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holding that abstention not warranted with regard to federal ERISA claim, but declining to exercise supplemental jurisdiction over related state law claims
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00 CIV. 4598 (SAS)
November 14, 2000
John P. McConnell, Esq., Hargraves McConnell Costigan, P.C., New York, New York, For Plaintiffs.
William F. Costigan, Esq., Costigan Company, P.C., New York, New York, For Defendants.
OPINION AND ORDER
On June 21, 2000, John P. McConnell, James D. McConnell Jr., and Andrew J. Costigan commenced this action against William F. Costigan and Costigan Company, P.C. (f/k/a William F. Costigan, P.C., Costigan Berns, P.C., and Costigan Hargraves McConnell, P.C.) (the "Firm") asserting claims under both the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1001 et seq., and state law.
All of the individual parties are related. John and James McConnell are brothers and are first cousins of Andrew and William Costigan, who are also brothers. See Complaint ¶¶ 9, 18.
Defendants now move to dismiss the state law claims pursuant to 28 U.S.C. § 1367(c)(2) because they substantially predominate over the ERISA claim, and request that this Court abstain from deciding the ERISA claim because defendants have raised the same claim in state court. For the foregoing reasons, defendants' motion is granted in part and denied in part.
I. BACKGROUND
The following facts are taken from the Complaint and are assumed to be true. William Costigan, an attorney licensed to practice law in the State of New York, is the controlling shareholder of the Firm, a professional corporation organized under the laws of the State of New York, with offices in New York County. See Complaint ¶¶ 1, 2, 4. Plaintiffs, each of whom is licensed to practice law in the State of New York, were employees of the Firm until late 1998. See id. ¶¶ 6, 8, 10, 13, 15, 17.
A. Defendants' Withholding of Plaintiffs' Compensation
Between 1995 through 1998, William Costigan caused the Firm to pay him approximately $659,000 in reported income. See id. ¶ 70. Of that amount, $345,000 was paid to him in 1995. See id. ¶ 25. In addition, by December 1998, William Costigan caused the Firm to loan him more than $130,000. See id. ¶ 69. These loans were not memorialized by contemporaneous promissory notes, had no terms of repayment, and accrued no interest. See id. ¶ 27.
Between January 1, 1996 and December 15, 1998, William Costigan was responsible for the payment of all employee compensation. See id. ¶ 32. During that period, defendants withheld plaintiffs' compensation and are now indebted to plaintiffs for hundreds of thousands of dollars, exclusive of statutory interest and penalties. For instance, the Firm is indebted to John McConnell for approximately $103,164 comprised of unpaid salary, unfunded salary increases, and bonuses. See id. ¶ 33. The Firm is indebted to James McConnell for approximately $68,750, comprised of unpaid salary and bonuses. See id. ¶ 34. The Firm is indebted to Andrew Costigan for approximately $56,820 comprised of unpaid bonuses, unfunded salary increases, and unreimbursed loans. See id. ¶¶ 35, 37.
B. Defendants' Contractual Obligations
Until approximately April 1998, William Costigan repeatedly informed plaintiffs that the Firm's delinquency in paying compensation resulted from a "cash-flow" problem and that he was operating the Firm profitably. See id. ¶ 50. During March and April 1998, plaintiffs, along with Daniel Hargraves, another attorney at the Firm, negotiated with defendants to resolve their compensation dispute. See id. ¶¶ 54, 55. On April 13, 1998, the parties memorialized an agreement entitled "Memorandum of Understanding" ("MOU"). See id. ¶ 56. Under the MOU, William Costigan was to transfer to John McConnell, James McConnell, and Daniel Hargraves a percentage of the Firm's shares and a percentage of the Firm's contingency fees from certain cases. See id. ¶ 57. The MOU also adjusted plaintiffs' salaries, established a payment schedule for the Firm's debts to plaintiffs, required a supermajority vote of the Firm shares to terminate any shareholder's employment, and appointed plaintiffs as directors of the Firm. See id. ¶ 57.
On May 11, 1998, William Costigan informed John McConnell, James McConnell, and Daniel Hargraves that he would not convey to them the Firm's share certificates. See id. ¶ 59.
Then, by letter dated May 13, 1998, William Costigan purported to terminate Daniel Hargraves' employment, over plaintiffs' and Hargraves' objection. See id. ¶¶ 60, 61. Thereafter, plaintiffs learned that in March 1998, prior to the execution of the MOU, "the Firm's corporate form had been dissolved for non-payment of corporate taxes." Id. ¶ 62.
