Should a party that brings a simple lawsuit to collect an unpaid debt or for breach of contract run the risk of having that case transformed into a multimillion-dollar class action against it? That is one of the issues presented when a defendant responds to a lawsuit with a counterclaim that seeks relief on a class-wide basis. A number of state and federal courts have assumed, typically with little substantive analysis, that a class action can properly be pled in a counterclaim. See, e.g., Westwood Apex v. Contreras, 644 F.3d 799 (9th Cir. 2011) (affirming remand of a counterclaim class action without questioning the permissibility of such class actions). Many parties facing such a counterclaim fail to fully litigate the issue of whether class allegations should be allowed in response to a complaint. However, a counterclaim class action arguably violates the applicable rules of civil procedure and undeniably creates numerous unmanageable practical problems. Creative “solutions” to many of those practical problems often trample on the rights of the plaintiff or absent class members.
Counterclaim class actions most often arise in consumer litigation. Typically, a consumer breaches the contract by failing to make required payments, and the other contracting party—often a financial institution—files a lawsuit based on the contract. In response, the consumer asserts a counterclaim alleging that a term in the contract or some other practice of the financial institution violates a state consumer-protection law or another type of regulation. The consumer then purports to bring that counterclaim on behalf of a class subjected to the allegedly unlawful practice or contract term. The propriety of counterclaim class actions often goes unchallenged. However, on close examination, their very existence is built on a shaky legal foundation.
A Rule-Based Analysis
The first issue that must be considered is whether the applicable procedural rules permit class allegations to be asserted in a counterclaim. In some states, the rules at least implicitly allow for counterclaim class actions. See, e.g., Cal. Civ. Proc. Code § 428.20 (providing that counterclaiming defendant “may join any person as a cross-complainant or cross-defendant, whether or not such person is already a party to the action, if, had the cross-complaint been filed as an independent action, the joinder of that party would have been permitted”); Fla. R. Civ. P. 1.220(c) (setting out requirements for bringing claim on behalf of class in “[a]ny pleading, counterclaim, or crossclaim”). While the practical concerns addressed below suggest that such rules may be unwise, the analysis here is limited to the federal rules and their state analogues.
Counterclaims May Be Brought Against an “Opposing Party”
Fed. R. Civ. P. 13 governs counterclaims. Rule 13(a) defines “compulsory” counterclaims, which arise when the counterclaim “arises out of the transaction or occurrence that is the subject matter of the opposing party’s claim.” If a counterclaim that is compulsory is not asserted, it becomes barred and may not later be asserted. See, e.g., Ross ex rel. Ross v. Bd. of Educ. of Twp. High Sch. Dist. 211, 486 F.3d 279, 284 (7th Cir. 2007) (citing Baker & Gold Seal Liquors, Inc., 417 U.S. 467, 469 n.1 (1974)). Rule 13(b) allows permissive counterclaims, which are essentially defined as “any claim that is not compulsory.” Fed. R. Civ. P. 13(b). Both subsections state that counterclaims may be brought against “an opposing party.” Fed. R. Civ. P. 13(a)(1), (b).
This requirement presents the first textual obstacle to a counterclaim class action. As discussed below, under Rule 13(h), a defendant asserting a counterclaim may bring in new “parties” as counterclaim defendants if those parties are being joined as parties in the sense of Rules 19 and 20, whether it be as parties needed to adjudicate the counterclaim under Rule 19 or parties who may be joined permissively under Rule 20. But there is no textual basis in Rule 13 to allow uninvolved persons to effectively bring counterclaims without becoming actual parties to the case, particularly when those claims are not against a party that was previously opposing those uninvolved persons.
In the original action in the example given above, the only parties are the financial institution and the consumer; similarly situated consumers are nowhere to be found and thus are clearly not parties the plaintiff was opposing. Therefore, their inclusion as part of a counterclaim class does not comport with Rule 13’s requirement that counterclaims be directed by a party to opposing parties. In addition, those similarly situated consumers would not be parties even if a counterclaim class was certified, as that would again take them outside the rule. And finally, if counterclaim class actions were contemplated by Rule 13(h), wouldn’t the rule refer not only to Rules 19 and 20 but also to Rule 23—the only rule that actually discusses class actions? It does not, and that is a very significant omission.
