Wisconsin Lawyer
Vol. 79, No. 3, March 2006

Landing in A.B.C.G. Soup:
The Compulsory Counterclaim Trap

by Donald Leo Bach

our client is a buyer of goods. The seller has sued your client for nonpayment. Your client reveals facts to you that indicate there was a mutual mistake in the formation of the contract justifying its rescission and return of the goods. When you advise the client of the availability of such claim for rescission, the client indicates he does not want to litigate that issue now in the pending lawsuit.

You check the pleading statutes to see if your client's claim has to be brought as part of the current action. Pleadings are controlled by the Wisconsin Rules of Civil Procedure, specifically by Wis. Stat. chapter 802, Civil Procedure - Pleadings, Motions and Pretrial Practice. You find a statute directly on point, namely Wis. Stat. section 802.07(1), which states:

"802.07 Counterclaim and cross-claim. (1) Counterclaim. A defendant may counterclaim any claim which the defendant has against a plaintiff, upon which a judgment may be had in the action. A counterclaim may or may not diminish or defeat the recovery sought by the opposing party." (Emphasis added.)

The statute is clearly a permissive counterclaim statute. There is no language in the statute that can be fairly read in any way to compel the bringing of any counterclaim. The statute says to the defendant, "you get your day in court when and where you see fit, not in the place, the proceeding, or the timeframe chosen by the opponent." Therefore, it is crystal clear that your client does not have to bring a counterclaim for rescission in the current suit and that you can wait right up to the statute of limitation expires to file an action for rescission. Right?

Wrong.

You have just fallen into the A.B.C.G. compulsory counterclaim soup.

The A.B.C.G. Common-law Compulsory Counterclaim Rule

In spite of the permissive language contained in Wis. Stat. section 802.07, in 2005 in Menard Inc. v. Liteway Lighting Products,¹ the Wisconsin Supreme Court confirmed a compulsory common-law counterclaim rule for certain claims. The court set forth the rule in 1994 in A.B.C.G. Enterprises Inc. v. First Bank Southeast N.A.² In that case, A.B.C.G. Enterprises Inc. and two individuals ("A.B.C.G.") sued First Bank Southeast. First Bank had previously sued A.B.C.G. in six separate foreclosure actions, all of which resulted in default judgments in favor of First Bank. A.B.C.G.'s follow-up suit asserted that First Bank's breach of the contract, misrepresentation, and failure to properly manage the properties that were the subject of First Bank's prior foreclosure actions caused A.B.C.G. to default. Accordingly, A.B.C.G. sought compensatory damages resulting from the foreclosure. The circuit court granted summary judgment to First Bank and dismissed A.B.C.G.'s action. The court of appeals affirmed. The Wisconsin Supreme Court upheld the dismissal, holding that "principles of res judicata [claim preclusion]³ preclude a defendant who may counterclaim in a prior action from bringing a subsequent action on the claim if the action would nullify the initial judgment or impair rights established in the initial action."⁴ Concluding that a favorable judgment for A.B.C.G. would undermine the previous judgments granted to First Bank, the supreme court affirmed the summary judgment dismissing A.B.C.G.'s action.⁵

In issuing its ruling, the supreme court relied on the common-law compulsory counterclaim rule as stated in the Restatement (Second) of Judgments section 22(2)(b) (1982):

"(2) A defendant who may interpose a claim as a counterclaim in an action but fails to do so is precluded, after the rendition of judgment in that action, from maintaining an action on the claim if ...

...

b. The relationship between the counterclaim and the plaintiff's claim is such that successful prosecution of the second action would nullify the initial judgment or would impair rights established in the initial action."⁶

The supreme court explained that section 22(2)(b) of the Restatement recognizes the need to preclude defendants - even in jurisdictions, like Wisconsin, that have a permissive counterclaim statute - from bringing a subsequent action that would undermine the rights established in the initial judgment. According to the supreme court, the rule "preserves the integrity and finality of judgments and the litigants' reliance on them."⁷

Observing that the claim preclusion doctrine is premised on the maxim that litigation must come to an end so as to ensure fairness to the parties and sound judicial administration, the court remarked that the doctrine "is applied with a broad brush so as to achieve these goals. It embraces not only what has been litigated in previous proceedings, but also extends to issues that could have been litigated."⁸

A.B.C.G. conceded that the doctrine of res judicata existed in Wisconsin. However, A.B.C.G. argued that even if its claims would traditionally be barred under a claim preclusion analysis, the doctrine was inapplicable because Wis. Stat. section 802.07(1) is a permissive counterclaim statute.⁹ A.B.C.G. argued that the statute's language does not require a defendant to bring any counterclaim; thus, to bar A.B.C.G.'s claims would transform Wisconsin's permissive counterclaim rule into a compulsory rule.

