Paramount Pictures Corporation, Appellant,v.Allianz Risk Transfer AG, et al., Respondents, et al., Defendant.BriefN.Y.January 10, 2018APL-2016-00221 To Be Argued By: RICHARD B. KENDALL Time Requested 30 Mirrutes New York County Clerk's Index No. 653708/14 Olnurt nf J\pp.eals STATE OF NEW YORK ..... PARAMOUNT PICTURES CORPORATION, Plaintiff-Appellant, -against- ALLIANZ RISK TRANSFER AG, MARATHON STRUCTURED FINANCE FUND, L.P., NEWSTAR FINANCIAL, INC. and MUNICH RE CAPITAL MARKETS NEW YORK, INC., Defendants-Respondents. BRIEF FOR PLAINTIFF-APPELLANT E. LEO MILONAS, ESQ. EDWARD FLANDERS, ESQ. PILLSBURY WINTHROP SHAW PITTMAN LLP 1540 Broadway New York, New York 10036 Telephone: (212) 858-1000 Facsimile: (212) 858-15 00 RICHARD B. KENDALL, ESQ. (pro hac vice) KENDALL BRILL & KELLY LLP 10100 Santa Monica BoulevaTd, Suite 1725 Los Angeles, Califomia 90067 Telephone: (31 0) 5 56-2700 Facsimile: (310) 556-2705 Attorneys for Plaintiff-Appellant Paramount Pictures Corporation JanuaTy 20, 2017 i CORPORATE DISCLOSURE STATEMENT Pursuant to Rules 500.1(f) and 500.13(c)(3) of the Rules of Practice of the Court of Appeals of the State of New York, Plaintiff-Appellant Paramount Pictures Corporation is a wholly-owned subsidiary of Viacom Inc., which is a publicly- traded corporation. The following entities are subsidiaries or affiliates of Plaintiff-Appellant Paramount Pictures Corporation: Paramount Channel Espana, S.L.U.; Paramount China B.V.; Paramount Digital Entertainment Inc.; Paramount Films of China, Inc.; Paramount Films of India, Ltd.; Paramount Films of Southeast Asia Inc.; Paramount Home Entertainment (Australasia) Pty Limited; Paramount Home Entertainment (Brazil) Limitada; Paramount Home Entertainment (France) S.A.S.; Paramount Home Entertainment (Germany) GmbH; Paramount Home Entertainment (Italy) SRL; Paramount Home Entertainment (Mexico) S. de R.L. de C.V.; Paramount Home Entertainment (Mexico) Services S. de R.L. de C.V.; Paramount Home Entertainment (UK); Paramount Home Entertainment Distribution Inc.; Paramount Home Entertainment Inc.; Paramount Home Entertainment International (Holdings) B.V.; Paramount Home Entertainment International B.V.; Paramount Home Entertainment International Limited; Paramount Images Inc.; Paramount International (Netherlands) B.V.; Paramount Japan G.K; Paramount LAPTV Inc.; Paramount Latin America SRL; Paramount ii Licensing Inc.; Paramount Movie and TV Program Planning (Beijing) Co., Ltd.; Paramount NMOC LLC; Paramount Overseas Productions, Inc.; Paramount Pictures Australia Pty.; Paramount Pictures Brasil Distribuidora de Filmes Ltda; Paramount Pictures China Limited; Paramount Pictures Corporation (Canada) Inc.; Paramount Pictures Entertainment Canada ULC; Paramount Pictures France Sarl; Paramount Pictures Germany GmbH; Paramount Pictures International Limited; Paramount Pictures Louisiana Production Investments II LLC; Paramount Pictures Louisiana Production Investments III LLC; Paramount Pictures Louisiana Production Investments LLC; Paramount Pictures Mexico S. de R.L. de C.V.; Paramount Pictures NZ; Paramount Pictures Services UK; Paramount Pictures UK; Paramount Poland sp. z.o.o.; Paramount Production Support Inc.; Paramount Productions Service Corporation; Paramount Spain S.L.U.; Paramount Sweden AB; Paramount Worldwide Productions Inc. iii STATEMENT OF RELATED LITIGATION Pursuant to Rule 500.13(a) of the Rules of Practice of the Court of Appeals of the State of New York, Plaintiff-Appellant Paramount Pictures Corporation states that, as of the date of the completion of this Brief, there is no related litigation pending before any court. iv TABLE OF CONTENTS Page CORPORATE DISCLOSURE STATEMENT ......................................................... i STATEMENT OF RELATED LITIGATION ........................................................ iii TABLE OF CONTENTS ......................................................................................... iv TABLE OF AUTHORITIES ................................................................................... vi QUESTIONS PRESENTED FOR REVIEW ......................................................... 1 JURISDICTION ......................................................................................................... 1 PRELIMINARY STATEMENT ............................................................................... 2 STATEMENT OF FACTS ........................................................................................ 6 A. Respondents Expressly Covenant Not To Sue Paramount In Connection With The Melrose Transaction ............................................................................... 6 B. Respondents Breach Their Covenant Not To Sue By Filing And Prosecuting The Federal Action ............................................................................. 8 C. The Proceedings To Date ............................................................................ 11 STANDARD OF REVIEW ..................................................................................... 13 ARGUMENT ........................................................................................................... 13 POINT I .................................................................................................................... 13 THE FIRST DEPARTMENT ERRED BY RELYING ON FEDERAL RULE OF CIVIL PROCEDURE 13(A) TO BAR PARAMOUNT’S COVENANT NOT TO SUE CLAIM UNDER NEW YORK’S LAW OF RES JUDICATA ....................................................................................................... 13 A. The First Department’s decision is contrary to the legislature’s considered judgment to fashion New York as a permissive counterclaim jurisdiction and a half-century of case law ........................................................................................ 13 B. The First Department’s decision ignores basic principles of federalism and violates the Rules Enabling Act, which forbids any federal procedural rule from abridging, enlarging, or modifying any substantive right .................................... 19 C. Declining to import Rule 13(a) into New York law will not invite any improper litigation splitting or encourage forum shopping .................................. 34 v POINT 2 ................................................................................................................... 38 THE FIRST DEPARTMENT ERRED BY HOLDING THAT PARAMOUNT’S COVENANT NOT TO SUE CLAIM, WHICH ARISES FROM THE FILING AND PROSECUTION OF AN UNDERLYING LAWSUIT, WAS COMPULSORY UNDER FEDERAL RULE OF CIVIL PROCEDURE 13(A) ............................................................................................... 38 CONCLUSION ........................................................................................................ 44 vi TABLE OF AUTHORITIES Page(s) Cases 67-25 Dartmouth Street Corp. v. Syllman, 29 A.D.3d 888 (2d Dep’t 2006) .......................................................................... 15 Aeroquip Corp. v. Chunn, 526 F. Supp. 1259 (M.D. Ala. 1981) .................................................................. 24 Amchem Prods., Inc. v. Windsor, 521 U.S. 591 (1997) ............................................................................................ 23 Artvale, Inc. v. Rugby Fabrics Corp., 363 F.2d 1002 (2d Cir. 1966) ............................................................................. 35 Baker v. Health Mgmt. Sys., 98 N.Y.2d 80 (2002) ........................................................................................... 36 Bannon v. Bannon, 270 N.Y. 484 (1936) ........................................................................................... 13 Batavia Kill Watershed Dist. in Greene County v. Charles O. Desch, Inc., 83 A.D.2d 97 (3d Dep’t 1981), aff’d 57 N.Y.2d 796 (1982) .............................. 17 Bezio v. Dorsey, 21 N.Y.3d 93 (2013) ........................................................................................... 21 Bingham v. N.Y. City Transit Auth., 99 N.Y.2d 355 (2003) ......................................................................................... 21 Brereton v. Bountiful City Corp., 434 F.3d 1213 (10th Cir. 2006) .......................................................................... 30 Bruce v. Martin, 680 F. Supp. 616 (S.D.N.Y. 1988) ..................................................................... 24 Chrysler Corp. v. Fedders Corp., 540 F. Supp. 706 (S.D.N.Y. 1982) ..................................................................... 40 vii Classic Automobiles, Inc. v. Oxford Resources, Corp., 204 A.D.2d 209 (1st Dep’t 1994) ....................................................................... 18 Clawson v. GMAC Mortgage, LLC, 2013 WL 1948128 (S.D. Tex. 2013) .................................................................. 31 Cohn v. Borchard Affiliations, 25 N.Y.2d 237 (1969) ......................................................................................... 23 Connors v. Suburban Propane Co., 916 F. Supp. 73 (D.N.H. 1996) ........................................................................... 25 De Sapio v. Kohlmeyer, 35 N.Y.2d 402 (1974) ......................................................................................... 21 Dolan v. Select Portfolio Serv., Inc., 2014 WL 4662247 (E.D.N.Y. Sept. 18, 2014) ................................................... 19 Douglas v. NCNB Texas Nat’l Bank, 979 F.2d 1128 (5th Cir. 1992) ................................................................ 31, 32, 33 Eubanks v. Liberty Mortgage Banking Ltd., 976 F. Supp. 171 (E.D.N.Y. 1997) ..................................................................... 18 Fresh Del Monte Produce Inc. v. Del Monte Foods, Inc., 2016 WL 236249 (S.D.N.Y. Jan. 20, 2016) ....................................................... 14 Gargiulo v. Oppenheim, 63 N.Y.2d 843 (1984) ..................................................................................passim Gasperini v. Ctr. for Humanities, Inc., 518 U.S. 415 (1996) ............................................................................................ 35 Grendene USA, Inc. v. Brady, 2015 WL 1499229 (S.D. Cal. Apr. 1, 2015) .......................................... 36, 41, 42 Hanna v. Plumer, 380 U.S. 460 (1965) ............................................................................................ 20 Harris v. Steinem, 571 F.2d 119 (2d Cir. 1978) ........................................................................passim viii Henry Modell & Co. v. Minister, Elders & Deacons of Reformed Protestant Dutch Church of the City of New York, 68 N.Y.2d 456 (1986) ......................................................................................... 19 Huston v. U.S. Bank Nat. Ass'n, 988 F. Supp. 2d 732 (S.D. Tex. 2013) ................................................................ 30 In re Ferrandina, 533 B.R. 11 (Bankr. E.D.N.Y. 2015) ................................................................. 14 In re Hunter, 4 N.Y.3d 260 (2005) ........................................................................................... 17 In re Kaplan, 8 N.Y.2d 214 (1960) ........................................................................................... 21 In re Temple, 851 F.2d 1269 (11th Cir. 1988) .......................................................................... 23 Indosuez Int’l Finance B.V. v. National Reserve Bank, 304 A.D.2d 429 (1st Dep’t 2003) ....................................................................... 37 L. F. Dommerich & Co. v. Bress, 280 F. Supp. 590 (D.N.J. 1968) .......................................................................... 20 Marathon Structured Fin. Fund, LP v. Paramount Pictures Corp., 622 Fed. Appx. 85 (2d Cir. 2015) ....................................................................... 11 Mason Tenders Dist. Council Pension Fund v. Messera, 1996 WL 351250 (S.D.N.Y. June 26, 1996) ...................................................... 17 McCollum Aviation, Inc. v. Cim Assocs., Inc., 438 F. Supp. 245 (S.D. Fla. 1977) ...................................................................... 25 McMahan & Co. v. Bass, 250 A.D.2d 460 (1st Dep’t 1998) ................................................................. 36, 37 McNichols v. Lennox Furnace Co., 7 F.R.D. 40 (N.D.N.Y. 1947) ............................................................................. 22 Miss. Pub. Corp. v. Murphree, 326 U.S. 438 (1946) ............................................................................................ 25 ix Mount Everest Ski Shops, Inc. v. Nordica USA, Inc., 736 F. Supp. 523 (D. Vt. 1989) .................................................................... 41, 42 Nunnery v. Ocwen Loan Serv., LLC, 641 Fed. App'x 430 (5th Cir. 2016) .................................................................... 33 Ortiz v. Fibreboard Corp., 527 U.S. 815 (1999) ............................................................................................ 