Rudell v. Comprehensive Accounting Corp.

• Decision Date: 30 September 1986
• Docket Number: No. 85-2815,85-2815
• Citation: 802 F.2d 926
• Parties: RICO Bus.Disp.Guide 6386 Glenn L. RUDELL, and Jean C. Rudell, and Edward W. Bergquist, as Bankruptcy Trustee for Glenn and Jean Rudell, Minnesota Bankruptcy Court file no. 4-84-230; individually and on behalf of all others similarly situated, Plaintiffs-Appellants, v. COMPREHENSIVE ACCOUNTING CORPORATION, Comprehensive Business Corporation, Leo G. Lauzen and Christopher J. Lauzen, Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 926

802 F.2d 926

RICO Bus.Disp.Guide 6386

Glenn L. RUDELL, and Jean C. Rudell, and Edward W Bergquist, as Bankruptcy Trustee for Glenn and Jean Rudell Minnesota Bankruptcy Court file no. 4-84-230; individually and on behalf of all others similarly situated, Plaintiffs-Appellants, v. COMPREHENSIVE ACCOUNTING CORPORATION, Comprehensive Business Corporation, Leo G. Lauzen and Christopher J Lauzen, Defendants-Appellees.

No. 85-2815.

United States Court of Appeals Seventh Circuit.

Argued April 15, 1986.

Decided Sept. 30, 1986.

Bruce C. Davidson, Chicago, Ill., for plaintiffs-appellants.

Reuben A. Bernick, Rudnick & Wolfe, Chicago, Ill., for defendants-appellees.

Before WOOD, and POSNER, Circuit Judges, and FAIRCHILD, Senior Circuit Judge.

HARLINGTON WOOD, Jr., Circuit Judge.

Plaintiffs-appellants Glenn and Jean Rudell and Edward Bergquist, in his role as bankruptcy trustee for the Rudells, ¹ appeal the district court's order granting summary judgment in favor of defendants-appellees Comprehensive Accounting Corporation and Comprehensive officers Leo and Christopher Lauzen. ² The Rudells allege that they were fraudulently induced to enter a franchise agreement with Comprehensive in violation of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. Sec. 1961 et seq., the Illinois Franchise Disclosure Act, Ill.Rev.Stat. ch. 121 1/2, p 701 et seq., and the Illinois Consumer Fraud and Deceptive Business Practices Act, Ill.Rev.Stat. ch. 121 1/2, p 261 et seq. Additionally, the Rudells seek relief on the basis of common-law fraud and deceit. ³ The district court ruled that the Rudells' action was barred as res judicata since they failed to raise their fraud claims as a defense in an arbitration proceeding initiated by Comprehensive. We affirm.

I.

On September 5, 1980, the Rudells became franchisees of Comprehensive Business Corporation. See note 2. Comprehensive was involved in a franchise program providing computerized accounting services. The Rudells' franchise relationship was memorialized by several contracts including a license agreement, a sales agreement, a finance agreement and an installment collateral note (collectively the "franchise agreement"). The franchise agreement provided for mandatory and binding arbitration of disputes between the parties. In September 1983, Comprehensive, claiming that the Rudells had defaulted on their obligations arising under the agreement, invoked this arbitration provision. The Rudells did not make an appearance at the arbitration proceeding nor did they seek to enjoin it. In the Rudells' absence, the arbitrator awarded Comprehensive both damages and equitable relief.

Thereafter, Comprehensive sought to have its award confirmed by the district court pursuant to section nine of the United States Arbitration Act, 9 U.S.C. Sec. 9 (1982). In the district court, the Rudells raised several objections to the confirmation of Comprehensive's award and requested that the award be vacated. One of the objections the Rudells raised in this proceeding was that the franchise agreement "was procured through fraud and misrepresentation, in violation of state and federal law." Although raising the objection, the Rudells did not present evidence substantiating their allegations of fraud and misrepresentation. The district court ultimately entered judgment confirming Comprehensive's arbitration award and denied the Rudells' motion to vacate. Comprehensive Accounting Corp. v. Rudell, No. 83 C 8568 (N.D.Ill. Jan. 3, 1984) (Leighton, J.). The Rudells then appealed alleging that the district court erroneously rejected their claim that the arbitration provision in the franchise agreement was invalid, and we affirmed. Comprehensive Accounting Corp. v. Rudell, 760 F.2d 138 (7th Cir.1985).

Prior to our decision to affirm the district court's confirmation of the arbitration award, the Rudells instituted the present suit alleging that the entire franchise agreement was procured by fraud. After the bankruptcy trustee was added as a party plaintiff, the appellees moved to dismiss the Rudells' complaint. Treating the motion to dismiss as a motion for summary judgment, the district court ruled that the Rudells' action was barred as res judicata since they failed to raise their fraud claims as a defense in the arbitration proceedings. The Rudells appeal the court's order granting summary judgment in favor of the appellees.

