Patrick Doherty v. FDIC , 932 F.3d 978 ( 2019 )

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 18-3133
PATRICK J. DOHERTY,
Plaintiff-Appellant,
v.
FEDERAL DEPOSIT INSURANCE CORPORATION, as receiver for
WASHINGTON FEDERAL BANK FOR SAVINGS, et al.,
Defendants-Appellees.
____________________
Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 18 CV 703 — Joan B. Gottschall, Judge.
____________________
ARGUED MAY 14, 2019 — DECIDED AUGUST 6, 2019
____________________
Before FLAUM, KANNE, and SCUDDER, Circuit Judges.
KANNE, Circuit Judge. Washington Federal Bank brought a
default action against Patrick Doherty, John Farano, Jr., and
Worth Conversion, LLC, for notes related to various real es-
tate ventures. Doherty raised affirmative defenses on behalf
of himself and Worth, but the bank dismissed Doherty and
Worth from the action, without prejudice, after obtaining a
default judgment against Farano. Doherty then attempted to
2 No. 18-3133
bring this suit against the bank with claims founded on simi-
lar grounds as his previously-raised affirmative defenses. But
the Cook County Circuit Court determined that Doherty’s
claims were barred by res judicata thanks to the default judg-
ment entered against Farano. Doherty appealed to the Illinois
Appellate Court, but before his appeal was heard, Washing-
ton Federal was placed into the Federal Deposit Insurance
Corporation’s receivership. The FDIC removed this action to
the district court, which adopted the Illinois Circuit Court’s
decision. Because res judicata does not bar Doherty’s claims,
we vacate and remand for further proceedings.
I. BACKGROUND
Patrick Doherty and John Farano, Jr., formed Worth Con-
version, LLC. In April 2006, Washington Federal Bank (“the
bank”) loaned Worth $400,000 in exchange for Worth’s prom-
issory note and Doherty and Farano’s personal guaranties of
the loan. Washington Federal extended the maturity date of
the loan multiple times, but Worth eventually defaulted. The
bank subsequently sued Worth, Farano, and Doherty in Cook
County Circuit Court in March 2014 (the guaranty action).
The twenty-seven count complaint also included counts re-
lated to other loans made to another entity affiliated with
Farano and Doherty, F & D Services, Inc. But the bank even-
tually dismissed those counts and F & D Services from the
suit.
Doherty is an attorney and he filed an appearance in the
guaranty action on behalf of himself and Worth. In his answer
to the bank’s complaint, Doherty raised affirmative defenses,
including that the bank extended the maturity date of the loan
No. 18-3133 3
without authorization, that the bank charged fees and an in-
terest rate not agreed upon, and that the bank charged exces-
sive fees.
Farano never appeared, however, and the trial court en-
tered a default judgment for the loan balance against Farano
for Count XXVI, which sought judgment on his personal
guaranty of the loan, on August 27, 2014. The default judg-
ment ordered:
1. [Washington Federal’s] Motion for Default and
Judgment is granted; 2. [The bank] has proven the
damages it incurred and reasonable attorney’s fees
and costs; 3. Judgment is entered in favor of [the
bank] and against Defendant John Farano Jr., in the
TOTAL AMOUNT of $228,739.81 due under the
Note; $2,804.50 due in attorney fees and $485.33 in
legal costs; 4. There is no just reason to delay the en-
forcement of the judgment, appeal, or both.
On April 27, 2015, Doherty received a report from a foren-
sic document examiner opining that his signature had been
forged on loan extension paperwork in 2010. Doherty sent a
copy of the report to the bank’s counsel, advising them that
he intended to file a suit for fraud and other claims. Around
that time, the bank moved the trial court to dismiss its claims
against Worth and Doherty from the action without preju-
dice. The trial court dismissed the bank’s remaining counts
(XXV—seeking judgment against Worth on default; and
XXVII—seeking judgment against Doherty on his guaranty of
the Worth loan) on June 15, 2015. Doherty did not object to
this order.