On November 2, 1998, defendants settled Hargraves' claims, paying him approximately $210,000. See id. ¶ 63. In consideration of this payment, William Costigan required Hargraves to release defendants for: (1) employment claims; (2) ERISA claims; (3) contractual, creditor, or shareholder claims, including claims arising under the MOU; and (4) statutory or common-law claims. See id. ¶ 64.
On November 15, 1998, William Costigan caused the Firm to reduce the salaries of John McConnell and James McConnell by nearly one-third, effective the following day. See id. ¶ 65.
James McConnell resigned effective November 16, 1998. See id. ¶ 66. John McConnell resigned on December 10, 1998, followed by Andrew Costigan on December 11, 1998. See id.
C. Defendants' ERISA Violations
Effective December 1, 1991, the Firm established and maintained a § 401(k) retirement plan. See id. ¶ 38. The Firm was designated the Plan Sponsor and Plan Administrative Committee. See id. ¶ 39. Between December 1995 and December 1998, plaintiffs authorized defendants to defer designated amounts from their compensation for deposit into their respective 401(k) retirement accounts. See id. ¶ 40. However, the Firm did not segregate and remit the amounts deferred as 401(k) contributions. See id. ¶ 42. Rather, on several occasions, William Costigan used these funds for defendants' benefit or to pay defendants' creditors. See id. ¶ 45. The funds deferred from plaintiffs' compensation remained in the Firm's general operating account until William Costigan caused the Firm to remit the funds for deposit in plaintiffs' respective 401(k) accounts. See id. ¶ 43.
D. The State Court Lawsuit
On July 31, 2000, defendants in this action — the Firm and William Costigan — commenced an action in the Supreme Court of the State of New York against John P. McConnell, James D. McConnell, Jr., Andrew J. Costigan, Daniel A. Hargraves, and the law firm Hargraves McConnell Costigan, P.C. ("the State Suit"). See Costigan Co., P.C. v. Costigan, No. 116489-00 (Sup.Ct. N.Y. Co. Jul. 31, 2000). The State Suit alleges that the State Court defendants intentionally interfered with the Firm's collection of fees in order to lay a foundation for a pretextual ERISA claim against the State Court plaintiffs. See Complaint ¶ 36 in Costigan Co., No. 116489-00. Further, the State Suit alleges that the Firm's cash-flow problem was caused by the State Court defendants' low productivity, delinquent timekeeping, development of slow-or non-paying clients, delinquent billing practices, and commitment of time to non-Firm matters. See id. ¶ 11. On August 17, 2000, the State Court defendants removed the case to federal court. See Notice of Removal, Ex. C. to Affidavit of John P. McConnell ("McConnell Aff."). On November 8, 2000, this Court granted the State Court plaintiffs' motion to remand the case. See 11/8/00 Opinion and Order in Costigan Co., No. 116489-00.
That same day, defendants submitted this motion to stay and dismiss.
Throughout this Opinion, defendants in the State Suit are referred to as the "State Court defendants" and plaintiffs in the State Suit are referred to as the "State Court plaintiffs." "Plaintiffs" and "defendants" refer only to the parties in this federal action.
More specifically, the State Suit alleges that the State Court defendants' conversion of incoming checks caused the Firm to become delinquent in its § 401(k) contributions. See Complaint ¶ 18 in Costigan Co., No. 116489-00.
The State Suit alleges state law claims for: (1) breach of duty of loyalty; (2) breach of contract; (3) conversion; (4) declaratory judgment that the MOU is not a legally enforceable contract; (5) tortious interference with business relations; (6) unjust enrichment; and (7) defamation. See Complaint ¶¶ 28-47 in Costigan Co., No. 116489-00.
In this action, plaintiffs have asserted seven claims, only one of which arises under federal law. The federal claim arises under ERISA and asserts that defendants violated their fiduciary duties by failing to segregate funds withheld from employee paychecks, failing to timely remit funds to plaintiffs' retirement accounts, and applying these funds for defendants' benefit. See id. ¶¶ 81-91. Plaintiffs seek any deferred income not yet transferred by defendants with interest thereon, damages caused by the untimely transfer of that income, and attorneys' fees and costs. See id. ¶¶ 92, 93.
Plaintiffs intend to file an amended complaint seeking damages caused by ongoing ERISA violations such as defendants' failure to respond to plaintiffs' request for information within thirty days of the request, as required by 29 U.S.C. § 1132(c). See Plaintiffs' Memorandum in Opposition to Motion to Stay and Dismiss ("Pl. Mem.") at 5-6.
Plaintiffs also assert six state law claims.