23 Pace v. Perk, 81 A.D.2d 444 (2d Dep’t 1981) .......................................................................... 17 People v. Chestnut, 19 N.Y.3d 606 (2012) ......................................................................................... 21 People v. N.Y. State Div. of Parole, 95 N.Y.2d 640 (2001) ......................................................................................... 21 Persky v. Bank of Am. Nat’l Ass'n, 261 N.Y. 212 (1933) ........................................................................................... 21 Petrie Method, Inc. v. Petrie, 1989 WL 47709 (E.D.N.Y. Apr. 26, 1989) .................................................. 39, 40 Piesco v. City of New York, Dep’t of Personnel, 650 F. Supp. 896 (S.D.N.Y. 1987) ..................................................................... 35 Pleasant Val. Packing Co. v. Talarico, 5 N.Y.2d 40 (1958) ............................................................................................. 38 Police & Fire Ret. Sys. of City of Detroit v. IndyMac MBS, Inc., 721 F.3d 95 (2d Cir. 2013) ................................................................................. 22 RA Global Servs., Inc. v. Avicenna Overseas Corp., 843 F. Supp. 2d 386 (S.D.N.Y. 2012) ................................................................ 15 Reach Music Pub., Inc. v. Warner/Chappell Music, Inc., 2014 WL 5861984 (S.D.N.Y. Nov. 10, 2014) .................................................... 35 Reines Distributors, Inc v. Admiral Corp, 182 F. Supp. 226 (S.D.N.Y. 1960) ............................................................... 20, 21 x Rivera v. Smith, 63 N.Y.2d 501 (1984) ......................................................................................... 21 Schiavone v. Fortune, 477 U.S. 21 (1986) .............................................................................................. 26 Seattle Totems Hockey Club, Inc. v. Nat'l Hockey League, 652 F.2d 852 (9th Cir. 1981) .............................................................................. 23 Semtek Int’l Inc. v. Lockheed Martin Corp., 531 U.S. 497 (2001) .......................................................................... 14, 29, 30, 33 Stichting v. Schreiber, 407 F.3d 34 (2d Cir. 2005) ................................................................................. 24 Sweet Constructors, LLC v. Wallkill Med. Dev., LLC, 106 A.D.3d 810 (2d Dep’t 2013) .............................................................. 18 Swergold v. Cuomo, 99 A.D.3d 1141 (3d Dep’t 2012) ........................................................................ 20 Urbanski v. Urbanski, 433 N.Y.S.2d 718 (N.Y. Sup. Ct. 1980) ............................................................. 16 Versatile Housewares & Gardening Sys., Inc. v. Thill Logistics, Inc., 819 F. Supp. 2d 230 (S.D.N.Y. 2011) ................................................................ 35 Weems v. Mcloud, 619 F.2d 1081 (5th Cir. 1980) ............................................................................ 25 Wells Fargo Bank N.A. v. Podeswik, 115 A.D.3d 207 (4th Dep’t 2014) ....................................................................... 17 Statutes 28 U.S.C. § 2072 .................................................................................................................. 22 § 2283 .................................................................................................................. 24 xi Civil Practice Law and Rules § 3011 ........................................................................................................ 4, 12, 15 § 3019 ........................................................................................................ 4, 15, 16 § 5602(a)(1)(i) ....................................................................................................... 2 § 5611 .................................................................................................................... 2 Rules Enabling Act of 1934 ..................................................................................... 21 Rules Federal Rule of Civil Procedure 13(a) .............................................................................................................passim 14 ................................................................................................................... 25, 29 17 ................................................................................................................... 24, 25 18 ......................................................................................................................... 28 41(b) .............................................................................................................. 29, 30 Other Authorities 11 Carmody-Wait 2d New York Practice with Forms § 71:109 ............................. 21 27 Federal Procedure, Lawyers Ed., § 62:200 ......................................................... 31 4 N.Y. Jur. 2d Appellate Review § 604 ................................................................... 21 6 Cyc. of Federal Proc. § 16:17 (3d ed.) .................................................................. 31 Adv. Committee on Prac. & Proc., First Prelim. Report (Feb. 1, 1957) ................. 16 Adv. Committee on Rules for Civ. Proc., Preliminary Draft of Rules of Civil Procedure for the District Courts of the United States and the Supreme Court of the District of Columbia (May 1936) .............................. 28 Adv. Committee on Rules for Civ. Proc., Report of Proposed Amendments to Rules of Civil Procedure for the District Courts of the United States, at 20 (June 1946) ................................................................... 29 Adv. Committee on Rules for Civ. Proc., Report of Proposed Rules of Civil Procedure for the District Courts of the United States (Apr. 1937) ................................................................................................................... 27 Alexander,Vincent C., The CPLR at Fifty: A View from Academia, 16 N.Y.U. J. Legis. & Pub. Pol'y 664, 676 (2013) .................................................. 23 xii American Bar Assoc., Proceedings of the Institute at Washington, D.C. and of the Symposium at New York City (1938) .................................. 28, 29 American Bar Assoc., Rules of Civil Procedure and Proceedings of the Institute on Federal Rules, Cleveland, Ohio (1938) ............................... 27, 28 Authorizing Supreme Court To Make And Publish Rules In Common- Law Actions, S. Rep. 69-1174 (1st Sess.), (July 1, 1926) .................................. 22 Proceedings of Advisory Committee on Rules for Civil Procedure of the Supreme Court of the United States (Feb. 1-4, 1937) .................................. 27 Proceedings of Advisory Committee on Rules for Civil Procedure of the Supreme Court of the United States (Vol. 4) (Nov. 17, 1935) ..................... 26 Wagstaffe, James M., Rutter Group Prac. Guide: Fed. Civ. Proc. Before Trial (Nat’l Ed.), §§ 8:1151-54 ............................................................... 31 Weinstein, Jack B., CPLR’s Genesis, 16 N.Y.U. J. Legis. & Pub. Pol’y 647, 649 (2013) ............................................ 16 Weinstein, Jack B., et al., Summary of Civil Prac. Law & Rules Effective Sept. 1, 1963 (1962) ............................................................................. 16 1 QUESTIONS PRESENTED FOR REVIEW 1. Whether New York is free to apply its long-established substantive law of res judicata in the New York courts, which explicitly permits the prosecution of an omitted counterclaim in a second lawsuit that is transactionally related to a prior action, without regard to Federal Rule of Civil Procedure 13(a)’s “compulsory” counterclaim rule? Answer: The First Department incorrectly answered this question in the negative. 2. Alternatively, whether the breach of a covenant not to sue, which stems solely from the commencement and prosecution of a prior federal lawsuit, and would have required the litigation of collateral issues if asserted in that action, is a permissive counterclaim under Federal Rule of Civil Procedure 13(a)? Answer: The First Department incorrectly answered this question in the negative. JURISDICTION This action originated in the Supreme Court. R.59-72. The First Department’s decision directed the Supreme Court to dismiss the action, which constitutes a final judgment. R.163-73. This Court, which granted Paramount’s 2 motion for leave to appeal, has jurisdiction to entertain this appeal pursuant to CPLR § 5602(a)(1)(i) and/or CPLR § 5611. The questions presented were raised below, and have been preserved for review. R.2-3; R.9; R.32-47, 52-55; R.163- 73. See also Addendum to Brief. PRELIMINARY STATEMENT Plaintiff-Appellant Paramount Pictures Corporation (“Paramount”) filed this lawsuit against Defendants-Respondents Allianz Risk Transfer AG, Newstar Financial Inc., and Munich Re Capital Markets New York, Inc. (“Respondents”)1 based on their breach of a contractual covenant not to sue. Respondents breached that covenant by filing and prosecuting a federal action for securities and common law fraud against Paramount. That federal action was resolved entirely in Paramount’s favor, and this action followed. Respondents filed a motion to dismiss on the basis that Paramount’s covenant not to sue claim constituted a compulsory counterclaim in the federal action under Federal Rule of Civil Procedure Rule 13(a), and that the claim is now barred under New York’s law of res judicata. In denying the motion, the Supreme Court, New York County (Jeffrey K. Oing, J.), correctly held that New York is a permissive counterclaim jurisdiction, and, as such, there are no 1 Paramount and Marathon Structured Finance Fund, L.P. (“Marathon”), which is also a defendant in this action, have resolved their dispute; thus, Paramount’s claims against Marathon are no longer at issue. 3 compulsory counterclaims in this state. Nonetheless, the Supreme Court, Appellate Division, First Department, reversed that ruling on the novel theory that the scope of New York’s res judicata law, as applied by the New York state courts with respect to New York state law claims, should not be determined by the state’s permissive counterclaim rule, but by a federal procedural rule related to the litigation of counterclaims in federal court. The First Department’s decision depends solely on dicta from Gargiulo v. Oppenheim, 63 N.Y.2d 843 (1984), in which this Court expressly “assume[d] … without deciding” that Rule 13(a) could be invoked, in the New York courts, to bar a compulsory counterclaim that should have been asserted in a federal lawsuit. In its opinion, the Court referred to Rule 13(a) only to explain that, even if the rule were applicable, the claim in that particular case was not “compulsory.” The Court nowhere suggested that this postulation should be embraced as the law of New York. Despite this, the First Department elevated Gargiulo’s “assump[tion]” into a binding rule of law. In mechanically applying this dicta, the First Department mistakenly conflated two distinct concepts: New York’s substantive law of res judicata and the federal procedures to be applied in the federal courts. This was error for multiple reasons. As an initial matter, when the New York legislature enacted the CPLR more than fifty years ago, it intentionally established this state as a permissive 4 counterclaim jurisdiction. Indeed, prior to its enactment in 1962, the legislature expressly rejected a proposal to incorporate the federal compulsory counterclaim rule into the CPLR. As a consequence of this decision, the New York courts have uniformly held that res judicata does not bar a claim that could have been filed as a counterclaim in a prior action, so long as the counterclaim would not impair a right established in the first action. If it were otherwise, New York would be a compulsory counterclaim jurisdiction, contrary to the legislative judgment expressed in CPLR §§ 3011 and 3019. The First Department not only failed to follow this legal precedent, but overreached its authority by judicially legislating a new exception to New York’s permissive counterclaim rule. Such a decision belongs to the legislature, and not to the judiciary. The First Department’s adoption of Rule 13(a) is also contrary to the fundamental precept that federal procedural rules are not binding on either the state courts or state substantive law. This rule of federalism is evidenced in substantial part by the federal Rules Enabling Act of 1934. While the Rules Enabling Act conferred on the U.S. Supreme Court the power to institute procedural rules to manage the docket of the federal courts, Congress expressly prohibited the promulgation of rules that “abridge, enlarge or modify any substantive right.” This crucial limitation on the Federal Rules of Civil Procedure, including the principle that the rules cannot be construed to modify 5 the meaning of a judgment (i.e., res judicata), was widely recognized by its drafters and has been confirmed by the U.S. Supreme Court. However, the First Department violated this principle by modifying the substance of New York’s res judicata law on the basis of a federal procedural rule. In response to this authority, Respondents have asserted that Paramount’s position should be rejected, as a matter of policy, because it would encourage “litigation splitting” and “forum shopping.” These alarmist contentions are devoid of support. First, there has been no improper litigation splitting, as Paramount’s lawsuit is fully consistent with New York’s permissive counterclaim rule. Second, there is no risk of forum shopping because, under the Erie doctrine, the same substantive principles of New York law must be applied to Paramount’s covenant not to sue claim regardless of whether it is adjudicated in federal or state court. Finally, the First Department erred for a further and independent reason unrelated to Gargiulo: under federal law, Paramount’s covenant not to sue claim was permissive, and not “compulsory,” in the Federal Action. As the Second Circuit has held, counterclaims that merely arise from the filing and prosecution of an action are permissive. This rule rightly reduces the risk of unduly complicating federal lawsuits through the litigation of ancillary issues. In ruling 6 to the contrary, the First Department misconstrued and created a conflict with governing federal law. Therefore, and as discussed in more detail herein, the First Department’s decision should be reversed. STATEMENT OF FACTS A. Respondents Expressly Covenant Not To Sue Paramount In Connection With The Melrose Transaction In 2004, Merrill Lynch created a special purpose vehicle, which was called Melrose Investors LLC (“Melrose”). A group of hedge funds and reinsurance companies, including Respondents, loaned and/or invested money in Melrose, which Melrose then invested in the production and distribution of 25 motion pictures that Paramount released between April 2004 and March 2006 (the “Melrose Slate Films”). R.64 at ¶ 13; R.65 at ¶ 16. In exchange for the funds provided, Melrose acquired “revenue participation interests” in the Melrose Slate Films. R.64 at ¶ 13. These revenue participation interests granted Melrose the right to receive revenue participation payments, based on a contractually-agreed upon formula, depending on how the Melrose Slate Films performed. R.64-65 at ¶ 14. Melrose, in turn, would forward those payments to investors in order of the seniority of their investment in Melrose-issued securities. See id. 7 There were three types of Melrose-issued securities: (1) Class A Notes; (2) Class B notes; and (3) investment in Melrose’s equity. Class A notes, which bore interest at approximately 4% and received an investment grade rating from Moody’s, were the safest form of investment and would be repaid first. The unrated and substantially riskier Class B Notes (bearing interest at 12%), as well the investments in Melrose’s equity, would be repaid last. Id. Respondents chose to invest only in Melrose’s Class B Notes and equity. R.65 at ¶ 15. Each Melrose investor, including the Respondents, agreed to be bound by a Subscription Agreement. R.65-66 at ¶ 17; R.67 at ¶¶ 20-21. In Paragraphs 4(s)(iii) and 4(s)(vii) of the Subscription Agreement, Respondents acknowledged that Paramount was making no representation as to whether any of the Melrose Slate Films “will be distributed in any particular manner” or “distributed according to any particular release pattern … in the United States or in any other territory.” R.65-66 at ¶ 17; R.88. In Paragraph 4(t), Respondents agreed to waive and release any claim against Paramount with respect to the foregoing acknowledgements. R.66-67 at ¶ 19; R.89. Critically, Respondents also expressly “agree[d] that in no event shall [they] assert any claim or bring any action contradicting the acknowledgments and agreements in [Paragraphs 4(s)].” R.66-67 at ¶ 19; R.89. Paramount was identified as a third-party beneficiary of the agreement. R.66-67 at ¶ 19; R.89. 8 B. Respondents Breach Their Covenant Not To Sue By Filing And Prosecuting The Federal Action In violation of their covenant not to sue, on December 2, 2008, Respondents filed a federal securities and common law fraud lawsuit in the United States District Court for the Southern District of New York, which was entitled Allianz Risk Transfer AG, et al. v. Paramount Pictures Corp., Case No. 1:08-cv-10420 KBF (the “Federal Action”). R.62 at ¶ 2; R.75-76 at ¶ 3. In their complaint, Respondents (as plaintiffs in the Federal Action) alleged that, in connection with the offering of Melrose securities, Paramount had misrepresented its intent to “pre-sell” foreign territories as part of its distribution of the Melrose Slate Films, which would have allegedly reduced Respondents’ risk of loss. R.68 at ¶ 22. A bench trial in the Federal Action commenced on October 21, 2014, and continued for seven trial days until Respondents rested. Paramount then made a motion for entry of judgment in its favor, which the district court granted. Id. at ¶ 24. In its ruling, the district court held that Respondents’ claims had been waived as a matter of law under Paragraphs 4(s) and 4(t) of the Subscription Agreement. The district court explained that “there is no legal reason why that claim waiver would not apply as a matter of law” and that “[t]here is no basis for disregarding the [S]ubscription [A]greement.” Id. Thus, in ruling that Respondents were 9 bound by the Subscription Agreement’s waiver provision, the district court necessarily confirmed that Respondents had breached their covenant not to sue by filing the Federal Action, which Respondents will be collaterally estopped from challenging in this action. R.68-69 at ¶ 25.2 In addition to ruling that Respondents had waived their right to file the Federal Action, the district court found that Respondents had failed to establish any of the elements of any of their claims. R.62 at ¶ 3. The district court declared that: “[T]here was no fraud here.” “[Respondents] have failed to prove by a preponderance of the evidence that the statements at issue were false. In fact, I would say not just a failure of proof as to falsity. The evidence in the record demonstrates the truth of the statements.” “[T]here was no actionable omission[]….[T]here was no omission because the very information sought was disclosed.” 2 The Subscription Agreement’s waiver and covenant not to sue clauses are both defined, in part, by reference to Paragraphs 4(s)(iii) and 4(s)(vii). The district court explicitly construed these provisions in holding that Respondents waived their claims as a matter of law. See R.132 at Tr. 1603:11-1604:7. Because Respondents are now collaterally estopped from challenging the district court’s interpretation of these provisions, Respondents will also be held to have breached their covenant not to sue by filing and prosecuting the Federal Action. See R.89 at ¶ 4(t). 10 “The evidence does not support that business practices with respect to foreign presales was material to [Respondents]. More affirmatively, the Court finds it was not material.” “[T]here was truthful disclosure. Therefore …, there has been a finding by me of no intent to mislead….Paramount has disclosed a lot of information which I referred to which undercuts scienter….[T]here was disclosure of what was and was not happening and the absence of foreign presales was there if anyone chose to open their eyes to see it.” “[Y]ou’re also to look at sophisticated businessmen and determine whether or not they could have been defrauded in the manner suggested and it’s just not credible to the Court that they could have been. Not these guys. Not the guys who testified in front of me. They were very sophisticated. I would say they knew what they were doing.” “[F]undamentally it was unreasonable for plaintiffs to have relied given all of this evidence. But the evidence is also that they didn’t actually rely, that is in the Court’s view classic fraud by hindsight….” R.69-70 at ¶ 26. On the next day, October 31, 2014, the Court formally entered judgment in Paramount’s favor. R.68 at ¶ 24. Respondents’ appeal of the district court’s judgment to the Second Circuit was summarily rejected in December 11 2015. See Marathon Structured Fin. Fund, LP v. Paramount Pictures Corp., 622 Fed. Appx. 85 (2d Cir. 2015). Due to Respondents’ seven-year prosecution of the Federal Action, Paramount incurred in excess of $8 million in attorneys’ fees and costs. R. 62 at ¶ 2; R.70 at ¶ 28; R.71 at Pray. for Rel. ¶ 1. C. The Proceedings To Date On December 2, 2014, approximately one month after judgment was entered in its favor in the Federal Action, Paramount commenced this lawsuit based on Respondents’ breach of the Subscription Agreement’s covenant not to sue. R.59-60. See also R.61-72. In response, Respondents filed a motion to dismiss Paramount’s complaint. R.73-74. In their memorandum of points and authorities, Respondents argued that dismissal as a matter of law was required on three independent bases: (1) the lawsuit was barred by New York’s law of res judicata because, pursuant to Rule 13(a), Paramount’s claim should have been asserted in the Federal Action as a compulsory counterclaim; (2) the “American Rule” prohibited Paramount from recovering, as damages caused by the covenant’s breach, the attorneys’ fees and costs incurred in the Federal Action; and (3) Paramount failed to mitigate its damages. 12 On September 8, 2015, the Supreme Court denied Respondents’ motion. R.7-58. In rejecting Respondents’ res judicata argument, the Supreme Court explained that “[t]his state has a permissive counterclaim rule that was enacted by the legislature” and that applying Rule 13(a) “would require [the Supreme Court] to ignore CPLR 3011,” which “would [not be] proper.” R.54. The Supreme Court also rejected Respondents’ “American Rule” and mitigation arguments. R.55-56. Respondents filed an appeal, but only with respect to their res judicata contention. R.5-6. On July 21, 2016, the First Department reversed the Supreme Court’s order, and directed that the action be dismissed. R.163-73. In its ruling, the First Department acknowledged, as both Paramount and Respondents agreed, that its decision was governed by New York’s law of res judicata. R.169-71. While further conceding that New York is a permissive counterclaim jurisdiction, that Paramount’s lawsuit would not impair any interest established in the Federal Action, and that no binding precedent exists that would require the importation of the federal compulsory counterclaim rule into New York’s substantive law, the First Department nevertheless held that: (1) Paramount’s state law covenant not to sue claim was compulsory to the Federal Action under Rule 13(a); and (2) the claim was barred by New York’s law of res judicata based on Paramount’s failure to comply with Rule 13(a) in the prior federal lawsuit. R.171-73. 13 Paramount timely filed a motion for leave to appeal, which this Court granted on November 22, 2016. STANDARD OF REVIEW The application of the doctrine of res judicata is a question of law that is reviewed de novo. See Bannon v. Bannon, 270 N.Y. 484, 490 (1936). ARGUMENT POINT I THE FIRST DEPARTMENT ERRED BY RELYING ON FEDERAL RULE OF CIVIL PROCEDURE 13(A) TO BAR PARAMOUNT’S COVENANT NOT TO SUE CLAIM UNDER NEW YORK’S LAW OF RES JUDICATA The First Department erred by creating new law through its importation of Federal Rule of Civil Procedure 13(a) into New York’s law of res judicata. The First Department’s decision does not comport with either New York’s permissive counterclaim rule, or the principle that the Federal Rules of Civil Procedure should not, and cannot, have any effect on the litigation of New York state law claims. The ruling must be reversed in order to ensure that the proper balance between federal and state law remains intact. A. The First Department’s decision is contrary to the legislature’s considered judgment to fashion New York as a permissive counterclaim jurisdiction and a half-century of case law In reversing the Supreme Court, the First Department held that, even though New York is a permissive counterclaim jurisdiction, New York’s law of 14 res judicata3 would apply Rule 13(a) so as to bar Paramount’s action. In effect, the First Department decided that a New York state law claim could be prohibited from proceeding in the New York state courts solely due to a federal compulsory counterclaim rule. This was improper. While admitting that its ruling was not based on any “binding precedent,” the First Department relied entirely on dicta from this Court’s opinion in Gargiulo. In Gargiulo, this Court evaluated whether a claim for restitution, which had not been advanced in a federal lawsuit, but could have been pled as a counterclaim, was barred by the doctrine of res judicata. 