Commercial Division Blog

Posted: November 12, 2018 / Categories Commercial, Fraud/Misrepresentation, Res Judicata/Collateral Estoppel/Entire Controversy Doctrine

Dismissal With Prejudice of Federal Securities Law Claims Does Not Bar Common Law Fraud Claims

On October 30, 2018, Justice Sherwood of the New York County Commercial Division issued a decision in Brown v. Cerebus Capital Mgt., L.P., 2018 NY Slip Op. 32782(U), holding that the prior dismissal with prejudice of federal securities law claims does not bar new common law fraud claims, explaining:

In the first through eighth causes of action, plaintiffs bring claims for common law fraud and state blue-sky law claims. Specifically, plaintiffs allege that defendants fraudulently misrepresented that US Holdco and MIP II owned material, appreciable assets; and (2) that plaintiffs were entitled to 2.9% of the Covis Enterprise's profits and a grossup (id. ~ 234). Plaintiffs also allege that defendants fraudulently set impossible and unreasonable performance targets in the 2012 and 2013 Award Agreements; fraudulently terminated plaintiffs in bad faith for pre-textual and false reasons when defendants anticipated a Winding Up Event; failed to disclose merger negotiations to Goeken; and fraudulently exercised MIP II's call right.

Defendants argue that four of these claims (counts one, two, five and seven) are each barred by the doctrine of collateral estoppel because they all require scienter, and the federal court dismissed plaintiffs' federal claims for lack of scienter. However, the federal dismissal of plaintiffs' failed securities fraud claims for failure to allege a strong inference of scienter is not preclusive.

Collateral estoppel comes into play when four conditions are fulfilled: (1) the issues in both proceedings are identical, (2) the issue in the prior proceeding was actually litigated and decided, (3) there was a full and fair opportunity to litigate in the prior proceeding, and (4) the issue previously litigated was necessary to support a valid and final judgment on the merits. Collateral estoppel will bar claims over which a federal court declined to exercise supplemental jurisdiction if the federal court decided issues identical to those raised by the plaintiffs state claims.

Defendants cannot demonstrate that they have satisfied the elements of collateral estoppel because the federal court did not decide issues identical to those raised here. The federal securities claims brought in the federal action were subject to Rule 9(b) and the PSLRA, which require a plaintiff to allege facts giving rise to a strong inference that the defendant acted with the required state of mind. In contrast, the complaint's fraud claims are subject to the CPLR and 3016(b) may be met when the facts are sufficient to permit a reasonable inference of the alleged conduct. New York courts have uniformly held that the federal strong inference standard is higher than New York's reasonable inference standard.

Accordingly, because the federal court applied the strong inference standard to the federal action's allegations of scienter, the federal dismissal is not preclusive of plaintiffs' state law fraud claims. Indeed, a dismissal pursuant to the PSLRA cannot be preclusive because the district court rendered a decision on a claim rooted in federal statutory law, based on federal rules of pleading. Accordingly, defendants' motion for dismissal of counts one, two, five and seven of the complaint is denied.

(Internal quotations and citations omitted).

Doctrines such as collateral estoppel and res judicata limit a plaintiff's ability to litigate a dispute more than once. Contact Schlam Stone & Dolan partner John Lundin at if you or a client have questions regarding whether a claim is barred by an earlier action.