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Practitioners should be aware of a recent decision in which the 2nd U.S. Circuit Court of Appeals discussed the standards applicable in determining a sanctions award for a frivolous complaint under the Private Securities Litigation Reform Act of 1995 (the Reform Act), Gurary v. Nu- Tech Bio-Med, Inc.,303 F3d 212 (2d Cir. 2002). Section 21D(c) of the Reform Act creates a presumption of an award of all the attorney fees incurred in the action for “substantial failure of [a] complaint to comply with … Rule 11(b).” 15 USC � 78u-4(c)(3)(A). The court’s majority and concurring opinions in Guraryagreed that the complaint warranted the imposition of full sanctions against the plaintiff’s counsel, but disagreed on the proper analysis to reach that determination. The different analyses and the issues left undecided are likely to affect the outcome of future sanctions applications and are worth careful review. THIRD TRIP This was Gurary’sthird trip to the 2nd Circuit. The plaintiff, a purchaser of Nu-Tech stock, asserted securities fraud claims against Nu-Tech and an individual who allegedly participated in a stock manipulation scheme. 303 F3d at 216. The district court granted summary judgment dismissing the complaint, but implicitly denied Nu-Tech’s motion for sanctions without making the specific findings required by the Reform Act. 1998 WL 54641, 3 (S.D.N.Y. Feb. 10, 1998). In Gurary I, 190 F3d 37, 47 (2d Cir. 1999), the 2nd Circuit affirmed the dismissal of the complaint but remanded for the required findings. On remand, the district court again denied the request for sanctions. 2000 WL 20706 (SDNY Jan. 12, 2000). The 2nd Circuit vacated and remanded in part in Gurary II, 235 F3d 792, 798-802 (2d Cir. 2000), finding that sanctions were warranted against the plaintiff’s attorney for the claims based on the plaintiff’s first two purchases but not for those based on his last two purchases. On remand, the district court imposed sanctions of approximately one-half of Nu-Tech’s fees and costs in the action based upon the “unreasonable burden” rebuttal to imposition of full costs. 153 FSupp 2d 489, 493 (SDNY 2001). In Gurary III, the 2nd Circuit found that the award did not comport with the Reform Act’s presumption of full costs. Remanding for the third time, the panel provided guidance on the proper analysis of sanctions determinations under the Reform Act. Section 21D(c) of the Reform Act makes sanctions mandatory rather than discretionary in certain cases. It provides that, upon “final adjudication” of an action, the court “shall” include in the record specific findings regarding compliance by each party and attorney with Rule 11(b) and, if it finds a violation, “shall” impose sanctions in accordance with Rule 11. 15 USC � 78u-4(c)(1) & (2). Subsection (3) creates certain presumptions as to the proper sanctions: (A) … the court shall adopt a presumption that the appropriate sanction — (i) for failure of any responsive pleading or dispositive motion to comply with any requirement of Rule 11(b) … is an award … of the reasonable attorneys’ fees and other expenses incurred as a direct result of the violation; and (ii) for substantial failure of any complaint to comply with any requirement of Rule 11(b) … is an award … of the reasonable attorneys’ fees and other expenses incurred in the action. 15 USC � 78u-4(c)(3)(A). However, those presumptions may be rebutted in one of two ways: (B) The presumption described in subparagraph (A) may be rebutted only upon proof by the party or attorney against whom sanctions are to be imposed that — (i) the award of attorneys’ fees and other expenses will impose an unreasonable burden on that party or attorney and would be unjust, and the failure to make such an award would not impose a greater burden on the party in whose favor sanctions are to be imposed; or (ii) the violation of Rule 11(b) … was de minimis. 15 USC �78u-4(c)(3)(B). In Gurary III, both the majority, led by Judge Guido Calabresi, and the concurring opinion, by Chief Judge John Walker Jr., concluded that the complaint suffered from a “substantial failure” to comply with Rule 11, triggering subsection (3)(A)(ii)’s presumption of an award of the full fees and expenses incurred in the action, and that Gurary’s counsel had not rebutted the presumption under either the unreasonable burden or de minimis prongs of subsection (3)(B). THE MAJORITY’S ANALYSIS The court found the statutory language to be unclear, noting that Congress failed to include definitions of “substantial failure” or “de minimis.” However, the court observed that “substantial failure” could not simply be the opposite of de minimis, because then the statutory presumption could never be rebutted by a showing that the violation was de minimis. 303 F3d at 215-16, 222. In wrestling with the issue in the context of the case, the court focused on whether a complaint containing both frivolous and nonfrivolous allegations triggers the “substantial failure” presumption, or whether the presence of nonfrivolous allegations can rebut the presumption by constituting evidence either that the violation is de minimis or that full sanctions would be an unreasonable, unjust burden. Id.After a lengthy investigation of the legislative history of the Reform Act, the majority essentially found no guidance. Congress’ only mention of a pleading containing a mixture of frivolous and nonfrivolous claims was a statement in the House Conference Report that one frivolous claim in a 20-count complaint is de minimis. Id.at 220. Gurary’s counsel argued that a complaint containing any nonfrivolous allegation is not a substantial violation triggering the presumption and, even if it were a substantial violation, his complaint fell within both the de minimis and unreasonable burden defenses. The majority disagreed, cautioning that if these contentions were accepted, courts would then “be free to engage in the ordinary Rule 11 analysis, which Congress found too often resulted