63 N.Y.2d 843. Faced with the possibility of deciding whether Rule 13(a) should be incorporated into New York law, this Court acted cautiously and declined to resolve the matter. Instead, the Court explained that, even assuming that Rule 13(a) was applicable, the restitution claim was not “compulsory.” Id. at 845-46. As part of this discussion, this Court made the following statement, on which the First 3 The parties agree that New York’s law of res judicata applies to this dispute. See R. 24- 25, 29, 50-51 (argument by Respondents’ counsel based on New York res judicata principles). This is because, consistent with the Erie doctrine, the res judicata effect of a state law claim in connection with a federal court proceeding is determined by state law. See Semtek Int’l Inc. v. Lockheed Martin Corp., 531 U.S. 497, 508-09 (2001) (holding that claim preclusive effect of a federal judgment on a state law claim is decided by state law); Fresh Del Monte Produce Inc. v. Del Monte Foods, Inc., 2016 WL 236249, at *3 n.4 (S.D.N.Y. Jan. 20, 2016) (“This Court would, therefore, apply federal rules of preclusion to judgments on claims premised on federal question jurisdiction, and New York rules of preclusion to judgments on claims premised upon diversity or supplemental jurisdiction.”); In re Ferrandina, 533 B.R. 11, 23 (Bankr. E.D.N.Y. 2015) (same). 15 Department’s decision is predicated: For purposes of the disposition of this appeal we assume, without deciding, that under the procedural compulsory counterclaim rule in the Federal courts (Fed Rules Civ Pro, rule 13, subd [a] [in US Code, tit 28, Appendix]) claim and issue preclusion would extend to bar the later assertion in the present State court action of a contention which could have been raised by way of a counterclaim in the answer in the prior Federal action between the same parties…. Id. at 845. The First Department, however, inferred far too much when it held that this passage provided “clear guidance” to apply the federal counterclaim rule (R.172), especially since this Court went to great lengths to clarify that it was providing no such guidance.4 The First Department should have instead relied on the legislature’s intention to establish New York as a permissive counterclaim jurisdiction, as provided for in CPLR §§ 3011 and 3019, and more than fifty years of case law confirming that “[i]n New York there are no compulsory counterclaims.” 67-25 Dartmouth Street Corp. v. Syllman, 29 A.D.3d 888, 889 (2d Dep’t 2006). Indeed, when the New York legislature enacted the CPLR in 1962, it expressly considered, and rejected, a proposal to adopt a compulsory counterclaim rule. The Hon. Jack B. Weinstein, who served as the Reporter to the state Advisory 4 The only other case cited by the First Department on this point is RA Global Servs., Inc. v. Avicenna Overseas Corp., 843 F. Supp. 2d 386, 390 (S.D.N.Y. 2012), which also depends on Gargiulo’s dicta. 16 Committee on Practice and Procedure, proposed that New York generally adopt the Federal Rules of Civil Procedure. See Hon. Jack B. Weinstein, CPLR’s Genesis, 16 N.Y.U. J. Legis. & Pub. Pol’y 647, 649 (2013). However, as Judge Weinstein recounted, “[t]his suggestion was rejected out-of-hand,” as he was told, among other things, that “New York was the leader, not the follower.” Id. at 650. Ultimately, when the New York legislature adopted the CPLR, it elected not to include a compulsory counterclaim rule. See Adv. Committee on Prac. & Proc., First Prelim. Report (Feb. 1, 1957), at 69 (“After consideration of the problem, the advisory committee decided that the adoption of a compulsory counterclaim rule in New York might raise more difficulties than it would solve.”). See also Jack B. Weinstein et al., Summary of Civil Prac. Law & Rules Effective Sept. 1, 1963 (1962), at 25 (“[A] compulsory counterclaim rule similar to Federal Rule 13(a) has not been included (CPLR 3019).”). New York’s permissive counterclaim rule evidences a considered judgment by the legislature that a defendant should be entitled to withhold a counterclaim while defending a lawsuit and then, after securing a favorable defense ruling, pursue that claim as a plaintiff in subsequent litigation. Urbanski v. Urbanski, 433 N.Y.S.2d 718, 719 (N.Y. Sup. Ct. 1980) (“Withholding asserting a counterclaim does not forfeit the right to bring a separate suit upon the cause of action.”). “While a compulsory rule would be more consistent with economical 17 court administration, the lack thereof is not a significant factor in burdensome case loads. The use of summary judgment procedures effectively precludes relitigation of issues and, from a pragmatic view, proceeding to a jury with liability established is not likely except in extraordinary cases.” Batavia Kill Watershed Dist. in Greene County v. Charles O. Desch, Inc., 83 A.D.2d 97, 100 (3d Dep’t 1981), aff’d 57 N.Y.2d 796 (1982). Thus, for the most part, “the question of judicial economy is not directly involved since the [relevant] facts … [will have been] established in the prior action.” Id. In accordance with the legislature’s judgment, the courts have uniformly held that res judicata does not bar a plaintiff from litigating a claim that could have been pursued as a counterclaim in a prior action. See Wells Fargo Bank N.A. v. Podeswik, 115 A.D.3d 207, 216 (4th Dep’t 2014) (“The general rule is that, when ‘a defendant may interpose a claim as a counterclaim but fails to do so, the doctrine of res judicata ... does not apply to prevent [it] from subsequently maintaining an action on that claim.’”) (citation omitted); Pace v. Perk, 81 A.D.2d 444, 460 (2d Dep’t 1981) (same).5 This rule has been given far-reaching 5 It is true, as Respondents have argued, that New York generally applies a broad “transactional” approach to res judicata. See In re Hunter, 4 N.Y.3d 260, 269-70 (2005). But Hunter has no application in the counterclaim context; were it otherwise, res judicata would transform New York into a compulsory counterclaim jurisdiction. See Mason Tenders Dist. Council Pension Fund v. Messera, 1996 WL 351250, at *10 (S.D.N.Y. June 26, 1996) (“if res judicata barred a permissive counterclaim, the ‘permissive’ counterclaim would, as a practical matter, become compulsory”). 18 effect. For example, a counterclaim is not barred even if it stems from the very same transaction as the original lawsuit. See Classic Automobiles, Inc. v. Oxford Resources, Corp., 204 A.D.2d 209 (1st Dep’t 1994) (“[t]he doctrine of res judicata did not bar plaintiff’s right to sue for [money damages],” notwithstanding the fact that the plaintiff “had failed to include a counterclaim for money damages in a prior lawsuit involving the same transaction….”). Similarly, res judicata does not prohibit, but permits, “counterclaims to be raised through separate litigation even if interposed as a defense in prior litigation…” Id. at 209. See also Sweet Constructors, LLC v. Wallkill Med. Dev., LLC, 106 A.D.3d 810, 811 (2d Dep’t 2013) (same). “New York’s res judicata rule thus has a narrower effect on a defendant who then brings her claim in a separate action than it does on the plaintiff who brings successive claims that arise from the same transaction.” Eubanks v. Liberty Mortgage Banking Ltd., 976 F. Supp. 171, 173 (E.D.N.Y. 1997). Therefore, while Respondents have noted that Paramount’s claim is premised on the same contractual provision as one of its affirmative 19 defenses (i.e., waiver) in the Federal Action, this serves as no obstacle to Paramount’s lawsuit.6 The First Department failed to adhere to these authorities by dismissing Paramount’s lawsuit and, in so doing, exceeded its authority by judicially legislating a compulsory counterclaim rule that has never been approved by the legislature in any form. Reversal is required to remedy this error and to effectuate the legislature’s expressed intent. B. The First Department’s decision ignores basic principles of federalism and violates the Rules Enabling Act, which forbids any federal procedural rule from abridging, enlarging, or modifying any substantive right The First Department’s importation of Rule 13(a), through its adoption of Gargiulo’s dicta, was further mistaken because it allowed the substance of state law to be defined by a federal procedural rule. This determination is contrary to 6 The permissive counterclaim rule does, however, prohibit a party from “remain[ing] silent in the first action and then bring[ing] a second one on the basis of a preexisting claim for relief that would impair the rights or interests established in the first action.” Henry Modell & Co. v. Minister, Elders & Deacons of Reformed Protestant Dutch Church of the City of New York, 68 N.Y.2d 456, 462 n.2 (1986). But as the First Department held, Paramount’s covenant not to sue claim would not impair any rights established in the Federal Action, as Paramount prevailed in that lawsuit. R.170-71. See also Dolan v. Select Portfolio Serv., Inc., 2014 WL 4662247, at *4 (E.D.N.Y. Sept. 18, 2014) (“Here, of course, Dolan is not attacking the judgment of the state court—Dolan prevailed in the state court action against TMS, the mortgagee to Dolan’s mortgage. Dolan’s cause of action here would in no way impair the rights established between the parties in the prior action. Accordingly, it is plain that the New York law of res judicata…does not bar Dolan’s claims here.”) (emphasis in original). 20 our system of federalism, and represents an unwarranted intrusion into the right of the New York citizenry to control the content of its laws. “[T]he scheme of our Constitution envisions an allocation of law-making functions between state and federal legislative processes.” Hanna v. Plumer, 380 U.S. 460, 474 (1965) (Harlan, J., concurring). For this reason, “the Federal Rules of Civil Procedure are not binding upon this Court—or, for that matter, any other state court…” Swergold v. Cuomo, 99 A.D.3d 1141, 1144 (3d Dep’t 2012). This includes Rule 13(a), which has been characterized for decades as “simply a federal court housekeeping rule.” Reines Distributors, Inc v. Admiral Corp, 182 F. Supp. 226, 230 (S.D.N.Y. 1960). See also L. F. Dommerich & Co. v. Bress, 280 F. Supp. 590, 599 (D.N.J. 1968) (referring to Rule 13(a) as a “‘good housekeeping’ rule”). 21 This federalist-based restriction on the effect of the Federal Rules of Civil Procedure is codified by the Rules Enabling Act of 1934.7 In the years prior to its 7 Respondents have claimed that, under this Court’s preservation doctrine, Paramount should be barred from even referring to the Rules Enabling Act. Respondents are incorrect, as Paramount specifically argued to the Supreme Court that the New York courts are not obligated to apply Rule 13(a). R.32-47, 52-55; see also Addendum to Brief. Additionally, in its briefing, Paramount cited to cases holding that Rule 13(a) could not be invoked to bar a state court action. See Addendum to Brief. These decisions recognized that no such injunction could issue due to the “absence of a Congressional mandate,” see Reines Distributors, Inc, 182 F. Supp. at 230 (cited in Addendum), which is derived from the Rules Enabling Act’s limited grant of rights. As reflected by this Court’s jurisprudence, such argument was more than enough to preserve Paramount’s discussion of the Rules Enabling Act herein, which merely describes the basis for Paramount’s position in more detail. People v. Chestnut, 19 N.Y.3d 606, 608-11 & n.2 (2012) (appellant’s argument that his trial should have been severed from co-defendant for good cause was sufficient to preserve separate argument that severance was required as a matter of law). See also Bezio v. Dorsey, 21 N.Y.3d 93, 98-100 (2013) (appellant preserved due process claim at the trial court regarding the use of a forced feeding tube even though he “did not reference the Due Process Clause” and instead relied on the Eighth Amendment). But even if Paramount’s reference to the Rules Enabling Act constitutes a new “argument,” it can be considered by this Court because it relates, at a minimum, to a legal “question” that was asserted below (i.e., Rule 13(a)’s inapplicability as to New York’s res judicata law). Persky v. Bank of Am. Nat’l Ass'n, 261 N.Y. 212, 218 (1933) (“In our review we are confined to the questions raised or argued at the trial, but not to the arguments there presented. ‘Nor is it material whether the case was well presented to the court below….’”); 11 Carmody-Wait 2d New York Practice with Forms § 71:109 (same); 4 N.Y. Jur. 2d Appellate Review § 604 (same). Furthermore, even an entirely new issue or question of law may be considered if it “could not have been avoided by factual showings or legal countersteps had it been raised below.” Bingham v. N.Y. City Transit Auth., 99 N.Y.2d 355, 359 (2003). Here, Respondents could not have taken any action before the Supreme Court to avoid the Rules Enabling Act’s conclusive impact. Rivera v. Smith, 63 N.Y.2d 501, 515-16 & n.5 (1984) (petitioner’s refusal to submit to a frisk could not be expunged, even though the issue had not been raised below, because it could not have been “obviated or cured” by any factual and legal showing); De Sapio v. Kohlmeyer, 35 N.Y.2d 402, 405 n.2 (1974) (“[D]efendant’s contention that we may not consider the waiver argument because it was not raised below is incorrect. Had the waiver issue been raised below defendant would not have been able to cure or answer it.”); In re Kaplan, 8 N.Y.2d 214, 220 (1960) (“It appears that in the present case this lack of a subpoena was not raised by appellant in the courts below but, being jurisdictional and conclusive, it may be acted on by us especially since the omission was not one which could have been supplied if attention had been called to it below.”). Finally, although not required for preservation purposes, People v. N.Y. State Div. of Parole, 95 N.Y.2d 640, 644 n.2 (2001), it is undisputed that Paramount asserted all of its arguments in its brief to the Appellate Division, a copy of which was submitted with Paramount’s motion for leave to appeal. 