Plaintiffs seek a declaration that the MOU is a legally enforceable contract. See id. ¶¶ 94-101. Further, plaintiffs allege that defendants breached the MOU, have been unjustly enriched by their breach of the MOU and ERISA violations, and have violated New York Labor Law § 190 et seq. See id. ¶¶ 75-80, 102-111. Plaintiffs also seek repayment of Andrew Costigan's $16,900 loan to William Costigan and to pierce the Firm's corporate veil. See id. ¶¶ 111(a)-(k).
II. LEGAL STANDARD
Defendants do not challenge this Court's jurisdiction over plaintiffs' ERISA claim. Nevertheless, defendants ask the Court not to exercise supplemental jurisdiction over plaintiffs' state law claims and to abstain from deciding the ERISA claim.
The decision whether to exercise supplemental jurisdiction is left to the discretion of the district court and will not be reversed absent an abuse of discretion. See Mauro v. Southern New England Telecomm., Inc., 208 F.3d 384, 388 (2d Cir. 2000); Purgess v. Sharrock, 33 F.3d 134, 138 (2d Cir. 1994). "A federal court's exercise of pendent jurisdiction over plaintiff's state law claims, while not automatic, is a favored and normal course of action." Promisel v. First Am. Artificial Flowers, Inc., 943 F.2d 251, 254 (2d Cir. 1991). However, supplemental jurisdiction should not be exercised merely because "the exercise of such judicial power is desirable or expedient." W.G. v. Senatore, 18 F.3d 60, 64 (2d Cir. 1994) (citing United States v. Town of N. Hempstead, 610 F.2d 1025, 1029 (2d Cir. 1979)); see also United Mine Workers of America v. Gibbs, 383 U.S. 715, 726 (1966) ("[Pendent jurisdiction] need not be exercised in every case in which it is found to exist. It has consistently been recognized that pendent jurisdiction is a doctrine of discretion, not of plaintiff's right."). In particular, "[a] district court ought not `reach out for . . . issues, thereby depriving state courts of opportunities to develop and apply state law.'" Young v. New York City Transit Auth., 903 F.2d 146, 164 (2d Cir. 1990) (quoting Mayer v. Oil Field Sys. Corp., 803 F.2d 749, 757 (2d Cir. 1986)).
With respect to abstention, it is beyond cavil that a federal court has "a virtually unflagging obligation" to exercise its jurisdiction. Moses H. Cone Mem'l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 15 (1983). Therefore, the party seeking abstention carries a heavy burden and district courts should abstain from hearing cases only in exceptional circumstances. See Village of Westfield v. Welch's, 170 F.3d 116, 121 (2d Cir. 1999).
III. DISCUSSION A. Motion to Dismiss Plaintiffs' State Law Claims
In any civil case where a district court has original jurisdiction, it also has supplemental jurisdiction "over all other claims that are so related to claims in the action within such original jurisdiction that they form part of the same case or controversy under Article III of the United States Constitution." 28 U.S.C. § 1367(a). To be part of the same case or controversy, "[t]he state and federal claims must derive from a common nucleus of operative fact." United Mine Workers, 383 U.S. at 725. The exercise of supplemental jurisdiction is appropriate "where the facts underlying the federal and state claims substantially overlap . . . or where presentation of the federal claim necessarily [brings] the facts underlying the state claim before the court." Lyndonville Sav. Bank Trust Co. v. Lussier, 211 F.3d 697, 704 (2d Cir. 2000) (internal citations omitted). Conversely, supplemental jurisdiction is lacking where the federal and state claims rest on essentially unrelated facts. See id. at 704-05 (reversing court's exercise of jurisdiction where the federal claim did not require the same evidence required for the state law claims); Wigand v. Flo-Tek, Inc., 609 F.2d 1028, 1033 (2d Cir. 1979) (reversing court's exercise of jurisdiction where the federal claim rested on events prior to the effective date of a contract while the state law claim rested on events occurring after that date).
Even where a court may exercise supplemental jurisdiction under § 1367(a), it may nonetheless decline to exercise that jurisdiction where the state law claims raise novel or complex issues of state law or where they substantially predominate over the federal claim. See 28 U.S.C. § 1367(c). A court must weigh several factors, including considerations of judicial economy, convenience, and fairness to litigants. See Purgess, 33 F.3d at 138. "[O]ne of the most significant factors a court should consider in exercising pendent jurisdiction is the interrelationship between the state-law claims and questions of federal policy. Where the two are closely tied the argument for exercis[ing] . . . pendent jurisdiction is particularly strong." Miller v. Lovett, 879 F.2d 1066, 1072 (2d Cir. 1989) (internal quotation marks omitted). However, the argument for exercising pendent jurisdiction is weak where "the state issues substantially predominate, whether in terms of proof, of the scope of the issues raised, or of the comprehensiveness of the remedy sought." United Mine Workers, 383 U.S. at 726.
