First Bank of Marietta, Plaintiff-Appellant/cross-Appellee v. Hartford Underwriters Insurance Company, Defendant-Appellee/cross-Appellant

(A) Loss resulting from dishonest or fraudulent acts committed by an Employee acting alone or in collusion with others.

Such dishonest or fraudulent acts must be committedby the Employee with the manifest intent:

(a) to cause the insured to sustain loss,and

(b) to obtain financial benefit for the Employee or another person or entity.

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As used throughout the Insuring Agreement, financial benefit does not include any employee benefits earned in the normal course of employment, including: salaries, commissions, fees, bonuses, promotions, awards, profit sharing or pensions.

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EXCLUSIONS

Section 2. This bond does not cover:

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(h) loss caused by an Employee, except when covered under Insuring Agreement (A). . . .

DISCOVERY.

Section 3. This bond applies to loss discovered by the Insured during the Bond Period. Discovery occurs when the insured first becomes aware of facts which would cause a reasonable person to assume that a loss of a type covered by this bond has been or will be incurred, regardless of when the act or acts causing or contributing to such loss occurred, even though the exact amount or details of loss may not then be known.

NOTICE/PROOF — LEGAL PROCEEDINGS AGAINST UNDERWRITER

Section 5.

(a) At the earliest practicable moment, not toexceed 30 days, after discovery of loss, the Insuredshall give the Underwriter notice thereof.

(b) Within 6 months after such discovery, theInsured shall furnish to thePage 505Underwriter proof of loss, duly sworn to, with fullparticulars.

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(d) Legal proceedings for the recovery of any loss hereunder shall not be brought prior to the expiration of 60 days after the original proof of loss is filed with the Underwriter or after the expiration of 24 months from the discovery of such loss.

On May 25, 1994 . . . I had a private discussion with Biehl concerning the Mascrete $301,500.00 line of credit and during that discussion Biehl acknowledged to me that he knew the loan was over the limits of the lending authority. I asked Jerry why he would do such a thing and he responded that at the time he made the loan he was angry at me and the bank for not receiving his bonuses and he wanted to get back at the bank and myself.

Q: So Mr. Giles is the only board member that you didn't talk with to confirm that your father had told them about the private Biehl conversation before the end of 1994; is that correct?

A: To the best of my recollection, you know again, I can't be exact on the date. But generally, you know, yes, we knew that Jerry Biehl had said that to my father.

In addition to the Proof of Loss, we request that you include the following:

1.Detailed narrative description of the loss.

2. Date of discovery of the loss.

3. Explanation of how the loss was recovered.

4. Copy of any accounting analysis prepared.

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10. Any other documentation that will help substantiate this claim.

I further certify that knowledge of this misappropriation first came to me on or about June 28, 1994, that the manner in which this money was misappropriated is as follows: fraudulent loans and loans in excess of lending authority that nothing has been suppressed, withheld, or misrepresented by me material to a knowledge of the facts of said loss and thatthe above statement is a complete and truthfulrecital of the facts.

Section B. of the Proof of Loss makes claim for loans made in excess of Jerry Biehl's lending limit.Underthe . . . bond issued by Hartford, the mere fact thanan officer exceeded his lending authority does notnecessarily constitute a covered loss. Please . . .explain how Mr. Biehl's activities fall within thefidelity coverage provided in the bond. Without thisadditional information, there is no basis to believethat coverage exists for these loans.

We understand that you are continuing your investigation. Until substantiating documentation is made available, we are not able to provide you with a position on this claim.

Since documentation is lacking at this time, we are unable to advise First Bank of how it should proceed in this matter. To the extent that First Bank can take action that would mitigate its loss, it should do so.

We are requesting copies of supporting documentation in connection with the Bank's claim . . . [.]

We have reviewed this matter and agree that First Bank's claim as to the Ohio Beth Rho and Keith Atkins loans are valid and have been established. For that reason, we enclose for execution and return and Release and Assignment. Upon its return to us, fully executed, we will remit our check in the amount of $63,000 ($88,000 minus $25,000 deductible).

As to the balance of First Bank's claim, it remains Hartford's position that First Bank has not demonstrated that Mr. Biehl acted with a "manifest intent" to cause a loss to First Bank; therefore, his acts do not constitute dishonesty within the meaning of the coverage. I understand that Mr. Powers has previously discussed this issue with you. As to this portion of First Bank's claim, therefore, Hartford reserves all rights and defenses available to it under thePage 508bond and applicable law. Hartford will have no objection to First Bank's reserving its rights as to this portion of its claim on the bottom of the Release and Assignment if you deem it appropriate to do so.