22 passage, Congress made clear that this law was solely intended to authorize the U.S. Supreme Court to draft a set of uniform procedural rules for the federal courts. Congress explained that while the law would “confer[] upon the court the power to make rules governing [procedure],” such authorization “d[id] not extend the power so as to affect substantive rights or remedies.” See Authorizing Supreme Court To Make And Publish Rules In Common-Law Actions, S. Rep. 69- 1174 (1st Sess.), at 9 (July 1, 1926). In fact, “[t]he purpose and the effect of th[e] bill … [was] to give to the Supreme Court of the United States the same authority to make rules governing the entire procedure on the law side of the district courts that it [already] possesses on the equity side and in admiralty and bankruptcy, and no more….” Id. at 12. Congress emphasized that the law entailed “[n]othing novel,” it would not alter “any jurisdictional or fundamental matter,” and “the rules prepared … will not have the effect of statutes.” Id. As enacted, the Rules Enabling Act delegated to the U.S. Supreme Court “the power to prescribe general rules of practice and procedure.” 28 U.S.C. § 2072(a). However, Congress explicitly limited this grant of authority by specifying that “[s]uch rules shall not abridge, enlarge or modify any substantive right.” 28 U.S.C. § 2072(b). “The use of the term ‘shall’ in the statute’s language indicates its mandatory nature.” Police & Fire Ret. Sys. of City of Detroit v. IndyMac MBS, Inc., 721 F.3d 95, 109 (2d Cir. 2013). See also McNichols v. 23 Lennox Furnace Co., 7 F.R.D. 40, 41-42 (N.D.N.Y. 1947) (“it is enough to recognize that the Rules relate to and effect process, practice and procedure, and that they do not either abridge, enlarge, nor modify the substantive law”). To this end, the U.S. Supreme Court has warned that caution must be applied in interpreting the Federal Rules of Civil Procedure to ensure that they do not violate the Rules Enabling Act. See Ortiz v. Fibreboard Corp., 527 U.S. 815, 845 (1999) (“[t]he Rules Enabling Act underscores the need for caution” and “counsel[s] against adventurous application” of the federal rules); Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 629 (1997) (the rules “must be interpreted with fidelity to the Rules Enabling Act”).8 Thus, under the Rules Enabling Act, a federal court cannot enjoin a state court action based on a purported violation of the rules. See In re Temple, 851 F.2d 1269, 1272 n.3 (11th Cir. 1988) (the Rules Enabling Act did not create an exception to the Anti-Injunction Act). In particular, Rule 13(a) cannot be invoked to enjoin a subsequent state court action even if it encompasses a claim that was “compulsory” to a first-filed federal litigation. See, e.g., Seattle Totems 8 It should be noted that such limitations do not apply to procedural rules contained within the CPLR, which, in contrast to the Federal Rules of Civil Procedure, was enacted by and remains under the control of the legislature. Cohn v. Borchard Affiliations, 25 N.Y.2d 237, 251- 52 (1969); See also Vincent C. Alexander, The CPLR at Fifty: A View from Academia, 16 N.Y.U. J. Legis. & Pub. Pol'y 664, 676 (2013) (“[t]he Legislature has sole control over changes to the CPLR”). 24 Hockey Club, Inc. v. Nat'l Hockey League, 652 F.2d 852, 855 n.5 (9th Cir. 1981) (“Rule 13(a) has been held not to create an express statutory exception to the proscriptions of [28 U.S.C. § 2283] and, accordingly, a federal court is barred by [28 U.S.C. § 2283] from enjoining a party from proceeding in state court on a claim that should have been pleaded as a compulsory counterclaim in a prior federal suit.”); Bruce v. Martin, 680 F. Supp. 616, 620 n.3 (S.D.N.Y. 1988) (“Rule 13(a) has been held not to create an express statutory exception to the Anti–Injunction Act and, therefore, a federal court is barred by the Act from enjoining a party from proceeding in state court on a claim that should have been pleaded as a compulsory counterclaim in a prior federal suit.”); Aeroquip Corp. v. Chunn, 526 F. Supp. 1259, 1260 (M.D. Ala. 1981) (“The first problem with this argument is that such an injunction would force the application of the federal rules of civil procedure in the state action by foreclosing the action for the sole reason that it is barred by Rule 13(a). This would go beyond the statutory limitations placed upon the rules by the Rules Enabling Act.”). See also R.29 (concession by Respondents’ counsel that Rule 13(a) cannot be enforced via injunction due to the Anti-Injunction Act). Likewise, the federal rules, including Rule 13(a), must yield to conflicting state substantive law. See Stichting v. Schreiber, 407 F.3d 34, 49 (2d Cir. 2005) (“The procedural mechanisms set forth in Rule 17(a) for ameliorating real party 25 in interest problems may not, under the Rules Enabling Act …, be employed to expand substantive rights…. [R]atification under Rule 17(a) would allow Stichting to accomplish through operation of the Federal Rules precisely what it could not accomplish under New Jersey law. This, the district court properly determined, is not permitted”); Weems v. Mcloud, 619 F.2d 1081, 1097-98 (5th Cir. 1980) (holding that, despite Rule 13(a), defendants were prohibited from asserting “compulsory” counterclaims in confirmation proceeding based on restrictions imposed by Georgia law); Connors v. Suburban Propane Co., 916 F. Supp. 73, 77-78, 81 (D.N.H. 1996) (applying state law requiring plaintiff to consent to the filing of a third-party contribution claim, as opposed to Rule 14, which has no consent requirement, to avoid encroachment on state substantive rights and the violation of the Rules Enabling Act); McCollum Aviation, Inc. v. Cim Assocs., Inc., 438 F. Supp. 245, 247-48 (S.D. Fla. 1977) (applying state law with respect to a corporation’s capacity to sue, and disregarding Rule 17(b), to avoid Rules Enabling Act violation). This principle also prohibits the federal rules from modifying the law of res judicata, a point that was repeatedly acknowledged by the federal Advisory 26 Committee that drafted the Federal Rules of Civil Procedure.9 In November 1935, when the Advisory Committee met to discuss an early draft of the federal rules, several of its members commented—in the context of a rule relating to class actions—that they lacked the power to prescribe the effect of a judgment: Mr. Olney: “I would like to make another objection to this rule. It goes on to prescribe what the effect of the judgment is in various classes of class suits. That is a matter of substantive law. That is not a matter of procedure.” Mr. Olney: “We want to provide that these actions can be brought and judgments obtained in these cases, but just what the effect of those judgments may be, in the way of res judicata, we ought not to determine.” Mr. Lemann: “In any event I do not think we have any power to say what the effect of the judgment is.” Prof. Sunderland: “I do not see how that could possibly be considered procedure—the effect of the judgment. It absolutely settles the ultimate rights of the party. And that is the very essence of substantive law.” 9 The U.S. Supreme Court, as well as other courts, have relied on the statements of the Advisory Committee and its members as relevant to the meaning of the Federal Rules of Civil Procedure. Miss. Pub. Corp. v. Murphree, 326 U.S. 438, 444 (1946) (citing to such statements and explaining that “in ascertaining the[] meaning [of the rules] the construction given to them by the Committee is of weight”). See also Schiavone v. Fortune, 477 U.S. 21, 31 (1986) (same). 27 Proceedings of Advisory Committee on Rules for Civil Procedure of the Supreme Court of the United States, at 862, 871-72, 875, 878 (Vol. 4) (Nov. 17, 1935), microformed on Records of the U.S. Judicial Conference, Committees on Rules of Practice and Procedures, 1935-1988, Nos. CI-113-35, CI-113-41 to -51 (Cong. Info. Serv.). This same sentiment was expressed again in subsequent meetings of the Advisory Committee. See, e.g., Proceedings of Advisory Committee on Rules for Civil Procedure of the Supreme Court of the United States, at 48 (Feb. 1-4, 1937), microformed on Records of the U.S. Judicial Conference, Committees on Rules of Practice and Procedures, 1935-1988, No. CI-220-64 (Cong. Info. Serv.) (“I move that the rules have no statement by us in this connection respecting the effect of the judgment. (Mr. Lemann seconded[.]) Carried.”). Additionally, as later summarized by Judge Charles E. Clark, who served as the Reporter to the Advisory Committee: “Now, in the first draft that we had, we attempted to state questions of jurisdiction and the effect of the judgment, which are most important. It was decided, however, that that was not our province, and so we have put in no provision of that kind.” American Bar Assoc., Rules of Civil Procedure and Proceedings of the Institute on Federal Rules, Cleveland, Ohio, at 264 (1938). See also Adv. Committee on Rules for Civ. Proc., Report of Proposed Rules of Civil Procedure for the District Courts of 28 the United States, at 60 (Apr. 1937) (“The Committee consider it beyond their functions to deal with the question of the effect of judgments….”). The Advisory Committee recognized this same limitation in its drafting of Rule 13(a). In the committee’s 1936 preliminary draft of the rules, which was sent to the U.S. Supreme Court and published for review, the compulsory counterclaim rule (then Rule 18) provided that “[i]f the action proceeds to judgment without such a claim being set up, the claim shall be barred.” Adv. Committee on Rules for Civ. Proc., Preliminary Draft of Rules of Civil Procedure for the District Courts of the United States and the Supreme Court of the District of Columbia, at 32 (May 1936). This sentence was later deleted, likely due to the committee’s concern that it not overstep its authority and that it make no statement regarding the effect of a judgment. Indeed, after Rule 13(a) was implemented, Judge Clark was asked whether the failure to comply with the rule would “operate to bar the presentation of that cause of action in the counterclaim in a state court later?” In response, and putting aside his speculation as to how a state court might independently resolve the matter, Judge Clark conceded that “I don’t suppose that we could govern that finally.” American Bar Assoc., Cleveland, Ohio, supra, at 248. Soon thereafter, while once again describing Rule 13(a)’s effect, Judge Clark confirmed that “[o]f course it is true that we probably can’t tell state courts what they should hold….” American Bar Assoc., 29 Proceedings of the Institute at Washington, D.C. and of the Symposium at New York City, at 58 (1938). Based on these statements, it is evident that the original Advisory Committee understood that Rule 13(a) could not be used, under the guise of res judicata, to dictate how state courts should rule.10 The Advisory Committee’s understanding of the relationship between Rule 13(a) and the law of res judicata has been confirmed by the courts. In 2001, the U.S. Supreme Court announced its decision in Semtek Int’l Inc. v. Lockheed Martin Corp., 531 U.S. 497 (2001). In Semtek, the petitioner first filed suit in California, where a federal court held that its claims were barred “on the merits” by the state’s two-year statute of limitations. Id. at 499. The petitioner then filed a subsequent action in Maryland state court, which the respondent argued, and the Maryland state courts agreed, was barred by res judicata. Id. at 499-500. In the U.S. Supreme Court, the respondent asserted that because the original California federal case was dismissed “on the merits,” Rule 41(b) required that the dismissal be afforded res judicata (or claim preclusive) effect. Id. at 501. The U.S. 10 Years later, in 1946, the Advisory Committee proposed that Rule 14, which relates to third-party practice, should be amended to delete the following sentence: “The third party defendant is bound by the adjudication of the third party plaintiff’s liability to the plaintiff, as well as of his own to the plaintiff or to the third party plaintiff.” Adv. Committee on Rules for Civ. Proc., Report of Proposed Amendments to Rules of Civil Procedure for the District Courts of the United States, at 20 (June 1946). The Advisory Committee explained that this revision was necessary “because the sentence states a rule of substantive law which is not within the scope of a procedural rule. It is not the purpose of the rules to state the effect of a judgment.” Id. at 23. The Advisory Committee’s proposal was accepted. 