Petition — Gross v. Newburger

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Supreme Court, U. S,

FILED

NOV 18 1977

IN THE

Supreme Court of the United Beh 004%, sk. cLere

Ocroser Term, 1977

No. .... UU-WM17

Cares Gross,

Petitioner,

—vVvV —_

Newsurcer, Lors & Co., a New York Limited Partnership,

Anprew M. Newsunrcer, Ropert L. Newsuroer, Rickarp

D. Srery, Warter D. Stern, and Roperr L. Srern as

Executors of the Estate of Leo Stern, Ropert L. Sreay,

Ricuarp D. Srern, Sanrorp Roccensure, Frep Kayne,

Rosert Mun, Pavu Risuer, Cuaries Sioane, Roserrt 8.

Persxy, and Fintey, Kumsiz, Waoner, Herne, Unver-

perc & Grurman, a Partnership (formerly known as

Finley, Kumble, Underberg, Persky & Roth and Finley,

Kumble, Heine, Underberg & Grutman), Newsvunrcer,

Lozs & Co., Lyo.,

Respondents.

— — LL

————— — — ——

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

___—_—_—_

Pru Manoet, Esq.

10 East 40th Street

New York, New York 10016

(212) 679-3760

Attorney for Petitioner

INDEX

PAGE

SN TD tictahnscsiseciihineciiiteinsecasiinensiaitindiiiniiaitliingienn 2

Jurisdiction 2.00... sichaaaiedatnbmmnatenennitamatvedn 2

ON 2

Constitutional Provisions, Statutes and Rules ................ 3

I ION ss cicisisntenaitidamnaniialaatinaasieiaianid 8

Reasons for Granting the Writ ..................:ccccccessesees 14

Point I

This Court Should Now Decide the Fundamental

Question Left Open by It in 1926 in Moore v.

New York Cotton Exchange, 270 U.S. 593, Namely:

What Is the Extent of Ancillary Subject Matter

Jurisdiction Over “Permissive” Counterdlaims?

Is Jurisdiction Over Such Counterclaims Limited

OR CRIED . ccnisinstcctaesnststtlnnstiatanniaidbinsitatatittninteteineinhitamniainsinnian 14

Port II

This Court Should Decide Whether the Federal

Courts Have Inherent Power to Protect the In-

tegrity and Dignity of Their Own Proceedings by

Awarding Punitive Damages, Without Reference

to State Law, Against Those Who Bring Baseless

and Fraudulent Actions Before Them .................... 31

Conclusion 33

PAGE

Appenpix A:

Opinion of the United States Court of Appeals

Bom Ge Bese GRIGG ccccresscsassccssssstcssnsnsenesstectibetecanice A-l

Apprenpix B:

Opinion after trial of the United States District

Court for the Southern District of New York

CE GD cncnstitecntnstennnsenctinecsiietentiniannaneenpas B-1

Appenpix C:

Judgment of the United States Court of Appeals

for the Second Circuit ey |

Appenpia D:

Judgment of the United States District Court for

the Southern District of New York ......................00-. D-1

Appenpix E:

Opinion of United States District Court for the

Southern District of New York on motions to dis-

miss and for summary judgment (Judge Ward) .... E-1

ili

TaBLe or AUTHORITIES

PAGE

Cases:

Great Lakes Rubber Corporation v. Herbert Cooper

Co. Inc., 286 F’. 2nd 631 (3rd Cir. 1961) 19

Gumbel v. Pitkin, 124 U.S. 131 (1888) 32

Krippendorf v. Hyde, 110 U.S. 276 (1884) ..0.......ccccc00e 32

Moore v. New York Cotton Exchange, 270 U.S. 593

(1926) 14, 19, 27

Pipeliners Local #798 v. Ellerd, 503 F. 2nd 1193 (10th

Cir. 1974) 19

Pueblo de Taos v. Archuleta, 64 F. 2nd 807 (10th Cir.

1933)

Reid v. Prentice-Hall, 261 F. 2nd 700 (6th Cir. 1958) .. 32

United Mine Workers v. Gibbs, 383 U.S. 715 (1966) passim

United States v. Heyward-Robinson Co., 430 F. 2nd

1077 (2nd Cir. 1970), cert. denied 400 U.S. 1021 ........ 15, 17

United States v. Powell, 379 U.S. 48 (1964) 32

Constitutional Provisions, Statutes and Rules:

U. 8S. Constitution, Article 3, §2, cl. 1 22

28 U.S.C. §1331 23

28 U.S.C. §1337 23

28 U.S.C. §1441 (a) through (c) 23, 24

15 U.S.C. §77v (a) 8,9

15 U.S.C. §78aa 8,9

Federal Rule of Civil Procedure 13 (a) and (b) ....22, 27, 28

Federal Rule of Civil Procedure 11 32

IN THE

PAGE

Other Authorities: Supreme Cont of the United States

Green, Federal Jurisdiction Over Counterclaims, 48 Ocroser Term, 1977

N.W.U.L. Rev. 271 (1953) 24 a vee

Moore’s Federal Practice o.cccccccccccocseeceneeeeeeeneeeee 15, 16, 19, 20

Wright & Miller, Federal Practice and Procedure ........ 20 —

Petitioner,

Newsurcer, Lozs & Co., a New York Limited Partnership,

Anprew M. Newsurcer, Ropert L. Newsurcer, Ricnarp

D. Stern, Warrer D. Stern, and Ropert L. Stern as

Executors of the Estate of Leo Stern, Roserr L. Stern,

Ricuarp D. Srern, Sanrorp Roccensurc, Frep Kayne,

Rosert Mun, Pauw Risuer, Coarites Sioane, Rosert 8.

Persky, and Finutey, Kumsie, Wacner, Herne, Unper-

perc & GrutTMan, a Partnership (formerly known as

Finley, Kumble, Underberg, Persky & Roth and Finley,

Kumble, Heine, Underberg & Grutman),

Respondents.

= —

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Charles Gross, the above Petitioner, requests that a Writ

| of Certiorari issue to review the judgment of the United

States Court of Appeals for the Second Circuit entered in

this case on August 24, 1977, insofar as said judgment

(1) reversed on jurisdictional grounds the award of judg-

ment to Gross for damages for conversion of his interest

in certain warrants, and (2) reversed the award of $50,000

| of punitive damages awarded to Gross.

Opinions Below

The Opinion of the United States Court of Appeals for

the Second Circuit has not yet been officially reported. A

copy thereof is set forth as Appendix A.

The Opinion of Judge Richard Owen in the United States

District Court for the Southern District of New York,

dated July 7, 1976, on which the judgment was based, has

not been officially reported. A copy is set forth as Appen-

dix B.

The Opinion of Judge Robert J. Ward in the United

States District Court for the Southern District of New

York, dated October 16, 1973 is officially reported in 365 F.

Supp. 1364 and a copy is set forth as Appendix E. Judge

Ward’s Opinion granted in part and denied in part motions

and cross-motions to dismiss and for summary judgment.

Jurisdiction

The judgment of the Court of Appeals was entered on

August 24, 1977. This Court’s jurisdiction is invoked under

28 U.S.C. § 1254(1).

Questions Presented

1. Did the Court of Appeals err in reversing the judg-

ment granting damages fer conversion of Gross’ securities

on the ground that no ancillary jurisdiction exists over

“permissive” counterclaims except as to set-off?

2. Did the Court of Appeals err in reversing the judg-

ment in Gross’ favor for punitive damages on the ground

that the same are not authorized by state law in this case?

Do the federal courts have inherent power to protect the

integrity and dignity of their own proceedings by awarding

_ punitive damages, without reference to state law, against

those who bring baseless and fraudulent actions before

them?

Constitutional Provisions, Statutes

and Rules

Article III, § 2, cl. 1 of the United States Constitution

reads as follows:

Section 2, Clause 1. Jurisdiction of Courts

Section 2. The judicial Power shall extend to all

Cases, in Law and Equity, arising under this Constitu-

tion, the Laws of the United States, and Treaties made,

or which shall be made, under their Authority ;—to all

Cases affecting Ambassadors, other public Ministers

and Consuls ;—to all Cases of admiralty and maritime

Jurisdiction ;—to Controversies to which the United

States shall be a Party ;—to Controversies between two

or more States ;—between a State and Citizens of an-

other State;—between Citizens of different States ;—

between Citizens of the same State claiming Lands

under Grants of different States, and between a State,

or the Citizens thereof, and foreign States, Citizens

or Subjects.

28 U.S.C. § 1331 reads as follows:

§ 1331. Federal question; amount in controversy ; costs

(a) The district courts shall have original jurisdic-

tion of all civil actions wherein the matter in contro-

versy exceeds the sum or value of $10,000, exclusive

of interest and costs, and arises under the Constitution,

laws, or treaties of the United States except that no

such sum or value shall be required in any such action

brought against the United States, any agency thereof,

or any officer or employee thereof in his official

capacity.

(b) Except when express provision therefor is other-

wise made in a statute of the United States, where the

plaintiff is finally adjudged to be entitled to recover

less than the sum or value of $10,000, computed with-

out regard to any setoff or counterclaim to which the

defendant may be adjudged to be entitled, and exclu-

sive of interests and costs, the district court may deny

costs to the plaintiff and, in addition, may impose costs

on the plaintiff.

28 U.S.C. § 1337 reads as follows:

§ 1337. Commerce and anti-trust regulations

The district courts shall have original jurisdiction of

any civil action or proceeding arising under any Act

of Congress regulating commerce or protecting trade

and commerce against restraints and monopolies.

28 U.S.C. § 1441(a) through (c) reads as follows:

§ 1441. Actions removable generally

(a) Except as otherwise expressly provided by Act

of Congress, any civil action brought in a State court

of which the district courts of the United States have

original jurisdiction, may be removed by the defendant

or the defendants, to the district court of the United

States for the district and division embracing the place

where such action is pending.

(b) Any civil action of which the district courts have

original jurisdiction founded on a claim or right aris-

ing under the Constitution, treaties or laws of the

United States shall be removable withuut regard to

the citizenship or residence of the parties. Any other

such action shall be removable only if none of the par-

ties in interest properly joined and served as defen-

dants is a citizen of the State in which such action is

brought.

cause of action, which would be removable if sued upon

alone, is joined with one or more otherwise non-remov-

able claims or causes of action, the entire case may

be removed and the district court may determine all

issues therein, or, in its discretion, may remand all

matters not otherwise within its original jurisdiction.

15 U.S.C. § 77v(a) reads as follows:

§$77v. Jurisdiction of offenses and suits

(a) The district courts of the United States, and the

United States courts of any Territory, shall have juris-

diction of offenses and violations under this subchapter

and under the rules and regulations promulgated by

the Commission in respect thereto, and concurrent with

State and Territorial courts, of all suits in equity and

actions at law brought to enforce any liability or duty

created by this subchapter. Any such suit or action

may be brought in the district wherein the defendant

is found or is an inhabitant or transacts business, or

in the district where the offer or sale took place, if the

defendant participated therein, and process in such

cases may be served in any other district of which

the defendant is an inhabitant or wherever the defen-

dant may be found. Judgments and decrees so rendered

shall be subject to review as provided in sections 225

and 347 of Title 28. No case arising under this sub-

chapter and brought in any State court of competent

jurisdiction shall be removed to any court of the

United States. No costs shall be assessed for or

against the Commission in any proceeding under this

ubehapter brought by or against it in the Supreme

Court or such other courts.

15 U.S.C. § 78aa reads as follows:

§ 78aa. Jurisdiction of offenses and suits

The district courts of the United States, and the

United States courts of any Territory or other place

subject to the jurisdiction of the United States shall

have exclusive jurisdiction of violations of this chapter

or the rules and regulations thereunder, and of all suits

in equity and actions at law brought to enforce any

liability or duty created by this chapter or the rules

and regulations thereunder. Any criminal proceeding

may be brought in the district wherein any act or trans-

action constituting the violation occurred. Any suit or

action to enforce any liability or duty created by this

chapter or rules and regulations thereunder, or to en-

join any violation of such chapter or rules and regula-

tions, may be brought in any such district or in the

district wherein the defendant is found or is an in-

habitant or transacts business, and process in such

cases may be served in any other district of which the

defendant is an inhabitant or wherever the defendant

may be found. Judgments and decrees so rendered

shall be subject to review as provided in sections 225

and 347 of Title 28. No costs shall be assessed for or

against the Commission in any proceeding under this

chapter brought by or against it in the Supreme Court

or such other courts.

Fed. R. Civ. P. 13(a) and (b) reads as follows:

Rule 13. Counterclaim and Cross-Claim

(a) Computsory Counterctams. A pleading shall

state as a counterclaim any claim which at the time of

serving the pleading the pleader has against any op-

posing 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 his 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 coun-

terclaim under this Rule 13.

(b) Permissive Counterciaims. 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.

FRCP Rule 11 reads as follows:

Rule 11. Signing of Pleadings. Every pleading of a

party represented by an attorney shall be signed by

at least one attorney of record in his individual name,

whose address shall be stated. A party who is not

represented by an attorney shall sign his pleading and

state his address. Except when otherwise specifically

provided by rule or statute, pleadings need not be

verified or accompanied by affidavit. The rule in equity

that the averments of an answer under oath must be

overcome by the testimony of two witnesses or of one

witness sustained by corroborating circumstances is

abolished. The signature of an attorney constitutes a

certificate by him that he has read the pleading; that

to the best of his knowledge, information, and belief

there is good ground to support it; and that it is not

interposed for delay. If a pleading is not signed or is

signed with intent to defeat the purpose of this rule,

it may be stricken as sham and false and the action

may proceed as though the pleading had not been

served, For a wilful violation of this rule an attorney

may be subjected to appropriate disciplinary action.

Similar action may be taken if scandalous or indecent

matter is inserted.

Statement of the Case

The complaint alleged that defendants were guilty of

“churning” the brokerage account of one Buckley in vio-

lation of the Securities Act of 1933 and the Securities

Exchange Act of 1934. Jurisdiction was based on 15 U.S.C.

§ 77v(a), 15 U.S.C. § 78aa, and pendent jurisdiction. The

complaint was asserted on behalf of Newburger, Loeb &

Co., Inc., a new corporation, which had taken the claim

by a purported assignment from Newburger, Loeb & Co.,

a partnership, which had, in turn, taken the claim by assign-

ment from Buckley. The defendants were Gross & Co.,

Charles Gross, a former general partner of Newburger,

Loeb & Co., his sister Jeanne Donoghue, a limited partner

of Newburger, Loeb & Co., and Mabel Bleich, Gross’s

former secretary, who was also a limited partner of

Newburger, Loeb & Co.

The defendants asserted various counterclaims, pri-

marily based on the following allegations: That the com-

plaint was brought in bad faith as part of a conspiracy

to deprive defendants of their rights and property in con-

nection with the Newburger, Loeb partnership; that the

general partners, the promoters of the new corporation,

the new corporation itself, and certain attorneys for the

promoters and for the new corporation, all conspired to

push through a sale of the assets of the Partnership to

the corporation without the consent of defendants, in vio-

lation of Section 98 of the New York Partnership Law,

and further conspired to hold off defendants’ right to the

return of their capital through the assertion of baseless

and fraudulent litigation. The counterclaims were pleaded

against the plaintiff corporation and also against the Part-

nership, certain partners, promoters of the new corporation

and their attorneys, all of whom were brought into the

action as additional defendants on counterclaims.

Many of the allegations in the answer were asserted as

defenses against plaintiff’s claims, and also as part and

parcel of the counterclaims. For example, the allegation

that the sale of the Partnership’s assets to the corporation

was invalid under Section 98 of the Partnership Law was

made defensively and offensively. This fact would defeat

the plaintiff's churning claim, because plaintiff’s title to

the claim depended upon the validity of the assignment

to it. Illegality of the assignment under the Partnership

Law was also asserted as a basis for defendants’ counter-

claim that the Partnership’s assets had been wrongfully

converted by the conspirators. Similarly, the allegation

that the churning complaint was brought in bad faith was

used defensively as an estoppel, and also was pleaded in

the counterclaim as a breach of fiduciary obligations. All

of the counterclaims, except one, were pleaded under state

law, and it was alleged that ancillary and pendent juris-

diction existed over them.

In the Third Counterclaim, which is particularly germanc

to this petition, defendant Gross alleged that he was the

beneficial owner of certain securities held in the name of

the Partnership, and that these securities were converted

when they were transferred by the Partnership to the

corporation, along with all of the other assets of the Part-

nership, under the illegal Transfer Agreement of Feb-

ruary 11, 1971.

Judge Ward's Decision

The plaintiff and additional defendants on counterclaims

moved to dismiss defendants’ state law counterclaims for

lack of subject matter jurisdiction, and each side also made

motions for summary judgment. On the jurisdictional

issues, Judge Ward held (Newburger, Loeb & Co., Inc.

v. Gross, 365 F. Supp. 1364 (S.D.N.Y. 1973) (App. E))

that the First, Second and Fourth Counterclaims were

“logically related” to the complaint and were thus com-

pulsory counterclaims within the Court’s ancillary juris-

diction. However, Judge Ward held that certain other

counterclaims, including the Third Counterclaim, were not

logically related to the complaint, and thus were merely

permissive counterclaims. Judge Ward held that, there

being no independent jurisdictional basis for these counter-

claims, they could be maintained only as a set-off, to defeat

or reduce any possible judgment on behalf of plaintiff

(App. E2).

Judge Ward granted partial summary judgment to de-

fendants. He found that the sale of the partnership assets

and business to the corporation, without the consent of

Bleich and Donoghue, violated Section 98 of the New York

Partnership Law. Judge Ward did not set aside the un-

authorized transfer of assets, but held that the amount of

damages should be left for trial (App. E4-5).

