UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT
decided: April 5, 1976.
POLORON PRODUCTS, INC. (WITH SUBSTITUTION APPLIED FOR BY DYNAMARK CORPORATION, ASSIGNEE), PLAINTIFF-APPELLANT,
LYBRAND ROSS BROS. & MONTGOMERY, DEFENDANT AND THIRD-PARTY PLAINTIFF-APPELLEE, V. POLORON PRODUCTS OF INDIANA, INC., SAMUEL LEVITT, CARL LEVITT, JAY LEVITT, DYNAMARK CORPORATION AND GEORGE FEIWELL, THIRD-PARTY DEFENDANTS
Appeal from an order of the United States District Court for the Southern District of New York, William C. Conner, District Judge, 66 F.R.D. 610 (S.D.N.Y. 1975), dismissing the amended complaint on the ground that Rule 41(a)(1), Fed. R. Civ. P., rendered two prior voluntary dismissals of the same action an adjudication on the merits and created a res judicata bar to the instant action. Also pending before this Court are motions to dismiss the appeal as moot and to substitute Dynamark Corporation as Plaintiff-Appellant. The motion to substitute is granted; the motion to dismiss the appeal is denied; and the order of the district court is reversed. Remanded to the district court for further proceedings.
Oakes, Van Graafeiland and Meskill, Circuit Judges.
MESKILL, Circuit Judge:
Poloron Products, Inc. ("Poloron") appeals from an order of the United States District Court for the Southern District of New York, Conner, J., dismissing its amended complaint on the ground that two prior voluntary dismissals of the action by the plaintiff in the present action had the effect of a dismissal on the merits. The district court's opinion is reported at 66 F.R.D. 610 (S.D.N.Y. 1975). The district court held that the instant suit was barred by the doctrine of res judicata because of the so-called "two dismissal" rule set forth in Rule 41(a)(1), Fed. R. Civ. P., quoted infra.
Before deciding the merits of the appeal we must first decide if it is properly before us. The right to pursue the appeal was assigned to Dynamark Corporation ("Dynamark") by Poloron shortly after the district court had dismissed the complaint and shortly after Poloron had settled all its claims against the defendant, Lybrand Ross Bros. & Montgomery ("Lybrand"). Lybrand contends that the assignment is champertous and therefore invalid under New York law and that because Poloron is no longer a party the appeal is moot. On the merits of the appeal Lybrand claims that even if the "two dismissal" rule does not create a res judicata bar, a result which it certainly does not concede, the complaint was properly dismissed in any event since the allegations contained therein failed to state a cause of action.
This case arises from the 1967 sale of the Levitt Manufacturing Company ("LMC") by its owners, Carl and Jay Levitt, to Poloron. Lybrand, a public accounting firm, prepared LMC's balance sheet, upon which a major term of the sale depended. The Levitts gave Poloron their personal guarantees of the balance sheet's accuracy. After the sale, Poloron caused LMC's name to be changed to Poloron Products of Indiana, Inc. ("Poloron-Indiana"). Later Poloron's own accountants discovered that LMC's assets apparently had been substantially overstated. When Poloron learned of this, it caused Poloron-Indiana to withhold certain payments due Dynamark under a sales representative agreement which LMC had entered into with Dynamark, a corporation wholly owned by the Levitts.
In May, 1970, the Levitts and Dynamark initiated an action against Poloron-Indiana in the United States District Court for the Northern District of Indiana to recover the sales commissions they claimed had been withheld improperly. In September, 1970, they amended their complaint to add Lybrand as a defendant on the theory that the losses were ultimately the result of the false balance sheet prepared by Lybrand. Dynamark alleged that Lybrand's false statements in the balance sheet constituted a violation of Section 10(b) of the Securities Exchange Act of 1934. On Poloron-Indiana's motion the action was then transferred to the Southern District of New York in November, 1970. Subsequently, the Levitts and Dynamark served and filed an amended complaint realleging the claims against Lybrand and adding Poloron, the parent corporation and a party to the sale, as a defendant. Later, Poloron and Samuel Levitt agreed that the losses which they had both sustained were principally the result of Lybrand's false financial statements. They agreed to terminate the pending litigation and assign all of their rights to damages to Poloron, which would pursue the action alone against Lybrand only. The settlement agreement provided that Dynamark would bear seventy-five percent of the costs of litigation and enjoy the same percentage of any recovery. The agreement further provided that under certain conditions Poloron would be required to reassign its entire claim back to Dynamark upon the latter's demand. Apparently, Lybrand was not made aware of the terms of the settlement agreement. On July 7, 1971, a stipulation of discontinuance, signed by all parties, was filed in the district court.