In response, the court acknowledged that the "general rule in Wisconsin is that where a defendant may interpose a counterclaim but fails to do so, he is not precluded from maintaining a subsequent action on that claim," but the court held that the rule is not absolute.¹⁰ The court said that the "better rule of law to apply" was section 22(2)(b) of the Restatement as a "common-law compulsory counterclaim" exception, finding:

"This rule preserves the integrity and finality of judgments and the litigants' reliance on them, by precluding a collateral attack upon a judgment in a subsequent proceeding when the attack would completely undermine the rights established in the initial judgment."¹¹

The court summarized its holding:

"We hold that the principles of res judicata preclude a defendant who may counterclaim in a prior action from bringing a subsequent action on the claim if the action would nullify the initial judgment or impair rights established in the initial action."¹²

Wisconsin Supreme Court Reaffirmation of A.B.C.G.

Although a decade has passed since the A.B.C.G. holding, the issue remains contentious. In 2005 the Wisconsin Supreme Court revisited the matter, confirming its A.B.C.G. decision in Menard Inc. v. Liteway Lighting Products.¹³

For six years, Menard purchased lighting fixtures from Liteway. Menard and Liteway ended their business relationship in 1999. In 2000, Liteway sued and obtained a default judgment against Menard for unpaid invoices totalling $355,000. About eight months after the judgment was docketed, Menard sued Liteway for unjust enrichment and for violating the Uniform Commercial Code. Menard alleged that it had returned some of Liteway's products due to their defective condition (before Liteway brought suit) and that Liteway had not reimbursed Menard for the returns. Liteway moved for summary judgment based on claim preclusion. The circuit court denied summary judgment, held a trial, and granted Menard a $140,000 judgment against Liteway. The court of appeals reversed, concluding that Menard's claims were barred by claim preclusion, because the claims were covered under the common-law compulsory counterclaim rule as set forth in A.B.C.G. The matter was appealed to the supreme court.

The supreme court agreed with the court of appeals, holding that the principles of A.B.C.G. applied. In its decision, the supreme court again addressed and rejected the argument that the common-law compulsory counterclaim rule was inconsistent with Wisconsin's permissive counterclaim statute, Wis. Stat. section 802.07. In Menard, the court reaffirmed its holding in A.B.C.G.:

"The common-law compulsory counterclaim rule creates an exception to the permissive counterclaim statute and bars a subsequent action by a party who was a defendant in a previous suit if `a favorable judgment in the second action would nullify the judgment in the original action or impair rights established in the initial action.' The common-law compulsory counterclaim rule operates to `preserve[ ] the integrity and finality of judgments and the litigants' reliance on them, by precluding a collateral attack upon a judgment in a subsequent proceeding when the attack would completely undermine the rights established in the initial judgment.'"¹⁴

The court concluded that for the common-law compulsory counterclaim rule to apply, a court must find that: 1) all the elements of claim preclusion are present and 2) a judgment favorable to the plaintiff in the second suit would undermine the judgment or impair the established legal rights of the plaintiff in the initial action.¹⁵

The court decided that Menard's claims in the second suit were part of the same transaction as the claims in the original suit because both suits arose from the same "common nucleus of operative facts."¹⁶ Further, the court found that Menard's claims in the second suit could have been raised in the original suit.¹⁷ Accordingly, it upheld dismissal of Menard's action against Liteway.

Justice Crooks, in a dissent joined by Justice Butler, asserted that claim preclusion and A.B.C.G.'s compulsory counterclaim rule did not apply. As to the latter, Justice Crooks stated:

"Although the resolution of this case rests on whether there was an identity of claims or causes of action for purposes of claim preclusion, it is also necessary to highlight the majority's misinterpretation of Wisconsin's counterclaim statute. In Wisconsin, the joinder of counterclaims is permissive, not mandatory. Wisconsin Stat. section 802.07(1) states in relevant part: `[a] defendant may counterclaim any claim which the defendant has against a plaintiff, upon which a judgment may be had in the action.' (Emphasis added.)

