Towers, Perrin, Forster & Crosby, Inc. v. Brown

• Decision Date: 20 April 1984
• Docket Number: No. 82-1526,82-1526
• Citation: 732 F.2d 345
• Parties: In the Matter of the Arbitration between TOWERS, PERRIN, FORSTER & CROSBY, INC., v. B. Peter BROWN and David F. Riding, Appellants.
• Court: U.S. Court of Appeals — Third Circuit

Page 345

732 F.2d 345

In the Matter of the Arbitration between TOWERS, PERRIN FORSTER & CROSBY, INC., v. B. Peter BROWN and David F. Riding, Appellants.

No. 82-1526.

United States Court of Appeals, Third Circuit.

Argued March 9, 1983.

Decided April 20, 1984.

Michael F. Eichert (argued), Bloom, Ochs, Fisher & Anderson, Philadelphia, Pa., William T. Murphy, The Law Offices of Chris Schaefer, San Rafael, Cal., for appellants.

Thomas M. Kittredge (argued), Deborah A. Lefco, Morgan, Lewis & Bockius, Philadelphia, Pa., for appellee.

Before SEITZ, Chief Judge, and HIGGINBOTHAM and SLOVITER, Circuit Judges.

OPINION OF THE COURT

SEITZ, Chief Judge.

This is an appeal from an order of the district court granting Towers, Perrin, Forster & Crosby's (TPFC) petition compelling arbitration and staying an action brought by Brown and Riding in the state court in California. Jurisdiction in the district court was based on diversity. The order compelling arbitration is appealable under 28 U.S.C. Sec. 1291. Gavlik Construction Co. v. H.F. Campbell Co., 526 F.2d 777, 782 (3d Cir.1975). TPFC argues that the Enelow-Ettelson doctrine prevents our hearing an appeal from the order staying proceedings in the state court. The Enelow-Ettelson doctrine applies only to a court's stay of its own proceedings, however, so the order staying proceedings in California is appealable under 28 U.S.C. Sec. 1292(a)(1). FDIC v. Santiago Plaza, 598 F.2d 634, 635-36 (1st Cir.1979); 16 Wright et al., Federal Practice & Procedure Sec. 3923 at 48.

I

Brown and Riding were employed as insurance agents and brokers in TPFC's San Francisco, California office. As one of the perquisites of employment they became eligible to purchase TPFC shares. Only employees were permitted to be shareholders, and the company repurchased shares held by employees who left the firm. The terms and conditions of share ownership were specified in a Shareholder's Agreement, which was later made part of TPFC's bylaws.

Among the terms in the Shareholder's Agreement was a noncompetition covenant, which provided that a stockholder leaving TPFC would forfeit the increase over purchase price of his shares unless he agreed not to compete with TPFC for two years after leaving the firm. Another term in the Agreement provided that any dispute "with respect to the provisions" governing share ownership would be subject to arbitration.

Brown and Riding decided to leave TPFC and start a competing business. TPFC gave notice that it would not redeem their stock at its appreciated value unless they agreed to, and did, abide by the noncompetition covenant. Brown and Riding filed an action in the state superior court seeking a declaratory judgment that the noncompetition and forfeiture provisions were unenforceable, and damages in the amount of the appreciation of their TPFC stock. In addition to its answer, TPFC filed a petition to compel arbitration pursuant to the California Arbitration Act, Cal.Civ.Proc.Code Secs. 1280 et seq. The superior court denied the petition to compel arbitration, and TPFC appealed.

Over two months after TPFC's petition in the state court was denied, and while its appeal was pending, TPFC filed a petition in the District Court for the Eastern District of Pennsylvania to compel arbitration pursuant to the Federal Arbitration Act, 9 U.S.C. Secs. 1 et seq., and to stay the California proceedings. The district court denied Brown and Riding's motion to dismiss, and TPFC moved for summary judgment. While this motion was pending, the California Court of Appeal affirmed the state court's denial of TPFC's petition on the ground that the Agreement involved employee compensation, and that California Labor Code Sec. 229 prohibits arbitrating such disputes. The state supreme court denied TPFC's petition for review on July 7, 1982. On August 25, 1982, the district court granted TPFC's motion to compel arbitration and stayed the California proceedings on the merits. This appeal followed.

II

Brown and Riding argue that the district court's order was error because the California decision that the dispute was not arbitrable is res judicata. The preclusive effect of the California judgment in the federal court is governed by 28 U.S.C. Sec. 1738, which provides that state court judgments "shall have the same full faith and credit in every court ... as they have by law or usage in the courts of such State ... from which they are taken." Thus, we must determine what preclusive effect California would give its own judgment in order to know what effect it should have been given in the district court. Migra v. Warren City School District Board of Education, --- U.S. ----, 104 S.Ct. 892, 79 L.Ed.2d 56 (1984); Allen v. McCurry, 449 U.S. 90, 101 S.Ct. 411, 66 L.Ed.2d 308 (1980); Davis v. United States Steel Supply, 688 F.2d 166, 170 (3d Cir.1982) (in banc), cert. denied, --- U.S. ----, 103 S.Ct. 1256, 75 L.Ed.2d 484 (1983).

