Wednesday, December 17, 2014

Arduini v. Hart (9th Cir. - Dec. 17, 2014)

There's only one published opinion from the Ninth Circuit today.  But it's a procedural doozy.

Do you remember your first year of civil procedure?  That's what this case is all about.  (At least as I read it.)  It's about the intersection between issue preclusion and the Erie doctrine.

Okay.  Stop screaming.  Sorry to take you back to that nightmarish era.  Fear not.  It's over now.  No one's going to test you on this stuff any more.  It's all for fun at this point.

Here's the basic scoop.  Shareholder A files a shareholder derivative suit against Company.  It gets dismissed because the shareholder never made a demand on the directors, with the court finding that a demand wouldn't have necessarily been futile.  Thereafter, Shareholder B files a similar derivative suit against Company, again without making a prior demand.  Shareholders A and B are entirely unrelated (different parties, counsel, etc.) apart from being shareholders in the same company.

Does the prior dismissal of the first lawsuit operate as issue preclusion, and thereby compel the dismissal of the second lawsuit, with respect to the futility of a demand?

The Ninth Circuit says "Yes."

Before we talk about Judge Callahan's conclusion, however, we have to mention something that her opinion somewhat curiously omits:  Erie.

Judge Callahan expressly analyzes issue preclusion here according to Nevada law.  Which might make some initial sense, since the first lawsuit was indeed filed in Nevada.

But there's a problem.  A little thing called Erie.  Because the first lawsuit was filed in federal court, not state court.

Preclusion is generally governed by the law of the rendering court.  That way the parties can know in advance what claims and/or issues will be subsequently precluded, and can conduct themselves in the litigation accordingly.  Makes sense.  Hence, if the first lawsuit had been filed in Nevada state court, of course Nevada issue preclusion would apply.

But it wasn't.  It was filed in federal court.

What issue preclusion rules apply when the first lawsuit's filed there?

If you're smart, you might think:  "Federal principles, of course."  On the same theory:  predictability, plus uniformity (of federal common law).

That might, in fact, be the right rule.  But, at least in contemporary jurisprudence, whether that's the extant rule is not so clear.

This much is clear:  If the first lawsuit's filed in federal court and it's a federal question case (i.e., the dispute is governed by federal law), federal issue preclusion rules clearly apply.  The Supreme Court has expressly said so.  Every circuit agrees.  End of story.

Judge Callahan's opinion doesn't say whether the first lawsuit at issue here invoked federal question jurisdiction.  That's a serious omission.  Because if it did, then the Ninth Circuit should be applying (and citing) Nevada law -- which would be irrelevant -- but rather, federal common law.

That's the first problem.

But, as it happens, I went back and did some digging, and it at least appears that at least one of the first shareholder derivative lawsuits was indeed a diversity (rather than federal question) case.  (I say "appears" because there's only the briefest reference in the relevant documents; moreover, there are in fact multiple prior derivative lawsuits here, something that only further complicates things.)  If that's the case, then maybe Judge Callahan rightly analyzes the issue pursuant to Nevada law.  Even if the opinion should probably mention expressly why we're applying state law here rather than federal law given that the first lawsuit was filed in federal court.

Except it's not even that easy.  Because it's unclear to me that even in a pure diversity case we should in fact be applying state law.

Recall that issue preclusion is expressly governed by federal law -- the law of the rendering court -- in federal question cases.  Recall too that issue preclusion is governed by state law when the first suit was filed in state court; again, the law of the rendering court.  That even appears to be true (I assume) when the state lawsuit contains a federal claim.  We don't care about the substantive claim for issue preclusion purposes; we simply care about the forum in which the suit was litigated.  Those are the res judicata principles that apply.

Except maybe it's not.

Sure, sometimes the Ninth Circuit has said that's the rule; e.g., that res judicata is governed by federal law (consistent with Supreme Court precedent) when the rendering court was federal.  But, when it's being more careful, the Ninth Circuit has also drawn a distinction between federal question as opposed to diversity cases, saying that issue preclusion should only be governed by federal law when the first lawsuit was a federal question case but should be governed by state law when the first lawsuit was a diversity case.

Why does the Ninth Circuit so hold?  Truth be told, there's probably a little holdover in that regard from some pre-Erie precedent.  But there's also an articulated policy rationale as well:  maybe we want to say that issue preclusion is "substantive" (even though that's not, in fact, the right standard under the Erie doctrine; nonetheless, it's close enough) and hence that the federal court's judgment in a diversity suit should be decided according to state law.

There are, however, tons of problems with such an approach.  (Recall also that we're assuming for purposes of argument that the prior suit here was a straight diversity suit; today's opinion doesn't say, and doesn't explain why it's applying Nevada law.)  For one thing, it seems weird.  Sure, sometimes we apply the forum state's law's; e.g., its statute of limitations.  But doing so with respect to issue preclusion seems strange, especially since this seems more of a "procedural" thing (e.g., the future effect of the judgment) and also because the diversity case might be applying the substantive law of a different state (e.g., here, Delaware) and yet we're applying Nevada substantive law to preclusion.  A mish-mash that's got a lot going against it.

Plus there's a matter of precedent.  Lots of circuits have held that federal preclusion law applies when the first suit was filed in federal court regardless of whether that action was a diversity or federal question case.  To the extent the Ninth Circuit wants to go the other way, we're creating a circuit split and heightening the already-problematic nonuniformity that arises from applying state preclusion law to federal judgments.

