Salwen Paper Co., Inc. v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

• Decision Date: 11 February 1980
• Citation: 72 A.D.2d 385,424 N.Y.S.2d 918
• Parties: SALWEN PAPER COMPANY, INC., Profit Sharing Retirement Trust, Appellant, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Respondent.
• Court: New York Supreme Court — Appellate Division

Page 918

424 N.Y.S.2d 918

72 A.D.2d 385

SALWEN PAPER COMPANY, INC., Profit Sharing Retirement Trust, Appellant, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Respondent.

Supreme Court, Appellate Division, Second Department.

Feb. 11, 1980.

Julien, Schlesinger & Finz, P. C., New York City (David Jaroslawicz, Alfred S. Julien and Stuart A. Schlesinger, New York City, of counsel), for appellant.

Brown, Wood, Ivey, Mitchell & Petty, New York City (E. Michael Bradley and A. Robert Pietrzak, New York City, of counsel), for respondent.

Before MOLLEN, P. J., and HOPKINS, LAZER and O'CONNOR, JJ.

HOPKINS, Justice.

The action is brought to recover damages for breach of fiduciary duty and negligent performance of that duty. The plaintiff is a corporation which formed a profit sharing plan for its employees. The defendant is a securities broker to whom allegedly the funds of the plan were given for investment.

The defendant moved to dismiss the complaint Inter alia on the ground that the action was barred by operation of the doctrine of Res judicata arising from the dismissal of a prior action brought by the plaintiff against the defendant in the United States District Court for the Southern District of New York. Special Term granted the defendant's motion to dismiss, and the plaintiff appeals.

We reverse. The action is not barred by the dictates of Res judicata, since the dismissal of the prior action in the Federal court did not touch the common-law claims asserted, but only the claims alleging violations of Federal securities statutes and rules; the Federal courts declined to consider the common-law claims under the theory of pendent jurisdiction. Hence, the common-law claims survive the dismissal in the Federal court, and may properly be the objects of the action before us.

I

The litigation between the parties has followed a winding path. The plaintiff filed a complaint in the District Court for the Southern District of New York on February 8, 1977. That complaint consisted of eight causes of action, some of which alleged claims for damages based on violations of the provisions of the Securities and Exchange Act (U.S.Code, tit. 15, § 78j, subd. (b); rule 10b-5; U.S.Code, tit. 15, § 78O ), and some of which alleged, as in the complaint under review, claims for damages based on breach of fiduciary duty and negligent performance of fiduciary duty.

The defendant moved to dismiss the complaint (Fed.Rules Civ.Pro., rule 12, subd. (b), par. 1; rule 6; rule 12, subd. (f)). On May 26, 1977 the District Court granted the motion, finding that the complaint contained "merely conclusory allegations", which were insufficient to constitute "securities law complaints" under the controlling precedents (see Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668; Shemtob v. Shearson, Hammill & Co., 2 Cir., 448 F.2d 442; Carroll v. Bear, Stearns & Co., D.C., 416 F.Supp. 998).

The plaintiff appealed the dismissal to the Second Circuit Court of Appeals. The Court of Appeals remanded the action to the District Judge "for further proceedings without prejudice to renewal of the appeal after completion of the proceedings" in the District Court, which the District Judge assumed "contemplated reconsideration by this Court of its order dismissing the action so that an application for leave to amend the complaint could be considered" (Salwen Paper Co., Profit Sharing Retirement Trust v. Merrill Lynch, Pierce, Fenner & Smith, Inc., D.C., 79 F.R.D. 130, 132-133). ^*

The plaintiff thereafter applied to the District Court for leave to amend its complaint. The District Court denied the application on June 23, 1978, finding that "the proposed amended complaint is no more successful in its attempt to state valid claims than was the original complaint" (Salwen Paper Co., Profit Sharing Retirement Trust v. Merrill Lynch, Pierce, Fenner & Smith, Inc., supra, p. 134). The District Court ended its opinion by stating (Id., at p. 137):

"Finally the proposed amended complaint repeats, with little or no alteration, the common law claims of the original complaint based on negligence (third and seventh claims), breach of contract (fourth claim) and common law fraud (sixth claim). It is well settled that if federal claims are subject to dismissal under Rule 12(b), then the allegedly 'pendent' common law claims should also be dismissed. United Mine Workers v. Gibbs, 383 U.S. 715, 726, 83 S.Ct. 1130, 16 L.Ed.2d 218; Kavit v. A. L. Stamm & Co., 491 F.2d 1176, 1179-80 (2d Cir. 1974). This is particularly true in a 'garden-variety customer-broker suit'. Carroll v. Bear, Stearns & Co., supra, 416 F.Supp. at 1002. Since the proposed amended complaint does not state a federal claim for relief, there is no federal jurisdiction for the third, fourth, sixth and seventh claims.