30 Supreme Court rejected respondent’s argument, and indicated that it would violate the Rules Enabling Act to construe a federal rule of civil procedure as supporting the application of res judicata: [I]t would be peculiar to find a rule governing the effect that must be accorded federal judgments by other courts ensconced in rules governing the internal procedures of the rendering court itself. Indeed, such a rule would arguably violate the jurisdictional limitation of the Rules Enabling Act: that the Rules “shall not abridge, enlarge or modify any substantive right.” In the present case, for example, if California law left petitioner free to sue on this claim in Maryland even after the California statute of limitations had expired, the federal court’s extinguishment of that right (through Rule 41(b)’s mandated claim-preclusive effect of its judgment) would seem to violate this limitation. Id. at 503-04 (internal citations omitted). In order to avoid a conflict with the Rules Enabling Act, the U.S. Supreme Court construed Rule 41(b) narrowly, and held that the action could not be dismissed on that basis. Id. at 504-06. Based on Semtek, courts have recognized that “the use of a Federal Rule of Civil Procedure to govern the preclusive effect of a federal judgment in state court would run afoul of both the Rules Enabling Act and [Erie].” Brereton v. Bountiful City Corp., 434 F.3d 1213, 1217 (10th Cir. 2006). As a result, Rule 13(a) cannot be applied to bar a claim that would otherwise be permitted by a state’s substantive law of res judicata. See, e.g., Huston v. U.S. Bank Nat. Ass'n, 988 F. Supp. 2d 732, 738 (S.D. Tex. 2013) (“This court may not mechanically apply Rule 13(a)’s definition of compulsory counterclaims if doing so violates 31 either the U.S. Constitution or the Rules Enabling Act. State law controls over a federal rule if application of the otherwise procedural rule abridges a litigant’s substantive right.”) (internal citations omitted); Clawson v. GMAC Mortgage, LLC, 2013 WL 1948128, at *5 n.6 (S.D. Tex. 2013) (“[T]he federal counterclaim rule, Federal Rule of Civil Procedure 13(a), is inapplicable in this case because it would abridge Defendants’ substantive rights and enlarge Plaintiffs’ substantive rights”) (internal citation omitted); 27 Federal Procedure, Lawyers Ed., § 62:200 (“[Rule] 13 is inapplicable if its application would modify rights granted to parties under state law.”); 6 Cyc. of Federal Proc. § 16:17 (3d ed.) (“An exception applies under the general principle that if the application of the compulsory counterclaim rule would abridge the claimant’s substantive rights under state law, the rule is inapplicable….”). Thus, [e]ven if the claim arises out of the same transaction as the complaint, a defendant need not counterclaim…if requiring it would abridge, enlarge or modify a party’s state law rights.” James M. Wagstaffe, Rutter Group Prac. Guide: Fed. Civ. Proc. Before Trial (Nat’l Ed.), §§ 8:1151-54. This rule of law is exemplified by the Fifth Circuit’s decision in Douglas v. NCNB Texas Nat’l Bank, 979 F.2d 1128 (5th Cir. 1992). In Douglas, two debtors filed a class action lawsuit, which was removed to federal court, in which they alleged that the defendant, First RepublicBank Abilene, N.A (“FRBA”), had 32 committed fraud in connection with the issuance of promissory notes. Id. at 1129. After the class action was dismissed with prejudice, the Federal Deposit Insurance Corporation (“FDIC”), as the successor-in-interest to FRBA, sought to recover from the debtors, pursuant to Texas state law, the monies due under their promissory notes. Id. In response, the debtors argued that the FDIC’s debt collection claims were compulsory to the class action, and that the “right to collect on the notes [had been lost] by [the] fail[ure] to counterclaim … in prior litigation.” Id. In response, the Fifth Circuit conceded that the “debt collection claims … might very well constitute compulsory counterclaims,” but cautioned that “this court must not apply a federal rule of civil procedure if application of the rules violates either the Constitution or the Rules Enabling Act.” Id. at 1129- 30. The Fifth Circuit also explained that while Texas is generally a compulsory counterclaim jurisdiction, its state law of res judicata had carved out an exception for debt collection claims in which the lender had a contractual right to pursue a nonjudicial foreclosure. Id. at 1130. In its final analysis, the Court concluded that Texas’ res judicata principles should govern, and that the FDIC’s debt collection claims would be allowed to proceed regardless of Rule 13(a), as follows: 33 Application of rule 13(a) in the instant case would abridge the lender’s substantive rights and enlarge the debtor’s substantive rights. Thus, we believe it is appropriate in this case to follow the state’s practice of permitting a lender to refrain from filing a counterclaim on overdue notes and to wait to pursue either a judicial or nonjudicial foreclosure remedy. Id. See also Nunnery v. Ocwen Loan Serv., LLC, 641 Fed. App'x 430, 433-34 (5th Cir. 2016) (“[W]e hold that Rule 13(a) does not apply and that loan servicers do not forfeit their right to a judicial foreclosure [under Texas law] by not moving for judicial foreclosure in a prior lawsuit.”). As illustrated by Douglas, courts must employ state res judicata principles, wholly apart from and irrespective of Rule 13(a), in determining whether a state law claim should be barred due to its omission as a counterclaim in a federal action. Any ruling to the contrary would allow the content of state law to be defined by a federal procedural rule, which would violate both the Rules Enabling Act and basic canons of federalism. Accordingly, this Court should apply New York’s substantive law of res judicata, which has never recognized a compulsory counterclaim rule, and permit Paramount’s lawsuit to proceed.11 In summary, the Rules Enabling Act does not permit any of the Federal Rules of Civil Procedure, including Rule 13(a), to modify or enlarge any 11 While Respondents have previously cited to certain rulings from other states that have reached a different result, those decisions are unpersuasive and should not be followed because: (a) none evidence any consideration of the Rules Enabling Act; and (b) the vast majority were issued before Semtek and Douglas. 34 substantive point of law, whether with respect to res judicata or otherwise. Rule 13(a) is a “housekeeping” procedural rule that federal courts follow in deciding the manner in which federal claims may be brought in federal court. The rule should not, and cannot, have any effect on state law claims brought in the New York state courts. The First Department’s decision must be reversed in order to ensure that federal procedural rules do not displace state (or, for that matter, federal) substantive law. C. Declining to import Rule 13(a) into New York law will not invite any improper litigation splitting or encourage forum shopping Perhaps due to the weaknesses in their substantive legal arguments, Respondents have asserted that the failure to bar this lawsuit pursuant to Rule 13(a) would unleash a “parade of horribles” on the New York court system: namely, that the decision would lead to litigation splitting and forum shopping. These contentions are meritless. First, Paramount’s lawsuit does not invite any inappropriate “litigation splitting.” As discussed above, the decision not to file a counterclaim in the Federal Action, and to commence this lawsuit in state court, is nothing more than a standard application of New York’s permissive counterclaim rule. Second, Paramount’s lawsuit would not encourage forum shopping. In this regard, Respondents have accused Paramount of intentionally filing its covenant 35 not to sue claim in state court because it supposedly would not have prevailed in federal court due to the “American Rule” regarding attorneys’ fees and costs. This argument, however, fails to account for the Erie doctrine, which requires federal courts to apply state law to state claims. See Gasperini v. Ctr. for Humanities, Inc., 518 U.S. 415, 427 (1996); Piesco v. City of New York, Dep’t of Personnel, 650 F. Supp. 896, 899 (S.D.N.Y. 1987). New York law, which is identified as the governing law in the Subscription Agreement (R.93 at ¶ 14), must be applied regardless of whether Paramount’s claim is adjudicated in state or federal court. Thus, if Paramount had pursued this same claim in federal court and Respondents had filed a motion to dismiss there on the basis of the “American Rule” rule, the motion would have been denied for the same reasons it was denied by the Supreme Court. R.9; R.55. Admittedly, the parties maintain different positions regarding the proper application of New York law on this matter. Respondents have claimed that, based on the Second Circuit’s decision in Artvale, Inc. v. Rugby Fabrics Corp., 363 F.2d 1002, 1008 (2d Cir. 1966), Paramount can only recover attorneys’ fees and costs, as damages resulting from Respondents’ breach, if their breach was “obvious” or in “bad faith.” Paramount disputes the relevance of that decision because “Artvale did not state explicitly whether its holding was based on New York or federal common law,” Reach Music Pub., Inc. v. Warner/Chappell Music, Inc., 2014 WL 36 5861984, at *8 n.11 (S.D.N.Y. Nov. 10, 2014), and because “Artvale appears never to have been endorsed by the New York state courts.” Versatile Housewares & Gardening Sys., Inc. v. Thill Logistics, Inc., 819 F. Supp. 2d 230, 245 (S.D.N.Y. 2011). Respondents have also argued that this Court made “clear” in Baker v. Health Mgmt. Sys., 98 N.Y.2d 80, 88 (2002), that only an “explicit” fee-shifting clause will be enforced, and that the Subscription Agreement’s covenant not to sue provision is insufficiently clear to permit the recovery of attorneys’ fees and costs. Paramount will show, however, that Baker is inapt because it only applies to a “statutory entitlement to attorneys’ fees” and not to a contractual entitlement. See id. at 88. Moreover, even under Baker, a covenant not to sue provision is adequately “explicit” to encompass all damages caused by its breach. In truth, and as Paramount has demonstrated to the courts below, New York law permits the recovery of all damages, including attorneys’ fees and costs, incurred by virtue of the breach of a covenant not to sue. The provision’s enforcement does not depend on any unique specificity requirement, nor is its application limited to only those breaches that are “obvious” or in “bad faith.” McMahan & Co. v. Bass, 250 A.D.2d 460, 461 (1st Dep’t 1998) (“Absent a covenant not to sue, there exists no implicit agreement by defendants to pay the attorneys’ fees, as would result from breach of a covenant not to sue.”); Grendene 37 USA, Inc. v. Brady, 2015 WL 1499229, at *3 (S.D. Cal. Apr. 1, 2015) (in denying a motion to dismiss a covenant not to sue claim that was governed by New York law, the district court declined to apply Artvale’s “bad faith” standard because “the court in McMahan made no reference to bad faith as a requirement for obtaining attorney fees pursuant to a covenant not to sue”). See also Indosuez Int’l Finance B.V. v. National Reserve Bank, 304 A.D.2d 429, 431 (1st Dep’t 2003) (“[c]ontrary to defendant’s contention, damages may be obtained for breach of a forum selection clause, and an award of such damages does not contravene the American rule that deems attorneys’ fees a mere incident of litigation.”) (internal citations omitted). This issue, of course, is not the subject of the current appeal. However, Respondents’ attempt to attribute a wrongful intent to forum shop on Paramount, based on the mere existence of competing legal positions, is groundless. Respondents’ assertion also defies Erie and belies common sense because the correct application of New York law does not, and cannot, hinge on the forum in which Paramount’s claim is litigated. Simply put, Respondents’ policy arguments for importing Rule 13(a) into New York’s law of res judicata are unfounded, and do not militate against the application of New York’s permissive counterclaim rule. 38 POINT 2 THE FIRST DEPARTMENT ERRED BY HOLDING THAT PARAMOUNT’S COVENANT NOT TO SUE CLAIM, WHICH ARISES FROM THE FILING AND PROSECUTION OF AN UNDERLYING LAWSUIT, WAS COMPULSORY UNDER FEDERAL RULE OF CIVIL PROCEDURE 13(A) The First Department erred when it held that Paramount’s covenant not to sue claim was compulsory under Rule 13(a). In its ruling, the First Department relied on multiple cases for the general proposition that a counterclaim is compulsory in federal court if it is “so logically connected that considerations of judicial economy and fairness dictate that all the issues be resolved in one lawsuit.” R.171 (citing cases). The First Department created a conflict with governing federal law by misapplying these cases, which, as discussed herein, demonstrate that this standard is not satisfied by claims that are based on the mere filing and prosecution of an underlying lawsuit. As such, even if the First Department was correct to apply Rule 13(a) (it was not), Paramount’s lawsuit should not have been dismissed because its covenant not to sue claim would only have been a permissive counterclaim to the Federal Action.12 12 This Court has also recognized that any doubts regarding the meaning and effect of federal law should be resolved in favor of allowing a state court lawsuit to proceed, so that the plaintiff will not suffer irreparable harm. See Pleasant Val. Packing Co. v. Talarico, 5 N.Y.2d 40, 47 (1958) (“In the light of the foregoing statement emanating from the Supreme Court, we do not think we should be quick to announce a lack of State jurisdiction in this general area. If we rule against jurisdiction and we are wrong in so ruling, the unsuccessful litigant may well be irreparably harmed. We are of the mind that any doubt should be resolved in favor of jurisdiction, leaving it to the Supreme Court to finally resolve the matter.”). 