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Defect is compulsory counterclaim

By: dmc-admin//July 6, 2005//

Defect is compulsory counterclaim

By: dmc-admin//July 6, 2005//

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“Menard’s suit is merely an attempt to collaterally attack the original judgment by raising defenses and counterclaims to Liteway’s original suit and avoid the circuit court’s determination that the failure to raise these claims in a timely fashion did not constitute excusable neglect.”

Hon. Jon P. Wilcox Wisconsin Supreme Court

A claim by a buyer of allegedly defective products is barred by the doctrine of claim preclusion and the compulsory counterclaim rule when the seller has previously sued the buyer for nonpayment of invoices, the Wisconsin Supreme Court held on June 29.

Menard, Inc., purchased lighting products from Liteway Lighting Products from 1993 until 1999. During their business relationship, Menard often held back sums of money due to Liteway as “credit” for products Menard claimed were defective. Following the cessation of their business relationship, the parties began disputing the amount of money Menard owed Liteway.

In 2000, Liteway filed suit for breach of contract, seeking over $350,000 for unpaid invoices. Default judgment was entered against Menard in that amount, plus interest.

While that case was pending, Menard filed a separate complaint against Liteway, alleging that it had returned some of the products due to their defective condition and that Liteway had not reimbursed it for the returns. Menard alleged that as a result, Liteway had been unjustly enriched and that it breached its obligations under the Uniform Commercial Code (UCC). Menard sought damages in the sum of $315,346, representing the cost of all goods returned plus storage and shipping fees.

Liteway answered, asserting that, because Menard’s claims could have been asserted in the pending action, they were barred by the doctrine of claim preclusion.

Eau Claire County Circuit Court Judge Lisa K. Stark held claim preclusion inapplicable, and Liteway appealed. The court of appeals reversed in a published decision, Menard, Inc., v. Liteway Lighting Products, 2004 WI 95, 273 Wis.2d 439, 685 N.W.2d 365.

The Supreme Court accepted review, and affirmed the court of appeals, in a decision by Justice Jon P. Wilcox. Justice N. Patrick Crooks dissented, in an opinion joined by Justice Louis B. Butler.

Claim Preclusion

The court concluded that claim preclusion applied because Menard’s claims are part of the same transaction as the claims in Liteway’s original suit.

The court acknowledged that the general rule in Wisconsin is that, where a defendant may assert a counterclaim, but fails to do so, he is not precluded from maintaining a subsequent action on that claim. A.B.C.G. Enterprises v. First Bank Southeast, 184 Wis.2d 465, 476, 515 N.W.2d 904 (1994)

However, an exception to the rule exists where if “a favorable judgment in the second action would nullify the judgment in the original action or impair rights established in the initial action.” Id. at 476-77.

What the court held

Case: Menard, Inc. v. Liteway, No. 2003AP1391

Issue: Does the doctrine of claim preclusion bar a claim by a buyer of allegedly defective products when the seller has previously sued the buyer for nonpayment of invoices?

Holding: Yes. Both suits arise out of the same transaction, and permitting the second suit would nullify the judgment in the first.

Counsel: Stephanie L. Finn, Webster A. Hart, Eau Claire, for petitioner; Carol S. Dittmar., Teresa E. O’Halloran, Eau Claire, for respondent.

The parties did not dispute that the parties were identical, but disagreed as to identity of claims. The court disagreed with a bright-line rule that had been adopted by the court of appeals — that in the realm of the sale of goods, shipment by the seller and acceptance or return by the buyer always deserve treatment as a unit — but found that, in this case, the claims are part of the same transaction.

The court reasoned as follows: “Liteway sold goods to Menard on credit. Menard returned some of the goods as allegedly defective and took a ‘credit’ for these and future customer returns. Liteway demanded payment on the open accounts. The parties stopped doing business and Menard did not pay the sum demanded by Liteway for the invoices because it disputed the amount of ‘credit’ to which it was entitled for the returned goods. The claims Menard asserts in its second suit are not based on a separate series of underlying events; rather, they are defenses and counterclaims to Liteway’s original claims and are premised on the same common nucleus of operative facts.”

Noting that the original suit plainly raised the issue of the amount owed on invoices, the court added, “The reasons why Menard asserts it does not owe as much as Liteway originally claimed are not unpleaded issues or new transactions; they are merely defenses and/or counterclaims to Liteway’s original claims based on the same set of facts as Liteway’s claims.”

Limited Holding

The court limited its holding, stating, “It is entirely plausible that in some cases, a buyer may not in fact discover the nonconformity, or legally be required to discover the nonconformity, until after the seller has obtained a judgment in a suit for the price of the goods. The court of appeals’ decision would hold that a
ny subsequent action based on the return of the goods was part of the same transaction as the original suit. Such a conclusion would clearly interfere with a buyer’s rights under the UCC in some circumstances.”

In this case, however, the court found that the parties stopped doing business almost a year prior to Liteway’s original suit, that the allegedly defective goods for which Menard sought credit were returned to Liteway, and allegedly defective products were the root of the original dispute. Thus, the court found this hypothetical limitation inapplicable.

The court then concluded that the compulsory counterclaim exception applied, because a judgment for Menard would nullify the default judgment entered in the first action.

The court wrote, “Liteway established the amount due and owing on its open invoices for the goods it sold to Menard in the first action. Now, Menard essentially challenges that amount by claiming that some of the goods for which it did not pay were defective and nonconforming. Menard attempts to put the amount of the judgment in issue by claiming that Liteway did not properly credit it for returned goods that were allegedly defective and was thus unjustly enriched. … Menard’s claims for credit for defective products were always integrally related to Liteway’s demand for payment on open invoices and were always the means by which Menard contested the amount claimed by Liteway on those invoices.”

The court noted that Menard has acknowledged that it “has consistently disputed the amount of damages as requested in [Liteway’s] Complaint and as set forth in the default judgment.” Menard also admitted that Liteway had provided some credit to Menard for returned goods, although Menard claimed it was entitled to a greater amount.

Addressing the interplay of the UCC, the court concluded that, because a recovery for goods depends on those goods being accepted or conforming, Menard’s claim necessarily attacks the legitimacy of Liteway’s original judgment.

The court reasoned, “A judgment in favor of Menard based on returns of defective products would thus directly undermine the original default judgment. Were we to allow Menard to enforce its judgment in the second action, Liteway would essentially be forced to return a portion of its previous recovery. Menard’s suit is merely an attempt to collaterally attack the original judgment by raising defenses and counterclaims to Liteway’s original suit and avoid the circuit court’s determination that the failure to raise these claims in a timely fashion did not constitute excusable neglect.”

Accordingly, the court affirmed the court of appeals’ decision that Men-ard is barred from maintaining the action.

The Dissent

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Case Analysis

Justice Crooks dissented, concluding that the majority opinion failed to apply the UCC, and erred in treating thousands of transactions over a six year period as a single transaction.

Crooks wrote, “The exchanges between Liteway and Menard totaled nearly $18 million over the six years that they did business with each other. Common sense dictates that thousands of purchases and returns over such a long period of time cannot constitute a single transaction for the purposes of claim preclusion.”

Crooks also disputed the majority’s findings of fact, concluding that, even after Liteway had commenced its suit, products continued to be returned. Thus, he concluded, “The majority is clearly wrong when it asserts ‘that all the facts giving rise to Menard’s suit were in existence at the time that Liteway filed its original action.’”

Crooks further found it significant that, even if Menard were successful, it would not nullify the entire judgment against it, but only reduce it partially.

Click here for Case Analysis.

David Ziemer can be reached by email.

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