"Accordingly, the plaintiff's motion for leave to file an amended complaint is denied."

The plaintiff did not appeal the decision of the District Court, but on October 25, 1978 moved in the Second Circuit Court of Appeals to renew the earlier appeal. On December 12, 1978 that motion was denied by the Second Circuit.

This action was commenced on December 15, 1978. The defendant moved to dismiss the complaint on the ground that the causes of action alleged were barred by Res judicata (CPLR 3013, 3016, subd. (b), 3211, subd. (a), pars. 5, 7). Special Term dismissed the complaint, holding that the prior determination in the Federal courts precluded a relitigation in the State court, since the underlying basis of the plaintiff's complaint in both the Federal and State courts was the same.

The sole issue before us, then, is whether the principles of Res judicata apply to this case.

II

Special Term relied largely on our decision in McLearn v. Cowen & Co., 64 A.D.2d 606, 406 N.Y.S.2d 538. There we said (at p. 606, 406 N.Y.S.2d at p. 538):

"The complaint should have been dismissed on the ground of Res judicata. In the prior action in Federal court, plaintiff made the same allegations of breaches by appellant of its common-law fiduciary duties as she complains of in the instant action. Moreover, the motion should have been granted for failure to state a cause of action, notwithstanding the fact that appellant did not specify such ground in its papers (see Wolfe v. Bellizzi, 58 Misc.2d 773, 296 N.Y.S.2d 860). Based on the history of the instant litigation, plaintiff is deemed to have had notice of the additional ground upon which our reversal is based."

The facts in McLearn are more elaborately treated in the memorandum of the majority and in the dissenting opinions in the Court of Appeals (48 N.Y.2d 696, 422 N.Y.S.2d 60, 397 N.E.2d 750). The plaintiff in McLearn had sued originally in the Federal courts alleging eight causes of action, some of which claimed violations of Federal statutes, and others breach of common-law fiduciary duties, negligence, and unprofessional conduct. The District Court granted the defendant's motion to dismiss for failure to allege fraud with sufficient particularity (Fed.Rules Civ.Pro. rule 9, subd. (b)). On appeal the Second Circuit affirmed.

The majority memorandum of the Court of Appeals affirmed this court in McLearn on the theory that the common-law claims alleged in the State action were barred by Res judicata, because it was not clear on the record that the Federal court had declined to exercise its pendent jurisdiction. Thus it was said (McLearn v. Cowen & Co., 48 N.Y.2d 696, 698, 422 N.Y.S.2d 60, 61, 397 N.E.2d 750, 751, Supra ):

"The only basis on which the present claim would not now be precluded would be that plaintiff-appellant's present common-law claim could not have been asserted in the Federal action. Although it is conceded that the common-law cause of action could have been considered only under the pendent jurisdiction of the Federal court and that the Federal court could have declined to exercise such jurisdiction, unless it is clear that the Federal court as a matter of discretion did decline or would have declined to exercise that jurisdiction, the State action is barred (see (Restatement, Judgments, 2d (Tent. Draft No. 1, 1973)) Id., § 61.1, Comment E and Illustration 10). In the present instance, on the record in the Federal action submitted to us it is not clear that the Federal court did decline or would have declined to exercise its pendent jurisdiction. That issue appears not to have been raised or even considered by the parties or by the court. Plaintiff-appellant made no application for any clarification or limitation with respect to the scope or the dismissal of the Federal action."

In dissent Chief Judge COOKE and Judge MEYER disagreed as to the majority's interpretation of Federal pendent jurisdiction. Chief Judge COOKE found that no presumption of exercise of pendent jurisdiction exists where the Federal claims are dismissed on the pleadings prior to trial (McLearn v. Cowen & Co., 48 N.Y.2d 696, 700, 422 N.Y.S.2d 60, 62, 397 N.E.2d 750, 752, Supra ). Judge MEYER found that the defendants had not sustained their burden of showing that the common-law claims had been in fact considered by the Federal courts (Supra, p. 705, 422 N.Y.S.2d p. 66, 397 N.E.2d p. 755). Hence, in the view of the Judges in the minority, in McLearn, res judicata did not apply, since there was no clear demonstration by the defendants that the Federal courts had in fact passed on the common-law claims. The Judges in the majority, on the other hand, placed the onus on the plaintiff to demonstrate that the Federal courts had not passed on the common-law claims.

We must now consider the present appeal in the light of McLearn.

III

The critical question to be answered is whether the Federal courts determined the merits of the plaintiff's common-law claims. The answer rests on a construction of the opinion of the District Judge following the remand by the Second Circuit. The District Judge's analysis of the plaintiff's proposed amended...