in the failure to compensate fully victims of abusive securities litigation.” Id.at 221. Adopting Nu-Tech’s suggestion, the majority decided that a “substantial failure” to comply with Rule 11 would exist “whenever the nonfrivolous claims that are joined with frivolous ones are insufficiently meritorious to save the complaint as a whole from being abusive.” Under this standard, “the district court must examine the qualitative substance of the nonfrivolous claims in order to assess whether these claims were, in fact, legitimate filings that had the potential of prevailing or whether they patently lacked merit and only narrowly avoided being deemed frivolous themselves.” Id.at 222. If the nonfrivolous claims are not of a “quality sufficient to make the suit as a whole nonabusive,” the statutory presumption applies. Id.at 223. The Gurarycomplaint, the majority found, contained “no plausible, nonfrivolous allegation that saves it from being rightly viewed as an abusive securities lawsuit.” Id.at 223-24. The claims based on Gurary’s first two purchases (made prior to the alleged wrongful conduct) were frivolous, and the claims based upon the last two purchases, though not frivolous, patently lacked merit. Thus, the “substantial failure” presumption applied. Counsel’s efforts to rebut the presumption failed. The court rejected his argument that the violation was de minimis because two of the four allegations were deemed nonfrivolous. The court believed it to be clear from the legislative history (referencing one out of 20) that two out of four claims is not enough. Id.at 224. The majority declined to consider what would suffice to meet the de minimis rebuttal standard because that possibility was “out of the question” in the Gurarycase, observing only that de minimis must mean something other than “not substantial.” Id.at 223 n.3. The majority also rejected counsel’s “unreasonable burden” argument, finding that counsel had failed “to offer, through financial statements or other proof, evidence that the award is unreasonable and unjust, given the party’s economic or other like status.” Id.at 221. Accordingly, the plaintiff’s counsel was subject to full sanctions, including the cost of the sanctions motion and appellate expenses. Id.at 226. THE CONCURRENCE’S ANALYSIS Chief Judge Walker, although concurring in the conclusion of the majority, emphasized that he saw no need to look beyond the text and structure of the statutory provisions to ascertain their meaning. He found the majority’s reliance on legislative history troubling, particularly to resolve a problem that the majority conceded “Congress did not seem to have in mind.” Id.at 226, 227 & n.1. He “easily conclude[d]” that the complaint substantially failed to comply with Rule 11(b) because the potentially nonfrivolous claims surfaced not in the complaint but in an appeal from the dismissal. Judge Walker did not view the statute as unclear, noting that terms like “ substantial” and “material” are “common coin of the legal realm.” Although there might be cases in which a finding concerning a “substantial failure” might be a tough call, “the difficulty of applying the provisions in some cases does not make the statute unclear.” Id.at 228. Judge Walker also easily concluded, from the “fees … incurred in the action” language of subsection 3(A)(ii), that the presumptive award for an offending complaint is the full amount of expenses, not just the costs incurred as a result of the frivolous claims, a standard expressly applicable only to responsive pleadings or dispositive motions. Id.at 228-29. As for rebutting the presumptions, Judge Walker agreed with the majority that counsel had failed to provide the requisite proof of “some financial or similar hardship” and had failed to produce evidence that his substantially frivolous complaint was de minimis, “however that provision is interpreted.” Id.at 231. However, Judge Walker disagreed with the majority’s quantitatively based analysis of a de minimis violation. Id.at 229-30. He believed that applicability of that rebuttal provision, which would apply not only to complaints but also to responsive pleadings and dispositive motions, should not depend on the majority’s too-narrow “frivolous versus non-frivolous counts” analysis. Id.at 229. He noted that a complaint with only one in 20 frivolous claims was unlikely to give rise to a substantial failure in need of a de minimis rebuttal. Judge Walker advocated a broader inquiry of whether a party’s Rule 11 violation was de minimis “in the context of the case as a whole” and in light of “the rest of that party’s conduct in the action and the conduct of the non-sanctioned party.” Id.at 230. Such an analysis, required to be made only upon “final adjudication” of the action, would resolve the majority’s perceived conflict between substantial failure and de minimis. CONCLUSION The Gurary IIImajority and concurring opinions provide helpful, if somewhat divergent, guidance as to the meaning and application of “substantial failure,” “unreasonable burden” and “de minimis” violation under the Reform Act’s sanctions provision. The court made clear that the sanctions provision must be strictly enforced, but left unanswered how the district courts should apply the provision in future cases to the myriad factual circumstances under which sanctions will be required by the Reform Act. [FOOTNOTE 1] Sarah S. Gold is a partner and Richard L. Spinogatti a senior counsel at Proskauer Rose ( www.proskauer.com). Karen E. Clarke, an associate at the firm, assisted in the preparation of this article. If you are interested in submitting an article to law.com, please click herefor our submission guidelines. ::::FOOTNOTE:::: FN 1In a recent case, Judge Denise Cote held that sanctions were not required at all where plaintiff withdrew a frivolous complaint because there had been no “final adjudication.” Blaser v. Bessemer Trust Co., N.A., 2002 WL 31359015 (SDNY Oct. 21, 2002).

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