Afier Judge Ward’s decision, plaintiff and additional

defendants on counterclaims filed an answer and reply

in which they asserted six additional claims against Gross,

all alleging acts of wrongdoing while Gross was the man-

aging partner of Newburger, Loeb & Co.

Judge Owen’s Decision

A seven week trial was held before Judge Owen in the

summer of 1975, after which he issued an unpublished

opinion (App. B), holding:

(1) All of the claims asserted against defendants in the

complaint and in the reply were dismissed as baseless.

(2) Judge Owen found that the plaintiffs and addi-

tional defendants on counterclaims (except Aixala and

Berkowitz) were guilty of a conspiracy, in breach of fi-

duciary duties, to injure Gross, Bleich and Donoghue in

their interests in the Partnership. Kayne, Risher, Sloan,

Muh and Persky planned to take over the new corporation

on a shoestring and directly enrich themselves, and they

persuaded the controlling partners to go along with their

plan by arranging unlawful forgiveness of about $500,000

of indebtedness owed by such partners to the firm. The

conspirators knowingly violated Section 98 of the New York

Partnership Law, when they transferred the Partnership’s

business and assets to the corporation. This unauthorized

transfer converted the partnership assets, including the

interests of Gross, Bleich and Donoghue. Judge Owen also

found that the conspirators used the baseless claims as-

serted in the complaint, and in the reply, for the purpose

of holding off payment to Gross, Bleich and Donoghue

of the sums owed to them. Judge Owen awarded the sum

of $76,868 each to Bleich and Donoghue, and the sum of

$337,921 to Gross, representing their respective dollar cap-

ital balances in the Partnership. Judge Owen also awarded

$50,000 in punitive damages to Gross against certain of

the conspirators.

(3) The Third Counterclaim, for conversion of Gross’s

warrants, which Judge Ward had ruled was merely per-

missive and therefore available only as set-off, was tried

in full. At the outset of the trial, defendants’ attorneys

stated that at the close of the evidence, they would move

to conform the pleadings to the proof with regard to this

claim, and Judge Owen later granted this motion. The

undisputed proof showed, and Judge Owen found, that

the warrants in question, issued by Geon Industries and

National Computer Software, had been earned by the Part-

nership in 1969. The warrants were kept in partnership

name because they were not transferable, but bencficial

ownership was vested in certain partners, including Gross,

who owned about 16% per cent of the total. Gross’s war-

rants were transferred to the new corporation along with

all the assets of the Partnership under the unlawful Trans-

fer Agreement of February 11, 1971, and the corporation

eventually realized substantial profits on the warrants.

Judge Owen found that Gross’s warrants were deliberately

purloined (App. B20), and awarded Gross damages of

$132,803.

The Decision of the Court of Appeals

The Court of Appeals partly affirmed and partly reversed

Judge Owen’s judgment. Liability of plaintiff and addi-

tional defendants on counterclaims was upheld for various

wrongful acts, including conspiring to bring baseless ac-

tions against defendants for the purpose of holding off

payment of sums owed to them and conspiring to convert

the capital assets of the Partnership, including capital

interests of defendants, by selling the same to the corpo-

ration in an agreement induced by self-dealing and made

in violation of Section 98 of the New York Partnership

Law. The Court of Appeals, however, reversed the award

of punitive damages to Gross on the ground that the same

were not authorized by state law in such a case, and re-

versed the award of damages to Gross for conversion of

his warrants on the ground that the Third Counterclaim

was not a compulsory counterclaim, but merely a per-

missive counterclaim, over which no jurisdiction existed

beyond set-off. The Court of Appeals also remanded to

the District Court for more specific findings regarding

computation of damages awarded to Gross, Bleich and

Donoghue in connection with the other portions of their

capital interests in the Partnership.

REASONS FOR GRANTING THE WRIT

This Court Should Now Decide the Fundamental

Question Left Open by It in 1926 in Moore v. New

York Cotton Exchange, 270 U.S. 593, Namely: What

Ie the Extent of Ancillary Subject Matter Jurisdiction

Over “Permissive” Counterclaims? Is Jurisdiction Over

Such Counterclaims Limited to Set-Off?

This petition raises an important and far-reaching ques-

tion affecting jurisdiction of the federal courts with regard

to counterclaims which lack independent grounds for fed-

eral jurisdiction. In Moore v. New York Cotton Exchange,

270 U.S. 593 (1926), this Court said that it need not con-

sider the scope of jurisdiction over permissive counter-

claims because the counterclaim then before it arose out

of the “transaction which is the subject matter of the suit,”

and hence was compulsory. The Court held that ancillary

federal subject matter jurisdiction exists over such com-

pulsory counterclaims, but left open the question of juris-

diction over other counterclaims.

Since 1926, lower federal courts, in the large, have ruled

that in the absence of independent grounds of jurisdiction,

ancillary jurisdiction over permissive counterclaims is

limited to set-off, so that if the plaintiff’s case is dismissed

on the merits, no jurisdiction extends to allowing an affirm-

ative judgment on the counterclaim on behalf of defendant.

See 3 Moore’s Federal Practice pp. 13-481 to 13-483. In the

instant case, that rule was applied by the Court of Appeals

to set aside, solely on jurisdictional grounds, a judgment

on one of the counterclaims which the trial court had

granted on the merits, on overwhelming evidence of wrong-

doing, after a seven-week trial.

Authoritative commentators have condemned the rule

restricting jurisdiction over permissive counterclaims to

set-off, pointing out that it is not justified by principle

under the relevant constitutional and statutory provisions,

that it wreaks havoc with judicial economy, and that it

works injustice among litigants. The rule also runs counter

to the policy favoring the broadest possible joinder of

claims which permeates the Federal Rules of Civil Proce-

dure and many decisions of this Court. See United Mine

Workers v. Gibbs, 383 U.S. 715, 724 (1965).

The rule has twice been questioned in judicial opinions

of the Court of Appeals for the Second Circuit: once by

Judge Friendly, in a concurring opinion in the case of

United States v. Heyward-Robinson Co., 430 F.2d 1077

(2d Cir. 1970), cert. denied 400 U.S. 1021, and again by the

decision in the instant case, wherein the Court stated (App.

A25, 26) that it did not reconsider this rule because it had

not been requested to do so by the parties.’

‘We did not »rgue the scope of jurisdiction over permissive

counterclaims because we thought that question would not be

reached. We were convinced that all the counterclaims were com-

pulsory, including the claim for conversion of Gross’s securities.

However, when the Court of Appeals disagreed with us, and held

Professor Moore has said of the rule that it “... is

supported by orthodoxy; and wholly undercut by practical

needs.” 3 Moore’s Federal Practice, 13-483, 13.19[1].

Professor Moore has also stated:

“The rule that there must be independent jurisdic-

tional grounds to support a permissive counterclaim,

except a defensive set-off, has been legitimately criti-

cized. There is nothing expressly stated in the history

of the Constitution or the jurisdictional statutes that

demand this restriction on federal court jurisdiction.

Thus the same procedural policies which favor dis-

posal of all questions between the same parties in one

suit should create federal jurisdiction over such per-

missive claims as part of the wholc ‘case’. Indeed, the

rule’s exception, which does allow federal jurisdiction

over a defensive set-off, but not over an offensive set-

off, may work unfairly at times. For the distinction

can often be applied realistically only after a trial, and

thus causes the defendant prematurely to choose

whether to split his claim. If the federal court has

initial jurisdiction to hear the defensive counterclaim

then judicial economy ought to allow jurisdiction to

utilize the same trial to give an affirmative recovery.”

3 Moore’s Federal Practice pp. 11-486 through 11-487,

913.19[1]. (Footnotes omitted).

this counterclaim was merely permissive. we think it should have

re-examined the rule that permissive counterclaims are available

only as set-off. It is apparent that the Court itself entertains grave

doubt as to the validity of the rule, and in the face of such doubt,

we respectfully submit that the Court should not have applied the

rule, without re-examination, to reverse the judgment of the trial

court. It has long been recognized that an appellate court may,

and should, raise sua sponte, any jurisdictional questions affecting

the judgment before it.

In his concurring opinion, in United States v. The Hey-

ward-Robinson Company, supra, Judge Friendly said, at

430 F.2d 1077, 1088:

“I would now reject the conventional learning,

which I followed too readily in O’Connell v. Erie

Lackawanna R.R., 391 F.2d 156, 163 (1968), that the

permissive counterclaim ‘needs independent jurisdic-

tional grounds to support it, with one exception,’ to

wit, set-off, 3 Moore, Federal Practice 913.19 at 53-54

(2d ed. 1968). The Supreme Court left this question

open in Moore v. New York Cotton Exchange, 270

U.S. 593, 609, 46 S.Ct. 367, 70 L. Ed. 750 (1926).”

“The reasons why the conventional view is wrong

are set out in detail in an article by Professor Thomas

F. Green, Jr., Federal Jurisdiction over Counter-

claims, 48 N.W.U.L. Rev. 271 (1953), and nothing

would be gained by repetition. I mention only two

points. One is that for reasons there developed, id. at

277-81, Professor Moore’s sound recognition—perhaps

more accurately creation—of the exception that set-off

requires no independent jurisdictional basis, see 3

Moore, Federal Practice, 13.19 at 54-55 n. 3; Marks

v. Spitz, 4 F.R.D. 348 (D.Mass. 1945); Fraser v. Astra

S. S. Corp., 18 F.R.D. 240 (S.D.N.Y. 1955), carries the

seeds of destruction of the supposed general rule. The

other is that at least since United Mine Workers v.

Gibbs, 383 U.S. 715, 86 S.Ct. 1130, 16 L.Ed.2d 218

(1966), it is no longer thought the heavens will fall if

a federal court deals with a non-federal claim when it

is convenient to do so.”

The instant case provides a quintessential example of

the mischief which can be wrought by this rule, and there-

fore is a fitting vehicle for this Court’s consideration of

the question.

The opinions in the District Court and in the Court of

Appeals both recognized that this action was instituted in

1971 as part of a conspiracy unlawfully to keep the capital

of defendants in the new corporate business owned bv the

conspirators. Defendants were told bluntly that if they

refused to approve the sale of the partnership business to

the corporation, and refused to accept securities of the new

corporation in lieu of their partnership interests, they still

would not be paid the sums owing to them, but, instead,

they would be subjected to many years of expensive and

damaging litigation. In his opinion after trial, Judge Owen

described the claims against defendants as follows: (App.

B21)

“All were baseless, see pp. 20-22, supra. These claims

and attendant vilification were solely used as bargain-

ing tools against Gross, which he had the personal

courage, fortified by the courage and determination of

his counsel, to oppose over long years.”

If defendants were not to surrender to these tactics, their

only alternative was to resist the false claims asserted

against them, while simultaneously counterclaiming to en-

force their own rights.

The Court of Appeals agreed with Judges Owen and

Ward that federal jurisdiction existed over the counter-

claims in which defendants demanded return of their dollar

capital converted by the conspirators. The Court of Ap-

peals did not disagree with Judge Owen’s determination

on the merits that the conspirators had also converted

Gross’s warrants, but set aside the judgment ($134,171) for

conversion of these securities, solely on the ground that

the Third Counterclaim was merely permissive, so that

jurisdiction over it was limited to set-off. Since all of

plaintiff’s claims were dismissed, no set-off was applicable

and, hence, ‘he Court of Appeals held that the federal

courts had no jurisdiction to redress the conversion of

these securities.

It is not realistic to say the claim for conversion of the

warrants should have been brought in the state courts in

the first instance. There was no possibility open to de-

fendants of allowing the churning claim to proceed in the

federal courts, while defendants pressed all their claims

in a new action started by them in the state courts. Fed.R.

Civ.P. 13(a), the Compulsory Counterclaim Rule, forced

defendants to assert in the federal action all claims “aris-

ing out of the same transaction,” which means all claims

“logically related” to the subject matter of the complaint:

Moore v. New York Cotton Exchange, 270 U.S. 593 (1926) ;

Great Lakes Rubber Corporation v. Herbert Cooper Co.

Inc., 286 F.2d 631, 634 (3d Cir. 1961); Pipeliners Local

#798 vy. Ellerd, 503 F.2d 1193 (10th Cir. 1974); 3 Moore’s

Federal Practice, § 13.13.

Both Judge Ward, in his summary judgment decision in

1973, and the Court of Appeals, in its decision in 1977,

recognized that the bulk of defendants’ claims fell into the

category of compulsory counterclaims. We respectfully

suggest that any practical analysis of the facts and legal

theories, viewed from the standpoint of an attorney forced

to make decisions at the time of drafting his answer and

counterclaims, would indicate that no chance should be

taken of omitting to plead in the federal action any claim

which could later be argued was a compulsory counter-

claim.’ All of the respective claims and counterclaims were

part of one dispute between the parties, and we suggest

that at the time of drafting the answer, a practitioner in

the field should not be required to make fine technical dis-

tinctions to form the basis of pleading some of defendants’

claims as counterclaims in the federal action, and pleading

other of these inter-related claims in a complaint in a sepa-

rate state court action.

Put into concrete terms, the practical implication of the

Court of Appeals’ decision in this case is that at the time

of pleading our counterclaims, we should have included in

the federal answer a claim for the dollar capital of Gross,

Bleich and Donoghue, but we should have drawn a fine line

and excluded the claim for conversion of Gross’s warrants,

and should have asserted that claim in a separate state

court action. This line of separation between the dollar

capital and the warrants was to be drawn—under the theory

below—even though the dollar capital and the warrants

were both being withheld from their true owners pursuant

to the same conspiracy; were both held off by means of

the same baseless claims and litigations; and even though

both forms of assets had been transferred to the new cor-

poration under the same unlawful Transfer Agreement,

which was illegally induced, and which was executed in

violation of Section 98 of the New York Partnership Law.

* Professor Moore advises:

“Of course, if defendant is in any doubt as to the nature of

his counterclaim, whether permissive or compulsory, careful

practice requires him to plead it in order to protect himself.”

3 Moore’s Federal Practice, Paragraph 13.12[1], page 13-272.

Professors Wright and Miller have said:

“Thus, the careful attorney can and usually will plead all of

his client’s claims as counterclaims if he has any reason to

believe that they might be considered compulsory.” 6 Federal

Practice and Procedure, § 1417, page 100.

We are unapologetically critical of such a rule of law,

which we feel to be pointless, unworkable, and mischie-

vous. As we have previously indicated, we believe that the

instant case may provide an extreme example of the dam-

age which may be worked by this rule, but, as so often

happens, the extreme example is the one most suited to

highlight inherent flaws in a general rule.

The conspirators threatened that if defendants did not

yield to their demands, they would be embroiled in litiga-

tion for many long years. This threat, the conspirators

fulfilled in full measure and still actively pursue, with

great help from the rule that permissive counterclaims are

available only as set-offs.

The result is disastrous from the point of view of justice

between the parties, and equally disastrous from the point

of view of judicial economy. The time and expense re-

quired to reach judgment were enormous. The conspirators

exercised every tactic to delay the trial. Dilatory motions

were employed without mercy. At one point the trial court

was forced to fine some of the additional defendants $750

for repeated failure to comply with orders regarding dis-

covery. When the plaintiff corporation went into receiver-

ship, that event was exploited to the full for further Gelay.

The conspirators changed and switched attorneys again

and again, causing still more delays. The trial, itself, took

seven full weeks, and the joint appendix in the Court of

Appeals consisted of eleven heavy volumes. The cost of

the case, in terms of legal hours, was staggering.

After all this travail, Gross succeeded in proving beyond

any challenge on the merits that the conspirators had de-

liberately converted his securities (App. B20). Yet, six

and one-half years after service of the summons, the rule

that permissive counterclaims are available only as set-offs,

operated to abort the judgment with regard to this conver-

sion.

True, as the Court of Appeals pointed out, Gross can

still bring timely action on this claim in the state courts

under a savings clause with regard to the statute of limi-

tations provided by the New York Civil Practice Law and

Rules. But this is rather incomplete solace under the

circumstances.

These unfortunate consequences do not stem from an

unavoidable lack of federal jurisdiction. We will show

below that the rule restricting jurisdiction over permissive

counterclaims to set-off is not justified by the Constitution;

is not justified by jurisdictional statutes; is inconsistent

with the provisions of Fed.R.Civ.P. 13(b); and is incon-

sistent with the reasoning of this Court in connection with

related jurisdictional questions.

The fundamental fact is that neither the Constitution

nor the statutes which define the jurisdiction of the fed-

eral courts mention counterclaims.

Article III, Section 2, of the Constitution provides in

part that: “he judicial power shall extend to all cases,

in Law and Equity, arising under this Constitution, the

Laws of the United States, and Treaties... .” The Constitu-

tion does not speak in terms of “causes of action” or

“claims” which may involve federal questions, but, instead,

confers jurisdiction upon “all cases” arising under the

federal Constitution, statutes, or treaties. We suggest that

this language means that whenever the plaintiff bases the

complaint upon the Constitution or a federal statute, the

whole case falls within the Constitutional scope of judicial

power and that the “case” comprehends all claims which

may properly be joined therein.

Nor does the Judicial Code confer jurisdiction over fed-

eral questions, federal claims or federal issues; instead

the operative statutes confer jurisdiction over the “action.”

Good examples are 28 U.S.C. §4 1331 and 1337. Section

1331 gives the district courts original jurisdiction of “all

civil actions” arising under the Constitution, laws, or

treaties of the United States, wherein the matter in con-

troversy exceeds the sum or value of $10,000. Section 1337

reads as follows:

“§ 1337. Commerce and anti-trust regulations

The district courts shall have original jurisdiction

of any civil action or proceeding arising under any Act

of Congress regulating commerce or protecting trade

and commerce against restraints and monopolies.”

(Emphasis added).

