Federal Courts' Compulsory Counterclaim Rule vs. New York's Permissive Rule
ALM Media
Updated
Under Rule 13(a) of the Federal Rules of Civil Procedure (FRCP), entitled "Compulsory Counterclaim," the defendant must plead a counterclaim that arises out of the same "transaction or occurrence" as plaintiff's main claim, or it is deemed waived. See Siegel, New York Practice 632 (Thomson 5th ed. 2011). The risk of waiver based on a pleading failure suggests that any doubt about whether a counterclaim has the kind of relationship to the main claim that would make it compulsory should be resolved in favor of pleading it instead of suing on it separately. This is especially so because the policy underlying this rule is judicial economy. See Transamerica Occidental Life Ins. v. Aviation Office of Am., 292 F.3d 384, 389 (3d Cir. 2002).
The "transaction or occurrence" standard in FRCP 13(a)(1)(A) has been liberally construed by most courts and looks to whether claims "'are so logically connected that considerations of judicial economy and fairness dictate that all the issues be resolved in one lawsuit.'" United States v. Aquavella, 615 F.2d 12, 22 (2d Cir. 1979). In other words, for a claim to qualify as a compulsory counterclaim under FRCP 13(a), there need not be a precise identity of issues and facts between the main claim and the counterclaim. See Xerox v. SCM, 576 F.2d 1057, 1059 (3d Cir. 1978).
Subject Matter Jurisdiction
The above rules deal primarily with pleading. There may also be an independent problem with subject matter jurisdiction of the counterclaim. Jurisdiction of the main claim may be based on a federal question, for example, and the counterclaim may not have that or any other predicate for subject matter jurisdiction. Or, if the main claim is based on diversity, which would serve the defendant's counterclaim as well, the main claim may satisfy the monetary jurisdiction required by the diversity statute, 28 U.S.C.A. 1332(a) (exceeding $75,000), while the counterclaim may not. Here, the ancillary jurisdiction doctrine, codified in 28 U.S.C.A. 1367 as "supplemental jurisdiction," comes into play. See Siegel, New York Practice 630. If it applies, it would support jurisdiction of the counterclaim as "ancillary" or "supplemental" to the main claim, even if the counterclaim standing alone would lack jurisdiction.
The doctrine of supplemental jurisdiction will apply to provide jurisdictional support to a compulsory counterclaim. See Baker v. Gold Seal Liquors, 417 U.S. 467, 469 n. 1 (1974). If the counterclaim is permissive, the defendant must independently demonstrate a ground for subject matter jurisdiction. See Federman v. Empire Fire and Marine Ins., 597 F.2d 798, 812 (2d Cir. 1979) (counterclaims that were not compulsory as defined by Rule 13(a) "were not automatically within the scope of the district court's ancillary jurisdiction"); see also Jones v. Ford Motor Credit, 358 F.3d 205 (2004) (concluding that "supplemental jurisdiction" may sometimes be available even for a merely "permissive" counterclaim).
State Court Actions
What happens if the plaintiff commences an action in federal court, where counterclaims are "compulsory," and the defendant withholds a counterclaim that arises out of the same transaction or occurrence as plaintiff's claim? Can the defendant in the federal court action then turn to state court and commence an action to assert that claim there under a state's permissive counterclaim rule?
Based on the above rules, a plaintiff might elect to sue in a federal court hoping to avoid this scenario and compel the defendant to interpose as a counterclaim any claim arising out of the transaction on which the plaintiff's claim is based. See Siegel, New York Practice 616 (discussing "Choice of Forum Factors" as between federal and New York State courts). This would, in effect, deny the defendant an independent choice of forum on the counterclaim. This proposition was recently tested in Paramount Pictures Corp. v. Allianz Risk Transfer AG, 141 A.D.3d 464 (1st Dep't 2016), which is currently before the New York Court of Appeals. Paramount, lv. granted, 28 N.Y.3d 909.
All counterclaims are "permissive" in New York state practice. See CPLR 3019; Siegel, New York Practice 224. This labeling can be misleading, however, as the doctrine of collateral estoppel will sometimes make this "permissive" counterclaim rule an illusion. The notion that a defendant (D) with a related counterclaim can safely withhold it and sue plaintiff (P) on it later can be perilous because any fact adjudicated or legal conclusion reached in P's action against D will often be conclusive and binding if it should become germane in D's later action against P. In sum, D's latter suit against P may not be barred under a compulsory counterclaim rule, but it may be subject to dismissal on collateral estoppel grounds. See Henry Modell & Co. v. Minister, Elders & Deacons of Ref. Prot. Dutch Church of City of N.Y., 68 N.Y.2d 456, 461-62 n.2 (1986) (defendant cannot "remain silent in the first action and then bring a second one on the basis of a preexisting claim for relief that would impair the rights or interests established in the first action"); Siegel, New York Practice at 224, 452.