This position should not be dismissed as overly literal. In the context of straightforward plaintiff class actions, courts have often held that counterclaims by a defendant against members of the plaintiff class are not allowed because such absent class members are not parties for purposes of Rule 13. See, e.g., Stickrath v. Globalstar, Inc., 2008 WL 2050990, at *6 n.10 (N.D. Cal. May 13, 2008) (citing Roberts v. Heim, 1994 WL 675261, at *1 (N.D. Cal., Sept. 16, 1994)); Allapattah Servs., Inc. v. Exxon Corp., 157 F. Supp. 2d 1291, 1323–24 (S.D. Fla. 2001). If plaintiff class members can use Rule 13 defensively to preclude counterclaims against them, it should follow that the rule likewise forbids offensive counterclaims by persons who are not even joined as defendants in the context of a counterclaim class action. A contrary position allowing a defendant to assert a counterclaim on behalf of persons who are wholly uninvolved in the lawsuit would be inconsistent with the weight of the authority barring parties that are opposing a class action from bringing counterclaims against absent class members. Thus, Rule 13’s limitation that counterclaims be brought only against opposing parties presents a significant obstacle to counterclaim class actions.
Rule 13(h) and Joinder Issues
This obstacle is not easily evaded by relying on the aforementioned Rule 13(h), which provides that “Rules 19 and 20 govern the addition of a person as a party to a counterclaim or crossclaim.” At least one commentator has suggested that Rule 13(h)’s invocation of Rule 19 may provide a basis for the existence of counterclaim class actions based on its rarely cited subsection (d), which simply provides that Rule 19 “is subject to Rule 23.” See Jay Tidmarsh, “Finding Room for State Class Actions in a Post-CAFA World: The Case of the Counterclaim Class Action,” 35 W. St. U. L. Rev. 193, 200–02 (2007). Professor Tidmarsh posits that because “Rule 13(h) allows the joinder of additional parties on a counterclaim pursuant to either Rule 19 or Rule 20, and Rule 19(d) makes joinder under Rule 19 subject to Rule 23,” then, “[t]ransitively, Rule 13(h) allows Rule 23 joinder on a counterclaim.” He concedes that “[t]his argument that Rule 13(h) acts as no bar to counterclaim class actions is hardly airtight, but it enjoys some policy support.” Id. at 201.
That argument is far less than “hardly airtight.” As an initial matter, Rule 13(h) applies when a person is sought to be added “as a party to a counterclaim,” and, as noted above, courts regularly hold that absent class members are not parties for Rule 13 purposes. This distinction alone should render subsection (h) inapplicable to counterclaim class actions. Furthermore, the purpose of Rule 13(h)’s allowance for the addition of parties along with the filing of a counterclaim “is to dispose of an action in its entirety and to grant complete relief to all the concerned parties.” 6 Charles Alan Wright et al., Federal Practice and Procedure § 1434 (3d ed. 2001). Of course, a simple two-party action can easily be disposed of, and complete relief provided, without the involvement of putative counterclaim class members who, as further explained below, may have little interest in pursuing their claims against the plaintiff.
The next issue is this: Rule 19 is limited to parties whose joinder is required, and persons who are merely similarly situated to a defendant cannot be said to be a required party under the standards of Rule 19. Simply put, the argument in favor of counterclaim class actions under this theory conscripts Rule 19(d) for a task for which it is not intended; the rule exists to allow class actions to proceed without being subject to the requirement that all persons described in Rule 19(a)(1) and (2) must be joined in the action. 7 id. § 1626. That principle has no relevance to whether a class action may be brought through a counterclaim. Rule 13(h) has its place in situations where there are relatively few persons or entities who were all involved in the same transaction or occurrence that is the subject of the original claim, and in whose absence it may be difficult to fairly grant complete relief. But it does not offer support for a transformative counterclaim class-action procedure.
The Rules Enabling Act Requires a Textual Approach
Even assuming that creative arguments could be made in favor of counterclaim class actions, the language of Rule 13 leaves no room. Practitioners should keep in mind that the Supreme Court has recently tended toward strict construction of procedural rules and has been very mindful of the Rules Enabling Act. See, e.g., Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2561 (2011); Shady Grove Orthopedic Assocs., P.A. v. Allstate Ins. Co., 130 U.S. 1431, 1442–43 (2010). As explained below, the procedural “solutions” that may be employed to address the significant practical concerns in counterclaim class actions often negatively impact or gloss over the rights of other parties, which is precisely the harm the Rules Enabling Act seeks to prevent. Ortiz v. Fibreboard Corp., 527 U.S. 815, 845 (1999) (“The Rules Enabling Act underscores the need for caution. . . . [N]o reading of [Rule 23] can ignore the Act’s mandate that ‘rules of procedure “shall not abridge, enlarge or modify any substantive right.”’”) (quoting Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 613 (1997), in turn quoting 28 U.S.C. § 2072(b)).