Over a year later, on June 28, 2016, Doherty filed suit
against the bank, its president, its corporate secretary, and its
4 No. 18-3133
attorneys, alleging breach of contract, forgery, excessive fees,
fraud, and legal malpractice against the bank’s law firm. He
claimed that during the first trial (the guaranty action), he did
not learn of the bank’s alleged forgery early enough to take
action before being dismissed. His suit sought to recover
damages for the fees he incurred defending the guaranty ac-
tion. The trial court dismissed Doherty’s complaint, and he
filed an amended complaint alleging the same facts and
counts, but he alleged malicious prosecution instead of mal-
practice against the bank’s legal counsel.
The bank and its attorneys moved to dismiss Doherty’s
amended complaint on the grounds of res judicata, lack of
standing, and (on the malicious prosecution count) failure to
state a claim. The trial court dismissed Doherty’s suit, holding
that most of Doherty’s claims were barred by res judicata be-
cause he should have brought them in the guaranty action.
The trial court also determined that he failed to state a claim
for malicious prosecution. Doherty appealed to the Illinois
Appellate Court. Before the court heard Doherty’s appeal,
however, Washington Federal was placed into the FDIC’s re-
ceivership. The FDIC removed this action to the Northern
District of Illinois under 12 U.S.C. § 1819(b)(2)(B).
II. ANALYSIS
The district court adopted the Illinois trial court’s ruling as
its own. We therefore review the Illinois trial court’s decision
and analyze this appeal under Illinois law. Baek v. Clausen, 886
F.3d 652, 660 (7th Cir. 2018). On appeal, Doherty claims that
the trial court erroneously dismissed his claims on the basis
of res judicata. His main point seems to be that the bank’s use
of Farano’s default judgment to defeat Doherty’s claims trans-
formed res judicata from a shield into a sword. In other words,
No. 18-3133 5
by holding that Doherty’s claims were barred, the district
court effectively allowed the bank to kill Doherty’s fraud
claims. The bank argues that the trial court correctly deter-
mined that res judicata barred Doherty’s claims, but even if it
does not, Doherty’s claims should be alternatively dismissed
for failure to state a claim.
“Whether a claim is barred by res judicata is a question of
law that we review de novo.” Curtis v. Lofy, 914 N.E.2d 248, 254
(Ill. App. Ct. 2009). “The party asserting res judicata as a pre-
clusion to the second action bears the burden of showing with
clarity and certainty what was determined by the prior judg-
ment.” BankFinancial, FSB v. Tandon, 2013 IL App (1st) 113152,
¶ 19.
A. Counterclaims and Affirmative Defenses in Illinois Civil
Procedure
A brief primer on Illinois civil procedure will help clarify
the nature of Doherty’s argument. The Illinois rules provide
that a “plaintiff may, at any time before trial or hearing be-
gins, upon notice to each party who has appeared or each
such party’s attorney, and upon payment of costs, dismiss his
or her action or any part thereof as to any defendant, without
prejudice, by order filed in the cause.” 735 Ill. Comp. Stat. 5/2-
1009(a). “[A] dismissal ‘without prejudice’ signals that there
was no final decision on the merits and that the plaintiff is not
barred from refiling the action.” Richter v. Prairie Farms Dairy,
Inc., 2016 IL 119518, ¶ 24. The rule also stipulates that a plain-
tiff’s dismissal of its claims against a defendant “does not dis-
miss a pending counterclaim or third party complaint.” 735
Ill. Comp. Stat. 5/2-1009(d). Illinois courts have held that a vol-
untary dismissal by the plaintiff is an appealable order. Du-
bina v. Mesirow Realty Dev., Inc., 687 N.E.2d 871, 874–75 (Ill.
6 No. 18-3133
1997) (a voluntary dismissal terminates an action in its en-
tirety and renders all final orders immediately appealable).
Doherty’s claims were styled as affirmative defenses, not
as counterclaims. That was probably because, under Illinois
civil procedure, a defendant must raise affirmative defenses in
the answer or reply. See 735 Ill. Comp. Stat. 5/2-613(d). Con-
versely, counterclaims are permissive in Illinois and can be
brought in their own action. See 735 Ill. Comp. Stat. 5/2-608.