Each of these statutes gives the district courts jurisdiction

over the whole action. Nothing in these statutes restricts

federal jurisdiction to the part of the action containing a

federal question.

28 U.S.C. § 1441, the general removal statute, expressly

recognizes that “civil action” means “entire case,” which

may include non-federal claims and causes of action. Sec-

tion 1441(a) provides that any civil action brought in a state

court of which the district courts have original jurisdiction,

may be removed to the district court. Section 1441(c) pro-

vides as follows:

“(c) Whenever a separate and independent claim or

cause of action, which would be removable if sued upon

alone, is joined with one or more otherwise non-remov-

able claims or causes of action, the entire case may be

removed and the district court may determine all issues

therein, or, in its discretion, may remand all matters

not otherwise within its original jurisdiction.” (em-

phasis added)

Thus, the Constitutional and statutory provisions, alike,

grant jurisdiction over the entire case, which must include

a federal claim, and may also include separate non-federal

claims or causes of action. Nothing in the Constitution or

statutes distinguishes between non-federal claims asserted

in the complaint and non-federal claims asserted in the an-

swer. If the phrase “civil action” were defined to include

only the plaintiff’s case, there would be no jurisdiction over

counterclaims whatsoever. If counterclaims were to be con-

sidered as separate civil actions, tried together with plain-

tiff’s civil actions, then it would follow that there could be

no federal jurisdiction over any counterclaim unless that

counterclaim independently satisfied all of the requisites

for federal jurisdiction.

It is for these reasons, as Judge Friendly and Professor

Green have pointed out, that all our doctrines of secondary

jurisdiction over counterclaims must be perceived as based

on the principle that an action includes not only the plain-

tiff’s claims but defendant’s claims as well. See Green, F'ed-

eral Jurisdiction over Counterclaims, 48 Nw.U.L. Rev. 271

(1953), and see the portion of Judge Friendly’s concurring

opinion quoted on page 17 supra.

The view that the entire action comprises the constitu-

tional case also underlies this Court’s decision in United

Mine Workers v. Gibbs, 383 U.S. 715 (1966), which con-

tains this Court’s definitive ruling with regard to pendent

jurisdiction. The Court there said:

“Pendent jurisdiction, in the sense of judicial power,

exists whenever there is a claim ‘arising under [the]

Constitution, the Laws of the United States, and Trea-

ties made, or which shall be made, under their Au-

thority ...,’ U. S. Const., Art. ITI, § 2, and the relation-

ship between that claim and the state claim permits the

conclusion that the entire action before the court com-

prises but one constitutional ‘case.’” 383 U.S. 715, 725

(Footnote omitted; emphasis added).

Although Unitea Mine Workers v. Gibbs directly con-

cerned plaintiff’s claims, rather than counterclaims, the

reasoning is equally applicable to counterclaims. Where a

state counterclaim has the requisite relationship with a

federal claim, then it, too, is part of the entire action be-

fore the court, comprising but one constitutional case. Ac-

cordingly it would seem that federal jurisdiction should

extend to any such counterclaim.

We pause for a moment to define certain phrases which

we will use to facilitate further analysis. We will speak

of claims having “primary” federal jurisdiction when those

claims, standing alone, present federal subject matter juris-

diction. Examples are claims posing a federal constitu-

tional question or raising a federal statutory question, or

claims satisfying the requisites for diversity jurisdiction.

We will speak of claims having “secondary” jurisdiction

when those claims, standing alone, would not fall within

federal subject matter jurisdiction, but acquire jurisdic-

tional status by reason of a relationship to other claims «s-

serted in the same action. Secondary federal jurisdiction

is derivative in nature, rather than independent, since it

exists only by reason of the relationship with another claim

in the action.

Thus, both “pendent” subject matter jurisdiction and “an-

cillary” subject matter jurisdiction are forms of secondary

subject matter jurisdiction. We believe that the use of these

different terms has tended to becloud the issues.

Are the constitutional and statutory limitations for sec-

ondary jurisdiction with regard to plaintiff’s claims any

different from the standards for determining secondary

jurisdiction with regard to defendant’s claims? As we have

shown, the Constitution and jurisdictional statutes make no

such distinction. Since the test of secondary jurisdiction is

comprehension within a constitutional case, it would seem

that the test should be the same whether the state claim is

asserted in a complaint, an answer or a reply. In each situa-

tion, the existence of secondary subject matter jurisdiction

is governed by the existence of the requisite relationship

between the state claim and some other claim in the action

possessing federal jurisdiction.

It is our view, therefore, that constitutional and statutory

limits of secondary federal subject matter jurisdiction are

the same for counterclaims and plaintiff’s claims. On the

other hand, practical considerations relating to judicial

economy and fairness between the litigants indicate that

there should be a greater liberality in recognizing secondary

jurisdiction with regard to counterclaims. It is the plain-

tiff who initiated the action, and, in many cases, elected to

employ the federal forum. The need to permit set-off has

long been recognized as necessary to protect defendant’s

rights, for set-off is akin to the defense of payment. As

commentators have pointed out, the fear of overburdening

the federa] court system is more realistic when applied to

plaintiff’s joinder options than to defendant’s options. Inso-

far as Fed.R.Civ.P. 13(a) compels defendants to bring cer-

tain counterclaims in the federal action, there ought to be a

somewhat greater elasticity afforded to defendants’ claims

in order to embrace those which might otherwise be doubtful

or borderline cases.

Unfortunately, the lower courts have failed to recognize

the impact of this Court’s decision in United Mine Workers

v. Gibbs upon the question of secondary jurisdiction over

counterclaims. In confining the application of the liberal

rule of United Mine Workers v. Gibbs to plaintiff’s claims,

while continuing to apply the older rule announced in Moore

v. New York Cotton Exchange, 270 U.S. 593 (1926) to

counterclaims, the lower courts have produced a situation

in which secondary jurisdiction over plaintiff’s claims is

recognized mc~e liberally than over counterclaims. This

is the reverse of what the situation ought to be.

There can be no doubt that beginning with the union of

law and equity, the thrust of modern jurisprudence has been

to break down artificial barriers to the joinder of claims in

the interest of justice and judicial economy. As this Court

said in United Mine Workers v. Gibbs, supra, at page 724:

“Under the Rules, the impulse is toward entertaining

the broadest possible scope of action consistent with

fairness to the parties; joinder of claims, parties and

remedies is strongly encouraged.”

Given the encouragement of liberal joinder of claims to

avoid piecemeal litigation, it seems anomalous that under

the conventional view of the lower courts, a defendant may

assert a counterclaim in an action only if he must assert

the claim, Fed.R.Civ.P. 13(a) provides that a defendant

must assert any counterclaim arising out of the transac-

tion. Rule 13(b) provides that the defendant has an option

with regard to any other counterclaim. It is clear from

the history of the Rule that Rule 13(b) was intended to per-

mit joinder of counterclaims wherever jurisdictionally pos-

sible. However, the restrictive view of counterclaim sec-

ondary jurisdiction taken by the courts below operates so

that no permissive counterclaim can ever be asserted be-

yond set-off under Rule 13(b), unless the claim possesses

primary jurisdiction.

We suggest that this anomaly can be corrected, and that

this Court can harmonize the provisions of the Constitution,

the statutes, the Federal Rules of Civil Procedure, and the

practical requirements of economical litigation and justice

between the parties. All this can be accomplished consis-

tently with the prior decisions of this Court, if the Court

will overrule the restrictive rule adopted by the lower

courts with regard to jurisdiction over permissive counter-

claims. We believe that full secondary jurisdiction should

be accorded to permissive counterclaims, on the same basis

as compulsory counterclaims. We believe this will best pro-

mote judicial economy and fairness to the parties for the

reasons advanced by Judge Friendly, Professor Moore and

Professor Green.

However, if this Court does not wish to go that far, it

should at least recognize that the federal courts have power

to take jurisdiction over ~ermissive counterclaims on ex-

actly the same basis as defined in United Mine Workers v.

Gibbs, supra, with regard to state claims set forth in the

complaint :

“The state and federal claims must derive from

a common nucleus of operative fact. But if, considered

without regard to their federal or state character, a

plaintiff’s claims are such that he would ordinarily be

expected to try them all in one judicial proceeding,

then, assuming substantiality of the federal issues,

there is power in federal courts to hear the whole.” 383

U.S. 715, 725 (1965).

This rule would work logically and practically to give

the federal courts discretionary jurisdiction over permis-

sive counterclaims. The application of judicial discretion

can provide the same safeguards against inappropriate

joinder as were mentioned in United Mine Workers v. Gibbs,

383 U.S. at pages 726, 727. In a case such as the instant

case, where the counterclaim has, in any event, been tried as

a possible set-off, the application of judicial discretion will

undoubtedly avoid the pointless waste imposed by the rigid

“conventional” view. Conversely, where a permissive state

counterclaim appears too burdensome, for any reason, in

the context of the entire action, the Court would have dis-

cretion to decline secondary jurisdiction over it at the start

of the case, even for purposes of set-off. No doubt, in the

vast majority of cases the equity of permitting a defen-

dant to assert a set-off would impel the trial court to exer-

cise its discretion in favor of accepting jurisdiction over a

permissive counterclaim, but the rule itself is sufficiently

flexible to permit adaptation to whatever developments the

future may bring with regard to the volume of traffic pre-

sented to the federal judiciary and with regard to the re-

sources made available to the judicial system.

In our opinion, it would make no difference with regard

to the instant case whether the Court decides that permis-

sive counterclaims satisfying the tests of United Mine

Workers v. Gibbs are absolutely within federal jurisdiction,

or whether it decides that such counterclaims are subject

to the Court’s discretionary exercise of jurisdictional power.

Under either variation of the rule, the Court of Appeals

erred in reversing Judge Owen’s award of damages for the

conversion of Gross’s securities. Under the facts of this

case, the joinder of Gross’s claim regarding his securities

was so inherently desirable that any exercise of discretion

to deny jurisdiction would be abusive and erroneous. This

is especially true in the posture of the case after the trial,

when the issues had been tried in full and there was no

doubt on the facts or the law that Gross was a victim of wil-

ful wrongdoing, and entitled to substantial damages.

Certainly, Gross’s claim for the conversion of his securi-

ties satisfies every jurisdictional test imposed by United

Mine Works v. Gibbs, supra. The common nucleus of

operative fact from which it derives includes: (1) the part-

nership relationship and Partnership Agreement, (2) the

conspiracy to deprive defendants of their partnership rights

and assets, (3) the unlawful Transfer Agreement of Febru-

ary 11, 1971, under which the Partnership purported to

transfer to the corporation the baseless churning claim,

all of the other assets of the Partnership, and Gross’s se-

curities held in partnership name.

United Mine Workers v. Gibbs, supra, poses one further

jurisdictional test: In the absence of any jurisdictional

problem, would one ordinarily expect the challenged claim

to be asserted within the action? Applying that test to this

case: Would one expect Gross to assert the counterclaim

for conversion of his securities along with the counterclaim

for conversion of his other partnership capital interest and

along with the other counterclaims in this case? We believe

the answer to this question is so plain that it requires no

discussion. Given the choice, no practitioner would dream

of bringing a separate action for the conversion of the se-

curities.

This Court Should Decide Whether the Federal Courts

Have Inherent Power to Protect the Integrity and Dig-

nity of Their Own Proceedings by Awarding Punitive

Damages, Without Reference to State Law, Against

Those Who Bring Baseless and Fraudulent Actions

Before Them.

Judge Owen awarded punitive damages in the amount

of $50,000 against the conspirators, saying, in part, as fol-

lows (App. B21):

“Next, I turn to the subject of punitive damages.

The new team and Persky—not only counsel thereto,

but one of its actors and spokesmen—asserted numer-

ous threats against Gross to coerce his acquiescence

and that of his sister and colleague. These parties

knowingly commenced baseless actions against him and

Bleich and Donoghue to stand off payment. Persky,

among others, made it clear to Gross that if he did not

go along with the new team, he would be tied up in

litigation for a long time and injured in his livelihood.

Persky solicited claims from partner Ned Frank to

use as threats against Gross. All were baseless, see

pp. 20-22, supra. These claims and attendant vilifica-

tion were solely used as bargaining tools against

Gross, which he had the personal courage, fortified

by the courage and determination of his counsel, to

oppose over long years.”

Judge Owen found that the pleading of the dishonest

claims violated Fed.R.Civ.P. 11 (App. B10).

The Court of Appeals set aside the award of punitive

damages on the ground that it was not authorized under

New York law. Apparently, the Court of Appeals did not

consider our argument that state law could not limit the

inherent power of the federal courts to protect the integrity

and dignity of their own proceedings by awarding punitive

damages in a case such as this.

While there is ample authority that the federal courts

have inherent power to protect the dignity and integrity

of their proceedings, whether such power extends to the

imposition of punitive damages seems to be a question of

first impression. We believe the denial of such power in

this case raises a fundamental question which should be

reviewed by this Court.

Cases affirming that the courts of the United States have

inherent power to take necessary steps to protect their

integrity and dignity include: Gumbel v. Pitkin, 124 U.S.

131 (1888); United States v. Powell, 379 U.S. 48 (1964) ;

Krippendorf v. Hyde, 110 U.S. 276 (1884); Reid v. Pren-

tice-Hall, 261 F.2d 700 (6th Cir. 1958); Pueblo de Taos

v. Archuleta, 64 F.2d 807 (10th Cir. 1933).

In United States v. Powell, swpra, this Court said:

“a court may not permit its process to be abused.”

(379 U.S. 48, 58).

In Pueblo de laos v. Archuleta, supra, the Court said:

“But all such objections m: be brushed aside with

the statement that the court is the protector of the

purity of its own process, and may take such steps as

are necessary to protect against its abuse, on its own

motion, or upon the suggestion of a stranger; and

neither state statutes nor ordinary procedural rules

can thwart a prompt and efficacious discharge of that

paramount obligation. Gumbel v. Pitkin, 124 U.S. 131,

8 8.Ct. 379, 31 L.Ed. 374; Lord v. Veazie, 8 How. 251,

12 L.Ed. 1067; Cleveland v. Chamberlain, 1 Black, 419,

17 L.Ed. 93; Haley v. Eureka County Bank, 21 Nev.

127, 26 P. 64, 12 L.R.A. 815; In re Burdick, 162 IIl.

48, 44 N.E. 413; Consolidated Liquor Co. v. Scotello

& Nizzi, 21 N.M. 485, 155 P. 1089.” 64 F.2d 807, 812.

CONCLUSION

For the reasons stated, the writ should be granted.

Dated: November 17, 1977

Respectfully submitted,

Puiuip Manpe., Esq.

10 East 40th Street

New York, New York 10016

(212) 679-3760

Attorney for Petitioner

Of Counsel:

Ratpo WIeENSHIENK

Howarp N. Goupen

Bernarp RoTHMAN

Marc Owen ManpeEL

Appendices

APPENDIX A

OPINION OF UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

UNITED STATES COURT OF APPEALS

For tHe Seconp Crovitr

eo wn

Nos. 897-904—September Term, 1976.

(Argued May 11, 1977 Decided August 24, 1977.)

Docket Nos. 76-7476, 76-7486, 76-7488, 76-7489,

76-7494, 76-7495, 76-7499, 76-7500

-_—_ =

NewsurcerR, Loes & Co., Inc. as Assignee of

Claims of David Buckley and Mary Buckley,

Plaintiff-A ppellant-Cross-A ppellee,

—Vv.—

Cuartes Gross, Mase, Buieicu, Gross & Co.,

and JEANNE DonoGHUE,

Defendants-A ppellees-Cross-Appellants,

Newsurcer, Loes & Co., a New York Limited Partnership,

Anprew M. Newsurcer, Ropert L. Newsurcer, Ricz-

arp D. Stern, Waurer D. Srern, and Rosert L. Stern

as Executors of the Estate of Leo Stern, Roserr L.

Stern, Ricuarp D. Srern, Joun F. Setrrer, Harow J.

Ricuarps, Saxnrorp Roccensurc, Harry B. Frank and

Jerome Tarnorr as Executors of the Estate of Ned D.

Frank, Frep Kayne, Rosert Mun, Pavu RisHer,

Cuarves Sioane, Rosert S. Persxy, Fintey, Kuma xe,

Wacner, Heine, Unperserc & Grutman, a Partnership

(formerly known as Finley, Kumble, Underberg, Per-

5453

Opinion of U.S. Court of Appeals

sky & Roth and Finley, Kumble, Heine, Underberg &

Grutman) and Lawrence J. Berxkowirz,

Additional Defendants on Counterclaims-

Appellants-Cross-Appellees.

-wwn

Before:

Lumsarp and Mesxuu, Circuit Judges,

and Jameson, District Judge.*

-—_ =

™

Cross appeals from a judgment of the Southern District,

Owen, Judge, which dismissed plaintiff’s churning claim

under section 10(b) of the Securities Exchange Act of

1934, 15 U.S.C. § 78j(b), awarded judgment on certain of

defendants’ counterclaims for civil conspiracy, violation

of state partnership law, breach of fiduciary obligation,

and conversion, and which dismissed the remaining state

and federal counterclaims of the plaintiff, defendants, and

additional defendants on the counterclaims.

Affirmed in part; reversed and remanded in part.

-—_ ==

Dowatp H. Saw, New York, N.Y. (Kantor,

Shaw & Davidoff, P.C., New York, N.Y.,

on the brief), for Plaintiff-A ppellant-Cross-

Appellee, Newburger, Loeb & Co., Inc.

Purim Manpet, New York, N.Y. (Golden, Wien-

shienk & Mandel, Ralph Wienshienk, Ber-

nard Rothman, Mare Owen Mandel and

Arthur Tarlow, New York, N.Y., on the

brief), for Defendants-A ppellees-Cross-Ap-

pellants.