1) Filing a civil action based upon the claim asserted in Count One of the Complaint even though Defendant Hartford had offered to voluntarilyPage 509pay [First Bank] more than the amount of the loss it sustained;

2) Filing a civil action based upon the claims asserted in Count Two of the Complaint even though Plaintiff had not even arguably "furnished the Underwriter proof of loss, duly sworn to, with full particulars" as required by Section 5 of the Conditions and Limitations of [First Bank's] Financial Institution Bond;

3) Attempting to improperly use the criminal justice systems to obtain false testimony from Third Party Defendant Jerry Biehl;

4) Abusing the discovery process and improperly concealing relevant evidence;

5) Refusing to produce Mr. Tonti for a deposition and failing to respond to Hartford's discovery requests with regard to Mr. Tonti's files including Hartford's March 26, 1996 Third Request for the Production of Documents — which remain unanswered more than two years after the requests were served;

6) Compelling Hartford to file a motion for summary judgment, while failing to respond to relevant discovery requests;

7) Filing improper affidavits in response to Hartford's May 28, 1996 Motion for Summary Judgment — which appear to contain false statements of fact — in an improper attempt to avoid the award of summary judgment.

We discern no basis for holding that the sanctioning scheme of the statute and the rules displaces the inherent power to impose sanctions for the bad-faith conduct described above. These other mechanisms, taken alone or together, are not substitutes for the inherent power, for that power is both broader and narrower than other means of imposing sanctions. First, whereas each of the other mechanisms reaches only certain individuals or conduct, the inherent power extends to a full range of litigation abuses.At the very least,the inherent power must continue to exist to fill in the interstices.

There is, therefore, nothing in the other sanctioning mechanisms or prior cases interpreting them that warrants a conclusion that a federal court may not, as a matter of law, resort to its inherent power to impose attorney's fees as a sanction for bad-faith conduct. This is plainly the case where the conduct at issue is not covered by one of the other sanctioning provisions.But neither is a federalcourt forbidden to sanction bad-faith conduct bymeans of the inherent power simply because thatconduct could also be sanctioned under the statute orthe Rules.A court must, of course, exercise caution in invoking its inherent power, and it must comply with the mandates of due process, both in determining that the requisite bad faith exists and in assessing fees. Furthermore, when there is bad-faith conduct in the course of litigation that could be adequately sanctioned under the Rules,the court ordinarilyshould rely on the Rules rather than the inherentpower.But if in the informed discretion of the court, neither the statute nor the Rules are up to the task, the court may safely rely on its inherent power.

[A] court may assess attorney's fees when a party has "acted in bad faith, vexatiously, wantonly, or for oppressive reasons." In this regard, if a court finds "that fraud has been practiced upon it, or that the very temple of justice has been defiled," it may assess attorney's fees against the responsible party, as it may when a party Ashows bad faith by delaying or disrupting the litigation or by hampering enforcement of a court order. "The imposition of sanctions in this instance transcends a court's equitable power concerning relations between the parties and reaches a court's inherent power to police itself, thus serving the dual purpose of Avindicat[ing] judicial authority without resort to the more drastic sanctions available for contempt of court and mak[ing] the prevailing party whole for expenses caused by his opponent's obstinacy."

Much of the bad-faith conduct by Chambers, however, was beyond the reach of the Rules;his entire courseof conduct throughout the lawsuit evidenced badPage 517faith and an attempt to perpetrate a fraud on thecourt, and the conduct sanctionable under the Ruleswas intertwined within conduct that only the inherentpower could address.In circumstances such as these in which all of a litigant's conduct is deemed sanctionable,requiring a court first to apply Rulesand statutes containing sanctioning provisions todiscrete occurrences before invoking inherent powerto address remaining instances of sanctionableconduct would serve only to foster extensive andneedless satellite litigation, which is contrary tothe aim of the Rules themselves.