Thereafter, on December 30, 1974, pursuant to the earlier settlement agreement, Poloron brought an action against Lybrand in the United States District Court for the Northern District of Illinois. The allegations against Lybrand were substantially similar to those charged against it in the first suit. On January 26, 1972, however, the United States Court of Appeals for the Seventh Circuit announced its decision in Parrent v. Midwest Rug Mills, Inc., 455 F.2d 123 (7th Cir. 1972), holding that the Illinois three-year statute of limitations for securities cases rather than its five-year general fraud statute of limitations "best effectuates" the federal policy for actions brought under Section 10(b) of the Securities Exchange Act of 1934, and must be used in actions brought in Illinois under the federal act. Afraid that that decision would time bar its action in the Northern District of Illinois, Poloron filed a notice of dismissal of this action under Rule 41(a)(1)(i), Fed. R. Civ. P., before any responsive pleadings had been served.
Shortly thereafter, Poloron refiled the same suit in the Southern District of New York, where the statute of limitations had not yet run on its claim. After the filing of an answer, a counterclaim and a third-party complaint against Poloron-Indiana, Carl Levitt, Jay Levitt, Dynamark and George Feiwell,*fn1 Lybrand moved to dismiss the action on the theory that the "two dismissal" rule barred the action and, alternatively, that the complaint failed to state a cause of action. On April 3, 1975, the court granted Lybrand's motion based on the "two dismissal" rule and dismissed Lybrand's counterclaims against the other parties.*fn2
Subsequently, Poloron and Lybrand settled all of their remaining differences, including the counterclaims against Poloron. Dynamark, however, demanded, pursuant to its agreement with Poloron, that it be assigned the right to proceed with an appeal. Poloron agreed to the assignment, and Lybrand stipulated that its settlement with Poloron would not by itself bar Dynamark's right to appeal. Lybrand, however, reserved its right to challenge the validity of the assignment of Poloron's claim back to Dynamark. With Lybrand's permission, Dynamark filed a timely notice of appeal in Poloron's name, even though the actual assignment of the claim did not occur until afterward.
In this Court Lybrand moved for dismissal of the appeal on the ground that the assignment to Dynamark was champertous under New York law and therefore invalid, and that since Poloron no longer had an interest in the appeal, it was moot. Dynamark moved to be substituted for Poloron as appellant.
Before turning to the issue raised on the merits of the appeal, we must first address Lybrand's motion that the appeal be dismissed because the only person seeking to prosecute the appeal, Dynamark, does so by virtue of an allegedly champertous assignment of the claim dismissed below. Lybrand claims that since Poloron no longer has an interest in the appeal, and since the assignment to Dynamark is invalid, the appeal should be dismissed as moot. We agree that if the assignment were invalid the appeal would have to be dismissed. We find no invalidity in the assignment, however, and therefore deny Lybrand's motion to dismiss the appeal.*fn3
Lybrand's only assertion that the assignment is champertous and thus invalid rests upon its theory that the assignment violated Section 489 of the New York Judiciary Law (McKinney 1968).*fn4 We disagree. Section 489 specifically prohibits a corporation from taking an assignment of a claim for the purpose of suing thereon. As stated in Lee v. Community Capital Corp., 67 Misc.2d 699, 701, 324 N.Y.S.2d 583, 585 (Sup. Ct. 1971):
Section 489 of the Judiciary Law is penal in nature, and manifests this State's public policy prohibiting such practices, and hence classifies all such transactions as void aside from the penal sanctions imposed. * * * This court will not lend its aid or grant relief to a party whose cause of action is predicated on such an act or transaction.
In Fairchild Hiller Corp. v. McDonnell Douglas Corp., 28 N.Y.2d 325, 329, 270 N.E.2d 691, 693, 321 N.Y.S.2d 857, 860 (1971), the New York Court of Appeals described the public policy reflected in the New York statute:
The legislative concern is clear. To prevent the resulting strife, discord and harassment which could result from permitting attorneys and corporations to purchase claims for the purpose of bringing actions thereon, the Legislature enacted sections 274 and 275 of the former Penal Law (the predecessor statutes to § 488 and § 489) declaring the practice of champerty and maintenance to be illegal.
The assignment here does no violence to the legislative concern as expressed by the New York courts; even if we assume that New York law governs, a matter which is not clear on the facts or the law, Dynamark had its own significant interest in the litigation from the outset. It was an original plaintiff in the first suit. In its settlement agreement with the Levitts and Poloron, it retained a seventy-five percent interest in any recovery and agreed to pay seventy-five percent of all litigation expenses in the anticipated future litigation. Furthermore, it is not taking an assignment for the purpose of bringing a new action or proceeding, but rather a reassignment of its own claim to pursue its own interests in an appeal.