"I recognize, as does the majority, that this court has established a narrow exception to the permissive counterclaim statute. In A.B.C.G. Enterprises, we stated that there is a `"common-law compulsory counterclaim rule" which requires a defendant to counterclaim if its claim, when brought in a subsequent, separate action, would nullify the initial judgment or impair rights established in the initial action.' A.B.C.G. Enters., 184 Wis. 2d at 474. However, the court emphasized that the application of this `common-law counterclaim' rule is definitely an exception to the general rule and is meant to preclude a collateral attack when the attack would completely nullify the rights established in the first judgment. See id. at 476-77. Specifically, it stated that the rule `applies only if a favorable judgment in the second action would nullify the judgment in the original action or impair rights established in the original action.' Id. (emphasis added.) In this case, consistent with our holding in National Operating, the narrow exception should not be applied, because the test for its application is not met here. Menard's UCC and unjust enrichment claims would not nullify, but would merely reduce, the amount that Liteway would realize on its judgment. The majority opinion extends the compulsory counterclaim exception in a manner contrary to Wisconsin's permissive counterclaim statute, the UCC, and the public policy expressed by the legislature in its adoption of the UCC."¹⁸

The Problem and the Fix

Due to A.B.C.G. and its progeny, an unfortunate situation has developed in which a statute clearly says one thing and a court doctrine says another, thus creating a veritable trap for unwary practitioners. Further, although the court has said that the A.B.C.G. compulsory counterclaim rule covers a "narrowly defined class" of counterclaims,¹⁹ ascertaining when that narrow exception applies can be difficult: not all counterclaims must be brought, only those that "would nullify the initial judgment or impair rights established in the initial action."²⁰ Indeed, the Restatement notes that subsection (2)(b) and its comments and illustrations "represent an effort to articulate the basis in precedent and policy for what might be termed a `common-law compulsory counterclaim rule.' It is perhaps impossible to define the scope of this concept with precision and in any event the problem is one of decreasing importance with the growth of compulsory counterclaim statutes. ..."²¹

The problem can be resolved; several options are available. First, the Wisconsin Supreme Court²² or the legislature could decree that no counterclaims of any type are required whatsoever, that is, create an "absolutely permissive" counterclaim statute. However, this option would obviously undercut the doctrine of claim preclusion and its underlying principles and might lead to potentially endless and multiple litigation, gamesmanship, and unnecessary cost.

Second, the Wisconsin legislature or supreme court could make all counterclaims mandatory no matter what the nature of the counterclaim. However, this option would deprive defendants of the ability to choose the time and place for bringing their claims and would require parties to litigate at one time all legal disputes between them - even those disputes unrelated to the original claim - just because one party started a lawsuit.

Third, the Wisconsin Supreme Court or the legislature could codify A.B.C.G. as an exception to the permissive counterclaim statute simply by incorporating the substance of the Restatement rule section 22(2)(b) language into Wis. Stat. section 802.07(1). Such a provision could read as follows:

"802.07 Counterclaim and cross-claim. (1) Counterclaim. A defendant shall interpose a claim as a counterclaim if the relationship between the counterclaim and the plaintiff's claim is such that successful prosecution of the claim in a subsequent action by the defendant would nullify the initial judgment or would impair rights established in the initial action. A defendant may counterclaim any other claim that the defendant has against a plaintiff, upon which a judgment may be had in the action. A counterclaim may or may not diminish or defeat the recovery sought by the opposing party. Except as prohibited by § 802.02(1m), the counterclaim may claim relief exceeding in amount or different in kind from that sought in the pleading of the opposing party."

Fourth, Wisconsin could essentially codify the finality-of-litigation policy underlying A.B.C.G. and Restatement 22(2)(b) and greatly simplify the A.B.C.G. rule by replacing Wis. Stat. section 802.07(1) with the text of Rule 13(a)-(c) and (e)-(f) of the Federal Rules of Civil Procedure (modified to refer to state law) as follows:

"(a) Compulsory Counterclaims. A pleading shall state as a counterclaim any claim which at the time of serving the pleading the pleader has against any opposing party, if it arises out of the transaction or occurrence that is the subject matter of the opposing party's claim and does not require for its adjudication the presence of third parties of whom the court cannot acquire jurisdiction. But the pleader need not state the claim if (1) at the time the action was commenced the claim was the subject of another pending action, or (2) the opposing party brought suit upon the claim by attachment or other process by which the court did not acquire jurisdiction to render a personal judgment on that claim, and the pleader is not stating any counterclaim under this rule.