'Paramount Pictures'
In Paramount, two entities commenced an action in federal district court against Paramount Pictures to recoup losses on their investment rights in the production and distribution of certain Paramount films. Following a trial, the district court ruled that the entities' claims were precluded under a waiver provision in Paramount's subscription agreement. The federal court did not, however, rule on a covenant not to sue, which was not raised by either party.
Paramount then set its sights on recovering damages for breach of the covenant not to sue by commencing an action in New York state court against the two investment entities. Plaintiff sought compensatory damages of $8 million, representing attorney fees incurred in the federal action, plus interest. The investment entities moved to dismiss the complaint on the ground that the judgment of the federal court was res judicata.
The First Department noted that under New York's transactional analysis approach to res judicata, once a claim is brought to final judgment, all other claims arising out of the same transaction, occurrence, or event are barred, even if based upon different theories. See Siegel, New York Practice 447. That doctrine would prohibit the investment entities, who were the plaintiffs in the federal action, from bringing a second lawsuit against Paramount for any claims arising out of the transaction that was at issue in the federal court litigation. It would not, however, necessarily bar Paramount, the defendant in the federal action, from bringing another action in New York state court to assert a claim it withheld in the first action.
As noted above, while New York state is a permissive counterclaim jurisdiction, any fact adjudicated or legal conclusion reached in the prior federal action would nonetheless be binding under the related, but distinct, doctrine of collateral estoppel if it was germane in Paramount's action in state court. Id. 224, 452. The court agreed that the relief sought by Paramount in state court was not precluded by the factual or legal determinations in the federal action, but also determined that "the inquiry does not end there where the prior action was adjudicated in a compulsory counterclaim jurisdiction." Paramount, 141 A.D.3d at 467.
The First Department held that Paramount's claim for breach of the covenant not to sue was a compulsory counterclaim under FRCP 13(a)(1) because it existed at the time Paramount served its answer to the complaint in the federal action and arose out of the same transaction that was the subject of the investment entities' claims. Furthermore, the interposition of the counterclaim by Paramount in federal court would not have required joining another party over whom the court could not acquire jurisdiction, see Fed. R. Civ. P. 13(a)(1)(B), and none of the exceptions to the compulsory counterclaim rule were applicable. See Fed. R. Civ. P. 13(a)(2).
Acknowledging that there was no binding precedent requiring state courts to apply FRCP 13(a) to actions involving matters that were compulsory counterclaims in a prior federal action, the First Department relied upon dicta in the Court of Appeals decision in Gargiulo v. Oppenheim, 63 N.Y.2d 843, 845 (1984), where it "assume[d], without deciding, that under the procedural compulsory counterclaim rule in the Federal Courts claim and issue preclusion would extend to bar the later assertion in the present State court action of a contention which could have been raised by way of a counterclaim ." Based on this prior Court of Appeals pronouncement, the Appellate Division ruled that "the later assertion in a state court action of a contention that constituted a compulsory counterclaim (FRCP rule 13[a]) in a prior federal action between the same parties is barred under the doctrine of res judicata." Paramount, 141 A.D.3d at 468. This principle of law required dismissal of the complaint in the state court action.
Full Faith and Credit Doctrine
Although not mentioned in the First Department's decision, we wonder if the result reached is compelled by the doctrine of Full Faith and Credit. The doctrine requires that the judgments of American courts rendered with jurisdiction be given recognition by all other American courts. See Siegel, New York Practice 443. If there is some difference between the law of the first forum (F-1) and the second forum (F-2) on the effect to be given the F-1 judgment, F-2 will ordinarily apply the F-1 rules on the theory that to do otherwise would be according less than full credit to the F-1 judgment. Id. at 471.
Section 87 of the Restatement of Judgments 2d addresses the issue. It states that "[f]ederal law determines the effects under the rules of res judicata of a judgment of a federal court." It then provides the following illustration:
3. P brings an action in federal court. D has a claim against P arising out of the same transaction but fails to assert it as a counterclaim as required by Federal Rule 13. Judgment is rendered after trial in the federal action. D then brings an action in state court on his claim. Federal law determines whether D may maintain the action. Under prevailing federal interpretation of Federal Rule 13, the action is barred.
We will await a decision on this important issue from the Court of Appeals, likely in the fall of 2017. Until then, let's be sure to enjoy the summer!