Lybrand refers us to Puro v. Puro, 31 App.Div.2d 837, 298 N.Y.S.2d 111 (1969), for the proposition that Section 489 applies to a reassignment of a claim that once belonged to the assignee. In that case, however, the court refused to decide the issue and remanded the case to determine the relationship between the assignor and assignee. Here, Poloron and Dynamark were the victims of an allegedly fraudulent misstatement in connection with a securities sale. In the settlement agreement, Dynamark had never relinquished its right to recover; it merely limited its right to proceed. By the assignment now in question, Dynamark simply reasserted its right to proceed. Such an assignment violates neither the spirit nor the letter of Section 489. Nor does it violate any other applicable theory of champerty of which we are aware.
We now turn to the district court's order granting Lybrand's motion to dismiss the amended complaint under the two dismissal rule, Rule 41(a)(1), Fed. R. Civ. P. That rule provides in pertinent part as follows:
(a) Voluntary Dismissal: Effect Thereof. (1) . . . An action may be dismissed by the plaintiff without order of court (i) by filing a notice of dismissal at any time before service by the adverse party of an answer or of a motion for summary judgment, whichever first occurs, or (ii) by filing a stipulation of dismissal signed by all parties who have appeared in the action. Unless otherwise stated in the notice of dismissal or stipulation, the dismissal is without prejudice, except that a notice of dismissal operates as an adjudication upon the merits when filed by a plaintiff who has once dismissed in any court of the United States or of any state an action based on or including the same claim.
The district court held that the two dismissal rule barred the instant action, since Poloron had both dismissed the first action by its participation in the stipulation of discontinuance and had filed a notice of dismissal in the second. It is undisputed that the first and second actions were "based on or including the same claim." There is also no question that the second action was terminated by Poloron's notice of dismissal. Dynamark argues that the two dismissal rule does not apply for two reasons: (1) Poloron was not the plaintiff in the first action, and (2) the first dismissal was by stipulation rather than notice of dismissal.
Dynamark's second argument, that the rule should not apply where a prior dismissal is by stipulation, is the more persuasive. The district court held that when literally read the rule "makes no distinction as to how the prior dismissal was effected, so long as the plaintiff was responsible for it" and that it "applies in the present circumstances." 66 F.R.D. at 613, 614. We agree with the district court and the authorities cited by it that the rule by its literal terms makes no distinction between a prior dismissal by notice and one by stipulation, but we disagree, however, with the conclusion that no distinction should be made here.
It seems to be universally accepted that the primary purpose of the "two dismissal" rule is to prevent an unreasonable use of the plaintiff's unilateral right to dismiss an action prior to the filing of the defendant's responsive pleading. Engelhardt v. Bell & Howell Company, 299 F.2d 480, 481-82 (8th Cir. 1962); 5 J. Moore, Federal Practice para. 41.04, at 1045, n. 16 (2d ed. 1974). The danger of such abuse diminishes, however, where the first dismissal is by stipulation. A dismissal by stipulation is not a unilateral act on the part of the plaintiff but rather is a mutual agreement by all the parties. Lybrand, however, claims that its consent to the stipulation was acquired by deception since it was not made aware that the second action was contemplated. While Poloron, Dynamark and the Levitts may have been less than candid by not informing Lybrand of the purpose of the first dismissal, the stipulation was without prejudice under Fed. R. Civ. P. 41(a)(1). That rule provides that a stipulation of dismissal will be without prejudice "unless otherwise stated . . . in the stipulation." Lybrand, which must be presumed to be familiar with the Rules of Civil Procedure, executed the stipulation with no provision to the effect that it was with prejudice. In Lybrand's argument to this Court it claims that "it was represented to Lybrand that the parties had reached a settlement and wished to terminate the litigation."*fn5 But there is no claim here that the "parties" had affirmatively indiccated that they would not pursue their claims against Lybrand. Had Lybrand truly been convinced that the claims against it had been resolved, it could easily have requested, and expected no objection to such a request, that the discontinuance include a "with prejudice" notation.
The "two dismissal" rule is an exception to the general principle, contained in Rule 41(a)(1) and honored in equity prior to the adoption of the Federal Rules, that a voluntary dismissal of an action does not bar a new suit based upon the same claim. 5 J. Moore, supra, para. 41.04, at 1045. Where the purpose behind the "two dismissal" exception would not appear to be served by its literal application, and where that application's effect would be to close the courthouse doors to an otherwise proper litigant, a court should be most careful not to construe or apply the exception too broadly. "The entire purpose of the rules was to strike from judges and litigants useless shackles of procedure to the end that a fair trial of the essential questions could be had." Glaspell v. Davis, 2 F.R.D. 301, 304 (D. Ore. 1942). "The basic purpose of the Federal Rules is to administer justice through fair trials, not through summary dismissals as necessary as they may be on occasion." Surowitz v. Hilton Hotels Corp., 383 U.S. 363, 373, 15 L. Ed. 2d 807, 86 S. Ct. 845 (1966). Consequently, we hold that the filing of a notice of dismissal preceded by a dismissal by stipulation knowingly consented to by all parties does not activate the "two dismissal" bar against bringing an action based on or including the same claim.