In California, a subsequent suit between the same parties on the same cause of action is barred by res judicata if a prior suit was concluded on the merits by a court having subject matter jurisdiction. Busick v. Workmen's Compensation Appeals Board, 7 Cal.3d 967, 104 Cal.Rptr. 42, 500 P.2d 1386, 104 Cal.Rptr. 42 (1972); Panos v. Great Western Packing Co., 21 Cal.2d 636, 134 P.2d 242 (1943); Bernhard v. Bank of America N.T. & S.A., 19 Cal.2d 807, 810, 122 P.2d 892 (1942). The bar applies to claims or defenses that could have been raised in the prior proceeding, as well as to matters that were raised. Sutphin v. Speik, 15 Cal.2d 195, 99 P.2d 652 (1940); City of Glendale v. Gardner, 10 Cal.App.3d 777, 89 Cal.Rptr. 219 (1970); Skidmore v. Solano County, 154 Cal.App.2d 449, 316 P.2d 646 (1956). TPFC argues that the California judgment is not res judicata because the state court lacked subject matter jurisdiction, that the proceedings in the district court involved a different cause of action than those in state court, and that the California judgment is not final and therefore not preclusive. The district court held that it was not bound by the California judgment because that judgment was not final.

We first address whether the state court acted without subject matter jurisdiction. In proceedings in state or federal court to compel arbitration, the arbitrability of a dispute is governed by the Federal Arbitration Act if the arbitration provision is part of an agreement involving interstate commerce. Southland Corp. v. Keating, --- U.S. ----, ---- - ----, 104 S.Ct. 852, 858-60, 79 L.Ed.2d 1 (1984); Moses H. Cone Memorial Hospital v. Mercury Construction Co., --- U.S. ----, ---- 103 S.Ct. 927, 942, 74 L.Ed.2d 765 (1983). ¹ TPFC argues that because its agreement with Brown and Riding involves interstate commerce, the superior court lacked subject matter jurisdiction to enter an order denying arbitration under California law. We reject this contention because in our view a state court's failure to apply controlling federal law does not go to that court's subject matter jurisdiction. The situation here is no different from any other where a federal right, because of the supremacy clause, is superior to a right arising under state law. The failure of the state court to give effect to the federal right is an error of law, not an act beyond the jurisdiction of the court. See Ultracashmere House, Ltd. v. Meyer, 664 F.2d 1176, 1184 (11th Cir.1981), where the federal court held that a state court had subject matter jurisdiction so that its denial of arbitration based on state law was res judicata.

TPFC next argues that the same cause of action is not involved in the California and the federal proceedings. For purposes of res judicata, California defines cause of action as "the obligation to be enforced." Panos, supra, 134 P.2d at 244. The California action, TPFC argues, is for a declaratory judgment and damages, while the federal action is for a stay and to compel arbitration. We believe, however, that the relevant comparison is not between the relief sought by Brown and Riding in the state court and by TPFC in the federal court, but between the relief TPFC sought in both actions. In California, a petition to compel arbitration involves a separate special proceeding. This proceeding was one brought by TPFC to enforce its right to arbitration, and TPFC could have asserted its rights under the Federal Arbitration Act but chose not to. This is precisely the type of situation in which the same cause of action is involved for res judicata purposes. It is irrelevant that TPFC was a defendant in state court but a plaintiff in federal court. A defendant's right to compel arbitration is considered a compulsory counterclaim or affirmative defense, and if it is not asserted by a defendant, res judicata will prevent it from being raised affirmatively in another proceeding. See Depuy-Busching General Agency v. Ambassador Insurance Co., 524 F.2d 1275 (5th Cir.1975); Butchers Union Local 532 v. Farmers Markets, 67 Cal.App.3d 905, 136 Cal.Rptr. 894 (1977); Restatement (Second) of Judgments, Secs. 22(2), 23. We conclude that the proceedings to compel arbitration in the California court and the district court involved attempts by TPFC to enforce the same right, and thus the same cause of action.

TPFC further contends that the order denying arbitration is not final for res judicata purposes. There appears to be no California decision that has determined whether an order denying arbitration is entitled to preclusive effect in subsequent proceedings. Thus, our duty is to predict how the California Supreme Court would treat such an order. Cf. Compagnie des Bauxites de Guinee v. Insurance Company of North America, 724 F.2d 369, 371 (3d Cir.1983); Pennsylvania Glass Sand Corp. v. Caterpillar Tractor Co., 652 F.2d 1165, 1167 (3d Cir.1981). We conclude for several reasons that the California Supreme Court would hold that the order denying arbitration was a final order, and that res judicata...