US-DIST-CT, FRANCHISE-GUIDE ¶10,281, David P. Lauzen v. Comprehensive Business Services, Inc., (July 16, 1993)

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U.S. District Court, Northern District of Illinois, Eastern Division. No. 92 C 7553. Dated July 16, 1993.

Attorneys’ Fees--Rule 11 Sanctions--Attempt to Stay Arbitration--Existence of Arbitration Agreement--Failure to Make Reasonable Inquiry.--A franchisee’s continued denial of the existence of an arbitration agreement after disclosure of the franchisee’s prior acknowledgement of the assignment of the franchise agreement containing the arbitration clause was a frivolous attempt to delay arbitration. Prior to the disclosure, the franchisee might not have been able to determine that the franchise had been assigned as part of the sale of a predecessor franchisor’s assets, even though the franchisee’s actions implied knowledge of the assignment. However, after the disclosure, there was no question that the franchisee knew of the assignment, and the franchisee’s continued contest of the right to arbitration was frivolous and dilatory.

Attorneys’ Fees--Rule 11 Sanctions--Complaint to Stay Arbitration--Amount of Sanctions.--A franchisee that filed a complaint to stay arbitration of a franchisor’s dispute was liable for attorneys’ fees incurred by the franchisor in contesting the complaint, beginning from the time that the complaint’s frivolity became apparent. Awarding the franchisor the fees that had been incurred in investigating, researching, and contesting the allegations of the complaint both shifts the litigation costs to the responsible party and deters future conduct of this type. A sanction awarding the franchisor $10,000 of the $18,637.18 that had been requested was reasonable and appropriate, and would deter similar conduct in the future.

NORGLE, D.J.: Before the court is defendant, Comprehensive Business Services, Inc.’s (CBS), motion for Rule 11 sanctions, attorney’s fees and costs. CBS claims that the plaintiff, David P. Lauzen, brought a complaint to stay arbitration without the prior investigation of the facts and law demanded by rule 11 of the Federal Rules of Civil Procedure.

On September 8,1992, CBS filed a demand for arbitration with the American Arbitration Association (the "AAA"). Lauzen responded to this demand with the complaint to dismiss arbitration, filed in the Circuit Court for the Sixteenth Judicial Circuit, Kendall County, Illinois. Lauzen claimed the arbitration proceedings should be dismissed because no agreement to arbitrate existed between the two parties. CBS removed the case to this court pursuant to 28 U.S.C. 1441.

The court rejected Lauzen’s complaint and compelled arbitration. In denying Lauzen’s attempt to stay the proceedings before the AAA, the court made the following findings:

In 1973, Lauzen became a franchisee of Comprehensive Accounting Corporation ("CAC"). On May 24, 1982, Lauzen executed a Franchise Agreement (the "Franchise Agreement") with Comprehensive Business Corporation ("CBC"), a wholly-owned subsidiary of CAC. The Franchise Agreement contained a provision whereby Lauzen and CBC agreed to resolve all disputes by submitting any grievances to binding arbitration and contained an addendum that referred to Lauzen’s prior agreement with CAC. By resolution of its board of directors, CBC was merged into CAC on December 30, 1983. By the merger, CAC assumed all of the obligations and liabilities of CBC, including the Franchise Agreement. Following the merger, Lauzen, as a franchisee of CAC, paid royalties, franchise fees, and deferred consideration under the Franchise Agreement.

In 1990, California Franchise Industries, Inc. ("CFI") was formed. On September 14, 1990, CFI purchased from CAC certain accounts receivable, notes receivable, and approximately 223 franchise agreements, including the Franchise Agreement between Lauzen and CBC. CFI changed its name to "Comprehensive Business Services, Inc." on November 15, 1990. After the sale from CAC to CFI/CBS, Lauzen performed under the Franchise Agreement as a franchisee of CBS.

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The issue before the court is simply this: is there an agreement to arbitrate between Lauzen and CBS? The facts presented by the parties in their pleadings and exhibits conclusively demonstrate that the answer to this query is yes. Through various mergers, assignments, and name changes, CBS has become CBC’s successor, and therefore a party to, the Franchise Agreement....

Rule 11 states in part:

The signature of an attorney or party constitutes a certificate ... that the signer has read the pleading, motion or other paper; that to the best of the signer’s knowledge, information, and belief formed after reasonable inquiry it is well grounded in fact and is warranted by existing law ..., and that it is not interposed for any improper purpose, such as to harass or to cause unnecessary delay or needless increase in the cost of litigation....