Oh, one more thing thing.  What do you do when there are multiple suits?  For example, doing a little more digging, in the present case, it looks like there were many different shareholder derivative suits, including but not limited to one (mentioned by Judge Callahan in footnote one of her opinion) that it appears raised federal question claims -- as is not entirely unusual, since derivative suits often raise federal securities counts.  When there's a federal question suit and a diversity suit, which preclusion law applies?  Why?  Especially when (as it often the case) they get consolidated and resolved at the same time.

Plus, what about prior cases that raise federal question claims and supplemental state law claims?  Do you apply federal or state preclusion law to those?  Or, bizarrely, both?  Now we're just getting weird.

Notice how applying federal law to determine the preclusive effect of all federal judgments avoids this complexity.  One rule.  One ring to rule them all.  Nice, simple, and straightforward.

So that's problem number one.  As well as two.  Judge Callahan's opinion doesn't say why she elects to apply Nevada law.  And there's good reason to think that might not be the right rule when you dig down and think deeply about it.

Let's now discuss problem number three.

Regardless of which law one applies -- and I think it's important (for straightforward reasons) to get this initial question right -- I blanch a little bit at saying that the outcome of a prior suit is res judicata of a subsequent suit when the plaintiffs in those two lawsuits are completely different.

Recall the usual rule from your first-year civil procedure class.  When P1 sues D, that doesn't stop P2 from suing D.  Either through claim or issue preclusion.  Why not, even if the issues are identical?  Because P1 hasn't had his day in court.  Moreover, this isn't just a prudential rule.  It's a matter of core constitutional rights.  The Due Process Clause bars us from precluding P1 in such a setting.

So why does the Ninth Circuit think that fundamental principle doesn't apply here?

You probably didn't go over the "privity" exception much in law school, but that's why.  The Ninth Circuit says that even though P1 and P2 are different shareholders, they're nonetheless in privity -- and hence issue preclusion applies -- because they're (1) both stockholders, and (2) both suing on behalf of the same company.  Since the "corporation" is the nominal party in a derivative suit, Judge Callahan says, it's the "same" party.  Hence the Due Process Clause doesn't apply and you're bound.


Admittedly, Judge Callahan's position has a lot going for it.  It is a derivative suit, after all,  Which is indeed technically the "company" filing suit.  So she's right?  Same party?  Or at least in privity?

I get it.  But I'm still troubled.

For one thing, if that's indeed the rule, and the parties are in privity, then isn't the lawsuit barred by claim preclusion as well?  After all, same transaction, same parties.  Why limit yourself to piddly issue preclusion, and instead go for "true" res judicata?

More centrally, I've got a profound problem with saying that the corporation is the "real" party to the suit given that the suit was dismissed.  Remember:  We're trying to figure out the preclusive effect of a judgment in which the court expressly held that the shareholder was not allowed to sue on behalf of the company since he didn't first make a demand.  Well, if he couldn't sue on behalf of the company, then he didn't in fact represent the company, right?  Which means that he's not in privity.  And yet the Ninth Circuit today holds that he did.

Doesn't that seem weird to you?

The first court held that X wasn't allowed to represent the company.  Then Y wants to represent the company.  At which point a second court says that Y can't represent the company since X already represented the company.


To me, the analogy to putative class actions seems pretty strong.  Sure, a dude may file a lawsuit that asserts class claims.  But if it's not certified, he does not, in fact, represent the class.  And included in that result is the fact that this prior putative lawsuit doesn't bar future lawsuits -- whether individual or class claims -- via res judicata.  It's an individual claim even though it tried to assert class claims.

What's true for class claims should equally be true for derivative claims, no?

So it seems to me that there's a strong argument that, whatever law applies, policy concerns -- as well as the Due Process Clause -- might well bar a finding of privity in dueling derivative claims like those here.

Judge Callahan's contrary approach also results in the strange types of machinations you see arise in the last part of her opinion.  Because she holds that Party A "represented" the company (even though he wasn't allowed to) in the first derivative suit, and hence is in privity with Party B, issue preclusion will apply (she says) to bar the second suit.  But she concedes, as indeed she must, that under the Due Process clause, that won't be the case if Party A) was an "inadequate representative" of Party B.  That is the Hansberry v. Lee case you may recall from your first year of law school:  the one that involved the racially restrictive covenants.

So now you have the second shareholder representative claiming that the first one was inadequate.  In part relying on the holding of the first court that the first plaintiff was indeed inadequate because he did not make a demand on the company.  All this stuff coming after the first lawsuit was dismissed.

The class action analogy again seems strong to me.  Normally we dispute the adequacy of the putative class representative at the certification stage.  If he's adequate, the lawsuit is certified and is allowed to go forward, and there is now preclusion (both issue and claim).  If he's not, it's not, and there's no future preclusion.  But Judge Callahan says that, in derivative suits, the rule is different.  I'm not sure that's the better principle.  Or practice.  Seems to me that a retrospective assessment of the adequacy of a representative who was never, in fact, allowed to represented the company isn't really helpful.  Or at least is inferior to a contemporary assessment.  Seems to me better to instead say that you're not in privity until you're actually allowed to represent the company.

None of this would stop res judicata if the derivative suit was in fact resolved on the merits.  If the first suit was indeed allowed forward, but simply lost, well, I'll spot you, there may well be privity (and hence issue preclusion) then.  At that point, the plaintiff does, in fact, represent the company, and the "company" can't sue again, even though another shareholder.

But that's not this case.  Here, the lawsuit never went forward.  It was dismissed on procedural grounds and the plaintiff wasn't permitted to represent the company on the merits.  To me, that's inconsistent with a finding of privity.  On whatever law -- federal, Nevada, Delaware, or Venusian -- we might feel like applying.  At least if the law is to make sense.

All of which is to say -- in many, many words -- that there are profound Erie and preclusion issues raised by today's Ninth Circuit opinion.