° Sitting by designation.

5454

Tae]

Opinion of U.S. Court of Appeals

Simon H. Rirxinp, New York, N.Y. (Paul,

Weiss, Rifkind, Wharton & Garrison, New

York, N.Y.; Finley, Kumble, Wagner, Heine

& Underberg, New York, N.Y.; Mark H.

Alcott, John M. Delehanty, Beryl A. Schatz,

and Alan M. Gelb, on the brief), for Addi-

tional Defendant on Counterclaims-Appel-

lant-Cross-Appellee Finley, Kumbel, Wag-

ner, Heine, Underberg & Grutman.

Paut D. Risner, New York, N.Y., for Addi-

tional Defendant on Counterclaims-A ppel-

lant-Cross-Appellee Pro Se.

Leon B. Borstrerx, New York, N.Y. (Shaw and

Stedina, New York, N.Y., on the brief),

for Additional Defendant on Counterclaims-

A ppellant-Cross-Appellee Robert Muh.

Martin E. Smren, Goip, Farrenn & Marks,

THomas R. Farrevt and Leonarp M. Marks,

New York, N.Y., on the brief, for Addi-

tional Defendant on Counterclaims-A ppel-

lant-Cross-Appellee Fred K ayne,

Osmonp K. Fraenxet, New York, N.Y., for

Additional Defendants on Counterclaims-

Appellants -Cross- Appellees Newburger,

Loeb € Co., Andrew M. Newburger, Rob-

ert L. Newburger, Robert L. Stern, Richard

D. Stern, Walter D. Stern and Robert L.

Stern, as Executors Under the Last Will

and Testament of Leo Stern, Deceased;

and Sanford Roggenburg.

Lawrence J. Berkowitz, New York, N.Y., on

the brief, for Additional Defendant on

Counterclaims-Cross-Appellee Pro Se.

5455

Opinion of U.S. Court of Appeals

Evaine Piatt and Leon B. Borsterx, New York,

N.Y., on the brief, for Additional Defendant

on Counterclaims-Appellant-Cross-Appellee

Charles Sloane.

Rosert S. Persxy, New York, N.Y., on the brief,

for Additional Defendant on Counterclaims-

A ppellant-Cross-Appellee Pro Se.

LumBarp, Circuit Judge:

These appeals and cross appeals from a judgment of the

Southern District, Owen, Judge, are the latest chapter in

the financial misfortunes of New York brokerage firm of

Newburger, Loeb & Co. (hereinafter the “Partnership’’)

and its successor, Newburger, Loeb & Co., Inc. (hereinafter

the “Corporation”) during the years 1969-71, which re-

sulted in the departure of the managing partner, Charles

Gross, and the arrangements made by the survivors and

others to reorganize and rescue the business.

We affirm so much of the judgment of the district court

which:

(1) Dismissed, as lacking in merit, the Corporation’s

churning claim, under section 10(b) of the Securities Ex-

change Act of 1934, 15 U.S.C. § 78j(b), against defendants

Charles Gross, Mabel Bleich, Jeanne Donoghue, and Gross

& Co.

(2) Awarded judgment to the defendants on their first,

second and fourth counterclaims against the Corporation,

and against the Partnership, individual members of the

Partnership,’ the promoters of the Corporation,? and

1 Andrew M. Newhurger, Robert L. Newburger, Leo Stern, Robert L.

Stern, Richard D. Stern, Harold J. Richards, Sanford Roggenburg, John

F. Settel, and Ned D. Frank.

2 Fred Kayne, Paul Risher, Robert Muh, Charles Sloane and Lawrence

Berkowitz were alleged by the defendants and found by the court to be

5456

Opinion of U.S. Court of Appeals

Robert S. Persky and his law firm, Finley, Kumble, Under-

berg, Persky & Roth (which at the time of judgment was

known as Finley, Kumble, Wagner, Heine, Underberg &

Grutman), who were brought in as additional defendants

on the counterclaims, for conspiracy to injure the defen-

dants with respect to their interests in the Partnership.

We hold that the district court properly exercised its

ancillary jurisdiction over these counterclaims.

(3) Dismissed, as lacking in merit, defendants’ ninth

counterclaim under the federal antitrust laws for destruc-

tion of Gross’ employment opportunity with Rafkind & Co.,

a New York brokerage firm.

(4) Dismissed defendants’ fifth, sixth, seventh and

eighth counterclaims for lack of subject matter jurisdiction.

(5) Dismissed the six counterclaims of the Corporation

and the additional defendants against Gross.

We reverse those parts of the judgment which:

(1) Awarded judgment to Gross on defendants’ third

counterclaim for conversion of Gross’ interest in warrants

to buy stock of Geon Industries, Inc., and Computer Soft-

wear Systems, Inc.

We hold that Judge Owen erroneously exercised jurisdic-

tion over this claim after Judge Ward correctly held that

it was not within the ancillary jurisdiction of the court.

(2) Awarded $50,000 punitive damages to Gross.

the promoters. The court dismissed defendants’ first, second and fourth

counterclaims against Berkowitz on the ground that there was not suff-

cient proof of his participation in the conspiracy. As the defendants

bave failed to provide any substantial argument why the district court's

findings of fact regarding Berkowitz are erroneous, we affirm the dis-

missal of these claims against Berkowitz.

The case against Alex Aixala was dismissed at the close of defendants’

proof and defendants have not argued that this was error.

5457

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Opinion of U.S. Court of Appeals

Finally, although we affirm the finding of liability on

defendants’ first, second and fourth counterclaims, we re-

mand these counterclaims for recomputation of damages in

light of our reversal of defendants’ third counterclaim and

certain difficulties with the court’s computation of damages.

To further discussion of the issues, we summarize the

underlying facts. The partnership was an established Wall

Street brokerage firm. From about May 1959 through De-

cember 31, 1968 it acted as a clearing house for the partner-

ship of Gross & Co., which consisted in part of Charles

Gross, his sister, Jeanne Donoghue, his secretary, Mabel

Bleich, and Charles Jordon; thus, the Partnership exe-

cuted orders for Gross & Co. and sent confirmations and

statements to its customers. Among these customers were

David and Mary Buckley, who had an active account with

Gross & Co. in 1962-66.

In 1969 Gross & Co. liquidated and on January 1, 1969,

Gross became a general partner in the Partnership with

an initial investment of about $400,000. Bleich and Dono-

ghue became limited partners, investing about $75,000 each.

Gross soon thereafter became managing partner of the

Partnership and invested another $400,000 in the firm. The

Partnership began to experience the record-keeping prob-

lems common on Wall Street in late 1969 and early 1970

caused by the greatly increased volume of transactions in

the 1960’s, which have come to be known as the “back office

crunch,” see, e.g., Hirsch v. du Pont, No. 76-7428, slip op.

2747 (2d Cir. April 7, 1977). By the summer of 1970 the

firm was experiencing serious capital problems. A number

of the partners expressed dissatisfaction with Gross’ man-

agement, and he stepped down as managing partner. As

he was not satisfied with the proposed new management,

Gross gave notice of his withdrawal from the firm on

August 31, 1970, which under the terms of the partnership

5458

Opinion of U.S. Court of Appeals

agreement became effective as of September 30, 1970.

Gross also demanded the return of his “additional capital”

(claimed to be $400,000) and fifteen per cent of his “com-

mitted capital,” pursuant to the partnership agreement.

The agreement provided that at least eighty-five per cent

of the “partnership interest” of a withdrawn general part-

ner remained in the firm, at the risk of the business, for

twelve months from the effective date of withdrawal. On

December 31, 1970, Bleich and Donoghue submitted notices

of withdrawal from the firm.

Fred Kayne became managing partner after Gross

stepped down. Before joining the Partnership Kayne and

Charles Sloane had been employed as registered represen-

tatives of the firm at its California office. According to

Kayne and Sloane, they were induced by Gross to join the

firm and became general partners in late February, 1970,

each investing $50,000. In the summer of 1970, after be-

coming managing partner, Kayne brought in Robert Muh

and Paul Risher as consultants. At about this time, the

law firm of Finley, Kumble, Underberg, Persky & Roth

began to handle legal matters for the Partnership, with

Robert S. Persky as the partner in charge.

Defendants allege that shortly after Kayne became man-

aging partner he began to plot with Muh, Risher, Sloane,

Lawrence J. Berkowitz (house counsel to the Partnership),

and Persky to transform the Partnership into a corpora-

tion and to gain control of its assets for a small investment.

According to the testimony of Gross, early in September,

1970, he met with Persky and Kayne who attempted to

persuade him not to withdraw from the Partnership and

who told him that he would “be sorry” if he did not co-

operate.

The fortunes of the Partnership continued to dwindle,

however, and in November, 1970, both Kayne and Sloane

5459

Opinion of U.S. Court of Appeals

withdrew. On November 17, 1970, the New York Stock Ex-

change notified the firm that if it was not in compliance

with the “required excess capital” provision of the Ex-

change constitution by November 20, steps would be taken

to suspend the firm. The Partnership was also directed to

prepare for possible liquidation.

Under continuing pressure from the Exchange, a re-

organization was proposed by Risher and Muh as an al-

ternative to the Partnership’s liquidation. The assets of

the Partnership were to be transferred to a corporation;

in return, the general and limited partners and the subor-

dinated lenders were to receive a variety of securities in

accordance with their capital positions. The corporation’s

promoters were Berkowitz, Kayne, Muh, Risher and Sloane.

See note 2, supra. In return for investments of $10,000

each, Kayne, Risher, and Muh would each receive sixteen

per cent of the common stock. Kayne and Sloane were to

participate in management along with Risher and Muh. An

infusion of fresh capital was to come from Alex Aixala

(in the form of $1,000,000 worth of Bacardi stock), an in-

vestor brought in by Persky.

After numerous negotiations, Gross, Bleich and Dono-

ghue refused to consent to the proposed transfer of assets;

apparently, Gross felt the proposed transfer was a plot by

the promoters to gain contro] of the Partnership assets

for a small investment. The Corporation and the additional

defendants contend, on the other hand, that Gross had no

legal right to object to the reorganization and was merely

attempting to gain a special benefit for himself by demand-

ing a cash return of part of his investment. Although it

appears that the promoters did not believe that Gross’

consent (as a withdrawn general partner) was necessary

to the reorganization, Gross contends they wished to dis-

suade him from withdrawing his capital. In any event,

5460

Opinion of U.S. Court of Appeals

Bleich and Donoghue would not consent to the transfer

without Gross’ approval, and the promoters believed that

the transfer could not be legally completed under New

York law without the consent of Bleich and Donoghue (who

were withdrawn limited partners).

According to the defendants, numerous attempts were

made to “persuade” the defendants (particularly Gross)

to consent to the transfer. The principal coercive tactic

was the threat to tie up the defendants in lengthy litiga-

tion, including (1) the threat to bring suit on a claim of

churning the account of David and Mary Buckley, and (2)

the threat to sue Gross for fraudulently inducing Kayne

and Sloane to join the Partnership and for mismanaging

the Partnership’s assets.

David and Mary Buckley maintained an account with

Gross & Co. from April, 1962, throngh August, 1966, which

was handled by Charles Jordon. Although the account was

extremely active, by August, 1966, it showed a deficit of

$332,000, which was owed to the Partnership as the clear-

ing house. Between 1966 and 1970 unsuccessful efforts

were made to collect the amounts owing. The Buckleys

threatened bankruptcy if the collection efforts were pressed.

In 1970 the Partnership commenced an arbitration pro-

ceeding under the rules of the Exchange. The Buckleys

asserted one set-off and two counterclaims against the

Partnership. The first counterclaim alleged that their ac-

count had been churned by Gross & Co. during the years

1962-66, for which the Buckleys claimed $75,000 in damages.

Richard Miles, director of compliance for the Partnership

in 1969-70, testified that the Buckley account was referred

to him in 1970 by Leo Stern, a general partner. Miles con-

cluded that the churning claim was without merit and was

asserted as a bargaining tool. Miles testified that he com-

municated this evaluation to Robert Stern, the general

partner to whom Miles reported, who agreed with this

5461

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Opinion of U.S. Court of Appeals

evaluation. According to Persky’s testimony, the collec-

tion file was turned over to him in November or December

of 1970. On December 30, 1970, the Partnership’s $332,000

claim against the Buckleys was settled; the Buckleys

agreed to pay the Partnership $50,000 and assign to it the

churning claim against Gross & Co. in exchange for a re-

lease.

Risher testified that after the settlement Persky called

him and stated that he thought it was a “guod idea” to get

the assignment of the churning claim. Persky stated in his

deposition that the idea of obtaining the Buckley claim

originated with him, that before and after the settlement

there were discussions as to how the claim might be used

in negotiations with Gross, and that he believed the churn-

ing claim might bring home to Gross “the reality of the

situation.” Despite the fact that there is no evidence that

the Buckleys ever dealt with Charles Gross personally, the

complaint in this case, which was prepared by Persky,

alleged that Cross was the customer’s man with whom the

Buckleys dealt;* further, as the district court found, when

this error was pointed out to Finley, Kumble, no attempt

was made to correct it or to add Charles Jordon as a party.

The amount of damages claimed by the Corporation was

¢250,000—more than three times the amount claimed by

the Buckleys.

3 At a general meeting of the limited partners, general partners and

subordinated lenders, held early in February, 1971, prior to the transfer,

Persky circulated a complaint prepared for the Partnership similar to the

Corporation's complaint in this case. It contained the same factual errors

concerning Gross’ dealings with the Buckleys. Defendants allege that the

complaint was circulated to convince the limited partners and sub-

ordinated lenders that there were valid claims outstanding against Gross,

Bleich and Donoghue, which could be used to prevent them from witb-

drawing their capital. Persky admitted at trial that the limited partners

and subordinated lenders would not have allowed the transfer to take

place if Gross, Bleich, and Donoghue's demands for immediate payment

of their capita) contributions bad been met.

5462

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Opinion of U.S. Court of Appeals

Gross testified that at a meeting on January 15, 1971,

attended by Risher, Muh, and Persky, be was told by Per-

sky that he should go along with the proposed transfer

and convince Bleich and Donoghue to consent. Persky

told Gross that there were many claims that could be used

against him if they “stood in the way of the deal,” includ-

ing the Buckley claim and allegations of malfeasance and

it was in Gross’ interest “not to be tied up in litigation

for a long, long time, and to be free to work in the street.”

Persky told Gross to take the Buckley claim “very, very

seriously.” Gross refused to bend. He told Persky, Risher

and Muh that they could keep their claims and that he

thought the fairest solution was for the Partnership to

liquidate. Shortly after this meeting concluded, Gross re-

ceived a call from Kayne and Sloane in California. Sloane

was extremely angry and told Gross that they had heard

what had happened at the meeting and that, “If you kill

this deal, we are going to sue you. You will be sued for

a long time. You may never get out of the courts.”

Similarly, on January 23, 1971, Kayne called Gross and

arranged to meet him for lunch. Gross testified that at

this meeting Kayne threatened him with litigation in Cali-

fornia if he did not consent to the transfer. The district

court credited Gross’ version of these meetings. In addi-

tion to finding that various threats had been made against

Gross, the court found, based on the testimony of Bleich,

that Risher threatened Bleich with the Buckley claim to a

point that made her cry.

On February 3, 1971, eight days prior to the date set

for the proposed transfer of assets, Kayne and Sloane

sued Gross in the District Court for the Central District

of California, charging that Gross had fraudulently in-

duced them to join the Partnership and had mismanaged

its assets. Eventually, this suit was dismissed after a.

5463

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Opinion of U.S. Court of Appeals

NYSE arbitration, which found in favor of Gross. The

present suit was commenced by the Corporation on Feb-

ruary 17, 1971.

Gross also claimed that an additional tactic used to coerce

his consent was the destruction of a job opportunity. The

Partnership articles, which were effective for a period of

two years, provided that any general partner who volun-

tarily withdrew from the Partnership (as did Gross) could

not “engage in the business of broker or dealer in secur-

ities and commodities whether for his own account or for

others” until the expiration of the partnership agreement

on December 31, 1971. After Gross left the Partnership,

he was offered a job opportunity as a trader by Rafkind

& Co. On January 19, 1971, Rafkind wrote the Partner-

ship requesting clearance to employ Gross. Gross alleges

that Berkowitz threatened Rafkind with suit, and in any

case, Berkowitz sent a letter to Rafkind informing it of

the Partnership covenant not to compete; the letter also

indicated that the Exchange had been notified that Gross

was subject to the restrictive covenant. Rafkind then

dropped the job offer and so informed the Partnership.

Gross claims that at a meeting on February 5, 1971, he

was told by Risher that if an “accommodation” could be

reached, he could have his job with Rafkind. However,

despite these and other coercive tactics alleged by the

defendants, Gross, Bleich and Donoghue refused to con-

sent to the transfer.

The closing date for the transfer of assets froin the

Partnership to the Corporation had been set for February

11, 1971. The Exchange had advised the Partnership that

if the required improvements in its capital position were

not made, the Partnership would be suspended on Feb-

ruary 12, 1971. The record indicates that at the January

15, 1971, meeting, attended by Persky, Risher and Muh,

0464

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Opinion of U.S. Court cf Appeals

counsel for the defendants Philip Mandel, stated that the

transfer could not legally take place without the consent

of Gross, Bleich and Donoghue.

