The California Court of Appeal, First District, recently ruled that res judicata barred a Federal Home Loan Bank's ("FHLB") state law claim against a securities dealer for control-person liability associated with misrepresentations allegedly made by a subsidiary in connection with the sale of residential mortgage-backed securities.
In so ruling, the Court determined in part that, under the so-called "primary rights" theory, the FHLB's state law claim was the same "cause of action" as its federal claim against the securities dealer that it dismissed with prejudice in prior litigation. The Court reasoned that, because the FHLB sought compensation for the same harm in both proceedings and could have pursued its state law claim against the securities dealer in the prior litigation, the FHLB's voluntary dismissal with prejudice of that claim against the securities dealer was a final judgment on the merits, thereby precluding the state law claim against the securities dealer in the subsequent proceeding.
A copy of the opinion is available at: http://www.courts.ca.gov/opinions/documents/A135898.PDF.
Plaintiff FHLB purchased mortgage-backed securities from various securities dealers, and later sued a number of those securities dealers as well as other entities, alleging that the defendants made untrue or misleading statements in the documents they used to sell the securities, in violation of both federal and California securities laws. Among the defendants in that action (the "Prior Action") was the same defendant securities dealer ("Dealer") named in this case.
Among other things, FHLB alleged in the Prior Action that Dealer violated Section 15 of the federal Securities Act of 1933 (the "1933 Act") based on Dealer's alleged control of a subsidiary and which, according to FHLB, Dealer used for the sole purpose of receiving and depositing mortgage loans into the trusts holding the mortgage-backed assets. Thus, under a "control-person" liability theory, FHLB asserted that Dealer was liable to it to the same extent as the securities dealer that Dealer allegedly controlled.
About six months later, FHLB filed the complaint in this case (the "Declaratory Relief Action"), seeking a declaration that a bank holding company that had purchased the assets of Dealer and its affiliates was liable for any damages Dealer was required to pay in the Prior Action.
When FHLB obtained an adverse ruling on a demurrer in the Prior Action, it voluntarily dismissed with prejudice a number of its 1933 Act claims against certain defendants in the Prior Action, including the Section 15 claim against Dealer.
Shortly thereafter, FHLB amended its complaint to add Dealer as a defendant in the Declaratory Relief Action, alleging that Dealer was liable as a "control person" under Section 25504 of the California Corporations Code. Specifically, FHLB alleged that Dealer was jointly and severally liable along with its subsidiary for the alleged misrepresentations in the sale to FHLB of the securities at issue in the Prior Action. FHLB attached to its complaint a copy of the complaint filed in the Prior Action alleging that the "control person liability claims asserted against [Dealer] arise out of the same facts alleged in [the Prior Action], and [the FHLB] seeks the same remedy that it sought in the [Prior Action], that is, rescission and recovery of the consideration paid for [the] certificates."
Dealer demurred in the Declaratory Relief Action, arguing in part that res judicata barred the FHLB's Section 25504 claim, because the Section 25504 claim was the same cause of action as its Section 15 claim under the 1933 Act in the Prior Action, and that FHLB claimed a violation of the same primary right, namely, the right to offering documents free of material misrepresentations.
In response, asserting that there had been no final judgment on the merits in the Prior Action because certain claims as to its "entire cause of action" still remained pending, FHLB argued that the Section 25504 claim in the Declaratory Relief Action was different than the Section 15 claim it voluntarily dismissed earlier and that res judicata thus did not bar it from asserting claims under a different statute.
The lower court sustained Dealer's demurrer without leave to amend, reasoning that the same primary right was at issue and that the core issue in both proceedings was control-person liability. FHLB appealed. The Appellate Court affirmed.
As you may recall, the California Corporations Code prohibits sales of securities "by means of any written or oral communication which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made . . . not misleading" and establishes liability for violations of this provision. See Cal. Corp. Code §§ 25401; 25501. In addition, Section 25504 "imposes joint and several liability for securities law violations on "[e]very person who directly or indirectly controls a person under Section 25501." Cal. Corp. Code § 25504.
Moreover, Section 15 of the 1933 Act ("Section 15") provides that "[e]very person who . . . controls any person liable" under Sections 11 or 12 is jointly and severally liable "with and to the same extent as such controlled person." 15 U.S.C. § 77o. Sections 11 and 12 of the 1933 Act in turn prohibit untrue or misleading statements of material fact in registration statements or prospectuses with respect to the sale of securities. 15 U.S.C. § 77k; 77l(2).
Finally, res judicata bars a cause of action that was or could have been litigated in a prior proceeding if: (1) the present action is on the same cause of action as the prior proceeding; (2) the prior proceeding resulted in a final judgment on the merits; and (3) the parties in the present action or parties in privity with them were parties to the prior proceeding."
In disagreeing with FHLB that its voluntary dismissal with prejudice of the Section 15 claim against Dealer in the Prior Action was not a final judgment on the merits because certain claims regarding primary liability of other defendants remained pending, the Appellate Court emphasized that dismissal with prejudice is indeed a final judgment on the merits. See, e.g., Torrey Pines Bank v. Superior Court, 216 Cal. App. 3d 813, 820 (1989)("Dismissal with prejudice is determinative of the issues in the action and precludes the dismissing party from litigating those issues again.").
The Court stressed that central to the issue of res judicata is whether FHLB could have raised a claim against Dealer in the Prior Action based on Dealer's control of its subsidiary, not whether it actually did. Citing precedent, the Court stated "[t]he law is settled that a 'prior judgment on the merits not only settles issues that were not actually litigated but also every issue that might have been raised and litigated in the first action." Mattson v. City of Costa Mesa, 106 Cal.App.3d 441, 446 (1980); Villacres v. ABM Industries, Inc., 189 Cal. App.4th 562, 576 (2010)(if a matter is within the "scope of the [prior] action, related to the subject matter and relevant to the issues, so that it could have been raised, the judgment is conclusive on it . . . .").
The Court also concluded that FHLB's Section 25504 claim was the same cause of action as the Section 15 claim it dismissed with prejudice in the Prior Action. In so ruling, the Court applied the "primary rights" theory, thus focusing on the harm suffered in determining the "cause of action" for res judicata purposes rather than on any particular legal theory. Accordingly, the Court looked at the various claims asserted in the Prior Action against the defendants, and, pointing out that FHLB also sought to hold Dealer liable as a control person under Section 15 in the Prior Act, determined that FHLB's attempt to hold Dealer similarly liable under Section 25504 in the Declaratory Relief Action was substantially the same as its Section 15 claim against Dealer.
Thus, concluding that the Section 15 and Section 25504 claims constituted identical causes of action, the Court ruled that the Section 25504 claim in this case was barred under res judicata. Accordingly, the Appellate Court affirmed the lower court's ruling sustaining Dealer's demurrer.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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