Tuesday, February 27, 2007

To stay or dismiss?

The major cases from the courts of appeals and all cases from the Supreme Court receive ample attention.   We'll continue to link to those decisions as they are decided, but many interesting procedural and jurisdictional issues arise in the more obscure recent cases, such as The Lexus Real Estate Group, Inc v. Bullitt County Bank, 2007 WL 542402.

The Bank obtained a default judgment against the debtors in an Indiana State Court foreclosure action.  The Debtors appealed, challenging improper service of process.  The intermediate appellate court noted some oddities with the service but affirmed.

While the Debtors were preparing their challenge to the Indiana Supreme Court, the Debtors also filed a federal-court action against the Bank, asserting claims related to the foreclosure.  The Bank moved for summary judgment, arguing that the Debtors were precluded from asserting the related claims.  By the time the federal district court ruled on the preclusion defense, the case was pending before the Indiana Supreme Court.

The Bank had a valid preclusion defense.  Since the allegedly preclusive judgment was rendered by an Indiana State Court, the Full Faith and Credit Act required the district court to apply Indiana preclusion principles.  Under Indiana law, the claims were precluded as compulsory counterclaims.  The Debtor argued that the state-court judgment was not entitled to preclusive effect because of improper service, but that argument was properly rejected based on the issue-preclusive effect of the state court's ruling on the service issue.  And as is common, the pendency of an appeal did not strip a judgment of preclusive effect.

The district judge dismissed the claims with prejudice.The Court then noted the challenge pending before the Indiana Supreme Court.  "If the Indiana Supreme Court ultimately decides that service of process was improper, Debtors will have an opportunity to file these claims as compulsory counterclaims...."

It seems to me that the district judge's dismissal with prejudice unnecessarily complicates matters, given the credible challenge to the validity of the judgment in state court.  If the Indiana Supreme Court reverses, the debtors will still be faced with a potentially preclusive judgment, only now it will be the federal court's judgment based on the preclusive effect of a judgment that has been reversed.  Perhaps the court's notation that the Debtors are free to refile their claims as counterclaims solves that problem.  At the least, the Debtors would succeed in reopening the federal judgment.  But isn't a stay preferable? If the Indiana Supreme Court reverses, the debtors are free to do more than the court suggests--file their claims as compulsory counterclaims in state court--they are free to refile this same federal suit, as the existence of parallel proceedings is no bar to federal jurisdiction.  If the Indiana Supreme Court affirms, then the federal district court can dismiss with "real" prejudice to the claims being filed again.  In this scenario, a stay doesn't infringe upon Colorado River Abstention policies; if anything, it advances them.



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