A condition precedent to the Corporation’s obligation

to execute the transfer agreement was the issuance of a

letter of opinion from counsel to the Partnership, stating

that the Partnership had the authority to make the trans-

fer. Paul Burak, whose firm, Rosenman, Colin, Kaye, Pets-

chek, Freund & Emil, had been retained to represent the

Partnership, testified that a member of his firm researched

the issue gnd concluded in a memorandum dated January

25, 1971, that under New York Partnership Law § 98, the

transfer could not take place without the consent of all of

the limited partners. Section 98(1)(b) provides, inter alia,

that without the consent of all limited partners, a general

partner or all of the general partners have no authority

to “[d]o any act which would make it impossible to carry

on the ordinary business of the partnership.” Burak con-

veyed his firm’s position, that the transfer could not be

conducted without the consent of all of the limited part-

ners, to the Partnership; specifically, he testified that he

discussed the matter with Andrew Newburger. Burak also

conferred with Persky, who unsuccessfully attempted to

persuade Rosenman, Colin to give a favorable opinion.

On the day of the closing, Rosenman, Colin refused to

issue the letter of opinion. However, Persky, whose firm

now represented the Corporation, stated that his firm had

done some research in the area and it was agreed that

Persky would issue the opinion letter as special counsel

to the Partnership. The letter was issued, examined by

counsel for the parties, and the deal was closed.

Under the transfer agreement the Corporation agreed

to assume all liability for the claims of Gross, Bleich and

Donoghue arising out of the transfer. The Corporation

5465

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Opinion of U.S. Court of Appeals

set up a reserve fund of $300,000 for this purpose.t How-

ever, no payments were or have been made to Gross, Bleich

or Donoghue.

On February 17, 1971, the Corporation commenced this

action as an assignee of the Buckley claim. The complaint

stated that the Buckleys had assigned their claims to the

Partnership and that the Partnership had assigned these

claims to the Corporation on February 11, 1971. Although

the complaint states five “causes of action,” essentially it

alleges that Gross, Bleich and Gross & Co. were liable for

the churning of the Buckleys’ account under the federal

securities law and state common law and that plaintiff was

entitled to attorney’s fees. In their amended answer, which

was joined in by Donoghue,’ defendants raised nine coun-

terclaims against the Corporation, the members of the

Partnership who participated in the transfer, the promoters

of the Corporation, Robert S. Persky and his former law

firm, Finley, Kumble.‘

The defendants’ nine counterclaims allege, in relevant

part, the following:

First counterclaim (and second defense): the transfer

agreement (which includes the assignment of the Buckley

4 While the Corporation stayed solvent for over two years after the

transfer, it appears the reorganization merely delayed the inevitable.

In November, 1973, the Corporation filed a petition in bankruptey under

Chapter XI, where, the litigants have informed us, it remains to date.

5 Although Donoghue was not named as a defendant in the original

complaint, sbe was later officially granted leave to intervene by Judge

Owen, apparently both as a defendant to the Buckley claim and as a

plaintiff on the counterclaims. See Newburger, Loeb & Co., Inc. v. Gross,

62 F.R.D. 397 (S.D.N.Y. 1974).

6 Finley, Kumble and Persky were not named as additional defendants

in the defendants’ original answer, filed on May 3, 1971. They were

brought in by the amended answer, filed on February 28, 1972. Defen-

dants explain that it was not until extensive discovery was had that

they discerned Persky's rvle in the conspiracy.

5466

A15

Opinion of U.S. Court of Appeals

claim to the Corporation) is ineffective because it was exe-

cuted in violation of section 98 of New York Partnership

Law; defendants demand the transfer be set aside and

the counterclaim defendants be held liable for damages.

Second counterclaim (and fifth defense): the settlement

of the Buckley claim and its subsequent assignment to the

Corporation was undertaken in bad faith in violation of the

Partnership’s fiduciary obligations to the defendants as a

means of resisting payment of the defendants’ capital in-

terests in the Partnership; further, defendants allege that

the transfer of the Partnership assets was itself a breach

of fiduciary obligation. Defendants demand an accounting

and the imposition of a constructive trust.

Third counterclaim: the counterclaim defendants con-

verted certain stock warrants, which were the property of

Gross, when these warrants were transferred to the Corpo-

ration as part of the Partnership’s assets.

Fourth counterclaim: all of the counterclaim defendants

engaged in a conspiracy to force the defendants to consent

to the transfer agreement, which included manipulating

the assignment of the Buckley claim and threatening the

defendants with litigation.

Fifth and sixth counterclaims: pursuant to the Partner-

ship agreement, Bleich and Donoghue are entitled to the

return of their capital investments.

Seventh counterclaim: pursuant to the Partnership

agreement, Gross is entitled to an accounting to determine

his capital interest.

Eighth counterclaim: the counterclaim defendants “ma-

liciously” blocked Gross’ employment with Rafkind & Co.

by informing it that his employment would violate the

Partnership agreement.

5467

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Opinion of U.S. Court of Appeals

Ninth counterclaim: the destruction of the Rafkind op-

portunity violates the federal antitrust laws; Gross de-

mands treble damages.’

Prior to trial, the Corporation and the additional defen-

dants moved to dismiss defendants’ state law counterclaims

for lack of subject matter jurisdiction. The parties also

made cross motions for summary judgment.

Judge Ward in his opinion of October 16, 1973, first held

that the defendants’ first and second state law counter-

claims were so closely linked to defenses to plaintiff’s

churning claims “that they must be considered ‘logically

related to the claim the opposing party is suing on,’”

quoting C. Wright, Law of Federal Courts 346 (2d ed.

1970), and, thus, were compulsory counterclaims within

the court’s ancillary jurisdiction. The court found that the

fourth counterclaim asserted the same allegedly wrongful

acts and should also be treated as a compulsory counter-

claim. Newburger, Loeb & Co., Inc. v. Gross, 365 F. Supp.

1364, 1367 (S.D.N.Y. 1973). However, the court found

that defendants’ third, fifth, sixth, seventh and eighth

counterclaims were not “logically related” to the Corpora-

tion’s claims and thus were not compulsory counterclaims;

there being no independent jurisdictional basis for these

state law claims, the court held they could be maintained

only as a set-off to defeat or reduce any recovery on the

7 Although the ninth counterclaim refers to numerous allegations as the

hasis for charging violation of the antitrust laws, the defendants’ brief

on appeal confines itself to the argument that the circumstances sur-

rounding the alleged destruction of the Rafkind opportunity violated

the antitrust laws.

8 It appears that neither the Corporation nor any of the additional

defendants made an attempt to pursue an interlocutory appeal from

Judge Ward's finding of jurisdiction over these counterclaims by seeking

certification pursuant to 28 U.S.C. $1292(b).

5468

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Opinion of U.S. Court of Appeals

Corporation’s claims.’ See United States v. Heyward-Rob-

i som Company, 430 F.2d 1077, 1081, n.1 (2d Cir. 1970),

cert. denied, 400 U.S. 1021 (1971).

Turning to defendants’ motion for summary judgment,

Judge Ward found that the transfer of the Partnership

assets to the Corporation without the consent of Bleich

and Donoghue violated section 98(1)(b) of New York

Partnership Law.’® However, since the only interest of

Gross, Bleich and Donoghue in the Partnership was the

right to be paid a certain sum of money, the court found

that damages were an adequate remedy and, thus, that

rescission would be inappropriate. 365 F. Supp. at 1370.

Determination of the amount of damages was left for trial.

Judge Ward also concluded that the Corporation’s

churning claim presented triable issues and that under

New York law, the Partnership was not prohibited from

taking the assignment of the Buckley claim “if such an

assignment is taken in good faith and does not breach the

fiduciary duty owed to the partners being sued. The issue

is that of the good faith of the Partnership and of Persky,

the attorney representing it.”” 365 F. Supp. at 1370. Since

the issue of good faith presented a question of fact, Judge

Ward denied summary judgment on this issue.

9 Defendants’ ninth counterclaim, of course, rested upon an independent

jurisdictional basis. Though Judge Ward found the claim “skeletal,”

it was held sufficient to withstand a motion to dismiss for failure to

state a claim. 365 F. Supp. at 1367-68.

10 As noted, supra, $98(1)(b) provides that general partners may not,

without the consent of all of the limited partners, “[d]o any act which

would make it impossible to carry on the ordinary business of the part-

nership.” Although Bleich and Donoghue bad withdrawn from the Part-

nership on December 31, 1971], prior to the transfer, as the district court

noted, under the Partnership articles they retained their status as

limited partvers for six months thereafter. Accordingly, the district

court found that under §98, their consent to the February 11, 1971,

transfer was required.

3469

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Opinion of U.S. Court of Appeals

On January 16, 1974, the Corporation and the addi-

tional defendants added six counterclaims against Gross,

which alleged that he had committed various acts of mis-

management as managing partner.

Trial commenced before Judge Owen on June 16, 1975,

and concluded on August 1, 1975. In his July 7, 1976

opinion, Judge Owen dismissed the Corporation’s first,

second, fourth and fifth claims, based on the alleged churn-

ing of the Buckley account.’ Although he noted that there

were a large number of transactions in the account, he

found that they were motivated by David Buckley’s desire

to make a fortune in the market by speculation. The court

found that Buckley was an experienced investor, that the

account was non-discretionary and that Buckley had to

and did authorize every transaction, and concluded that

there was “no question that the churning claim has not

been proved.”

Turning next to defendants’ counterclaims, the court

held that the promoters (except Berkowitz) as officers of

the Corporation, guided by Persky, and the members of the

Partnership had engaged in a conspiracy “to injure Gross,

Bleich and Donoghue in their interests in the Partnership.”

Specifically, the court found that the injury to the defen-

dants was part of a plot instituted by Kayne, Risher,

Sloane, Muh, and Persky, “to take over the new opera-

tion on a shoestring and directly enrich themselves.”

Judge Owen found that “in major measure” the consent

of the general partners was obtained by arranging a “for-

giveness” of some $500,000 of capital arrears owed to the

Partnership by various partners. Gross, who owed no

11 The Corporation's third cause of action, which alleged that the churn-

ing of the Buckley account violated section 15(c)(1) of the Securities

Exchange Act of 1934, 15 U.S.C. §780(c)(1), and Rule 15C-1(7) pro-

mulgated thereunder, had previously been dismissed by Judge Ward as

time-barred. 365 F. Supp. at 1371-72. The Corporation has not appealed

the dismissal of this claim.

5470

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Opinion of U.S. Court of Appeals

capital arrears and had invested some $800,000 in the firm,

specifically objected to the forgiveness in refusing to go

along with the transfer.

The court found that another “problem” faced by the

promoters was to minimize any outflow of cash to Gross,

Donoghue and Bleich. It was determined that the way to

deal with Gross was to threaten him with prospective or

actual litigation, which would either coerce his consent or

provide a basis for refusing to pay him his capital in-

terest. Thus, Persky manipulated the Buckley settlement,

Kayne and Sloane instituted a $3,600,000 fraud suit in

California (the court found the damages were an in ter-

rorem figure), and Ned Frank (a general partner) pre-

pared a list of alleged instances of malfeasance by Gross,

six of which were asserted as counterclaims against Gross

in this litigation. A further lever used against Gross was

the denial of the Rafkind opportunity. Judge Owen found

that the “direct and circumstantial proof is quite clear that

all the foregoing was participated in by all [of the pro-

moters, except Berkowitz,] acting out of the single mo-

tive to force Gross into accepting [their] dictates.” Fur-

ther, the court found that when the threats failed, the pro-

moters decided to proceed with the transfer “in knowing

violation of Section 98,” and “based upon Persky’s worth-

less opinion letter.” The court found that Persky, Risher,

Muh, Kayne and Sloane “were actively participating, know-

ing what each was doing and hoping to reap substantial

benefits from this joint conduct.”

As for the general partners, the court found that, mo-

tivated by the promise of debt forgiveness and the desire

to salvage their interests in the firm, they “lent themselves

to the goals of this conspiracy by affirmatively perwi‘ting

the Partnership to transfer its assets to the Corporation

in violation of Section 98 of the Partnership Law and in

violation of their fiduciary duties to Gross, Bleich and

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Opinion of U.S. Court of Appeals

Donoghue as other partners, and by their knowing ac-

quiescence in the use by the [promoters] of the various

baseless litigation threats against Gross.” Accordingly, the

court held the Corporation and the additional defendants

on the counterclaims” jointly and severally liable on de-

fendants’ first, second, and fourth counterclaims for the

“wrongful conversion” of the capital of Gross, Bleich and

Donoghue. The court awarded Donoghue and Bleich each

$76,868, and awarded Gross $337,921."*

Judge Owen also found for Gross on defendants’ third

counterclaim, which Judge Ward had held could be as-

serted only as a set-off. This claim alleged that in 1970 the

Partnership had distributed to the partners as profits an

interest in certain stock warrants, which the record indi-

cates were earned by the Partnership in 1969. These war-

rants were never physically distributed but were held in

the Partnership’s name and were transferred to the Cor-

poration as part of the Partnership’s assets. The court

found that Gross did own an interest in the warrants and

that the Corporation, Kayne, Risher, Persky and Finley,

Kumble were liable in the sum of $58,368 and $75,803 for

the willful conversion of Gross’ interest in the warrants."

Although Judge Owen noted that Judge Ward had ruled

that the third counterclaim could only be asserted as a set-

12 As noted, the court disinissed the counterclaims as to Berkowitz and

Aixala, see text and notes at 1-2, supra, and as used here the terms

“additional defendants” do not apply to them.

13 The sum of $76,868 represented the initial capital investments of

Bleich and Donoghue of $75,000, plus $1,868 owing as interest as of

December 31, 1970. The court found an accounting would have shown

Gross’ capital interest on February J], 1971, to be $337,921.

14 The court found that Kayne, Risher and Iersky had conspired to

“purloin” avd had accomplisbed the purloining of the securities by

placing them in a secret vault to ensure they would be transferred to

the Corporation. Since we dismiss the third counterclaim on jurisdic.

tional grounds, we need not examine the merits of these findings.

472

A21

Opinion of U.S. Court of Appeals

off, he held that this claim had been fully litigated and

ordered that the pleadings be amended to conform to the

proof.

Further, Judge Owen awarded Gross $50,000 in punitive

damages against the Corporation, Kayne, Risher, Persky

and Finley, Kumble."* Although he indicated that the non-

competition clause in the Partnership articles had been

asserted against Gross without “economic justification,” he

found that the Partnership “had the legal right to assert”

the clause. Judge Owen concluded that the alleged destruc-

tion of the Rafkind opportunity did not state a cause of

action and dismissed the defendants’ ninth (antitrust)

counterclaim. Finally, as for the six counterclaims as-

serted against Gross, four were abandoned at trial and

Judge Owen dismissed the remaining two claims on the

merits.’* Final judgment was entered on September 1, 1976.

The Corporation appeals from the dismissal of its churn-

ing claims. Defendants appeal from the dismissal of their

fifth, sixth, seventh, eighth and ninth counterclaims. The

Corporation and most of the additional defendants on the

counterclaims appeal from the judgments entered against

15 Muh and Sloane were listed among those parties held liable for con-

version of the warrants and for punitive damages in the final judgment

entered on September 1, 1976. However, in an order filed on November

18, 1976, Judge Owen stated that Sloane and Muh had heen added to

that part of the judgment dealing with damages for conversion of the

warrants and punitive damages by inadvertence and ordered their names

deleted therefrom. See Fed. R. App. P. 10(e).

16 Although at one point the Corporation suggests that the court erred

in dismissing the claim that Gross engaged im “secret trading” while

managing partner, it concedes that the court's decision was not “plainly

erroneous’—apparently in reference to Fed. R. Civ. P. 52(a). Neither

the Corporation nor any of the additional defendants have stated any

basis for disturbing the dismissal of their counterclaims against Gross;

accordingly, this portion of the district court's opinion is affirmed.

5473

A22

Opinion of U.S. Court of Appeals

them on defendants’ first, second, third’’ and fourth coun-

terclaims and for punitive damages.”

I. The Churning Claim

The Corporation argues that Judge Owen’s finding that

the Buckley account was not churned is clearly erroneous.

“Churning” occurs when a securities dealer abuses his

customer’s confidence for personal gain (e.g. to create com-

missions) by inducing transactions in the customer’s ac-

count which are disproportionate to the size and character

of the account. Churning has been held to be a deceptive

device within §10(b) of the Securities Exchange Act of

1934 and Rule 10b-5, for which a private cause of action

for damages will lie. See, e.g., Ruskay v. Waddell, 552 F.2d

392, 393 n.2 (2d Cir. 1977); Carras v. Burns, 516 F.2d 251,

258 (4th Cir. 1975); Landry v. Hemphill, Noyes & Co., 473

F.2d 365, 368 n.1 (1st Cir.), cert. denied, 414 U.S. 1002

(1973) ; Hecht v. Harris, Upham € Co., 430 F.2d 1202, 1206-

07 (9th Cir. 1970); Powers v. Francis I. DuPont & Com-

pany, 344 F. Supp. 429, 431 (E.D. Pa. 1972); Moscarell v.

17 In the final judgment entered by Judge Owen on September 1, 1976,

he found for Gross on the claim of conversion of the stock warrants

but actually dismissed the third counterclaim for lack of jurisdiction.

Apparently, Judge Owen found that the claim of conversion of the

warrants was included in the second counterclaim; thus, in his opinion

of July 7, 1976, Judge Owen stated that this claim was “arguably

pleaded” in the second counterclaim. Since we have found that the

court lacked jurisdiction over the claim, it makes little difference whether

it is denominated the third counterclaim or part of the second counter-

claim. We have used the term “third counterclaim” for purposes of

clarity.

18 Three of the additional defendants on the counterclaims—John F.

Settel, Harold J. Richards, and the estate of Ned D. Frank—who were

held jointly and severally liable to Gross, Donoghue and Bleich for their

capital interescs in the Partnership, bave not filed notices of appeal or

participated in this appeal. Accordingly, the judgment of the district

court insofar as it relates to these additional defendants is not before

this court, see 28 USC $1291; Fed. R. App. P. 3, 4.