Ignoring the Text of Rule 13 Creates Unmanageable Practical Problems
Perhaps in part to avoid these textual problems, some courts and commentators have simply declared that Rule 13 has no application at all to putative class members. See, e.g., James D. Hinson Elec. Contracting Co. v. BellSouth Telecomms., Inc., 2011 WL 2448911, at *6 (M.D. Fla. Mar. 28, 2011); Buford, 168 F.R.D. at 363–64; Wright et al., supra, § 1434. This principle is espoused primarily to protect plaintiff class members in cases where the defendant attempts to assert counterclaims against absent class members. But where a defendant responds to a lawsuit with a counterclaim class action, Rule 13 must have some application, for otherwise there is no basis for bringing, or any standard governing, that counterclaim. The practical issues created by a counterclaim class action and discussed below arise in part from fitting such a counterclaim in under Rule 13 and in part from general pragmatic concerns with administering such an action, as well as legal issues raised by the typical facts of such an action.
Under the strictures of Rule 13, counterclaims brought on behalf of a putative class must be either compulsory or permissive. If they are merely permissive and thus do not “arise out of the transaction that is the subject matter of” the plaintiff’s claim (Fed. R. Civ. P. 13(a)), why should they be litigated in the original parties’ otherwise straightforward lawsuit? They should not, and should instead be dismissed, as the “allowance thereof would unduly complicate resolution of [the original] claims.” Jacklitch v. Redstone Federal Credit Union, 463 F. Supp. 1134, 1136 (N.D. Ala. 1979); see also Howell v. Town of Fairfield, 123 F.R.D. 429, 430–31 (D. Conn. 1988). Allowing Rule 13(b) to transform a simple breach-of-contract action into a sprawling class action at the defendant’s behest would arguably violate Federal Rule of Civil Procedure 1, which provides that the rules “should be construed and administered to secure the just, speedy, and inexpensive determination of every action and proceeding.”
Conversely, if the claims of the putative counterclaim class are not permissive, they must be compulsory, which raises a host of different issues. It is one thing for the individual defendant’s counterclaim against the plaintiff to be deemed compulsory. As explained in the textual analysis above, however, it strains credulity to find that a person who is not even a party to an action could be compelled to be part of an action in which he has no involvement and assert counterclaims—even only as an absent class member—or be forever barred from litigating those claims. But for counterclaim class actions to be proper, it must be that absent class members’ claims are in some way compulsory. The problems raised by that unavoidable conclusion are legion.
The Plaintiff Will Be Forced to File Counter-Counterclaims
First, given the nature of consumer litigation, the original plaintiff likely will have claims against absent class members. For instance, if the original action is brought to foreclose on a mortgage, and the counterclaim class is defined as those who are in default on their mortgage due to deceptive trade practices or other unlawful acts, then the plaintiff will have (or may have already brought) claims against every member of the class for their defaults. Once that class’s apparently compulsory class counterclaims have been pled, the plaintiff must assert all of its claims against the class members as counter-counterclaims, for those claims too must be compulsory. Failure to do so, of course, would bar it from asserting what may be hundreds or thousands of viable claims.
That action will in turn raise the specter, referred to above, of whether counterclaims may be pled against absent class members under Rule 13. But, in this context, the court already will have allowed a class action counterclaim, albeit from the opposite side. It would be the height of unfairness to then say that the original plaintiff has no recourse under Rule 13 to bring its counter-counterclaims. That position would in essence be that the original plaintiff, faced with compulsory counterclaims against it on behalf of hundreds or thousands of individuals, should not be allowed to assert its own compulsory counterclaims. The court will have two options at that point: allow the plaintiff’s counter-counterclaims against absent class members, thus creating an unmanageable death spiral of litigation in any decent-sized class action, or preclude the plaintiff from asserting its compulsory counterclaims against newly added class members who were brought into the lawsuit solely to assert counterclaims against it. The absence of any guiding principle for the latter option is clear. Accordingly, there is simply no manageable, defensible method for handling the parties’—and class members’—competing claims once a counterclaim class action has been allowed.
Counterclaim Class Actions Based on Previous Litigation
There are numerous other headaches that will be created in most contexts in which counterclaim class actions have been attempted. For instance, some recent counterclaim class actions have been based on financial institutions’ alleged conduct in carrying out foreclosure lawsuits against the putative counterclaim class members. See, e.g., GMAC Mtg. LLC v. Contreras, No. 2010-CA-002868-NC (Fla. Sarasota County Ct. filed Mar. 11, 2010); Bank of N.Y. Trust Co. v. Downs, No. F-24114-08 (Gloucester, N.J. County Ct. filed July 2, 2009). When the subject of the counterclaim is previous litigation and that counterclaim is now found to be compulsory, one must question why the class member’s claim wasn’t brought as a compulsory counterclaim in the underlying foreclosure lawsuit (and is thus now barred). In addition, if the counterclaim class action is asserted in federal court, that court will be precluded from considering the validity of actions taken in state court by, inter alia, the Rooker-Feldman doctrine (Fielder v. Credit Acceptance Corp., 188 F.3d 1031, 1034–36 (8th Cir. 1999)) and Younger abstention. See, e.g., Huber v. GMAC Mtg., LLC, 2011 WL 6020410, at *1–3 (S.D. Fla. Dec. 2, 2011).