39 In the Second Circuit, “[a] claim that stems from the filing of the main action is not a compulsory counterclaim.” Petrie Method, Inc. v. Petrie, 1989 WL 47709, at *2 (E.D.N.Y. Apr. 26, 1989). This rule of law was first announced by the Second Circuit in Harris v. Steinem, 571 F.2d 119 (2d Cir. 1978). In Steinem, the plaintiff filed suit alleging that the defendants had violated the securities laws. Id. at 121. In response, the defendants “counterclaimed for libel based both on the complaint itself…and also on several subsequent published statements of [plaintiff] concerning [the] lawsuit.” Id. After dismissing the complaint with prejudice, the district court declined to adjudicate the defendants’ libel counterclaims. Id. On appeal, the Second Circuit affirmed the lower court’s decision that the libel counterclaims were permissive. The Second Circuit held that “the case law seems clear that a counterclaim which stems from the filing of the main action and subsequent alleged defamations is not a compulsory counterclaim covered by Rule 13(a).” Id. at 124. Furthermore, the Steinem Court explained that it was appropriate to “postpone[]…suits that w[ould] ordinarily not arise if plaintiff wins the main action….” and thereby avoid counterclaims that might be raised in federal court as a “defensive stratagem,” especially with respect to matters that “are based on state law” and which “are best decided by the state courts.” Id. at 125 (internal quotations omitted). 40 Respondents have previously suggested—based on its reference to “subsequent alleged defamations”—that Steinem’s ruling is necessarily limited to counterclaims that involve conduct after the main action is filed, and that it does not apply to counterclaims premised on the main action alone. Respondents are incorrect in reading Steinem so narrowly. Importantly, the Steinem Court inserted a clarifying footnote indicating that its rule would extend to (without the requirement of any subsequent conduct) “a counterclaim arising only at the time of, and because of, the main suit.” Steinem, 571 F.2d at 124 n.16. In any event, Paramount has alleged in its complaint that it was injured not merely by the filing of the Federal Action, but also by Respondents’ post-filing prosecution of the lawsuit. R.71 at ¶ 31. As a result, Paramount’s claim meets Steinem’s rule regardless of whether post-filing conduct is required. Since Steinem, courts in the Second Circuit have held that, in addition to defamation, other torts arising out of the filing of a lawsuit should be construed as permissive counterclaims. See, e.g., Petrie Method, Inc., 1989 WL 47709, at *2 (following Steinem and holding that a claim that is “essentially” for malicious prosecution is a permissive counterclaim); Chrysler Corp. v. Fedders Corp., 540 F. Supp. 706, 713 n.2 (S.D.N.Y. 1982) (following Steinem and holding that claims for abuse of process and malicious prosecution are permissive counterclaims). Given that Steinem has been applied generally to torts caused by 41 the filing of a lawsuit, it would only be logical for its rule to govern contract claims resulting from the same conduct. Not surprisingly, courts have extended Steinem in precisely this manner. In Grendene, the plaintiff filed a breach of contract action in which it alleged that the defendants had violated a covenant not to sue by instituting (years earlier) a federal trademark infringement action. 2015 WL 1499229, at *1. Defendants moved to dismiss, inter alia, on the basis that plaintiff’s breach claim was a compulsory counterclaim in the trademark lawsuit. In rejecting defendants’ motion, the federal court persuasively explained that: The Trademark Action involves facts dealing with alleged infringement. This action involves facts dealing with the [defendants’] decision to file a lawsuit based on that alleged infringement. These are separate facts as the decision to bring a legal cause of action is separate from the elements of that cause of action. Accordingly, the Court finds that [plaintiff’s] breach of contract cause of action was not a compulsory counterclaim. Id. at *3 (internal citations omitted). Similarly, in Mount Everest Ski Shops, Inc. v. Nordica USA, Inc., 736 F. Supp. 523, 524 (D. Vt. 1989), the plaintiff filed various antitrust, fraud, and contract claims. In response, the defendant counterclaimed for fees and costs incurred in defending against plaintiff’s claims. After plaintiff’s claims were dismissed, the Court evaluated whether the remaining counterclaim was compulsory (which would require no independent basis for federal jurisdiction) 42 or permissive (which would be dismissed absent an independent jurisdictional basis). Id. at 524-25. Relying on Steinem, the Court held that the counterclaim was permissive: A counterclaim which depends upon the judgment in the main action itself is not a compulsory counterclaim. The plaintiff’s claims and the defendant’s counterclaim for the cost of defending against them do not arise out of the same “transaction or occurrence.” The counterclaim is permissive within the terms of rule 13. Id. at 525 (internal citations omitted). Paramount’s lawsuit is therefore controlled by Steinem. Paramount’s breach of contract claim is based on Respondents’ commencement and prosecution of the Federal Action for securities and common law fraud (R.71 at ¶ 31). Thus, the “facts dealing with [Respondents’] decision to file a lawsuit” based on the breach of a covenant not to sue involve “separate facts” from the elements of Respondents’ underlying “cause[s] of action” in the Federal Action. See Grendene, 2015 WL 1499229, at *3. See also Mount Everest Ski Shops, Inc., 736 F. Supp. at 525 (same). Paramount’s decision to postpone this lawsuit was appropriate because its claim would have almost certainly been rendered moot if Respondents had prevailed in the Federal Action. See Steinem, 571 F.2d at 125. Additionally, the claim would have added collateral issues to the Federal Action—for example, the parties would have been forced to introduce evidence bearing on Respondents’ assertion that Paramount overspent on legal fees and 43 thus failed to mitigate damages, as well as any other defenses that Respondents may have concocted—and surely would have been castigated by Respondents as a “defensive stratagem.” See id. Finally, as in Steinem, it is most appropriate for the New York state courts to address matters of New York state law. Id. In conclusion, Paramount’s breach of contract claim was not a compulsory counterclaim in the Federal Action. Moreover, if the First Department’s decision is reversed on this basis, this Court can proceed, as it did in Gargiulo, by declining to finally resolve whether Rule 13(a) should be incorporated into New York’s law of res judicata. CONCLUSION For the reasons stated above, the First Department's Decision and Order should be reversed, Respondents' motion to dismiss should be denied, and this action should be remanded to the Supreme Court for further proceedings. Dated: January 20, 2017 E. LEO MILONAS, ESQ. EDWARD FLANDERS, ESQ. PILLSBURY WINTHROP SHAW PITTMAN LLP 1540 Broadway New York, New York 10036 Telephone:(212) 858-1000 eleo. milonas@pillsburylaw. com edward.flanders@pills burylaw. com Respectfully submitted, RICHARD B. KENDALL. ESQ. (PRO HAC VICE) KENDALL BRILL & KELLY LLP 10100 Santa Monica Blvd., Suite 1725 Los Angeles, CA 90067 Telephone: 310.556.2700 Facsimile: 310.556.2705 rkendall@kbkfirm. com Attorneys for Plaintiff-Appellant Parammmt Pictures Corporation 44 WORD COUNT CERTIFICATION I certify pursuant to 5 00.13 (c)( 1) that the total word count for all printed text in the body of the brief, exclusive of the statement of the status of related litigation; the corporate disclosure statement; the table of contents, the table of cases and authorities and the statement of questions presented required by subsection (a) of this section; and any addendum containing material required by subsection 500.1(h) of this Part is 10,763 words. Dated: January 20, 2017 Respectfully submitted, RICHARD B. KENDALL. ESQ. (PRO HA C VICE) KENDALL BRILL & KELLY LLP 10100 Santa Monica Blvd., Suite 1725 Los Angeles, CA 90067 Telephone: 310.556.2700 Facsimile: 310.556.2705 ADDENDUM 501575282v1 SUPREME COURT FOR THE STATE OF NEW YORK COUNTY OF NEW YORK --------------------------------------------------------------- x PARAMOUNT PICTURES CORPORATION, : Index No. 653708/2014 : Plaintiff, : : -against- : : : ALLIANZ RISK TRANSFER AG; : MARATHON STRUCTURED FINANCE FUND, : L.P.; NEWSTAR FINANCIAL, INC.; and : MUNICH RE CAPITAL MARKETS NEW : YORK, INC., : : Defendants, : --------------------------------------------------------------- x PLAINTIFF’S MEMORANDUM OF LAW IN OPPOSITION TO DEFENDANTS’ MOTION TO DISMISS PILLSBURY WINTHROP SHAW PITTMAN LLP E. Leo Milonas Edward Flanders 1540 Broadway New York, NY 10036-4039 Tel: (212) 858-1000 KENDALL BRILL & KLIEGER LLP Richard B. Kendall (pro hac vice) Phillip M. Kelly (pro hac vice) Randall L. Jackson (pro hac vice) 10100 Santa Monica Boulevard, Suite 1725 Los Angeles, California 90067 Tel: (310) 556-2700 Attorneys for Plaintiff Paramount Pictures Corporation FILED: NEW YORK COUNTY CLERK 03/23/2015 04:43 PM INDEX NO. 653708/2014 NYSCEF DOC. NO. 28 RECEIVED NYSCEF: 03/23/2015 i 501575282v1 TABLE OF CONTENTS Page INTRODUCTION ...........................................................................................................................1 BACKGROUND .............................................................................................................................3 I. Defendants Expressly Covenant Not To Sue Paramount In Connection With The Melrose Transaction.............................................................................................................3 II. Defendants Breach Their Covenant Not To Sue By Filing The Meritless Federal Action And Cause Paramount To Suffer Millions Of Dollars In Damages ........................4 ARGUMENT ...................................................................................................................................6 I. Legal Standards ....................................................................................................................6 II. Paramount’s New York State Court Lawsuit Is Not Barred By The Federal Rules Of Civil Procedure ...............................................................................................................7 A. Under New York Law, Res Judicata Does Not Prohibit A Party From Filing A Lawsuit Based On A Claim That Could Have Been Asserted As A Counterclaim In A Prior Action ...........................................................................8 B. Federal Rule of Civil Procedure 13(a) Is Inapplicable To This Lawsuit ...............10 III. Paramount Has Properly Alleged That It Suffered Damages As A Result Of Defendants’ Breach Of The Subscription Agreement .......................................................13 A. The “American Rule” Does Not Prohibit Paramount From Recovering The Damages Caused By Defendants’ Breach Of Contract .........................................13 1. New York Law Allows A Plaintiff To Recover Attorneys’ Fees And Costs Resulting From The Breach Of A Covenant Not To Sue ........14 2. Paramount’s Lawsuit Cannot Be Dismissed Under The Federal Cases Cited By Defendants Because Their Breach Was “Obvious” Or In “Bad Faith” .......................................................................................16 B. Defendants Have Not “Conclusively Established” That Paramount Willfully Failed To Mitigate Damages ..................................................................17 CONCLUSION ..............................................................................................................................22 8 501575282v1 A. Under New York Law, Res Judicata Does Not Prohibit A Party From Filing A Lawsuit Based On A Claim That Could Have Been Asserted As A Counterclaim In A Prior Action “In New York there are no compulsory counterclaims.” 