Unpublished Disposition, 862 F.2d 875 (9th Cir. 1988)

MEMORANDUM^* 

Rodney Rummelsburg, d/b/a White Star Data Systems, and his attorneys, Conkle & Olesten, a professional law corporation (collectively referred to as "White Star") appeal a district court order imposing sanctions against them under Fed. R. Civ. P. 11. We have jurisdiction over this timely appeal under 18 U.S.C. § 1291. Because the district court improperly levied sanctions against White Star, we reverse.

STANDARD OF REVIEW

Our circuit uses a three-part approach to review decisions awarding sanctions: "Whether specific conduct violated Rule 11 is a legal question which we review de novo. We review factual determinations concerning the conduct for clear error and the amount or nature of the sanctions for an abuse of discretion." Lemos v. Fencl, 828 F.2d 616, 618 (9th Cir. 1987) (citing Golden Eagle Distrib. Corp. v. Burroughs Corp., 801 F.2d 1531, 1538 (9th Cir. 1986)).

DISCUSSION

In February, 1987, Amtec sued White Star in the Los Angeles Superior Court for unfair competition and other business torts. Part of Amtec's claim alleged that White Star lured employees away from Amtec by promising to classify them as independent contractors rather than employees, thereby implying that White Star would not withhold certain federal taxes from their paychecks. Amtec charged a violation of 26 U.S.C. § 3402, the federal tax withholding section of the Internal Revenue Code. In March, 1987, White Star demurred to the complaint and argued that the state court lacked subject matter jurisdiction over the suit on the grounds that Amtec's complaint amounted to an action to enforce the Internal Revenue Code. The state court overruled the demurrers and held that it possessed subject matter jurisdiction.

The day after this ruling, White Star filed a removal petition pursuant to 18 U.S.C. § 1441 in the district court on the grounds that the section 3402 allegation in Amtec's complaint conferred federal jurisdiction. The district court remanded the case to the state court and levied sanctions in the sum of $2900 against White Star. In an amended order filed after White Star submitted its notice of appeal, the district court explained that sanctions were warranted because the state court had resolved the federal jurisdiction issue and that White Star's removal petition, consequently, was improper and brought in bad faith.¹ 

Rule 11 functions to discourage frivolous filings and the abusive use of judicial proceedings. Zaldivar v. City of Los Angeles, 780 F.2d 823, 830 (9th Cir. 1986). Our circuit has adopted a two-part test developed by the Second Circuit to determine when sanctions are proper.

Sanctions should be imposed if (1) "after reasonable inquiry, a competent attorney could not form a reasonable belief that the pleading [or other paper] is well grounded in fact and is warranted by existing law for a good faith argument for the extension, modification or reversal of existing law" or if (2) "a pleading [or other paper] has been interposed for any improper purpose."

Golden Eagle Distrib. Corp. v. Burroughs Corp., 801 F.2d 1531, 1537 (9th Cir. 1986) (citing Eastway Constr. Corp. v. City of New York, 762 F.2d 243, 254 (2d Cir. 1985) (other citation omitted)).

The district court's sanctions order is unjustified under Rule 11. Contrary to the district court's interpretation, the state court's demurrer ruling addressed only the issue of whether the state court had jurisdiction over Amtec's complaint. It did not consider or rule on the issue of whether federal jurisdiction also existed. A finding of state court jurisdiction does not, of course, preclude in itself the possibility that federal jurisdiction may also exist. The district court incorrectly concluded that the state court had resolved the federal jurisdiction question. Because the district court relied on this mistake to find that White Star had no reasonable basis in law for its removal petition and had proceeded in bad faith, its sanctions order is unjustified.

Amtec argues in its reply brief that, under the recent Supreme Court holding in Merrell Dow Pharmaceuticals, Inc. v. Thompson, 106 S. Ct. 3229 (1986) (5-4 decision), White Star had no legal basis for its removal petition. In Merrell Dow, the Court interpreted the well-known federal question doctrine announced in Franchise Tax Board v. Construction Laborers Vacation Trust, 463 U.S. 1 (1983), to mean that "a complaint alleging a violation of a federal statute as an element of a state cause of action, when Congress has determined that there should be no private, federal cause of action for the violation, does not state a claim" sufficient to invoke federal jurisdiction. Merrell Dow, 106 S. Ct. at 3237.

Although this argument is, in all probability, correct, it does not alter our conclusion that sanctions were improper. We cannot punish White Star for failing to recognize or cite Merrell Dow when Amtec itself first referred to the case only in its reply brief on appeal and when the district court based neither its remand nor its sanction orders on Merrell Dow.

REVERSED.