Participants Can Be Forced into Litigation Against Their Best Interests
On the other hand, less easily resolved problems are created when the plaintiff has valid claims against the members of the putative counterclaim class, but has not yet asserted them in a lawsuit. In certain circumstances, it may be that the plaintiff’s claims against some persons in the counterclaim class are simply not valuable enough for the plaintiff to pursue of its own accord. When those persons’ claims are asserted through a class counterclaim, however, the plaintiff is essentially forced by Rule 13 to assert, as counter-counterclaims, claims that it may have otherwise refrained from pursuing. As several courts have noted, in this situation, “class members would probably find themselves exposed to much greater liability on the [original plaintiff’s] counterclaims than they would ever stand to recover from the [original plaintiff] in a class action, and probably would never choose to bring individual actions.” George v. Beneficial Fin. Co. of Dallas, 81 F.R.D. 4, 6 (N.D. Tex. 1977) (quoting with approval Defts.’ Br., in turn quoting Carter v. Public Fin. Corp., 73 F.R.D. 488, 491 (N.D. Ala. 1977)). Given that those class members’ best interests and wishes may have been to stay out of litigation and avoid poking the proverbial sleeping dragon, involving them in a class counterclaim simply results in substantial unnecessary litigation that was not wanted by, and does not serve to benefit, anyone.
Frustration of CAFA’s Intent and Purpose
In addition, counterclaim class actions have repeatedly been held to be not removable, even after the Class Action Fairness Act of 2005 (CAFA). Almost every court to consider the issue has found that, even if all of the other requirements for removal under CAFA are met, the original plaintiff cannot remove a state-court counterclaim class action to federal court, because only parties who were originally defendants in the case may remove. See, e.g., Westwood Apex v. Contreras, 644 F.3d 799, 803–07 (9th Cir. 2011); First Bank v. DJL Props., LLC, 598 F.3d 915, 916-18 (7th Cir. 2010); Palisades Collections, LLC v. Shorts, 552 F.3d 327, 333-37 (4th Cir. 2008). There is a viable argument that the language and purpose of CAFA should permit an original plaintiff to remove a counterclaim class action (see, e.g., Palisades Collections, 552 F.3d at 338–42 (Niemeyer, J., dissenting)); as the law stands now, however, the purpose of CAFA is easily frustrated when potentially nationwide, multimillion-dollar class actions that would otherwise be removable are left in state court merely because they were allowed to be wedged into a case through a counterclaim.
Barring Counterclaim Class Actions Will Not Deprive Anyone of a Remedy
Finally, it must be noted that no party would be denied access to a remedy if counterclaim class actions are disallowed. The defendant can of course still assert his or her own individual counterclaim in the case, and, if there are class allegations in need of adjudication, other class members can file them as original class-action complaints. However, allowing counterclaim class actions to be asserted as a way of avoiding debts, delaying foreclosure, and raising the costs of litigating simple collection actions is neither sound law nor sound policy.
A class-action counterclaim changes the entire scope, purpose, and center of gravity of a lawsuit. Where allowed, it injects myriad additional facts, claims, and persons into a case that were of no relevance to the original action, and it results in an interminable delay in deciding the claims brought by the plaintiff. It also seeks to give procedural rights to class members that are usually not permitted to defendants in plaintiff class actions. The litany of pragmatic difficulties listed above is likely only the tip of the iceberg, given the various contexts and concerns that may be created by the addition of hundreds or thousands of counterclaim class members in any given case.
Parties facing a counterclaim class action should fully litigate this issue and request that the court find that there is no basis under the applicable rules for a class action to be brought in a counterclaim. Even if the lack of support in the rules is ignored, Rule 23 vests courts with the ability to consider whether “the likely difficulties in managing a class action” render a class action an inferior method “for fairly and efficiently adjudicating the controversy.” Fed. R. Civ. P. 23(b)(3). Given the legal, practical, and management concerns created by any counterclaim class action, courts should find that those difficulties render counterclaim class actions a far inferior method for adjudicating the limited controversy presented by the original case.
As posted online for the ABA Section of Litigation: Class Actions & Derivative Suits, March 2012 issue.