(b) Permissive Counterclaims. A pleading may state as a counterclaim any claim against an opposing party not arising out of the transaction or occurrence that is the subject matter of the opposing party's claim.

(c) Counterclaim Exceeding Opposing Claim. A counterclaim may or may not diminish or defeat the recovery sought by the opposing party. It may claim relief exceeding in amount or different in kind from that sought in the pleading of the opposing party.

(d) Counterclaim Maturing or Acquired After Pleading. A claim which either matured or was acquired by the pleader after serving a pleading may, with the permission of the court, be presented as a counterclaim by supplemental pleading.

(e) Omitted Counterclaim. When a pleader fails to set up a counterclaim through oversight, inadvertence, or excusable neglect, or when justice requires, the pleader may by leave of court set up the counterclaim by amendment."

This last option solves the potential malpractice problem; eliminates much if not all of the guesswork under A.B.C.G. as to which counterclaims must be brought; promotes judicial efficiency by ensuring that the parties litigate the claims they have against each other arising out of the same transaction or occurrence; and brings years of case law to bear on interpreting the statutes. Further, it would reduce the process to deciding one issue - whether the claim arises out of the same transaction or occurrence on which the plaintiff's suit was brought - by eliminating the troublesome task of deciding whether the claim would "nullify the initial judgment" or "(completely) impair rights in the initial action."

Conclusion

Although the statutes indicate exactly the opposite, certain counterclaims are mandated by case law. This not only presents a trap for the unwary but also continues to generate confusion, uncertainty, and litigation over whether a claim must be (or must have been) brought. A rule change would greatly assist circuit courts, litigants and their attorneys, and attorneys' insurers from taking a bath in the A.B.C.G. alphabet soup.

Endnotes

¹Menard Inc. v. Liteway Lighting Prods., 2005 WI 98, 282 Wis. 2d 582, 698 N.W.2d 738.

²A.B.C.G. Enters. Inc. v. First Bank Southeast N.A., 184 Wis. 2d 465, 515 N.W.2d 904 (1994).

³Wisconsin courts now use the term "claim preclusion" instead of "res judicata." See Northern States Power Co. v. Bugher, 189 Wis. 2d 541, 550, 525 N.W.2d 723 (1995).

⁴A.B.C.G., 184 Wis. 2d at 480.

⁵Id. at 482-84.

⁶Id. at 477.

⁷Id.

⁸Id. at 473.

⁹Id.

¹⁰Id. at 476.

¹¹Id. at 477.

¹²Id. at 480. It is unclear whether the difference between "impairing" rights established in the initial action and "completely undermining" rights established in the initial judgment is a distinction without a difference or an intended substantive qualification. Nevertheless, the wording presents an ambiguity in determining exactly which counterclaims must be brought. Dissenting in Menard, Justice Crooks did find and relied on a distinction between "nullifying" and "merely reducing" the initial judgment rendered. Menard, 2005 WI 98, ¶ 70.

¹³Menard, 2005 WI 98.

¹⁴Id. ¶ 28 (quoting A.B.C.G., 184 Wis. 2d at 476-77).

¹⁵Id. ¶ 28.

¹⁶Id. ¶ 21.

¹⁷Id. The court did note that instances in which the common-law compulsory counterclaim rule applies are to be distinguished from instances in which the defendant has grounds for relief from the judgment that were not available to the defendant in the form of a counterclaim in the original action. Id. ¶ 54 n.15. However, the court found that the situation at hand did not fit within this exception to the rule.

¹⁸Id. ¶¶ 69-70 (footnotes omitted)

¹⁹A.B.C.G., 184 Wis. 2d at 476. The supreme court in Menard termed the compulsory counterclaim rule as "a narrow exception" to Wisconsin's permissive counterclaim statute. Menard, 2005 WI 98, ¶ 47.

²⁰A.B.C.G., 184 Wis. 2d at 474. Or, again, "completely undermine" the rights established in the initial action.

²¹Restatement (Second) of Judgments, reporter's note at 193.

²²The Wisconsin Supreme Court has the power to enact procedural rules on its own. See Wis. Stat. § 751.12(1), (2).

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