5474

A23

Opinion of U.S. Court of Appeals

Stamm, 288 F. Supp. 453, 457 (E.D.N.Y. 1968) ; see gener-

ally Note, Churning by Securities Dealers, 80 Harv. L. Rev.

869 (1967). In order to recover, the customer must show

that the dealer effectively exercised control over trading

in the account and manipulated the account to his benefit.

Where, as here, the account is non-discretionary (i.e., the

dealer may not make trades in the account without the

customer’s authorization), the plaintiff must show that he

relied extensively on his broker’s advice and that the

broker abused the plaintiff’s trust. Thus, if a customer is

fully able to evaluate his broker’s advice and agrees with

the broker’s suggestions, the customer retains control of

the account. See Carras v. Burns, supra, 516 F.2d at 258-59.

In essence, the Corporation contends that the Buckley

account was excessively traded by Jordon in order to gen-

erate commissions and that, at least on one occasion, Jor-

don gave Buckley false information. The short answer to

this contention, however, is that the evidence in this area

was conflicting and Judge Owen’s conclusion is amply sup-

ported by the record.

It is evident from David Buckley’s testimony that he is

an intelligent, well-educated man with a Bachelor’s Degree

from Cornell University, where he majored in Economics,

and a post-graduate degree in International Marketing.

When Buckley opened his account with Gross & Co. he was

thirty-one years old and had prior experience in the mar-

ket. He testified that he spent over $100 per month on

investment advisory services, in addition to subscribing

to various financial journals. Buckley frequently communi-

cated with Jordon by telephone concerning his account and

testified that he was “intensely interested” in the account.

According to Buckley, as many as eighty or ninety per

cent of the transactions in the account occurred as a result

of Jordon’s suggestions; however, Jordon testified that

5475

A24

Opinion of U.S. Court of Appeals

Buckley initiated at least as many transactions as he did.

In any case, Buckley authorized every transaction that

took place and he testified he frequently rejected Jordon’s

recommendations.

The Corporation contends that the turnover ratio—the

ratio of the total cost of purchases to the amount invested

—averaged seven times per year and that the total amount

of commissions generated was approximately $75,000.

While these factors may serve as useful indicators, sce,

e.g., Carras v. Burns, supra, 516 F.2d at 258, they must be

examined in light of the character of the account. As

Judge Owen found, the evidence shows that Buckley was

interested in speculation and a greater volume of activity

will normally be expected in such an account. See, e.g.,

Landry v. Hemphill, Noyes € Co., supra, 473 F.2d at 374;

Note, supra, 80 Harv. L. Rev. at 875. The expert testi-

mony regarding the significance of this evidence was con-

flicting.

In sum, the determination of whether Buckley exercised

control over the account involved a question of fact, which

turned largely upon the court’s assessment of the wit-

nesses’ credibility and its judgment regarding Buckley’s

ability to evaluate the advice given to him by Jordon.

Such issues are particularly the province of the trier of

fact and Judge Owen’s conclusion was not clearly errone-

ous. See Fed. R. Civ. P. 52(a).

Il. The Counterclaims

A. Jurisdiction

The Corporation and the additional defendants on the

counterclaims contend that the court erred in finding that

the defendants’ first, second and fourth state law counter-

claims were compulsory counterclaims within the court’s

5476

A25

Opinion of U.S. Court of Appeals

ancillary jurisdiction. It is well-established that counter-

claims that are “compulsory” within the meaning of Fed.

R. Civ. P. 13(a) are within the district court’s ancillary

jurisdiction and, thus, require no independent hasis of

federal jurisdiction. See, e.g., Moor v. County of Alameda,

411 U.S. 693, 714-15 (1973); United States v. Heyward-

Robinson Company, supra, 430 F.2d at 1080-81; United

Artists Corp. v. Masterpiece Productions, 221 F.2d 213,

216 (2d Cir. 1955); further, if a counterclaim is compul-

sory, the district court’s ancillary jurisdiction extends to

third parties (in this case the additional defendants) whose

presence is required for adjudication of the counterclaim.

See Moor v. County of Alameda, supra, 411 U.S. at 714-15;

United Artists Corp. v. Masterpiece Productions, supra,

221 F.2d at 216-17.

On the other hand, the district court has no jurisdiction

over a permissive ¢ unterclaim, see Fed. R. Civ. P. 13(b),

unless it rests upon an independent jurisdictional ground.

United States v. Heyward-Robinson Company, supra, 430

F.2d at 1080-81; O’Connell v. Erie Lackawanna R.R. Co.,

391 F.2d 156, 163 (2d Cir. 1968), vacated as moot, 395

U.S. 210 (1969) ; Lesnik v. Public Industrials Corporation,

144 F.2d 968, 976 n.10 (2d Cir. 1944). Although there has

been some criticism of the requirement of an independent

jurisdictional ground for permissive counterclaims, see

United States v. Heyward-Robinson Company, supra, 430

F.2d at 1087-88 (Friendly, J., concurring) ; Green, Federal

Jurisdiction over Counterclaims, 48 N.W.U.L. Rev. 271

(1953), the cases have uniformly adhered to this require-

ment. See Sue € Sam Mfg. Co. v. B-L-S Const. Co., 538

F.2d 1048, 1051 (4th Cir. 1976); Pipeliners Local Union

No. 798, Tulsa, Okl. v. Ellerd, 503 F.2d 1193, 1198 (10th

Cir. 1974); 6 Wright and Miller, Federal Practice and

5477

A26

Opinion of U.S. Court of Appeals

Procedure, § 1414 (1971).’* At their core, the compulsory

counterclaim doctrine and the parallel doctrine of ancillary

jurisdiction both seek to further the same policy, which is

to avoid piecemeal litigation in the federal courts. See,

e.g., United States v. Heyward-Robinson Company, supra,

430 F.2d at 1082; Great Lakes Rubber Corporation v. Her-

bert Hoover Company, 286 F.2d 631, 633-34 (3rd Cir. 1961) ;

United Artists Corp. v. Masterpiece Productions, supra,

221 F.2d at 216-17. Since a compulsory counterclaim is by

definition closely related to the subject matter of the op-

posing party’s claim, common sense and judicial economy

compel the conclusion that such claims should be tried

together and the extension of ancillary jurisdiction to com-

pulsory counterclaims is consistent with Article ITI’s grant

of jurisdiction over “cases” arising under the Constitution

and federal laws. See Aldinger v. Howard, 427 U.S. 1, 6-16

(1976); 6 Wright and Miller, supra, at § 1414.

Fed. R. Civ. P. 13(a) provides, inter alia, that a counter-

claim is compulsory, “if it arises out of the transaction or

occurrence that is the subject matter of the opposing

party’s claim.” In interpreting this language we have

adopted what has been termed the “logical relation” test.

See 6 Wright and Miller, supra, at § 1410. Thus, in United

Artists Corp. v. Masterpiece Productions, supra, 221 F.2d

at 216, Chief Judge Clark said, “In practice this criterion

has been broadly interpreted to require not an absolute

identity of factual backgrounds for the two claims, but

only a logical relationship between them.” *° .

19 The parties are in agreement with respect to the applicability of this

rule and bave not asked us to examine its continuing validity. Accord-

ingly, we refrain from undertaking such an examination.

20 In United Artists we relied on our earlier holding in Lesnick v. Public

Industrials Corporation, supra, which relied, in turn, upon Moore v. New

York Cotton Exchange, 270 U.8. 593 (1926). There, in interpreting

the scope of Equity Rule 30, the Supreme Court stated, “ ‘Transaction’

5478

A27

Opinion of U.S. Court of Appeals

Applying this standard, Judge Ward found that the

controversy surrounding the sale of assets to the Corpora-

tion had “become inextricably intertwined” with the Cor-

poration’s churning claims. Newburger, Loeb & Co., Inc.

v. Gross, supra, 365 F. Supp. at 1367. He concluded that

defendants’ first and second counterclaims were so closely

tied to its defenses to the Corporation’s claims that they

were “logically related” to those claims and that since the

fourth counterclaim asserted the same allegedly wrongful

acts, it too should be considered a compulsory counter-

claim. We agree with Judge Ward’s findings and note that

the evidence at trial demonstrates the soundness of his

ruling.

Essentially, the defendants asserted two defenses to the

Corporation’s churning claims. First, they contended that

the February 11 transfer, which included the transfer of

the Buckley claim from the Partnership to the Corporation,

was ineffective because conducted in violation of New York

Partnership Law $98; accordingly, they contended that

the Corporation could not press the Buckley claim because

it did not own it. Second, the defendants claimed that the

Corporation was estopped from asserting the claim be-

cause it was brought as part of a conspiracy against them

in violation of the fiduciary duties owed to them; thus, the

defendants alleged, inter alia, that the Buckley claim was

taken by the Partnership in bad faith for the sole purpose

of creating a colorable claim against them, that the transfer

of assets was induced by “fraudulent special consideration”

as part of a plot by Kayne, Muh and Risher to gain control

of the Partnership’s assets, and that the transfer itself

was a violation of fiduciary duty.

is a word of flexible meaning. It may comprebend a series of many

occurrences, depending not so much upon the immediateness of their

connection as upon their logical relationship.” Id. at 610.

5479

A28

Opinion of U.S. Court of Appeals

It is obvious that there was a substantial overlap be-

tween the defendants’ defenses and their first. second, and

fourth counterclaims; indeed, proof of these defenses was

tantamount to establishing defendants’ case on their coun-

terclaims. To require the defendants to ass*rt these de-

fenses against the Corporation and then bring a separate

action on their counterclaims in state court would amount

to considerable duplication of judicial time and effort and

could lead to mutually inconsistent results. Thus, in a

similar situation this court held that where the plaintiff

brought suit upon a note and the defendant counterclaimed

on the ground that the suit was part of a broader con-

spiracy to injure its business, the counterclaims should be

viewed “as arising out of the occurrence, and surely out

of the transaction, by which [plaintiff] took the note upon

which his complaint was based.” Lesnik v. Public Indus-

trials Corporation, supra, 144 F.2d at 975. Further, Judge

Clark, speaking for the court, found that “proof of the

conspiracy bears directly upon [plaintiff's] allegation of

due and proper assignment of the note to him and should

be here tried, to avoid multiplicity of suits and secure

economy of judicial action.” Id. at 975. See United Artists

Corp. v. Masterpiece Productions, supra, 221 F.2d at 216.

In sum, we find that defendants’ first, second and fourth

counterclaims arose out of the series of assignments upon

which the Corporation’s claims are based and that “the

pleadings disclose a sufficient logical relationship so that,

in the interest of avoiding circuity and multiplicity of ac-

tion, [these counterclaims] should be considered compul-

sory.” United Artists Corp. v. Masterpiece Productions,

supra, 221 F.2d at 216.

We further conclude that defendants’ fifth, sixth and

seventh counterclaims were correctly dismissed for lack of

subject matter jurisdiction. These claims alleged that

5480

A29

Opinion of U.S. Court of Appeals

under the terms of the Partnership agreement Gross,

Bleich and Donoghue were entitled to the return of their

capital interests; apparently, these claims were based on

the theory that the Partnership had effectively dissolved.

We can find no significant relationship between these con-

tract claims and the substance of the Corporation’s claims

or the assignment of the churning claim to the Corporation.

In any case, the successful assertion of defendants’ first,

second and fourth counterclaims has effectively made moot

any claim for damages on the fifth, sixth and seventh coun-

terclaims.

Judge Ward’s holding that the court lacked ancillary

jurisdiction over defendants’ eighth counterclaim (which

was followed by Judge Owen), presents a somewhat closer

question. This claim alleged that the Corporation and the

additional defendants had “wrongfully and maliciously

brought about the destruction of Gross’ opportunity for

employment with Rafkind & Co. by informing it of the re-

strictive covenant in the Partnership agreement. Essen-

tially, this claim presented a state law issue of whether

the restrictive covenant was reasonable as to time and area

and necessary to protect legitimate interests. See Gelder

Medical Group v. Webber, 41 N.Y.2d 680, 683 (1977). Un-

like defendants’ first, second and fourth counterclaims,

resolution of this issue was largely unrelated to the validity

of the assignment of the Buckley claim to the Corporation;

indeed, even if the restrictive covenant was exercised solely

as a coercive tactic, as defendants’ alleged, it is not clear

that this would affect the validity of the covenant if it was

otherwise enforceable under state law. See id. at 684. Al-

though the use of the restrictive covenant against Gross

tended to support the defendants’ claim of breach of fidu-

ciary duty, we conclude that Gross’ claim that the exercise

of the clause was an independent violation of state law was

5481

A30

Opinion of U.S. Court of Appeals

not sufficiently related to the Corporation’s claims to ren-

der it a compulsory counterclaim.

The Corporation and certain of the additional defen-

dants argue that Judge Owen erroneously granted Gross

relief on defendants’ third counterclaim after Judge Ward

had held that this claim was not within the ancillary juris-

diction of the court and could be asserted only as a set-off.

We agree.

The third counterclaim presented the issue of whether

an interest in certain stock warrants had been distributed

as profits to Gross under the Partnership agreement and,

thus, whether this interest was converted when the war-

rants were transferred to the Corporation as part of the

Partnership assets. It is undisputed that the warrants

were at all times held by the Partnership, in the Partner-

ship’s name, and were never physically distributed. The

basic issue was simply whether the Partnership could (con-

sistently with the Partnership agreement) and did distrib-

ute to the general partners interests in the warrants.

There was simply no logical relation, either in law or in

fact, between proof of this counterclaim and proof of the

Corporation’s churning claim; indeed, had the transfer of

assets never taken place, this would not have affected the

basic nature of Gross’ claim for possession of the warrants.

Further, we fail to see how Judge Owen’s amendment of

the pleadings to conform to the proof could overcome this

basic jurisdictional defect. See Fed. R. Civ. P. 82. Accord-

ingly, we reverse the judgment insofar as it grants relief

on defendants’ third counterclaim.”

21 We note that under the tolling provisions applicable to the state stat-

ute of limitations, it would appear that defendants are free to bring

a separate action on their third and eighth counterclaims in state court,

without fear of the limitations period having run during the pendency

of this suit. See CPLR §205.

5482

A31

Opinion of U.S. Court of Appeals

Finally, defendants claim that irrespective of the doc-

trine of ancillary jurisdiction, all of their counterclaims

were properly before the court because their first eight

counterclaims were pendent to their ninth counterclaim,

which rests upon the federal antitrust laws. With the ex-

ception of defendants’ eighth counterclaim, discussed infra,

we think defendants’ reliance on the doctrine of pendent

jurisdiction is without merit. The test for the presence of

pendent jurisdiction was formulated by the Supreme Court

in United Mine Workers v. Gibbs, 383 U.S. 715 (1966) as

follows:

The state and federal claims must derive from a com-

mon nucleus of operative fact. But if, considered

without regard to their federal or state character, a

plaintiff’s claims are such that he would ordinarily

be expected to try them all in one judicial proceeding,

then, assuming substantiality of the federal issues,

there is power in federal] courts to hear the whole.

Id. at 725 (footnote omitted).

The operative facts of the antitrust claim were simply

whether the enforcement of the restrictive covenant vio-

lated the federal antitrust laws. In contrast, defendants’

first through seventh counterclaims involved issues of state

partnership and tort law, and interpretation of the part-

nership agreement and the distribution of profits under it,

all of which were dependent upon proof of facts that were

entirely irrelevant to the antitrust claim. Such claims

would not ordinarily be tried together and the only com-

mon link between these claims—the allegation that en-

forcement of the restrictive covenant was part of a larger

conspiracy involving the transfer agreement—simply does

not provide the “common nucleus of operative fact” essen-

tial to the exercise of pendent jurisdiction.

9483

A32

Opinion of U.S. Court of Appeals

B. Defendants’ First, Second and Fourth Counterclaims

Liability.

The Corporation and the additional defendants raise

numerous claims of error regarding Judge Owen’s

finding that they were each liable on defendants’ first,

second and fourth counterclaims for conspiring “to injure

Gross, Bleich and Donoghue in their interests in the Part-

nership,” which may be summarized as follows: first, the

Corporation and the additional defendants claim that

under New York law there is no tort of “conspiracy” and

it was incumbent upon defendants to prove that each in-

dividual sought to be held liable knowingly participated

in some actionable wrong; second, they claim that no ac-

tionable wrong was suffered by Gross, Bleich or Donoghue;

and, third, that if any such wrong was committed, they did

not knowingly participate in it.

At the outset, the significance of an allegation of con-

spiracy under New York law is to charge that an action-

able wrong was committed jointly by the defendants so

that the acts of one may be imputed to the others because

of their common purpose and intent. See Original Ballet

Russe v. Ballet Theatre, Inc., 133 F.2d 187, 189 (2d Cir.

1943); A. S. Rampell, Inc. v. Hyster Co., 3 N.Y.2d 369, 379

(1957) ; Green v. Davies, 182 N.Y. 499, 504 (1905) ; Dalury

v. Rezinas, 183 App. Div. 456, 459-60 (1st Dept. 1918),

aff'd, 229 N.Y. 513 (1920). “The allegation of conspiracy

carries no greater burden, but also no less, than to assert

adequately common action for a common purpose by com-

mon agreement or understanding among a group, from

which common responsibility derives.” Goldstein v. Siegel,

19 App. Div. 2d 489, 493 (1st Dept. 1963) (Breitel, J.).

Judge Owen found that Kayne, Risher, Sloane and Muh,

guided by Persky, had engaged in a plot to gain control

of the assets of the Partnership in the course of which they

participated in at least two separate wrongs to the de-

5484

A33

Opinion of U.S. Court of Appeals

fendants: (1) the “knowing” violation of Donoghue and

Bleich’s rights as limited partners under section 98, which

he found to be a conversion of their capital interests in

the Partnership; and, (2) the violation by the members

of the Partnership of the fiduciary obligations owed to

Gross, Bleich and Donoghue. Thus, Judge Owen found

that the partners had lent themselves to the goals of the

promoters’ plan by “affirmatively permitting” the transfer

to take place in violation of section 98, and by their “know-

ing acquiescence” in the promoters’ use of “various base-

less litigation threats.” We hold that these findings are

supported by the record and are sufficient in law to im-

pose liability upon the Corporation and the additional de-

fendants, both on a conspiracy theory and on the related

principle that one who knowingly participates with a fidu-

ciary in a breach of trust is liable to the beneficiary for

any damage caused thereby. See Wechsler v. Bowman, 285

N.Y. 284, 291, modified, 286 N.Y. 582 (1941); 5 Scott on

Trusts, §506 (3rd ed. 1967).