See Laue v. Leifheit, 473 N.E.2d 939, 943 (Ill. 1984) (describing
that section 2–608’s language should be construed as estab-
lishing permissive counterclaims).
B. Res judicata in Illinois
“The doctrine of res judicata bars the refiling of an action
previously adjudicated on the merits when the action is di-
rected against the same parties and involves the same claims.”
DeLuna v. Treister, 708 N.E.2d 340, 344 (Ill. 1999) (citing Rein v.
David A. Noyes & Co., 665 N.E.2d 1199, 1204 (Ill. 1996)). “Res
judicata promotes judicial economy by preventing repetitive
litigation and [additionally] protects parties from being
forced to bear the unjust burden of relitigating essentially the
same case.” Piagentini v. Ford Motor Co., 901 N.E.2d 986, 990–
91 (Ill. App. Ct. 2009) (quoting Arvia v. Madigan, 809 N.E.2d
88, 97 (Ill. 2004) (alteration in original)).
There are three requirements for res judicata in Illinois: “(1)
a final judgment on the merits … entered in the first lawsuit
by a court of competent jurisdiction; (2) an identity of causes
of action exists; (3) the parties or their privies are identical in
both lawsuits.” DeLuna, 708 N.E.2d at 344. “The requirement
of a final order or judgment is a ‘critical’ component in show-
ing the applicability of res judicata.” Richter, 2016 IL 119518 at
No. 18-3133 7
¶ 22 (citing Hernandez v. Pritikin, 2012 IL 113054, ¶ 41). And
the Supreme Court of Illinois has explained that “default
judgments are always res judicata on the ultimate claim or de-
mand presented in the complaint.” Hous. Auth. for La Salle Cty.
v. Young Menʹs Christian Assʹn of Ottawa, 461 N.E.2d 959, 963
(Ill. 1984).
Illinois courts have applied res judicata broadly. “The doc-
trine extends not only to what was actually decided in the
original action, but also to matters which could have been de-
cided in that suit.” Doe v. Gleicher, 911 N.E.2d 532, 537 (Ill. App.
Ct. 2009) (quoting Rein, 665 N.E.2d at 1204). However,
“[e]quity dictates that the doctrine of res judicata will not be
technically applied if to do so would create inequitable and
unjust results. [It] should not be applied … where it would be
fundamentally unfair to do so … [and] should only be applied
as fairness and justice require.” Piagentini, 901 N.E.2d at 990–
91 (citations and quotations omitted). “Although it is recom-
mended that the doctrine receive a liberal construction and
should be applied without technical restrictions, it has also
been recommended that the doctrine should not be applied so
rigidly as to defeat the ends of justice.” Fed. Signal Corp. v. SLC
Techs., Inc., 743 N.E.2d 1066, 1077 (Ill. App. Ct. 2001) (quoting
Thornton v. Williams, 412 N.E.2d 157, 159 (Ill. App. Ct. 1980)).
C. Doherty’s Claims
The Illinois circuit court determined that res judicata
applied because the default judgment against Farano
constituted a final judgment on the merits. It stated that
identity of parties existed because the bank named Doherty
as a defendant in the guaranty action, and because the bank
was originally the plaintiff in the guaranty action (and the
other named defendants were its agents and attorneys). The
8 No. 18-3133
trial court determined that identity of causes existed because
Doherty raised his affirmative defenses in the guaranty
action, and the same underlying facts supporting his
affirmative defenses provided the basis for his claims in the
later lawsuit against the bank and its attorneys.
The circuit court’s opinion relied on Corcoran-Hakala v.
