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Collateral Estoppel may Apply to Vacated Judgments Post-settlement

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Think your case is settled and over? Maybe not after this recent federal appeals court ruling involving the legal principle of collateral estoppel.

Here’s a fun one. It turns out that collateral estoppel may apply even to cases that are settled. Here’s how.

Collateral estoppel, or “issue preclusion,” applies when (1) a question of fact essential to a judgment is actually litigated and answered by a valid and final judgment, (2) the same parties had a “full and fair” opportunity to litigate the issue, and (3) there is mutuality of estoppel. See, Monat v State Farm Ins Co, 469 Mich 679, 682-683; 677 NW2d 843 (2004). 

Issue preclusion exists to serve three purposes: (1) to shield parties from the cost and trouble of multiple lawsuits, (2) to conserve judicial resources and (3) to prevent inconsistent decisions. See, City of Detroit v Qualls, 434 Mich 340, 357 n 30; 454 NW2d 374 (1990).  

In a recent decision coming out of the U.S. Court of Appeals for the Sixth Circuit, Watermark Senior Living Retirement Communities, Inc v Morrison Management Specialists, Inc, ___ F3d ___; 2018 WL 3396403 (6th Cir., Sept. 20, 2018), the question of the applicability of issue preclusion stemming from a prior judgment that had been vacated after a settlement was addressed for the first time under Michigan law.

Watermark had been sued in a prior Michigan state court lawsuit resulting in a jury finding that Watermark had been negligent in causing the death of a patient at one of its nursing homes. After a judgment was entered, Watermark and the patient’s estate settled the case. This settlement ultimately resulted in the trial court vacating the judgment.

After the settlement and the judgment was vacated Watermark sued Morrison Management, the company responsible for managing the nursing home, in a second state court case. Watermark claimed in this second case that it was Morrison Management that actually was responsible for the patient’s death. Watermark sought recovery for the amount paid out in the prior settlement based on claims for breach of contract and indemnification. The case was removed to federal court.

On Morrison Management’s motion to dismiss under Federal Rules of Civil Procedure Rule 12(b)(6) the district court dismissed both of Watermark’s claims concluding that they were barred by collateral estoppel as a result of the first lawsuit. On appeal the Sixth Circuit appellate court was asked to decide, for the very first time, if under Michigan law “a judgment that is set aside upon settlement can be used for collateral-estoppel purposes in future litigation?” The appellate court said that it could. 

Before reaching this conclusion, the appellate court first addressed Watermark’s claim that collateral estoppel could not apply because the prior “judgment” had been set aside by the parties’ settlement and, therefore, it was neither final nor valid. The appellate court acknowledged that, generally, under federal law a judgment that is vacated loses its preclusive effect. However, the appellate court also recognized that to this rule is sometimes applied an exception when a judgment is vacated because of a settlement. In those limited cases, a judgment may still retain its finality and preclusive effect. 

Although the Michigan Supreme Court had not spoken on this issue, the appellate court, nonetheless, concluded that the Supreme Court, if asked, would hold “that judgments can support issue preclusion even though they are set aside or vacated upon settlement.” Id. at *4.

Underpinning this conclusion was the appellate court’s observation that, in Michigan, mutuality of estoppel is not required when collateral estoppel is asserted defensively. Further, the appellate court felt that if collateral estoppel did apply “[i]t would incentivize losing parties to pay to settle adverse judgments in order to avoid their issue-preclusive effects.” The appellate court further reasoned that:

While such a rule might encourage settlement of the first action, it also would authorize losing parties to take another stab at litigating their claims, in the hope that they might garner a more favorable result the second time around.  Permitting this litigation strategy therefore would increase the probability of inconsistent decisions and require the judicial system to expend its scarce resources readjudicating these issues. Id. at *5.

Lastly, the appellate court considered and concluded that the interest of equity supported the applicability of issue preclusion. Specifically, the appellate court distinguished between judgments that are vacated because of a defect in the underlying proceedings and judgments that are set aside because of a settlement. In the first instance, the appellate court concluded that it made no sense to treat a vacated judgment as final and conclusive since the validity of the underlying proceedings could be challenged. 

Similarly, the appellate court concluded that it would be unfair to give preclusive effect to a judgment that is vacated for reasons unrelated to the fault of the party against whom preclusion was sought. However, in a settlement context the appellate court observed that the “losing” party had essentially acquiesced in the fact finder’s decision, had received its “day in court,” and by the settlement also had waived its right of appeal.  In such a case, put simply, “One bite at the apple is enough.” Id. at *6.

Applying this rule, the appellate court determined that Watermark’s indemnification claim was barred because it was seeking damages that the prior jury had determined were the result of its own negligence, something the applicable indemnification provision did not permit. However, the appellate court also found that Watermark’s breach of contract claim was improperly dismissed because the prior jury’s finding of Watermark’s negligence did not also mean that Morrison Management had not breached its contract with Watermark. Simply, the two were different issues and the latter of which the prior jury had not decided.

The appellate court’s ruling is one of first impression, and it is based on the its prediction on how the Michigan Supreme Court would decide the same issue. Of course, the Supreme Court might disagree with the appellate court, and even the Michigan Court of Appeals is not bound by the Watermark decision. However, the appellate court’s ruling was well reasoned and may be viewed as persuasive by the Michigan courts so - stay tuned.

Tags: Business Risk Management, Business Torts, Commercial Liability

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