Turning first to the claims of Donoghue and Bleich, we

agree with Judges Ward and Owen that the transfer of

the Partnership assets without the consent of Donoghue

and Bleich was a violation of section 98 of New York

Partnership Law. See, e.g., Executive Hotel Associates v.

Elm Hotel Corporation, 41 Misc. 2d 354 (Civ. Ct. City of

New York), aff'd, 43 Misc. 2d 153 (App. Term, 1st Dept.

1964). The February 11 transfer effectively terminated

the Partnership and funneled its assets into a new entity.

It is difficult to conceive of an act that would make it

more “impossible to carry on the ordinary business of the

partnership.” Partnership Law, §98(1)(b). Relying on

Mist Properties, Inc. v. Fitzsimmons Realty Co., 228 N.Y.S.

2d 406 (Sup. Ct. Kings County 1962), Persky argues that

the transfer did not violate section 98 because the part-

nership agreement provided that the general partners

5485

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Opinion of U.S. Court of Appeals

could terminate the partnership prior to its natural ex-

piration date and delegated to the general partners the

authority to manage the business. We disagree.

Mist Properties held that a transfer of the partnership

property by general partners, without the consent of the

limited partners, did not violate section 98(1)(b) where

the partnership agreement “specifically contemplated and

provided for” the transfer that took place. Id. at 410.

Judge Ward rejected the argument that the rights of lim-

ited partners under section 98(1)(b) could be abrogated

by the partnership agreement on the grounds that “[t)his

section, by its terms, is absolute and not subject to varia-

tion by agreement of the parties.” Newburger, Loeb € Co.,

Inc. v. Gross, supra, 365 F. Supp. at 1369. However, there

is simply no language in the Partnership agreement that

can be construed as granting the general partners the right

to conduct the February 11 transfer; indeed, this is the

precise conclusion reached by the Rosenman, Colin memo-

randum of January 25, 1971, discussed supra. The Febru-

ary 11 transfer did not merely terminate the Partnership

(which, in fact, is what Gross, Bleich and Donoghue sought

by liquidation), it transferred all of the Partnership as-

sets, including the capita] interests of Bleich and Dono-

ghue, to an entirely new entity, with new management and

different rights between the parties. This drastic change

in the rights and relations of the parties went far beyond

any powers granted the general partners to terminate or

manage the business. Bleich and Donoghue were under

no obligation to consent to the transfer and were entitled

to insist that the Partnership be dissolved. See Partner-

ship Law, § 99(1)(c).

We also reject Persky’s claim that the transfer was

“necessary” to enable the Partnership to carry on its busi-

ness and that section 98(1)(b) does not apply to partner-

ships in “financial distress.” We think Judge Ward cor-

5486

A35

Opinion of U.S. Court of Appeals

rectly dismissed these arguments as plainly contrary to

the language and intent of the statute. See Newburger,

Loeb & Co., Inc. v. Gross, supra, 365 F. Supp. at 1369-70.

Judge Owen found that the promoters, guided by Persky,

caused the transfer to take place “in knowing violation of

Section 98” and tbat the partners participated in the trans-

fer and permitted it to go forward “in knowing contra-

vention” of section 98. Since the transfer of assets was

in violation of section 98, the unauthorized exercise of

dominion over the capital interests of Bleich and Donoghue

by the Corporation amounted to conversion.** See McCoy

v. American Express Co., 253 N.Y. 477, 482 (1930) ; Suzwks

v. Small, 214 App. Div. 541, 556 (1st Dept. 1925), aff’d,

243 N.Y. 590 (1926). Further, by causing the transfer to

take place in knowing violation of section 98, the partners

wrongfully appropriated the capital interests of Bleich

and Donoghue and were liable to them in an action for an

accounting. See, e.g., Bassett v. American Meter Co., 20

22 As noted, the effect of the transfer was to terminate the Partnership

and convey its assets to a new entity. Although as a general proposition,

limited partners have no property right in the partnership assets, see,

e.g., Alley v. Clark, 71 F. Supp. 521, 526-28 (E.D.N.Y. 1947), Bleich

and Donoghue had a capital investment in the Partnership and upon

its termination had the right to demand their appropriate share of the

assets. Thus, we conclude that at the time of the transfer Bleich and

Donoghue had a possessory interest in specific moneys, which was wrong-

fully converted.

23 Although Judge Owen's finding of conversion against the non-partner

additional defendants was proper, see Mannaberg v. Herbst, 45 N.Y.S.2d

197, 201 (Sup. Ct. N.Y. County 1943), aff'd, 267 App. Div. 818 (1st

Dept.), aff'd, 293 N.Y. 657 (1944), it is unclear whether the partners

could be sued in an action at Jaw for conversion. As a general rule,

in a going partnership a partner may not sue another partner at law

for conversion of or injury to partnership property and is limited to

an action in equity for an accounting. See Bassett v. American Meter

Co., 20 App. Div.2d 956, 957 (4th Dept. 1964); Dalury v. Rezinas,

supra, 183 App. Div. at 460. This rule is based upon the convenience

of the parties, the fact that equitable relief may be necessary to pro-

tect the rights of the parties, and the notion that only after a balance

5487

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Opinion of U.S. Court of Appeals

App. Div. 2d 956, 957 (4th Dept. 1964); Sohon v. Rubin,

282 App. Div. 691 (1st Dept. 1953) ; Hasday v. Barocas, 10

Misc. 2d 22, 25-26 (Sup. Ct. N.Y. County 1952). The pro-

moters (who also acted as officers of the Corporation) and

Persky were properly held liable for causing the wrongful

appropriation of the capital interests of Bleich and Dono-

ghue, see, e.g., Mannaberg v. Herbst, 45 N.Y.S.2d 197, 201

(Sup. Ct. N.Y. County 1943), aff’d, 267 App. Div. 818 (ist

Dept.), aff'd, 293 N.Y. 657 (1944), and for participating

has been struck can the relative rights of the parties be definitively

established. See, e.g., Bassett v. American Meter Co., supra; Crane and

Bromberg, Law of Partnership, §69 (1968). However, where the part-

nership has terminated and the plaintiff seeks to recover for a wrong

to his individual interest, as bere, the rule against actions at law has

not always applied. See Mannaberg v. Herbst, supra, 45 N.Y.S. at 199;

Crane and Bromberg, supra, §69.

However, even assuming that Gross, Bleich and Donoghue could not

bring an action at law against the partners, we do not think that be-

cause Judge Owen stated that the partners were guilty of “converting”

the Partnership interests of the defendants, his finding of liability on

defendants’ first, second and fourth counterclaims must be reversed.

The first and second counterclaims alleged that the Corporation and

the additional defendants were required to account for the capital in-

terests of the defendants and should be held as constructive trustees.

The grounds upon which an accounting was sought were breach of fidu-

ciary duty and Judge Owen specifically found that the partners had

breached their fiduciary obligations by permitting the transfer to go

through in violation of section 98 and by furthering the goals of the

conspiracy initiated by the promoters. This inquiry was the proper

subject of the accounting requested by the defendants. See Bassett v.

American Meter Co., supra, 20 App. Div. 2d at 957; Crane and Brom-

berg, supra, §72 at 411. We find that Judge Owen correctly concluded

that the transfer and the events leading up to it constituted a violation

of the fiduciary duties owed to the defendants and, for reasons discussed

infra, we remand for a determination of what an accounting would show

to be the capital interests of the defendants as of February 11, 1971.

There are no significant differences between this procedure and an

accounting in equity and we reject the additional defendants’ claim that

Judge Owen erred in finding the partners liable for “conversion.” Cf.

Sohon v. Rubin, 282 App. Div. 691, 692 (1st Dept. 1953) (trial court's

finding of conversion against defendant partner was improper but plain-

tiffs awarded the amount an accounting would have shown them entitled

to).

0488

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Opinion of U.S. Court of Appeals

in the partners’ breach of trust. See Wechsler v. Bowman,

supra, 285 N.Y. at 291; Mannaberg v. Herbst, supra, 45

N.Y.S.2d at 201.

The partners, promoters and Persky argue that they

cannot be held liable to Bleich and Donoghue if they be-

lieved in good faith that the transfer was not in violation

of their rights. Assuming this to be so, we find there was

ample evidence to support Judge Owen’s finding that they

caused the transfer to go forward in knowing violation of

the rights of Donoghue and Bleich.

Turning first to the promoters and Persky, the record

indicates that at least by January 15, 1971, Persky, Risher,

and Muh had been informed by counsel to Donoghue and

Bleich that it was their position that the transfer could

not be legally accomplished without their consent. By

January 25, 1971, the Rosenman, Colin firm, acting as coun-

sel to the Partnership, had prepared a memorandum con-

cluding that under section 98(1)(b) the transfer could not

go forward without the consent of all of the limited part-

ners; their memorandum specifically rejected Persky’s

main argument on appeal—that the consent of Bleich and

Donoghue was not necessary under Mist Properties. Burak

testified that around the time the memorandum was pre-

pared he told Persky that his firm had concluded that the

consent of all of the limited partners was necessary and

gave Persky either a copy of the mcmorandum or the rele-

vant citations. It is uncontroverted that in a letter to all

counsel, dated February 2, 1971, Persky stated that he

had been advised that Bleich would not consent to the

transfer and that “[u]nless we are advised in writing that

Miss Bleich will consent . . . our plans to close on Febru-

ary 11, 1971 will be cancelled and .. . [the Partnership]

will be liquidated.” j

Burak testified that on February 10, 1971, Persky un-

successfully attempted to persuade the Rosenman, Colin

5489

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Opinion of U.S. Court of Appeals

attorneys to issue a favorable opinion. Judge Owen found

that at the February 11 closing Persky “professed aston-

ishment” when the Rosenman, Colin attorneys announced

that they would not issue the opinion letter.** Although

Persky represented the Corporation at this time, he never-

theless acted as “special counsel” to the Partnership and

issued an opinion letter which Judge Owen characterized

as “worthless.”

The record demonstrates that Persky, Kayne, Sloane,

Risher and Muh were in close communication. At the same

meeting that counsel for Gross, Bleich and Donoghue told

Persky, Risher and Muh that the transfer could not be

conducted without their consent, Gross was told that if

he wanted to avoid being sued he should go along with

the transfer and convince Bleich and Donoghue to do so.

Gross refused to comply and shortly after this meeting

concluded Kayne and Sloane called Gross from California

and renewed the threats. On January 23, Kayne met with

Gross and again threatened him. Bleich testified that some

time in January Risher threatened her with the Buckley

claim in an attempt to coerce her consent. On February 3,

1971, the day after Persky had sent out the letter indi-

cating that the transfer would be cancelled if Bleich did

24 Finley, Kumble argues that the opinion letter was immaterial because

the condition of its issuance could have been waived by the Corporation

and because Gross, Bleich and Donoghue did not rely on the letter. This

argument simply misconceives the importance of the letter as one of

the steps in the plot to gain control of the Partnership assets. Judge

Owen found that the letter was an “essential document” to the closing

and this finding is supported by the testimony of Robert D. Steefel,

counsel to one of the limited partners; he testified that he and the otber

attorneys representing the limited partners stated at the closing that

the transaction could not be completed without the opinion letter. Sim-

ilarly, Muh testified that on the night of the closing Berkowitz told him

“that we have to have an opinion letter.” Thus, as a practica] matter,

it appears that the deal would not have gone through unless a Jetter of

opinion was issued.

5490

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Opinion of U.S. Court of Appeals

not consent, Kayne and Sloane brought suit in California.

There was evidence that other threats were made as the

closing date drew nearer but we think that the evidence we

have summarized is sufficient to support Judge Owen’s con-

clusion that Persky, Kayne, Risher, Muh and Sloane be-

lieved that the consent of Donoghue and Bleich was neces-

sary to the transfer and conspired to coerce the necessary

acquiescence. When this plan failed they proceeded with

the transfer, as promoters, officers, and counsel to the Cor-

poration, in knowing violation of the rights of Donoghue

and Bleich.

As to the liability of the partners, the Partnership had

been informed by Burak that the transfer could not be con-

ducted without the consent of Bleich and Donoghue; Burak

specifically discussed the matter with Andrew Newburger

and Persky. Thereafter, Persky sent out a letter to counsel

stating that if Bleich did not consent, the transfer would

be cancelled. On the date of the closing Rosenman, Colin

refused to issue an opinion letter stating that the Partner-

ship had the authority to make the transfer. Judge Owen

specifically rejected the argument that the partners simply

went along with the transfer based on the advice of other

counsel present. In this regard, it is significant that the

record is devoid of any testimony by any of the defendant

partners that they believed in the correctness of Persky’s

opinion and disbelieved the advice of their own counsel

and that, in its final form, the transfer agreement pro-

vided that the Corporation accepted liability for the claims

of Gross, Bleich and Donoghue. Judge Owen concluded

that “the partners consenting did so as a matter of business

judgment having been forgiven substantial capital arrears

and hoping that the transfer to the Corporation would save

their deeply threatened interests . . . they were prepared

to accept the letter Persky proposed and delivered and the

5491

A40

Opinion of U.S. Court of Appeals

risks of illegality which went with it as a deliberate busi-

ness choice.” We conclude that the findings of Judge Owen

in this regard were not clearly erroneous.

A number of the additional defendants argue that even

if the transfer violated section 98, judgment as to Gross

on the first, second and fourth counterclaims must be re-

versed because he had no standing as a withdrawn general

partner to complain of the violation. The additional de-

fendants contend that section 98 protects only limited part-

ners and that under the terms of the partnership agree-

ment, the Partnership or its successor had the right to

retain and use Gross’ capital for a period of twelve months

from the effective date of his withdrawal (until September

30, 1971). Gross contends that, even if this argument is

correet, the finding of liability must be affirmed because

the transfer and the events leading up to it constituted a

breach of fiduciary duty, entitling him to a return of his

capital interest in the Partnership. We agree.”

25 The parties have expended considerable effort disputing what Judge

Owen actually found. The additional defendants contend that the award

to Gross was based on a finding of conversion and not upon breach of

fiduciary obligation. Although Judge Owen did not specify which alle-

gations in defendants’ first, second and fourth counterclaims he was

relying on, the theory of breach of fiduciary obligation was clearly pre-

sented to him. Judge Owen laid out in detail the conspiracy by the

promoters to grasp control of the Partnership assets and found that

the partners had violated their fiduciary duties to Gross, Bleich and

Donoghue by permitting the conspiracy to reach fruition and lending

themselves to its goals. See note 22, supra. Aside from this conclusion

of law, we find that the facts as found by Judge Owen independently

support a finding of breach of fiduciary obligation. Thus, even had

Judge Owen not specifically found a breach of duty, Gross would not

be barred from raising this claim on appeal. See, e.g., Dandridge v.

Williams, 397 U.S. 471, 475 0.6 (1970) (“The prevailing party may,

of course, assert in a reviewing court any ground in support of his

judgment, whether or not that ground was relied upon or even con-

sidered by the trial court’); Ajax Hardware Manufacturing Corp. Vv.

Industrial Plants Corp., No. 75-7663, slip op. 4703, 4710 n.3 (2d Cir.

July 13, 1977).

5492

A41

Opinion of U.S. Court of Appeals

Essentially, the issue before Judge Owen was whether

the misconduct on behalf of the partners was sufficient to

entitle Gross to terminate his obligations under the part-

nership agreement and have his share of the transferred

assets returned—that is, in effect, to have a decree of dis-

solution and an accounting effective February 11, 1971.

See Partnership Law, §4 62, 63; Crane and Bromberg, Law

of Partnership, § 78(c) (1968) ; note 22, supra.

Although there is no set formulation of the fiduciary

duties of partners, the main elements of the obligations

owed by one partner to another have been defined as

“utmost good faith, fairness, loyalty.” Crane and Brom-

berg, supra, § 68, at 390. In Meinhard v. Salmon, 249 N.Y.

458 (1928), Chief Judge Cardozo described the obligations

of co-partners as follows:

Many forms of conduct permissible in a workaday

world for those acting at arm’s length, are forbidden

to those bound by fiduciary ties. A trustee is held to

something stricter than the morals of the market

place. Not honesty alone, but the punctilio of an honor

the most sensitive, is then the standard of behavior.

As to this there has developed a tradition that is un-

bending and inveterate. Uncompromising rigidity has

been the attitude of courts of equity when petitioned

to undermine the rule of undivided loyalty by the “dis-

integrating erosion” of particular exceptions. Only

thus has the leypl of conduct for fiduciaries been kept

at a level higher than that trodden by the crowd.

Id. at 464 (citations omitted).

Further, although Gross withdrew from the Partner-

ship, effective September 30, 1970, this did not terminate

the fiduciary obligations of the partners to him; indeed,

as a withdrawn general partner Gross no longer had any

0493

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Opinion of U.S. Court of Appeals

voice in management, although his capital remained in the

firm at the risk of the business and Gross continued to

share in an allocated portjon of the firm’s profits and

losses. Thus, we conclude that at least up to and perhaps

after the transfer, the Partnership and its members owed

to Gross the duties of good faith, fairness and loyalty in

their dealings with him regarding the Partnership busi-

ness. See, e.g., Partnership Law, §43(1); R. C. Gluck &

Co., Inc. v. Tankel, 24 Misc. 2d 841, 846 (Sup. Ct. N.Y.

