118 East 60th Owners, Inc. v. Bonner Properties, Inc.

• Decision Date: 13 April 1982
• Docket Number: No. 68,D,68
• Citation: 677 F.2d 200
• Parties: TH OWNERS, INC., Plaintiff-Appellant, v. BONNER PROPERTIES, INC. and Bertram F. Bonner, Defendants-Appellees. ocket 81-7284.
• Court: U.S. Court of Appeals — Second Circuit

Page 200

677 F.2d 200

118 EAST 60TH OWNERS, INC., Plaintiff-Appellant, v. BONNER PROPERTIES, INC. and Bertram F. Bonner, Defendants-Appellees.

No. 68, Docket 81-7284.

United States Court of Appeals, Second Circuit.

Argued Sept. 23, 1981.

Decided April 13, 1982.

Alan E. Bandler, New York City for plaintiff-appellant.

Lawrence W. Boes, New York City (Andrew N. Krinsky and Reavis & McGrath, New York City, on the brief), for defendants-appellees.

Before NEWMAN and KEARSE, Circuit Judges, and DALY, ^* District Judge.

NEWMAN, Circuit Judge:

Federal courts must regularly try to determine the content of state law in exercising diversity jurisdiction and must occasionally do so in exercising federal question jurisdiction; it is the diversity jurisdiction, however, that obliges federal courts to make the delicate accommodation between state substantive law and federal procedural law in adjudicating state-created causes of action. The subtlety of that process, compared to the relatively more straightforward adjudication of federal causes of action, is illustrated by this appeal from the denial of a declaratory judgment. The suit sought, among other things, to test the validity of a defense to enforcement of a commercial lease and a mortgage note. If the basis for the defense had been alleged affirmatively to secure rescission, modification, or an accounting, it would have encountered the bar of a state statute of limitations. Plaintiff in this diversity action relies on state law that permits an otherwise time-barred defense to be interposed against an adversary's claim. The District Court for the Southern District of New York (Lee P. Gagliardi, Judge) ruled that state law did not permit such a defense to be used to obtain a declaratory judgment of non-liability. We affirm because we conclude that use of the federal procedure of a declaratory judgment remedy in this case would undermine state substantive policies concerning the statute of limitations.

The corporate predecessor of defendant-appellee Bonner Properties, Inc. ("Bonner") erected an apartment building at 118 East 60th Street, New York, New York, in 1964. In 1969 and 1970, Bonner made plans for the building to become a residential cooperative apartment to be owned by its tenant-shareholders. As part of the deal plaintiff-appellant, the incorporated association of tenant shareholders, leased the building's commercial space to Bonner for a period of 30 years, assumed Bonner's outstanding first mortgage, and executed a purchase money second mortgage with Bonner.

Over 10 years later, on June 17, 1980, plaintiff commenced this diversity action, alleging that the commercial lease contained unfair and unconscionable terms that were not fully disclosed in the Offering Statement distributed to potential purchasers of the cooperative building. Plaintiff also alleged that by including such undisclosed terms in the lease defendants breached a fiduciary duty owed by promoters to purchasers. Plaintiff claimed that these wrongs entitled it to various forms of affirmative relief, including damages, an accounting, and rescission or modification of the lease and the mortgage. The District Court ruled, and plaintiff does not dispute on appeal, that all of such claims for affirmative relief are time-barred under New York law, which applies to this diversity action, Walker v. Armco Steel Corp., 446 U.S. 740, 100 S.Ct. 1978, 64 L.Ed.2d 659 (1980); Ragan v. Merchants Transfer & Warehouse Co., 337 U.S. 530, 69 S.Ct. 1233, 93 L.Ed. 1520 (1949); Guaranty Trust Co. v. York, 326 U.S. 99, 65 S.Ct. 1464, 89 L.Ed. 2079 (1945). Nevertheless, plaintiff asserts that the alleged prior wrongs afford it (a) a setoff to any further claims by defendant for payments due under the mortgage and lease, and (b) a defense in the event the defendant seeks to enforce the mortgage and lease obligations. Since defendants take the position that no prior wrongs occurred that would constitute a defense to any claims they might have under the mortgage and lease, plaintiff alleges a present controversy with the defendants, ¹ and pursues on appeal its claim for a declaratory judgment to establish its non-liability.