Here, the state law claims and the ERISA claim derive from a common nucleus of operative facts. Plaintiffs allege that defendants breached their fiduciary duties by failing to segregate funds withheld from employee checks and applying these funds for defendants' benefit. These acts comprised part of a course of conduct whereby defendants allegedly withheld funds owed plaintiffs — whether by defendants' failure to pay plaintiffs' compensation, to transfer a portion of the Firm's share certificates to plaintiffs, or to make timely 401(k) contributions — in an effort to enrich themselves.
However, pursuant to § 1367(c)(2), I decline to exercise supplemental jurisdiction over the state law claims.
The ERISA claim relates to a relatively narrow issue concerning whether defendants failed to make timely payments into plaintiffs' retirement accounts. In contrast, the state law claims will require resolution of much broader issues — such as whether the Firm's corporate veil should be pierced and whether dissolution of the Firm's corporate structure renders the MOU an unenforceable contract. Resolution of these state law questions is unnecessary to a resolution of the ERISA claim. Such a weak interrelationship between the state law claims and the ERISA claim counsels against the exercise of supplemental jurisdiction. Cf. Ackoff-Ortega v. Windswept Pac. Entertainment Co., 98 F. Supp.2d 530, 535 (S.D.N.Y. 2000) (exercising supplemental jurisdiction over state law claims in part because resolution of the state law claim is antecedent to resolution of the federal claim). "Principles of comity, as well as the duty to promote justice, counsel against federal courts rendering needless decisions of state law." Hoffman v. Empire Blue Cross and Blue Shield, No. 96 Civ. 5448, 1999 WL 782518, at *9 (S.D.N.Y. Sept. 30, 1999) (dismissing state law claims that relate to non-ERISA plans while retaining state law claims that relate to ERISA plans).
Furthermore, the proof required to decide the state law claims is much broader than that required to decide the ERISA claim. The state law claims require proof concerning the Firm's financial condition, the Firm's compensation packages, the meaning and effect of the MOU, and the relationship between the Firm and William Costigan. Moreover, the evidence presented on these claims will duplicate that required in the pending state court action. For instance, the State Court plaintiffs allege that the State Court defendants have caused the Firm's cash-flow problem. See supra Part I.D. The State Court defendants will surely argue that William Costigan's excessive compensation caused the Firm's deficient cash flow. Additionally, both suits seek a declaration as to whether the MOU is a legally enforceable contract. Given that plaintiffs are already in state court addressing these issues, it would be a waste of limited judicial resources to address the same issues in this federal action. For these reasons, I decline to exercise supplemental jurisdiction over the state law claims.
Defendants argue that the state law claims predominate over the ERISA claim because the ERISA damages amount to only $541.01. See Defendants' Memorandum of Law in Support of Their Motion to Stay and Dismiss ("Def. Mem.") at 6. In contrast, plaintiffs have submitted an extensive twenty-three page letter contending that the damages on the ERISA claim amount to $90,100 plus attorneys' fees. See 10/16/00 Letter from John P. McConnell. Even assuming that defendants' calculations are correct, the size of a potential damages award is irrelevant to a determination of whether the state law claims predominate over the federal claims. In deciding that issue, a court must focus on the legal and factual questions presented by each claim — not on the amount of damages.
B. Abstention
Defendants ask this Court to abstain from deciding the ERISA claim pursuant to Colorado River Water Conservation Dist. v. United States, 424 U.S. 800 (1976). The Second Circuit recently summarized the relevant standard:
The Supreme Court has recognized that courts should abstain from the exercise of jurisdiction only in the exceptional circumstances where the order to the parties to repair to the state court would clearly serve an important countervailing interest. The test for determining whether abstention is appropriate, first articulated in Colorado River, now requires examination of six factors: (1) assumption of jurisdiction over a res; (2) inconvenience of the forum; (3) avoidance of piecemeal litigation; (4) order in which the actions were filed; (5) the law that provides the rule of decision; and (6) protection of the federal plaintiff's rights. The test does not rest on a mechanical checklist, but on a careful balancing of the important factors as they apply in a given case, with the balance heavily weighted in favor of the exercise of jurisdiction.
FDIC v. Four Star Holding Co., 178 F.3d 97, 101 (2d Cir. 1999) (internal quotation marks and citations omitted).
1. Assumption of jurisdiction over res
This case does not involve jurisdiction over property.
As a result, this factor weighs against abstention. See Village of Westfield, 170 F.3d at 122 ("[T]he absence of a res point[s] toward exercise of federal jurisdiction.") (internal quotation marks omitted).