67-25 Dartmouth St. Corp. v. Syllman, 29 A.D.3d 888, 889 (2d Dep’t 2006). See also CPLR 3011 (“An answer may include a counterclaim against a plaintiff and a cross-claim against a defendant.”) (emphasis added); CPLR 3019. This legal rule evidences a considered judgment by the New York legislature that it is preferable to allow litigants to secure a ruling on the merits of their claims than to require forfeiture solely because the claims were not asserted in a prior lawsuit. Urbanski v. Urbanski, 433 N.Y.S.2d 718, 719 (Sup. Ct. 1980) (“Withholding asserting a counterclaim does not forfeit the right to bring a separate suit upon the cause of action.”). “While a compulsory rule would be more consistent with economical court administration, the lack thereof is not a significant factor in burdensome case loads. The use of summary judgment procedures effectively precludes relitigation of issues and, from a pragmatic view, proceeding to a jury with liability established is not likely except in extraordinary cases.” Batavia Kill Watershed Dist. in Greene County v. Charles O. Desch, Inc., 83 A.D.2d 97, 100 (3d Dep’t 1981), aff’d 57 N.Y.2d 796 (N.Y. 1982). Thus, for the most part, “the question of judicial economy is not directly involved since the [relevant] facts … [will have been] established in the prior action.” Id. In their motion, Defendants cite to various cases for the alleged proposition that “New York courts historically and invariably dismiss claims that should have been asserted in related and resolved actions under the doctrine of res judicata.” Mem. at 13. Defendants, however, misstate the law. “[S]ince there is no compulsory counterclaim rule in New York, the doctrine of res judicata does not bar claims that could have been raised as counterclaims in a previous action but were not actually raised.” Masudi v. Maximo Couture Inc., 971 N.Y.S.2d 72 (Sup. Ct. 2013). See also Associated Fin. Corp. v. Kleckner, No. 09 Civ. 3895 (JGK), 2010 WL 3024746, at *3 (S.D.N.Y. Aug. 3, 2010) (“New York, unlike the federal system, does not have a compulsory 9 501575282v1 counterclaim rule, and, therefore, res judicata does not bar claims that could have been raised by the defendant as counterclaims in a previous action but were not actually raised.”). Additionally, Defendants emphasize that Paramount’s breach claim is based on “the very same contractual provision” that was cited as an affirmative defense in the Federal Action. See Mem. at 2. But, in fact, “New York's permissive counterclaim rule allows counterclaims to be raised through separate litigation even if interposed as a defense in prior litigation…” Classic Automobiles, Inc. v. Oxford Resources, Corp., 204 A.D.2d 209, 209-210 (1st Dep’t 1994). See also Sweet Constructors, LLC v. Wallkill Med. Dev., LLC, 106 A.D.3d 810, 811 (2d Dep’t 2013) (same). Thus, Paramount’s reliance on Paragraph 4(t) in the Federal Action does not assist Defendants. There is only one limitation to New York’s permissive counterclaim rule, which is that a party cannot “remain silent in the first action and then bring a second one on the basis of a preexisting claim for relief that would impair the rights or interests established in the first action.” Henry Modell & Co. v. Minister, Elders & Deacons of Reformed Protestant Dutch Church of the City of New York, 68 N.Y.2d 456, 462 n.2 (1986). Defendants, however, cannot possibly argue that Paramount’s lawsuit would “impair” rights established in the Federal Action. To the contrary, the entire purpose of this lawsuit is to confirm rights that the Federal Action has already decided in Paramount’s favor (see, e.g., Cmplt. ¶ 25), and which Paramount expects to accomplish, with a minimal effect on the Court’s judicial resources, by way of a summary judgment motion hereafter. See Batavia, 83 A.D.2d at 100 (“the question of judicial economy is not directly involved since the facts that Desch breached the contract as to timely performance and that plaintiff was justified in terminating the agreement were established in the prior action”). Clearly, Paramount’s lawsuit is authorized under New York law and its permissive counterclaim rule. Defendants’ citations to general res judicata principles are irrelevant. 10 501575282v1 B. Federal Rule of Civil Procedure 13(a) Is Inapplicable To This Lawsuit Because Defendants’ res judicata defense fails under governing New York law, Defendants’ motion is primarily predicated on persuading the Court that it must apply Federal Rule of Civil Procedure 13(a), and not CPLR 3011, to this lawsuit. See Mem. at 3, 15-17. Defendants’ position, as a starting point, is odd because “the Federal Rules of Civil Procedure are not binding upon this Court—or, for that matter, any other state court…” Swergold v. Cuomo, 952 N.Y.S.2d 813, 816 (Sup. Ct. 2012). This should be especially true for Rule 13(a), which has been characterized for decades as “simply a federal court housekeeping rule.” Reines Distributors, Inc. v. Admiral Corp, 182 F. Supp. 226, 230 (S.D.N.Y. 1960). Indeed, consistent with this understanding of the rule, federal courts have held that Rule 13(a) cannot be relied upon to enjoin a party from proceeding in state court on a claim that should have been asserted in a federal action as a compulsory counterclaim. See, e.g., Seattle Totems Hockey Club, Inc. v. Nat'l Hockey League, 652 F.2d 852, 855 n.5 (9th Cir. 1981) (“Rule 13(a) has been held not to create an express statutory exception to the proscriptions of [28 U.S.C. §] 2283 and, accordingly, a federal court is barred by [28 U.S.C. §] 2283 from enjoining a party from proceeding in state court on a claim that should have been pleaded as a compulsory counterclaim in a prior federal suit.”); Bruce v. Martin, 680 F. Supp. 616, 620 n.3 (S.D.N.Y. 1988) (“Rule 13(a) has been held not to create an express statutory exception to the Anti–Injunction Act and, therefore, a federal court is barred by the Act from enjoining a party from proceeding in state court on a claim that should have been pleaded as a compulsory counterclaim in a prior federal suit.”). Thus, since Rule 13(a) cannot be invoked to enjoin a party from litigating a “compulsory counterclaim” in state court, it would make no sense for this Court to be prohibited from considering such a claim pursuant to the same rule. In what can only be described as an intentional attempt to mislead the Court, Defendants represent that “New York courts give effect to Fed. R. Civ. P. 13(a) in this kind of situation” and even claim that “[t]he Court of Appeals went out if its way to articulate this point over 30 years ago…” Mem. at 15-16 (emphasis added). In fact, Defendants’ quotation from the Court of 11 501575282v1 Appeals’ opinion in question, Gargiulo v. Oppenheim, 63 N.Y.2d 843 (1985), is glaringly misstated. Specifically, Defendants quote Gargiulo as follows: under the procedural compulsory counterclaim rule in the Federal courts, claim and issue preclusion would extend to bar the later assertion in the present State court action of a contention which could have been raised by way of a counterclaim in the answer in the prior Federal action between the same parties. Mem. at 16. There is only one problem with Defendants’ quotation: they deleted the introductory portion of this sentence, which entirely changes its meaning. In its complete form, Gargiulo actually states that: For purposes of the disposition of this appeal we assume, without deciding, that under the procedural compulsory counterclaim rule in the Federal courts, claim and issue preclusion would extend to bar the later assertion in the present State court action of a contention which could have been raised by way of a counterclaim in the answer in the prior Federal action between the same parties. 63 N.Y.2d at 845 (emphasis added). Similarly, Defendants cite to a concurrence in Cummings v. Dresher, 18 N.Y.2d 105 (1966) in support of this same argument (Mem. at 16), but fail to inform the Court that the Court of Appeals majority concluded that “[i]t [was] unnecessary to deal with Federal Rule 13 (subd. [a]) which was not briefed by the parties or considered by either court below.” Id. at 108.1 Defendants have gone to these extraordinary lengths to misrepresent Gargiulo because there is not a single New York state court case that has ever barred a claim based on Federal Rule of Civil Procedure 13(a). See McMahan & Co. v. Bass, 250 A.D.2d 460 (1st Dep’t 1998) (plaintiff brought suit seeking attorneys’ fees and costs incurred in underlying federal action that was filed in alleged violation of a release provision; the Court nowhere suggested that plaintiff’s 1 Defendants’ citation to Citimortgage, Inc. v. Samuel, 986 N.Y.S.2d 864 (Sup. Ct. 2014), is also of no assistance. In that case, although the Court referred skeptically to the “so-called federal bar of compulsory counterclaims,” it held that, even “assuming arguendo” that the rule was applicable, it would not bar the claim at issue in the state court proceeding. Id. at *2. 12 501575282v1 claim might be barred because it should have been asserted in the federal action as a compulsory counterclaim). Cf. Stroock & Stroock & Lavan, LLP v. KSW, Inc., Index No. 110886100, 2001 WL 1682878, at *1 (Sup. Ct., N.Y. County, Oct. 24, 2001) (in ruling on motion to dismiss for forum non conveniens, recognizing that “the fact that Stroock's legal fee claim appears to constitute a compulsory counterclaim in California … has no bearing on Stroock's right to commence a separate action for the same relief in New York, which, in any event, has a permissive counterclaim rule”).2 Moreover, such a rule would not comport with the New York courts’ reluctance to apply res judicata principles to state law claims that were not clearly adjudicated in a prior federal proceeding. See, e.g., Lamontagne v. Board of Trustees of the United Wire, Metal & Mach. Pension Fund, 183 A.D.2d 424, 426 (1st Dep’t 1992) (“Since plaintiff’s federal complaint [did] not adequately present a recognizable State claim, and since there was no indication by the federal court … that it intended to dismiss any implicit State claims on the merits, the federal court decision [ruling against plaintiff on federal claims based on the same underlying facts] can have no res judicata effect on the instant action.”) (citation omitted). In sum, even if the Court were to assume that Paramount’s breach of contract claim was “compulsory” to the Federal Action under Federal Rule of Civil Procedure 13(a), this lawsuit would still be permitted to proceed under New York law.3 2 Defendants do cite to a federal district court case that held that New York’s permissive counterclaim rule “does not apply when the forum in which the prior litigation occurred was a compulsory counterclaim jurisdiction.” RA Global Servs., Inc. v. Avicenna Overseas Corp., 843 F. Supp. 2d 386, 390 (S.D.N.Y. 2012). That Court’s ruling, however, was erroneous, and relied solely on Gargiulo—which, as stated above in the text, did not actually rule on the issue. That Court also erred (as Defendants do) in its interpretation of Stroock. See id. at 390 n.4. See also Mem. at 17. It is true that the Stroock Court noted that “the claims asserted herein can, and indeed must, be asserted as a counterclaim [in the California action].” 2001 WL 1682878, at *1. However, the Court made this observation after having decided that it would stay the New York action on forum non conveniens grounds. Thus, because the dispute would only be proceeding in California, the Court’s comment merely highlighted the obvious conclusion that Stroock’s claim would, as a practical matter, be litigated as a counterclaim in California. 3 In any event, if pertinent to its analysis, the Court should hold that Paramount’s claim is not compulsory under Federal Rule of Civil Procedure 13(a), as the breach merely stemmed from the Federal Action’s filing. Under federal law, a counterclaim is considered to be permissive in such circumstances. See, e.g., Harris v. Steinem, 571 F.2d 119, 123-25 (2d Cir. 1978) (holding that defamation counterclaim filed in response to complaint was permissive and not compulsory); Petrie Method, Inc. v. Petrie, No. 88 3289, 1989 WL 47709, at *2 (E.D.N.Y. Apr. 26, 1989) (“A claim that stems from the filing of the main action is not a compulsory counterclaim.”).