Fed. R. Civ. P. 11. Rule 11 applies to every statement and claim contained in a pleading, motion or other paper filed with a United States District Court. Id.; Frants v. U.S. Powerlifting Federation, 836 F.2d 1063, 1067 (7th Cir. 1987). Unlike prior provisions regarding sanctions, "sanctionability" under rule 11 is not determined on a subjective basis. "The standard for imposing sanctions under Rule 11 is an objective determination of whether a sanctioned party’s conduct was reasonable under the circumstances." Brown v. Federation of State Medical Boards, 830 F.2d 1429, 1435 (7th Cir. 1987). Good faith alone is not a defense; "[a]n empty head but a pure heart is no defense." Thornton v. Wahl, 787 F.2d 1151, 1154 (7th Cir. 1986).

With regard to Rule 11 sanctions, CBS claims that Lauzen and his counsel were aware, or could easily ascertain, that a franchise agreement existed between these parties and, accordingly, that Lauzen and his counsel failed to conduct a reasonable inquiry to determine whether their complaint and other pleadings were well grounded in fact and legally tenable prior to their filing. Specifically, CBS claims that Lauzen’s complaint denying or claiming ignorance of the CAC/CBC merger and the subsequent sale of CBC’s assets to CBS was filed for the improper purpose of delaying the arbitration proceeding.

With regard to the merger of CAC and CBC, Lauzen admits that the merger is a matter of public record and claims that he never raised the issue of whether CAC had rights from CBC to assign. Nevertheless, Lauzen cited case law in support of his position that CAC had no right to assign the Franchise Agreement to CBS. Lauzen argued, "[t]he law and common sense both dictate that an assignor can convey no greater title or interest than it possesses .... to the contrary, the record demonstrates that [CBS] purchased assets from a seller who was not a party to the 1982 Agreement...." Thus, Lauzen maintained a position that CAC had no rights from CBC to assign the Franchise Agreement in question, an argument which Lauzen now denies.

Lauzen also alleged "insufficient knowledge to admit or deny" the merger of CBC with CAC. A cursory check with the Delaware Secretary of State would have confirmed that CBC had merged with CAC. Furthermore, although insufficient to impute direct knowledge to Lauzen, the court finds Lauzen’s claimed ignorance improbably given the fact that Lauzen’s father was the chief executive officer of CAC at the time of the merger as well as at the time of the asset sale to CBS’s predecessor. Furthermore, Lauzen’s brother was the president of CAC at the time of the merger and signed the certificate of ownership, merging CBC into CAC. Lauzen did not consult with his father regarding the merger prior to the filing of the lawsuit, nor did he contact the Delaware Secretary of State. Lauzen admits to relying on his counsel for the filing of his complaint, and has denied even reading the complaint before it was filed, although he has subsequently claimed that he may have skimmed it.

Lauzen’s complaint and other pleadings attempted, in part, to demonstrate that no contract existed between CBS and himself by failing to acknowledge the merger between CAC and CBC. The validity of this merger was readily acertainable by Lauzen or his counsel, and failure to make the simple inquiries necessary to learn of the merger prior to filing his materials with the court violated Rule 11.

In addition to denying the merger of CBC into CAC, Lauzen also asserts that CAC’s sale of assets to CBS did not include the franchise agreement to which Lauzen was a party. Despite Lauzen’s assertion, he conducted himself as a franchisee of CBS after the asset sale and purchase agreement was executed on September 14, 1990. The fact that a party conducts itself as an assignee does not prove that the assignment itself was legally valid. See Neptune Society Corp. v. Longanecker, 194 Cal. App. 3d 1233 (1987). However, the fact that Lauzen acted as a franchisee of CBS was sufficient to place counsel on notice that a contract existed between these parties and to require counsel to make an inquiry into the parameters of that contract before the filing of the complaint. Furthermore, the court, in concluding the validity of the assignment, did not solely rely on Lauzen’s performance nor on the sale of asset and purchase agreement itself, but also considered various other documents, attachments and communications.

As Lauzen points out, the sale of assets and purchase agreement fails on its face specifically to identify Lauzen’s franchise agreement. Lauzen, therefore, claims that "sloppy legal draftsmanship" may have allowed his franchise agreement "to fall through the cracks of a large and complex transaction." Because a party may not proceed with arbitration and then challenge the existence of an agreement to arbitrate when the prevailing party seeks to confirm the arbitration award, Comprehensive Accounting Corp. v. Rudell, 760 F.2d 138 (7th Cir. 1984), Lauzen suggests that he was justified in filing his complaint.