As Justice Scalia pointed out in his dissent, however, the fact thatfee-shiftingas a sanction requires a finding of bad faith "in no way means thatallsanctions imposed under the courts' inherent authority required a finding of bad faith."Id.at 59,111 S.Ct. at 2140. Thus a court need not always find bad faith before sanctioning under its inherent powers: "[s]ince necessity does not depend upon a litigant's state of mind, the inherent sanctioning power must extend to situations involving less than bad faith."Id.;see generally Estate of LeonSpear v. Commissioner of IRS,41 F.3d 103,111-12(3d Cir. 1994) (discussing role of bad faith in sanctioning).

Under its inherent power, this Court finds that both bases upon which sanctions are appropriate are met in this case. First, there is evidence indicating that there was no "colorable basis" for Count II, the Mascrete line of credit claim. Second, there is an abundance of evidence which demonstrates that First Bank acted in bad faith, not only in filing the claim, but in prosecuting it.

First Bank had in its possession the requisite proof to show that its second claim fell within the coverage of the Bond Agreement. With this information in its possession, First Bank had no legal or factual basis for bringing suit against Hartford.

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With the information concerning Mr. Biehl's motivation in the hands of First Bank, the Bank would have known that litigating this matter was not necessary — at least not until after they presented this information to Hartford. Looking at these facts alone, First Bank's actions bespeak bad faith.

Not telling the insurance company about a conversation with a thief that made no difference to the insurance company is not bad faith. Bad faith is defined as situations where the claims were brought for improper purposes such as harassment or delay . . . The District Court made no finding that the claim was brought for an improper purpose such as harassment or delay.

The filing of a lawsuit after there has been a denial of coverage is not bad faith because it was not filed for purposes of harassment or delay. The suit was filed to seek recovery under an insurance bond that was believed by the bank to be covered under the bond. The District Court abused its discretion in finding bad faith.

[I]n order to award attorney's fees under the bad faith exception, a district court must find that the plaintiff's suit was both "entirely without color and . . . asserted wantonly, for purposes of harassment or delay,or for other improper reasons. . . Neither meritlessness alone . . . nor improper motives alone . . . will suffice."

In this case Appellee could have complied with the safe harbor provision of Civil Rule 11 and its failure to do so was itself a Rule 11 violation and the District Court abused its discretion in not awarding Appellant Rule 11 sanctions. Had Appellee complied with the safe harbor condition precedent none of the litigation would have been necessary or at least the Appellant would have been on notice of the potential Rule 11 sanction.

A motion for sanctions . . . shall be served as provided in Rule 5, but shall not be served or presented to the court unless, within 21 days after service of the motion . . ., the challenged paper, claim, defense, contention, allegation, or denial is not withdrawn or appropriately corrected.

[A]dhering to the rule's explicit language and overall structure, we hold that sanctions under Rule 11 are unavailable unless the motion for sanctions is served on the opposing party for the full twenty-one day "safe harbor" period before it is filed with or presented to the court; this service and filing must occur prior to final judgment or judicial rejection of the offending contention.Quite clearly then, aparty cannot wait until after summary judgment tomove for sanctions under Rule 11.

[S]erving plaintiff, through her counsel Mazer, with a copy of his proposed motion for sanctions on July 2, 1997. He also gave Mazer advance notice of his intention to move for sanctions in the May 9, 1997 letter. Plaintiff had . . . a period of almost four months, to consider the motion for sanctions. . . .

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The prompt filing of Alexander's Rule 11 motion . . . fourteen days after the dismissal of plaintiff's complaint, did not operate to deprive plaintiff and Mazer of the benefits of the "safe harbor" provision.

After you have reviewed our Motion for Summary Judgment, I think that First Bank should give serious consideration to voluntarily dismissing its action against Hartford and voluntarily reimbursing Hartford for the substantial feesPage 528and expenses incurred in this action. I will not repeat the arguments presented in the Memorandum in Support of the Motion or Appendix A; however, I think it is clear beyond any possible dispute that First Bank does not have any probative evidence to support the allegations of Count Two . . . No proper purpose is served by the continuation of this litigation by First Bank.

To the extent that theBarkercourt held that the warning letters will satisfy the requirement of service of the motion to the offending party prior to the entry of judgment as well as the safe harbor, it is inconsistent with the holding in the same circuit inRidder v. City of Springfield,109 F.3d 288,296(6th Cir. 1997). . . .

A motion for sanctions . . . shall be served as provided in Rule 5, but shall not be served or presented to the court unless, within 21 days after service of the motion . . ., the challenged paper, claim, defense, contention, allegation, or denial is not withdrawn or appropriately corrected.