County 1960), aff'd, 12 App. Div. 2d 339 (1st Dept. 1961) ;

Bozill v. Bozill, 201 Misc. 386, 391 (Sup. Ct. N.Y. County

1952) ; Pearlstein v. Baff, 60 N.Y.S.2d 713 (Sup. Ct. Queens

County), rev’d on other grounds, 270 App. Div. 1043, mod-

ified, 271 App. Div. 834 (2d Dept. 1946), aff'd, 296 N.Y.

881 (1947).

Judge Owen found that the promoters threatened Gross

with baseless litigation in order to force him to go along

with the transfer. In making such threats Kayne, Sloane,

Muh, Risher and Persky were acting in various capacities,

such as agents of or counsel to the Partnership and pro-

moters and future officers of the Corporation. On various

occasions, members of the Partnership were either present

while threats were made or were aware of such actions.

Thus, at a meeting of the limited partners, general part-

ners and subordinated lenders Persky circulated a copy of

a complaint which falsely accused Gross of churning the

Buckleys’ account. See note 3, supra. The Partnership had

cleared all of the Buckley transactions and, as Judge Owen

found, had never raised any question as to their propriety;

indeed, the director of compliance for the Partnership

testified that after investigation he concluded that the

churning claim was without merit and that he so informed

Robert Stern, who agreed with him. The record indicates

that members of the Partnership either knew or had reason

to know that the Buckleys had never dealt with Gross, yet

5494

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Opinion of U.S. Court of Appeals

even after this error was pointed out, no effort was made

to correct the false allegation. In this regard, Judge Owen

found that Persky, who at this time was acting as counsel

for the Partnership, “not only did not care about the facts,

he obviously did not want to know about them.” The record

also shows that as early as September 3, 1970, Kayne had

stated in the presence of Frank and Richard Stern (gen-

eral partners) that he intended to get a withdrawal of

Gross’ resignation “nicely or otherwise”; at this time,

Kayne, Persky and the Sterns drew up a list of “griev-

ances” and “threats” to be used in negotiations with Gross.

Similarly, Ned Frank, another general partner, drew up a

list of instances of alleged malfeasance by Gross. Gross

was threatened with claims of malfeasance and six claims

from the Frank list were asserted as counterclaims in this

action; no proof was offered on four of these claims and

the other two were dismissed by Judge Owen. See note 16,

supra.

Although the use of threats and the assertion of these

questionable claims against Gross may not constitute mali-

cious prosecution, coercion or abuse of process, we find

that they were inconsistent with the high standards of

loyalty and fair dealing demanded of fiduciaries. Cf. A. S.

Rampell, Inc. v. Hyster Co., supra, 3 N.Y. 2d at 377; Duane

Jones Co., Inc. v. Burke, 306 N.Y. 172, 187-89 (1954). We

find no merit to the argument that Gross cannot complain

of this treatment because he was attempting to use Bleich

and Donoghue in order to gain special advantage. Gross

was under no obligation to go along with a transfer he felt

was being conducted in bad faith. It is understandable that

he would seek to protect his sister and his secretary (both

of whom followed him into the Newburger investment)

from what he perceived as a plot to grasp the Partnership

assets; indeed, Gross’ apprehension was borne out by the

5495

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Opinion of U.S. Court of Appeals

findings of the district court. Further, partners are not

relieved of fiduciary duties by strained relations between

them. Crane and Bromberg, supra, § 68 at 394,

The record indicates that as part of the February 11

transfer, the Corporation agreed that it would not seek to

recover approximately twenty-five per cent of the outstand-

ing capital arrears of certain gencral partners, which

Judge Owen found amounted to one-half million dollars in

debt forgiveness. Andrew Newburger deposed that the

debt forgiveness was bargained for in negotiations with

the promoters and that the general partners with deficit

positions agreed that they “should get as much forgiveness

as [they] could.” Judge Owen found that the debt forgive-

ness, which was undertaken by several general partners

and acquiesced in by the rest (Gross specifically objected

to the forgiveness during negotiations, however), was the

quid pro quo for consent to the transfer. We find that it

was also a form of self-dealing in violation of the fiduciary

obligations owed to Gross, Bleich and Donoghue. See, e.8.,

Meinhard v. Salmon, supra, 249 N.Y. at 468; Executive

Hotel Associates v. Elm Hotel Corporation, supra; In re

Kohn’s Estate, 26 Misc. 2d 659, 663 (Sur. Ct. N.Y. County

1952), aff’d, 282 App. Div. 1045 (1st Dept. 1953).

In sum, although there are no New York cases precisely

on point, we conclude that the partners in negotia‘ing and

conducting the transfer breached their fiduciary obliga-

tions to Gross and that the promoters and Persky, acting

on behalf of the Partnership and the Corporation, induced

and participated in this breach of duty; accordingly, we

affirm Judge Owen’s findings of liability on defendants’

first, second and fourth counterclaims.

We also reject Finley, Kumble’s argument that it cannot

be held liable for the acts of the Partnership and the Cor-

poration. Under New York law an attorney generally can-

not be held liable to third parties for actions taken in

5496

A45

Opinion of U.S. Court of Appeals

furtherance of his role as counsel] unless it is shown that

he “did something either tortious in character or beyond

the scope of his honorable employment.” Dallas v. Fass-

nacht, 42 N.Y.S.2d 415, 418 (Sup. Ct. N.Y. County 1943).

Thus, while an attorney is privileged to give honest advice,

even if erroneous, and generally is not responsible for the

motives of his clients, admission to the bar does not create

a license to act maliciously, fraudulently, or knowingly to

tread upon the legal rights of others. See Steinberg v.

Guild, 22 App. Div. 2d 775, 776 (1st Dept. 1964), aff’d, 16

N.Y.2d 791 (1965); D. & C. Textile Corp. v. Rudin, 41 Mise.

2d 916, 918-19 (Sup. Ct. N.Y. County 1964); Kasen v. Mor-

rell, 18 Mise. 2d 158, 162 (Sup. Ct. Kings County 1959).

The issue here is simply whether Judge Owen was war-

ranted in finding that Persky had violated this standard.

Judge Owen found that “[w]ithout question, Persky was

at the heart of this entire matter, guiding the entire plan,

carrying threats to the dissidents and knowingly counsel-

ing, advising and instituting baseless and fraudulent law-

suits to achieve the [promoters’] goal.” Judge Owen’s

findings indicate that, inter alia, Persky was responsible

for: (1) manipulating the settlement and assertion of the

Buckley claim in bad faith; (2) threatening the defendants

with the Buckley claim and other claims in bad faith; (3)

naming Gross in the complaint as the customer’s man with

whom the Buckleys dealt in disregard of the truth, thereby

needlessly vilifying Gross; (4) issuing a false opinion

letter as “special counsel” to the Partnership, thereby fur-

thering the transfer in violation of the rights of Bleich

and Donoghue; and, (5) inducing and participating in the

partners’ breach of fiduciary obligation to Gross, Bleich

and Donoghue. We find that the record supports the con-

clusion that Persky went “beyond the scope of his honor-

able employment” and the disurict court’s finding of li-

ability.

5497

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Opinion of U.S. Court of Appeals

Damages. Finally, we turn to the subject of damages.

In addition to awarding defendants what it found to be

their capital interests, the court awarded Gross $50,000

in punitive damages. This was error.

In Koufakis v. Carvel, 425 F.2d 892 (2d Cir. 1970), we

found that under New York law an award of punitive

damages would not be proper where the wrong complained

of was not “‘aimed at the public generally,’” id. at 908,

quoting Walker v. Sheldon, 10 N.Y.2d 401, 405 (1961), and

where the possibility of punitive damages was not neces-

sary to induce suit to right a wrong that would otherwise

go unpunished. See Big Seven Music Corp. and Adam VII,

Ltd. v. Lennon, No. 76-7454, slip op. 2847, 2865 (2d Cir.

April 13, 1977); Garrity v. Lyle Stuart, Inc., 40 N.Y.2d

354, 358 (1976). Judge Owen did not find either of these

factors present nor can we on this record. See Vinlis

Construction Co., Inc. v. Roreck, 27 N.Y.2d 687, 689 (1970).

We can perceive no other basis for upholding this part of

the judgment and, accordingly, the award of punitive dam-

ages must be reversed.

As the district court recognized, the sum of money to

which the defendants were entitled was dependent upon

what an accounting would show to be the capital interests

of Gross, Bleich and Donoghue as of February 11, 1971.

However, rather than ordering an accounting, the district

court simply accepted the testimony of defendants’ ex-

pert, Irving Lauterbach. Essentially, Lauterbach attacked

the financial statement and schedule of partners’ capital

accounts prepared by Peat, Marwick, Mitchell & Co. on the

ground that it inflated the Partnership’s 1970 operating

losses, thereby decreasing the amount of assets available

for distribution. The district court apparently accepted

each of Lauterbach’s objections to specific losses attributed

by Peat, Marwick to the 1970 financial year and adopted

5498

A47

Opinion of U.S. Court of Appeals

Lauterbach’s calculation of the defendants’ interests with

these items removed from the Partnership’s balance sheet.

The Corporation and the additional defendants contend

that Lauterbach’s testimony was inherently inconsistent

and in conflict with Judge Owen’s findings; further, some

of the additional defendants renew their contention that a

proper accounting would have shown that the defendants

had little or no capital interest in the Partnership. Al-

though we note that at least in one significant instance

Judge Owen’s findings are inconsistent with Lauterbach’s

calculations,** we find it impossible to evaluate the Corpo-

ration and additional defendants’ claims without more spe-

cific findings from the district court. It was incumbent

upon the district court to resolve this dispute, which in-

volves interpretation of the partnership agreement and a

determination of the propriety of a number of additions

to the 1970 operating losses, by making specific findings

capable of review in this court. See Fed. R. Civ. P. 52(a) ;

Rapisardi v. United Fruit Co., 441 F.2d 1308, 1312-13 (2d

Cir. 1971); Fuchstadt v. United States, 434 F.2d 367, 369-

70 (2d Cir. 1970). Further, we can find no support in the

record for the district court’s conclusion that the transfer

destroyed the opportunity for an accounting. There is no

evidence that any of the books or records of the Partner-

ship necessary for an accounting were not available. Al-

though we recognize the difficult position of the district

court, which decided this case without the benefit of a

transcript, we think the proper procedure here would have

26 In determining the capital interests of Gross, Bleich and Donoghue,

Judge Owen specifically relied on the fact that the Partnership's “finan-

cial picture” would have been strengthened had the $500,000 in debt

forgiveness been collected; however, according to Lauterbach’s calcula-

tions, which were relied on by Judge Owen, after certain adjustments

were made to decrease the 1970 operating losses, there would have been

little or no capital arrears to collect.

5499

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Opinion of U.S. Court of Appeals

been for Judge Owen to make findings, in the nature of

an accounting, indicating the assets and liabilities of the

Partnership, the capital interest of each defendant, and

how these figures were arrived at; accordingly, we remand

for this purpose. We leave it to the discretion of the dis-

trict court on remand as to whether this determination ca»

be made on the present record or whether further proceed-

ings will be advisable.”

C. The Antitrust (Ninth) Counterclaim

In January 1971, Rafkind & Co., which was a competitor

of the Partnership in the brokerage business in New York

City, asked Gross to be a trader for the firm’s own account.

In accordance with NYSE Rule 345.18, which requires a

thorough inquiry into the previous record and reputation

of any prospective employee, Rafkind & Co. wrote to the

Partnership requesting clearance to employ Gross as a

“registered representative.” The Partnership responded by

threatening to enforce the covenant in the partnership

articles which barred Gross from working as a trader at

another firm before January 1972. Rafkind & Co. then

withdrew its offer to Gross. On these facts, the district

court found no antitrust violation. We agree.

In affirming the district court, we need not pass upon

the general applicability of the federal antitrust laws to

postemployment restraints. Although such issues have not

often been raised in the federa] courts, employee agree-

ments not to compete are proper subjects for scrutiny

under section 1 of the Sherman Act. When a company

27 In calculating Gross’ share of the Partnership assets, Lauterbach did

not include as part of the Partnership assets the value of the warrants

claimed by Gross in his third counterclaim. Since we reverse the judg-

ment for Gross on the third counterclaim, we would have to remand in

any event for a determination of whether the value of the warrants

should be included in determining defendants’ capital interests in the

Partnership and what effect this would have on their recovery.

5500

wake ee

TROD LRA Ap tel ONT HI Cory AT

A49

Opinion of U.S. Court of Appeals

interferes with free competition for one of its former

employee’s services, the market’s ability to achieve the

most economically efficient allocation of labor is impaired.

See Blake, Employee Agreements Not To Compete, 73

Harv. L. Rev. 625, 627 (1960). Moreover, employee-non-

competition clauses can tie up industry expertise and ex-

perience and thereby forestall new entry.

In certain cases, postemployment restraints do serve le-

gitimate business purposes: they prevent a departing em-

ployee from expropriating his employer’s secrets and clien-

tele. See Blake, supra at 651-74. Consequently, we have held

that a per se ban on all such restrictive covenants would

not be warranted. Bradford v. New York Times Co., 501

F.2d 51, 60 (2d Cir. 1974). In Bradford we also expressed

some concern Over whether the federal antitrust laws

should be brought to bear on employer-employee contro-

versies which individually have only a small impact on com-

merce and which have traditionally been handled in state

courts. See also Capital Temporaries, Inc. of Hartford v.

Olsten Corp., 506 F.2d 658, 666 (2d Cir. 1974). On the other

hand, it has been argued that involvement of the federal

courts is needed because widespread use of overbroad post-

employment restrictions is causing serious anticompetitive

harm to the national economy. See Goldschmid, Antitrust’s

Neglected Stepchild: A Proposal for Dealing with Restric-

tive Covenants under Federal Law, 73 Colum. L. Rev. 1193,

1206-07 (1973).

If section 1 of the Sherman Act were to be applied, two

lines of inquiry seem relevant. First, there is the question

of facial overbreadth: Will the restrictive covenant operate

in circumstances where no valid business interest of the

ex-employer is at stake? Restraints on postemployment

competition that serve no legitimate purpose at the time

they are adopted would be per se invalid. See generally

Northern Pacific Ry. Co. v. United States, 356 U.S. 1, 5

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Opinion of U.S. Court of Appeals

(1958). Second, even if the clause is not overbroad per se,

it might still be scrutinized for unreasonableness: Are the

restrictions so burdensome that their anticompetitive pur-

poses and effects outweigh their justifications? Restraints

that fail this balancing test might be struck down under a

rule of reason. See generally Golden v. Kentile Floors,

Inc., 512 F.2d 838, 844 (5th Cir. 1975); United States v.

Addyston Pipe & Steel Co., 85 F. 271, 281 (6th Cir. 1898),

modified & aff’d, 175 U.S. 211 (1899); Lektro-Vend Corp.

v. Vendo Co., 403 F. Supp. 527, 532-33 (N.D. Dil. 1975),

aff'd, 545 F.2d 1050 (7th Cir.), cert. granted, 429 U.S. 815

(1976) (No. 76-156).

We find no support in the record for Gross’ claim on

either of these possible theories. A brokerage firm has

a legitimate interest in curtailing a former partner’s free-

dom to handle customer accounts at competing firms in

order to prevent him from taking their customers with him.

Gross contends the noncompetition clause in this case was

overbroad because it also prohibited him from serving

simply as a trader for another firm. However, the record

does not indicate that anyone at the Partnership was in-

formed that Gross would not be handling customer accounts

at Rafkind & Co. Indeed, in its initial letter to the Partner-

ship, Rafkind & Co. announced that Gross was to be em-

ployed as a “registered representative,” which, as defined

in NYSE Rule 10, means a broker who trades for custom-

ers’ accounts and not solely for the firm account. Thus,

Gross has not proved that the Partnership knowingly en-

forced the arguably overbroad portion of the noncompeti-

tion clause. Nor did Gross show anticompetitive impact,

industry practice, etc., such as might conceivably warrant

a finding that the scope of the restriction enforced was un-

reasonable. Since Gross failed to prove the Partnership

guilty of enforcing a restraint that was overbroad per se

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Opinion of U.S. Court of Appeals

or otherwise unreasonable, he failed to make out a case

under any possible interpretation of the Sherman Act.

Gross also contends the district court erred in dismissing

for lack of jurisdiction, prior to trial, his claim that the

restrictive covenant violated state law. However, since we

affirm the dismissal of Gross’ federal antitrust claim, no

principles of judicial economy, convenience, or fairness

would now be served by a remand for further proceedings

on the related state law issues. Regardless whether pendent

jurisdiction once existed over the state law claim, there is

no longer any reason for that claim to be adjudicated in

federal court. At this point, the claim can be dealt with

more appropriately by a state court. See United Mine

Workers v. Gibbs, supra, 383 U.S. at 726-27 (1966); note

20, supra,

In summary, we affirm the dismissal of the Corporation’s

churning claim, the six counterclaims against Gross, and

defendant’s fifth, sixth, seventh, eighth and ninth counter-

claims. We also affirm the district court’s finding of lia-

bility on defendants’ first, second and fourth counterclaims

but reverse the award of punitive damages and remand for

recomputation of damages. We reverse the judgment on

defendant’s third counterclaim and remand with instruc-

tions to dismiss this claim.

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APPENDIX B

OPINION OF THE UNITED STATES DISTRICT

COURT FOR THE SOUTHE

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