Giving Lauzen the benefit of the doubt--that despite his performance as a franchisee of CBS and the fact that his father and brother were officers of CAC, he was unable to determine through reasonable inquiry that his franchise agreement had been sold to CBS--the court agrees that the Lauzen’s attempt to dismiss arbitration based on the argument that CBS had not been assigned his franchise agreement is not sanctionable. The issue of the sale of Lauzen’s franchise agreement, however, was conclusively established on or about November 9, 1992, when counsel for CBS delivered to the AAA and Lauzen’s counsel a letter identifying the existence of a release, signed by Lauzen, in which he acknowledged the existence and the assignment of the franchise agreement from CAC to CBS. Lauzen’s pursuit of his complaint after review of the release can only be viewed as a frivolous attempt to delay the arbitration proceedings, and all filings made subsequent to the receipt of the November 9,1992, letter violate Rule 11.

Having found sanctionable conduct under Rule 11, the court must now impose sanctions. The court has determined that the appropriate and reasonable sanctions for Lauzen’s Rule 11 violations is a partial award of the "excess costs, expense, and attorneys fees reasonably incurred." As the sanction that the court imposes is substantial, the court will discuss the reasons for, the computations of, and the equitable considerations behind the sanction. Flip Side Productions, Inc. v. JAM Productions, Ltd., 843 F.2d 1024, 1037 (7th Cir. 1988). The "American Rule" mandates that a party in litigation is responsible for its own legal fees, and courts must ensure that each party really does bear its costs and does not foist expenses off on its adversaries. Alyeska Pipeline Co. v. Wilderness Society, 421 U.S. 240, 246-47 (1975). Here, Lauzen "foisted" upon CBS the costs of investigating and researching his denial of the CBC/CAC merger and the sale of CAC assets to CBS. Therefore, it is appropriate that as a sanction for the sanctionable conduct that the court order Lauzen’s attorney to compensate CBS for those attorney’s fees incurred attributable to investigating, researching and fighting Lauzen’s claims. This sanction both shifts litigation costs to the responsible person and it will deter future conduct of this type.

In CBS’ motion for sanctions, CBS requests attorneys’ fees for the legal work performed from the day Lauzen filed his complaint to stay arbitration through the day that CBS filed its motion for sanctions. Attached to CBS’ brief in support of its motion is its summary of attorney fees. The court has analyzed the summary of fees so as to determine from the descriptions of the work performed the reasonable amount of fees and costs to award.

In determining the amount of the sanction in this case, the court has considered several principles underlying the imposition of sanctions. In general, the court will attempt to impose costs on the careless, reckless, or indifferent lawyer who puts the burden of study and illumination on the defendants or the court. This is the compensation element of Rule 11 sanctions; Compensation, however, is not the only component of Rule 11. An even more important aspect of the Rule is the deterrent effect that the imposition of sanctions will have on future conduct of the attorney in question. Furthermore, because of the impact sanctions may have on a party or an attorney’s career or personal well-being, the court will also evaluate equitable considerations to determine the least severe sanction that will adequately serve the purposes of Rule 11. Upon consideration of all the above principles, the court has decided to fashion a sanction which awards part, but not all, of CBS’ attorneys’ fee request.

Although the court found Lauzen’s denial of the CAC/CBC merger to be sanctionable, the court will combine the sanctions for that Rule 11 breach with those imposed for the sale of assets issue, since the denial of the merger was alleged to be subordinate to the sale of asset question in terms of supporting the complaint to dismiss arbitration. Furthermore, because the court found that prior to November 8, 1992, Lauzen’s claimed basis for dismissing arbitration was justifiable, no attorney’s fees shall be awarded for work performed prior to that date. In reviewing the description of the work performed by CBS’ counsel, the court has adjusted the number of hours requested by CBS so as to eliminate time spent on matters that do not pertain to the issues raised by the complaint to dismiss. The court has also allowed a reasonable number of hours for the preparation and prosecution of the Rule 11 motion. Finally, the court adjusted the number of hours requested so as to eliminate excessive time that CBS did not properly mitigate. See Dubisky v. Owens, 849 F.2d 1034, 1037 (7th Cir. 1988).

From the above analysis and adjustments, the court finds that the reasonable sanction to be imposed is $10,000.00. While this is less than the $18,637.18 of compensation requested by CBS, it is a reasonable and appropriate sanction and is an amount that will deter this type of conduct in the future. Accordingly, the court orders that Lauzen’s counsel pay to CBS the amount of $10,000.00 as a sanction for the continued pursuit of the complaint to dismiss arbitration based on frivolous grounds.

It Is So Ordered.