2. Inconvenience of the forum
Because both the federal and state suits are in New York, the federal forum is just as convenient as the state forum, which weighs against abstention. See id.
3. Avoidance of piecemeal litigation
Defendants argue that a stay would avoid piecemeal litigation because "the State Court proceedings . . . will likely yield preclusive findings of fact that draw the curtain on the ERISA claims." Def. Mem. at 7. Defendants maintain that the State Suit will prove that the plaintiffs' actions "push[ed] the employer into technical non-compliance as a means to create a pretextual ERISA claim." See id. However, proof of a defendant's good faith is no defense to a fiduciary's breach of duty under ERISA. See Gray v. Briggs, 45 F. Supp.2d 316, 330 (S.D.N.Y. 1999) (stating that breach of fiduciary duty claims under ERISA "do not require proof of willfulness, and good faith is not a defense"); United States v. Mason Tenders Dist. Council of Greater New York, 909 F. Supp. 882, 888 (S.D.N.Y. 1995) ("Good faith alone is not recognized as a defense to a breach of fiduciary duties."). Defendants' claims against plaintiffs for plaintiffs' own alleged misconduct should not determine whether this action can proceed. Cf. Katsaros v. Cody, 744 F.2d 270, 280-81 (2d Cir. 1984) ("[T]he possibility that [defendants] may recover from [a third party] . . . does not excuse them from liability as fiduciaries for losses incurred because of their own imprudent actions. If they should later recover the $30,474 in their action against [the third party], the district court will then credit them for that recovery in its order mandating that they compensate the Fund for losses caused by them.") (emphasis added). Therefore, any finding in the State Suit faulting plaintiffs for defendants' failure to make timely ERISA payments would not excuse defendants' breach of fiduciary duties, and can have no preclusive effect in this action.
Moreover, the state court does not have concurrent jurisdiction to adjudicate plaintiffs' ERISA claim. See 29 U.S.C. § 1132(e)(1). In such a situation, "abstention might only serve to encourage piecemeal adjudication of the issues raised in the federal suit." Andrea Theatres, Inc. v. Theatre Confections, Inc., 787 F.2d 59, 62 (2d Cir. 1986); see also Levy v. Lewis, 635 F.2d 960, 967 (2d Cir. 1980) ("[F]ederal courts must hear claims within their exclusive jurisdiction, for otherwise the right alleged would never be fully adjudicated."). Therefore, this factor weighs against abstention.
4. Order in which actions were filed
"In evaluating the order in which jurisdiction was obtained, the court does not look only to which action was commenced first, but rather to the relative progress of the actions in the two forums." Wiggin Co. v. Ampton Inv., Inc., 66 F. Supp.2d 549, 553 (S.D.N.Y. 1999). Because neither case is significantly advanced, this factor weighs against abstention.
5. Law that provides the rule of decision
"Although in some rare circumstances the presence of state-law issues may weigh in favor of [abstention] . . . the presence of federal-law issues must always be a major consideration weighing against [abstention]." Moses H. Cone Mem'l Hosp., 460 U.S. at 26; see also De Cisneros v. Younger, 871 F.2d 305, 308 (2d Cir. 1989) ("When the applicable substantive law is federal, abstention is disfavored."). Given that the state law claims have been dismissed, the only claim that remains is federal. This weighs strongly against abstention.
6. Protection of the federal plaintiffs' rights
In analyzing this factor, "federal courts are to determine whether the parallel state-court litigation will be an adequate vehicle for the complete and prompt resolution of the issues between the parties." Village of Westfield, 170 F.3d at 124 (internal quotation marks and citations omitted). "If there is any substantial doubt as to this, it would be a serious abuse of discretion to grant the stay or dismissal at all." Moses H. Cone Mem'l Hosp., 460 U.S. at 28. The State Suit cannot adequately protect plaintiffs' rights because the federal courts have exclusive jurisdiction over plaintiffs' ERISA claim. See supra Part III.B.3.
In short, all six Colorado River factors favor the Court's retention of jurisdiction. Defendants have not shown any "exceptional circumstances" justifying the Court's abdication of its "virtually unflagging obligation . . . to exercise the jurisdiction given [it]." Colorado River, 424 U.S. at 817.
IV. CONCLUSION
For the foregoing reasons, defendants' motion to dismiss plaintiffs' state law claims is granted, and defendants' motion to stay this action pending resolution of the state court action is denied. An initial conference is scheduled for November 29, 2000 at 4:30 p.m. at which time a Scheduling Order will be entered.
SO ORDERED.