presented novel legal issues that
could well have gone in the plaintiff's favor; and
(4) summarily dismissed claims that, while not
legally frivolous, lack any merit.
Id. at 220-21. The Second Circuit further recognized that the
PSLRA is unclear as to which of these situations create a
substantial violation of Rule 11 and call into play the
application of the statutory presumption. Id. at 221. In
Gurary, there were two non-frivolous claims that fell into the
fourth category, but did not save the plaintiff from the
statutory presumption calling for full attorneys' fees, and costs
to be imposed. Id. at 224. Two reasons were advanced by the
plaintiff. First, the district court denied plaintiff's attempt
to amend his complaint so as to make his claims colorable. On
appeal, the Second Circuit held that if the district court
afforded the plaintiff the opportunity to amend his complaint,
cognizable claims could have been asserted. Id. Second, the
claims were patently without merit. Id. at 224. As a result,
the claims were not sufficient "to relieve the . . . complaint
from being an unfounded action as a whole." Id. at 224
In contrast, here, Byrne's claim for common law fraud suffered
from neither infirmity. Rather, it was adequately pled, and
although admittedly weak, it was not "patently without merit."
Accordingly, Byrne's common law fraud claim saves his Complaint
from being considered an unfounded action as a whole.
Therefore, the statutory presumption does not apply, and full
compensation of Lusk's attorney's fees and costs is not required.
C. Applicable Sanctions
Although Byrne's common law fraud claim is sufficient to
prevent application of the statutory presumption in favor of an
award of full attorney's fees and costs, partial sanctions
shall be imposed for his frivolous securities fraud claims. The
Second Circuit has held that where no "substantial" failure
exists under the PSLRA, and the statutory presumption of full sanctions does not apply, partial sanctions are still warranted
to punish the party that brought the frivolous claims, regardless
of the presence of a non-frivolous claim. Gurary,
303 F.3d at 220 at 222 ("The PSLRA require[s] . . . mandatory sanctions
whenever any portion of a complaint violate[s] Rule 11."); see
also DeBartolo, 186 F.3d at 177-78 (where appellants' Rule 10b-5
claim was non-frivolous, and the Rule 10b-13 claim was frivolous,
"the district court was required by the PSLRA to impose
sanctions with respect to [the latter] claim").
Where a plaintiff has joined frivolous claims together with
non-frivolous claims, the PSLRA demands the imposition of
sanctions in a manner that enables the defendant to recover the
litigation expenditures associated with the frivolous claims
only. See e.g., Adams v. Buck-Luce, No. 04 Civ. 1485, 2005
WL 822910, at *2 (S.D.N.Y. Apr. 8, 2005) (limiting sanctions to
all the reasonable costs and attorney's fees associated with a
single frivolous claim). The defendant is not entitled to recover
attorney's fees and costs incurred to defend against any
non-frivolous claims. Id.; see also Gorman v. Coogan, No. 03
Civ. 173, 2004 WL 2713095 (D. Me. Nov. 24, 2004). Here, Lusk is
entitled to recover the reasonable attorney's fees and costs he
incurred to defend against Byrne's frivolous securities fraud
claims, but not against Byrne's non-frivolous common law fraud
and past wages claims.
According to invoices provided by Lusk, his litigation
expenditures through June 2004 totaled $55,109.73. (Hunter Aff.
Ex. J). It would be inappropriate to award Lusk 50% of his
expenditures in this suit simply because two out of four of
Byrne's claims were frivolous. A significant portion of the
defense Lusk mounted against Byrne's frivolous securities fraud
claims was necessary to defend against Byrne's non-frivolous
common law fraud claim. Lusk conceded this point in his
memorandum of law in support of his motion for summary judgment,
in which he noted that the arguments that demonstrate Byrne's
failure to establish a prima facie case for securities fraud
apply equally to the common law fraud claim. Where Lusk's defense
to the common law fraud claim overlaps the securities fraud
claims, the Court need not impose sanctions.
However, for the portion of Lusk's defense that related solely
to the securities fraud claims, the Court is required to impose
sanctions. Gurary, 303 F.3d at 220. Lusk's securities fraud
defense focused primarily on four arguments. Only the fourth
argument, statute of limitations, related to Byrne's frivolous
securities fraud claims and is unique to those claims. As such, I find that 25%, or $13,777.23, of Lusk's litigation
expenses is the appropriate amount for sanctions in this matter.
For the reasons set forth above, Lusk's Rule 11 motion is
hereby GRANTED in part. Sanctions in the amount of $13,777.23 are
awarded against Byrne's counsel. The Clerk of Court is INSTRUCTED
to close this motion and REMOVE this case from my docket.
IT IS SO ORDERED.
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