Dowd to establish that res judicata bars Doherty’s claims. See
840 N.E.2d 286, 293–94 (Ill. App. Ct. 2005). In that case, the
Illinois Appellate Court explained that the common law
principle of compulsory counterclaim applies in some
instances in Illinois, even though the statutorily-established
rules of civil procedure explicitly hold that counterclaims are
permissive: “res judicata bars a subsequent action if successful
prosecution of that action would in effect nullify the judgment
entered in the initial action.” Id. at 294 (citing Restatement
(Second) of Judgments § 22(2)(b) (1982)); Carey v. Neal, Cortina
& Associates, 576 N.E.2d 220, 225 (Ill. App. Ct. 1991)
(describing subsection 22(2)(b) of the Restatement as a
“common law rule of compulsory counterclaim”). This is true
if “the defendant’s claim involves the same operative facts as
the plaintiff’s claim.” Id. at 293–94 (citing Torcasso v. Standard
Outdoor Sales, Inc., 597 N.E.2d 772, 775 (Ill. App. Ct. 1992),
revʹd on other grounds, 626 N.E.2d 225 (Ill. 1993)).
We conclude that res judicata should not apply in this case
for two main reasons. First, none of the Illinois cases relied on
by the circuit court or the FDIC address a situation like this
one. And the most illuminating cases—if not exactly square
with the posture of this case—suggest that applying the
doctrine would be inappropriate. Second, applying the
doctrine in this situation neither advances the purposes of res
No. 18-3133 9
judicata nor meaningfully serves the interests of judicial
economy.
Illinois case law does not support an application of the
doctrine in these circumstances. Two wrinkles in this case
complicate the typical res judicata analysis and lead us to
conclude that the doctrine should not apply here. First, most
of the cases addressing res judicata in Illinois involve a
situation in which a plaintiff in the first action attempts to
bring the same or similar claims in a later action—not a
situation in which a defendant to the first action brings
affirmative defenses as independent claims in the second
action. Second, the default judgment applied to a different
defendant.1
The FDIC responds to Doherty’s arguments on appeal by
directing our attention to the broad and liberal application of
res judicata found throughout Illinois case law. Doherty
argues that because the circuit court dismissed him without
prejudice on the bank’s section 2-1009 motion in the guaranty
action, res judicata should therefore not apply. The FDIC relies
on Rein for the proposition that even though the final
judgment on the merits did not apply to all the claims in the
guaranty action, res judicata still applies. But Rein involved a
case where, in the first action, plaintiffs received a dismissal
with prejudice on some of their claims and voluntarily
dismissed their remaining claims pursuant to section 2-1009.
665 N.E.2d at 1205. They later re-filed those claims in a second
1 The FDIC does give examples of cases in which a defendant in the
first action attempts to bring claims that would have been suitable for an
affirmative defense in a later action, but this second factor distinguishes
them. See, e.g., Henry v. Farmer City State Bank, 808 F.2d 1228, 1235 (7th Cir.
1986).
10 No. 18-3133
action, engaging in the classic claim-splitting that res judicata
attempts to prevent. Id. at 1206. Here, Doherty neither made
a section 2-1009 motion nor had a final judgment that
addressed any of the bank’s claims as they pertained to him
or his defenses.
And although we have found no case that directly applies
to this situation, a string of Illinois cases leads us to conclude
that the doctrine should not apply here. “The Illinois Supreme
Court has held that if the basis of dismissal against one party
bears no relationship to the merits of the case, it is
‘inappropriate to apply the doctrine of res judicata [against]
another party to the action.’” Curtis, 914 N.E.2d at 260(quoting Downing v. Chicago Transit Auth,, 642 N.E.2d 456, 460
(Ill. 1994)). In Downing the Supreme Court of Illinois held that
an order that granted summary judgment in favor of an
employee on statute-of-limitations grounds did not preclude
a later suit based on a respondeat superior theory against his
employer because the summary judgment order was not
based on the merits of the case. According to the court, to label
a summary judgment order based on the statute of limitations
as “an adjudication on the merits would be the quintessential
act of exalting form over substance.” 642 N.E.2d at 460.
Similarly, in DeLuna v. Treister, the court refused to apply
res judicata in a medical malpractice case for a defendant
hospital after its doctor obtained an involuntary dismissal
due to the plaintiff’s failure to meet statutory pleading
requirements. 708 N.E.2d at 348–49. The involuntary
dismissal with prejudice barred the plaintiff’s subsequent
action against the doctor, but not the hospital. Id.In Leow v. A & B Freight Line, Inc., the court addressed the
proper interpretation of Illinois Supreme Court Rule 273,
No. 18-3133 11
which explains the effects of involuntary dismissals. 676
N.E.2d 1284, 1286 (Ill. 1997). The court determined that an
involuntary dismissal against a different party acted as an
adjudication on the merits against another party only where
“the prior dismissal must have caused the defendant to
prepare to address the actual merits of plaintiff’s claim.”