To bring into focus the nature of the potential conflict between New York's substantive limitations policy and the federal declaratory judgment procedure, we must distinguish plaintiff's claim from the more typical suit in which a claim for a declaratory judgment encounters a limitations defense. When the declaratory judgment sought by a plaintiff would declare his entitlement to some affirmative relief, his suit is time-barred if the applicable limitations period has run on a direct claim to obtain such relief. What determines the applicable limitations period is "the basic nature of the suit in which the issues involved would have been litigated if the Declaratory Judgment Act had not been adopted." Romer v. Leary, 425 F.2d 186, 188 (2d Cir. 1970). Since the plaintiff has acknowledged that his claims for affirmative relief are time-barred, he likewise can secure no declaration of entitlement to such relief. Nevertheless, the plaintiff contends that he is entitled to a "defensive" declaration that he has a valid setoff to claims by the defendants and that he is not liable to the defendants. See Luckenbach Steamship Co. v. United States, 312 F.2d 545, 548-49 (2d Cir. 1963). Transposing the language of Romer from the context of a declaration of entitlement to affirmative relief, plaintiff contends that the "basic nature" of his declaratory judgment claim is the establishment of a defense. He then invokes N.Y.Civ.Prac.Law § 203(c) (McKinney 1972), which provides a partial exemption of defenses from the bar of a statute of limitations. Section 203(c) provides:

A defense or counterclaim is not barred if it was not barred at the time the claims asserted in the complaint were interposed, except that if the defense or counterclaim arose from the transactions, occurrences, or series of transactions or occurrences, upon which a claim asserted in the complaint depends, it is not barred to the extent of the demand in the complaint notwithstanding that it was barred at the time the claims asserted in the complaint were interposed.

Combining his contentions, plaintiff asserts that since New York law would permit him to assert his defense to a claim by defendants on the mortgage or lease, plaintiff can secure a declaration of the validity of his defense under the Federal Declaratory Judgment Act, 28 U.S.C. § 2201 (1976).

Since § 203(c) is a carefully constructed exception to New York's substantive law of limitations, we think analysis of plaintiff's contention must start with consideration of whether New York law permits a time-barred defense to be used to initiate a declaratory judgment action. Normally, the availability of state declaratory relief would be irrelevant to whether a federal court may grant such a remedy. Plainly the fact that a state might not have any declaratory remedy is "immaterial" to whether the federal remedy may be used. Skelly Oil Co. v. Phillips Petroleum Co., 339 U.S. 667, 674, 70 S.Ct. 876, 880, 94 L.Ed. 1194 (1950). ² But when a state that has a declaratory remedy withholds it in a particular class of cases in order to vindicate a state substantive policy, such as a limitations policy, it is entirely appropriate for a federal court to assess the impact of its grant of a declaratory remedy on that substantive policy of the state. See Great Lakes Dredge & Dock Co. v. Huffman, 319 U.S. 293, 298-301, 63 S.Ct. 1070, 1073-1074, 87 L.Ed. 1407 (1943); Beacon Construction Co. v. Matco Electric Co., 521 F.2d 392, 397-98 (2d Cir. 1975); Allstate Insurance Co. v. Charneski, 286 F.2d 238, 243-44 (7th Cir. 1960). ³

The plain words of § 203(c) strongly imply that escape from a time bar is available only to a party that is called upon to defend. The statute contemplates interposing an otherwise time-barred defense to a complaint, and, then, only "to the extent of the demand in the complaint."

The history of the statute indicates that New York would not extend it, in the circumstances of this case, to permit the use of a time-barred defense to initiate a declaratory judgment action. The Practice Commentary indicates that § 203(c) codifies the doctrine of equitable recoupment. ⁴ See SCM Corp. v. Fisher Park Lane Co., 40 N.Y.2d 788, 358 N.E.2d 1024, 1026, 390 N.Y.S.2d 398, 401 (1976); id. 358 N.E.2d at 1030, 390 N.Y.S.2d at 404 (Cooke, J., dissenting). Under that doctrine a defense that would be time-barred as a claim for affirmative relief may be used to reduce an adverse recovery where the defense establishes an equitable defect inhering in the adverse party's claim. The doctrine is founded in considerations of fairness; it would be highly inequitable to permit a party to place a question before a court and then prevent the opposing party from disputing issues lying at the foundation of the claim. Bull v. United States, 295 U.S. 247, 262, 55 S.Ct. 695, 700, 79 L.Ed. 1421 (1935); Pennsylvania R. Co. v. Miller, 124 F.2d 160, 162 (5th Cir. 1941), cert. denied, 316 U.S. 676, 62 S.Ct. 1047, 86 L.Ed. 1750 (1942); Williams v. Neely, 134 F. 1, 4-5, 12-13 (8th Cir. 1904). The purposes underlying statutes of limitation-the prevention of stale litigation and the protection of repose-do not apply when a time-barred defense is asserted against a timely claim that initiates a lawsuit. See United States v. Western Pacific R. R., 352 U.S. 59, 72, 77 S.Ct. 161, 169, 1 L.Ed.2d 126 (1956). In fact, preventing such use of the defense would provide an incentive to delay bringing some claims until a defense would be time-barred. Marsh v. Richer, 68 Misc. 587, 125 N.Y.S. 245 (1910) (negligence defense to physician's claim for services performed).

In New York, the doctrine can be traced back at least as far as Maders v. Lawrence, 49 Hun. 360, 2 N.Y.S. 159 (S.Ct.1888), which involved an exchange of horses...