II.

The Rudells' case presents the issue of whether the doctrine of res judicata will, under certain circumstances, bar a party from subsequently raising claims based on facts which could have constituted a defense to a prior proceeding. The Rudells concede that they could have raised as a defense to arbitration their contention that the franchise agreement was procured by fraud and was therefore unenforceable. The validity of the obligations due and payable under the franchise agreement is not in question here and the Rudells do not allege that the arbitration award was improperly secured. Rather, they claim to raise the fraud issue not as a defense to the obligations due under the agreement, but as an affirmative weapon to undercut the validity of the agreement itself. The Rudells contend that, although the same facts underpin both their present claims and the fraud defense that they concede could have been raised in arbitration, the failure to raise that defense earlier is not a bar to the instant action.

We dealt with a similar issue in Martino v. McDonald's System, Inc., 598 F.2d 1079 (7th Cir.), cert. denied, 444 U.S. 966, 100 S.Ct. 455, 62 L.Ed.2d 379 (1979). Like the present case, Martino involved a franchise agreement. The franchisor in Martino brought suit against the franchisee alleging that the franchisee had violated a restrictive covenant in the agreement. The lawsuit was eventually resolved by a consent judgment pursuant to which the franchisee divested itself of a business that the franchisor claimed was in violation of the franchise agreement. Several years thereafter, however, the franchisee brought suit alleging that enforcement of the restrictive covenant constituted an antitrust violation. Id. at 1081.

In affirming the district court's grant of summary judgment in favor of the franchisor on res judicata grounds, we noted that, in most instances like Martino in which the same facts underpin both a defense and a counterclaim, failure to raise the defense or counterclaim in a prior proceeding does not bar a party from raising a claim based on those same facts in a subsequent action. Id. at 1084. The reasoning underlying such a result is generally sound in cases in which a party is not otherwise required to assert a compulsory counterclaim pursuant to Fed.R.Civ.P. 13(a). As we stated at the time:

Should the earlier litigation end in its very first stage, no great burden on the court results from permitting a counterclaim to be raised at a more convenient time and place. Notions of judicial economy give way to fairness. The defendant in the earlier action has his day in court when and where he sees fit.

Id. at 1085.

Nonetheless, we observed that this rule is not universally applicable. The "long-standing principles of res judicata establish a narrowly defined class of 'common law compulsory counterclaims,' " and in limited circumstances failure to raise such counterclaims or related defenses in previous proceedings does constitute a bar to related claims being raised later. Id. at 1083.

Both precedent and policy require that res judicata bar a counterclaim when its prosecution would nullify rights established by the prior action. Judicial economy is not the only basis for the doctrine of res judicata. Res judicata also preserves the integrity of judgments and protects those who rely on them.

Id. at 1085 (emphasis added). See Restatement (Second) of Judgments Sec. 22(2)(b) (1982) (a defendant is precluded from raising a claim that could have been raised as a counterclaim or a defense in a previous action if the relationship between the claim now being raised and the counterclaim or defense "is such that successful prosecution of the second action would nullify the initial judgment or would impair rights established in the initial action").

Applying this reasoning in Martino, we concluded that the plaintiff could have raised the antitrust claim as a defense to the imposition of the consent judgment but failed to do so. Accordingly, because litigation of the antitrust claim in a subsequent action was in essence an attack upon the earlier consent judgment, we ruled that the plaintiff's antitrust claim was barred as res judicata. Id. at 1083.

Similarly, in Lee v. City of Peoria, 685 F.2d 196 (7th Cir.1982), we affirmed the trial court's dismissal of the plaintiff's civil rights suit alleging racial discrimination. In Lee, the plaintiff police officer was dismissed by the Board of Fire and Police Commissioners after he had allegedly given false testimony as to his whereabouts to the Board. The plaintiff's only defense was that he was in fact telling the truth. The plaintiff thereafter sought administrative review of the Board's order in state court and alleged, among other things, that his discharge was racially motivated. Although the plaintiff alleged racial discrimination, the record indicated that he presented no evidence with respect to this claim either before the Board or during the administrative review in state court. The state court ultimately upheld the Board's decision to discharge the plaintiff and no further appeal was taken. Id. at 197-98.

Subsequently, the plaintiff filed a civil rights suit in the district court alleging that his discharge constituted unlawful discrimination. The district court dismissed the suit on res judicata and collateral estoppel grounds. Id. Citing the general rule enunciated in Martino, and noting that raising the issue of discriminatory motive "would have been a complete defense" to...