DeLuna, 708 N.E.2d at 347 (quotations omitted). See Leow, 676
N.E.2d at 1288.
The FDIC attempts to distinguish these cases because this
case involves neither involuntary dismissal nor vicarious lia-
bility for employers. And, as we have noted, default judg-
ments are typically considered final judgments on the merits
for the purposes of res judicata. Hous. Auth. for La Salle Cty., 461
N.E.2d at 963.
But we believe the principles of equity underlying this
string of cases may be applied here. In the guaranty action,
Doherty appeared, filed a response, and raised his affirmative
defenses against the bank’s claims. After obtaining its default
judgment against Farano—and shortly after Doherty received
the handwriting expert’s report and threatened to bring a suit
for fraud—the bank dropped its claims against Worth and
Doherty and dismissed those defendants without prejudice.
This posture ensured that the bank never had to address or
defend itself against Doherty’s fraud allegations.
Accordingly, because the bank never had to address (and the
circuit court likewise never had to consider) Doherty’s fraud
claims, we do not believe the default judgment against a
different defendant barred Doherty’s later action.
Applying res judicata in this situation also does not
advance the purposes of the doctrine. One of those purposes
is to prevent a second litigation from undermining the prior
12 No. 18-3133
judgment. See Restatement (Second) of Judgments § 22(2)(b)
(1982) (explaining that a defendant who fails to interpose a
permissible counterclaim in an action is precluded from
bringing a subsequent action on that claim if the claim’s
successful prosecution “would nullify the initial judgment or
would impair rights established in the initial action”). The
FDIC argues that if Doherty were to succeed on his claims of
fraud, it could undermine the circuit court’s conclusion that
Worth owed money to the bank and that Farano defaulted on
his personal guaranty of the Worth loan. We find that
argument unpersuasive. The FDIC provides no explanation
for how Doherty would have standing to challenge Farano’s
default judgment. And at oral argument, Doherty himself
even conceded that he likely has no standing to challenge the
default judgment against Farano.
Additionally, Doherty’s action here seeks redress for the
bank’s alleged fraud but does not challenge the default
judgment entered against Farano. Even if Doherty manages
to prosecute this action successfully, the default judgment
against Farano would go undisturbed. Therefore, the bank’s
interest in the previous litigation—its judgment against
Farano—would remain in place.
Similarly, as explained above, preventing claim splitting
serves as one of the ends of applying res judicata. However,
that concern is not implicated in a case like this, where
Doherty was a defendant and did not dismiss the first action
himself. See Rein, 665 N.E.2d at 1206 (“[P]laintiffs generally
are not permitted to split their causes of action. The rule
against claim-splitting, which is an aspect of the law of
preclusion, prohibits a plaintiff from suing for part of a claim
No. 18-3133 13
in one action and then suing for the remainder in another
action.”).
Nor are concerns about judicial economy implicated by
allowing Doherty’s claims to proceed. In this case the circuit
court never considered or weighed in on Doherty’s fraud
claims because the bank dismissed him without prejudice.
The bank never had to litigate these claims in the guaranty
action—addressing them now will not force the bank into
redundant litigation.
Lastly, the FDIC encourages us to affirm the circuit court’s
dismissal of Doherty’s claims on the alternative grounds that
his complaint fails to state a claim. Because neither the Illinois
trial court nor the district court have engaged Doherty’s
arguments, we decline to do so now. The district court should
have the first opportunity to consider that question.
III. CONCLUSION
Based on the foregoing, the circuit court incorrectly deter-
mined that Doherty’s claims were barred by res judicata. Ac-
cordingly, we REVERSE the district court’s dismissal of
Doherty’s claims and REMAND for further proceedings.