Lastly, Lybrand asserts that the district court's dismissal of the complaint should nevertheless be affirmed since the complaint fails to state a proper claim for which relief can be granted under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b). It is clear from even a cursory reading of the district court's opinion that, although Lybrand raised the issue below, the court did not reach or even consider it. Even though an appellate court may affirm a judgment of a lower court upon a theory not considered below, Le Tulle v. Scofield, 308 U.S. 415, 421-22, 60 S. Ct. 313, 84 L. Ed. 355 (1940), we prefer in this case, where such a theory has been briefed and argued only cursorily in this Court, to remand for the district court to consider the issue in the first instance.
The order of the district court dismissing the amended complaint on res judicata grounds is reversed and the matter is remanded for further proceedings consistent with this opinion.
Lybrand Ross Bros. & Montgomery ("Lybrand") having petitioned for rehearing on April 19, 1976, it is hereby ordered that the petition is denied.
In its petition for rehearing, Lybrand has pointed out a factual error in the panel's opinion, Poloron Products, Inc. v. Lybrand Ross Bros. & Montgomery, No. 75-7271 (2d Cir., April 5, 1976), slip op. 2999, which error, in our view, does not alter the underlying reasoning of the opinion nor does it require a reconsideration of the result reached.
In that opinion we noted erroneously that the stipulation of discontinuance of the first suit "specifically provided that the dismissal was 'without prejudice.'" The stipulation, however, contained no suh language and provided simply that "It Is Hereby Stipulated and Agreed by and between the undersigned [attorneys for the parties] that the above-entitled action be discontinued without costs to any party as against any other." Accordingly, the original panel opinion is hereby modified and amended as follows:
1. On page 3002, omit the following: "The stipulation specifically provided that the dismissal was 'without prejudice.'"
2. On pages 3008-09, omit the following: "While Poloron, Dynamark and the Levitts may have been less than candid by not informing Lybrand of the purpose of the first dismissal, the stipulation called for a dismissal 'without prejudice,' which should have automatically altered Lybrand to the possibility of a second suit. In Lybrand's argument to this Court, it claims that 'it was represented to Lybrand that the parties had reacched a settlement and wished to terminate the litigation.' There is no claim here that the 'parties' had affirmatively indicated that they would not pursue their claims against Lybrand. It is significant that the specific inclusion in the stipulation of the 'without prejudice' caveat was unnecessary since Rule 41(a)(1) provides that such a stipulation will be without prejudice 'unless otherwise stated . . . in the 'stipulation.' That caveat, therefore, should have been a clear warning to Lybrand that Poloron and Dynamark did not consider the matter to be at an end. Their intent in including the 'without prejudice' reference should have stood out in bold relief. Indeed, had Lybrand truly been convinced that the claims against it had been resolved, it could easily have requested, and expected no objection to such a request, that the discontinuance include a 'with prejudice' notation."
3. In place of the passage omitted in #2 above, insert the following: "While Poloron, Dynamark and the Levitts may have been less than candid by not informing Lybrand of the purpose of the first dismissal, the stipulation was without prejudice under Fed. R. Civ. P. 41(a)(1). That rule provides that a stipulation of dismissal will be without prejudice 'unless otherwise stated . . . in the stipulation.' Lybrand, which must be presumed to be familiar with the Rules of Civil Procedure, executed the stipulation with no provision to the effect that it was with prejudice. In Lybrand's argument to this Court it claims that 'it was represented to Lybrand that the parties had reached a settlement and wished to terminate the litigation.' But there is no claim here that the 'parties' had affirmatively indicated that they would not pursue their claims against Lybrand. Had Lybrand truly been convinced that the claims against it had been resolved, it could easily have requested, and expected no objection to such a request, that the discontinuance include a 'with prejudice' notation."
4. Footnote 5 should remain unchanged.
Since the filing of the original opinion, the Supreme Court's decision in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668, 44 U.S.L.W. 4451 (U.S. Mar. 30, 1976), has come down. There it was held that a private cause of action for damages will not lie under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder absent any allegation of scienter. Whether the complaint in the instant case is sufficient under Ernst & Ernst v. Hochfelder, supra, including note 12 thereof, is a matter for determination by the district court in the first instance.
The petition for rehearing, with the foregoing modifications, is denied.