Commercial Litigation and Arbitration

Trust 1 Is Not Collaterally Estopped by Judgment Against Trust 2 — Even Though They Share the Same Testators, Counsel and a Majority of Trustees — Given the Supreme Court’s Limitations on the Doctrine of “Virtual Representation”

From Henry E. and Nancy Horton Bartels Trust for the Benefit of Cornell Univ. v. United States, 88 Fed. Cl. 105, 2009 U.S. Claims LEXIS 236, 2009-2 U.S. Tax Cas. (CCH) ¶50,475 (U.S. Claims Ct. July 1, 2009):

Plaintiff, the Henry E. and Nancy Horton Bartels Trust for the Benefit of Cornell University ("Cornell Trust"), is a tax-exempt nonprofit organization pursuant to § 501(c)(3) of the I.R.C., formed to provide support for Cornell University.... During the 1999 and 2000 tax years, plaintiff's trustees invested some of the Cornell Trust's funds in stocks "on margin[.]" ... Following an audit of its 1999 tax return, plaintiff paid tax on the income derived from selling those margin-purchased securities for both the 1999 and 2000 tax years pursuant to the UBIT [unrelated business income tax] provisions of I.R.C. §§ 511-14.... The Internal Revenue Service ("IRS") denied plaintiff's refund claims on September 9, 2003.... Plaintiff filed the complaint in the instant action on October 31, 2003....

In addition to the Cornell Trust, Henry and Nancy Bartels used a "substantially similar" instrument to create a trust for the benefit of the University of New Haven ("UNH Trust").... The UNH Trust and the Cornell Trust each have five trustees, three of whom are common to both.... During the 1991, 1992, and 1993 tax years, the UNH Trust also bought securities on margin, subsequently paid income tax (including interest and penalties) on the securities pursuant to the UBIT, and then sought a refund for those taxes, which the IRS denied in 1996.... Thereafter, the UNH Trust, relying on the same arguments as the instant plaintiff, unsuccessfully challenged the IRS's denial of its refund.... Based on the similarities between the instant case and Bartels-UNH Trust, defendant has moved for leave to amend its answer to include the affirmative defense of collateral estoppel.... As elaborated below, this court grants defendant's motion, though it ultimately concludes that Bartels-UNH Trust has no preclusive effect. ***

The Federal Circuit has developed a four-part test, under which the party invoking collateral estoppel (in this case, defendant) must show that:

(1) the issue is identical to one decided in the first action; (2) the issue was actually litigated in the first action; (3) resolution of the issue was essential to a final judgment in the first action; and (4) the party against whom estoppel is invoked had a full and fair opportunity to litigate the issue in the first action.

Innovad Inc. v. Microsoft Corp., 260 F.3d 1326, 1334 (Fed. Cir. 2001.... The parties dispute only whether this final prong applies....

Defendant contends that plaintiff has already had "full and fair opportunity to litigate" the UBIT issue before this court because plaintiff was "virtually represented" through the UNH Trust in Bartels-UNH Trust, even though the two trusts are legally discrete entities..... Specifically, defendant highlights that although five trustees control each trust, the trusts share three trustees in common.... What is more, one of those shared trustees, Mr. Philip H. Bartels, is the attorney of record in the instant matter, just as he was in Bartels-UNH Trust.... Because the two trusts also used the same stockbroker and investment advisor, defendant asserts that "[i]t thus seems inescapable that plaintiff here was effectively in control of [Bartels-UNH Trust] through the attorney and three trustees it shares with [the UNH Trust]." ... Based on what it characterizes as the "common control" of the two trusts, defendant maintains that plaintiff has already had its day in court and thus asks this court to deny it "a second bite at the apple." ***

However, defendant made its "virtual representation" argument supporting collateral estoppel before the Supreme Court curtailed the scope of the doctrine in Taylor v. Sturgell, U.S. , 128 S. Ct. 2161, 2167, 171 L. Ed. 2d 155 (2008)....

In Taylor, the Supreme Court, for the first time, addressed whether the general rule barring preclusion against nonparties was subject to a "virtual representation" exception. Id. at 2167. Significantly, the Court explicitly rejected a broad application of the doctrine. Id. ("We disapprove the doctrine of preclusion by 'virtual representation.'").

The Supreme Court had granted Mr. Taylor's petition for certiorari "to resolve the disagreement among the Circuits over the permissibility and scope of preclusion based on 'virtual representation.'" Id. at 2171. After discussing claim preclusion and issue preclusion in general, the Court explained that because a nonparty typically has not had a "full and fair opportunity" to litigate a suit, applying issue and claim preclusion against nonparties implicates due process concerns. See id. According to the Court, those concerns underlie "the general rule that one is not bound by a judgment in personam in a litigation in which he is not designated as a party or to which he has not been made a party by service of process." Id. (internal quotations omitted). But despite this general rule, the Court identified six categories of exceptions that permit nonparty preclusion in certain cases. Id. at 2172-73.

The first category is contractual, when a party agreed to be bound by the prior determination of issues in an action between others, as in a test case. See id. at 2172. The party need not have an express agreement to be bound; implied agreement and conduct inducing reliance are also sufficient to constitute an agreement for the purposes of this type of nonparty preclusion. See id. at 2172 & n.7. This type of nonparty preclusion is well-established and is common in the federal courts. See RESTATEMENT (SECOND) OF JUDGMENTS § 40 (1980).

The second category comprises "pre-existing substantive legal relationships between the person to be bound and a party to the judgment . . . . [such as] preceding and succeeding owners of property, bailee and bailor, and assignee and assignor." Id. at 2172. The Court explained that although these exceptions originated as much in property law as in the law of preclusion and were sometimes grouped together as relationships of "privity," it declined to use the term "privity" because it had become an unhelpful, overly-broad, conclusory label. See Id. at 2172 & n.8.

The third category consists of those "certain limited circumstances" in which the nonparty is precluded because it was "adequately represented by someone with the same interests who [was] a party to the same suit." Id. at 2172.... Shared motivation alone is insufficient to qualify for this "same interests" requirement; rather, the earlier party must have had some legal obligation to vindicate the rights of the nonparty later precluded. See id. at 2172-73. Thus, the Taylor Court listed a proper class action representative, and a trustee, guardian, or other fiduciary, as examples of those earlier parties whose presence will subsequently preclude their nonparty beneficiaries. See id. at 2172-73.

The fourth category precludes a nonparty who had "assume[d] control over the litigation in which that judgment was rendered" because that party, through the opportunity to present proof and argument, has already had its day in court. See Id. at 2173.... Such extensive control exceeds mere influence and instead requires the extensive involvement of the party-to-be-precluded in funding, arguing, and formulating the legal theory of the case....

The fifth category prevents the proxy or designated representative of the party to earlier litigation from escaping its preclusive effect. Id. at 2173. This exception also covers situations in which the nonparty in the subsequent suit acts as the agent for a party bound by a judgment. Id.

The sixth and final category comprises "special statutory schemes . . . otherwise consistent with due process" that explicitly foreclose successive litigation by nonparties. Id. at 2173. The Court listed bankruptcy and probate proceedings, quo warranto actions, and "other suits that, under the governing law, [may] be brought only on behalf of the public at large" as examples of this category of exceptions.... For the purposes of clarity, this opinion will refer to the six categories of exceptions permitting nonparty preclusion as "contractual," "property," "fiduciary," "control," "agency," and "statutory," respectively.

Held, none of the six categories applies to the present case; no collateral estoppel effect found.

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