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Henry v. Farmer City State Bank

decided: December 29, 1986.


Appeals from the United States District Court for the Central District of Illinois, Springfield Division, No. 85 C 3365, Richard Mills, Judge.

Author: Cummings

Before CUMMINGS and CUDAHY, Circuit Judges, and CAMPBELL, Senior District Judge.*fn*

CUMMINGS, Circuit Judge. Plaintiffs appeal the district court's dismissal of their fifty-eight page, thirty-count amended complaint alleging claims under the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. §§ 1961-1968, and 42 U.S.C. § 1983 against twenty-nine defendants. We affirm the dismissal of the amended complaint.

Plaintiffs also appeal the district court's order ejoining ongoing state court proceedings which the plaintiffs initiated in Illinois circuit court after their federal court complaint had been dismissed and while their appeal of that dismissal was pending. Because the district court lacked jurisdiction to enjoin the state court proceedings, we must reverse the order granting the injunction.

I. The Proceedings Below

This case arose out of an ordinary mortgage foreclosure in state court. Plaintiffs John and Evelyn Henry were the beneficial owners of certain business real estate in Farmer City, Illinois. The property was held in a land trust. On July 24, 1980, the Farmer City State Bank ("the Bank") loaned the Henrys $60,000, and they executed a promissory note in favor of the Bank. To secure the payment of the indebtedness, the Henrys signed a Letter of Direction ordering their land trustee, the Champaign National Bank, to place a mortgage on their business property. The Henrys allege that the letter only directed the trustee to place a first mortgage on the property to secure the $60,000 loan, and that the Bank later inserted additional language, without the Henrys' knowledge or consent, directing the trustee to place a second mortgage on the property to secure payment of a preexisting debt which the Henrys owed the Bank in the approximate amount of $345,000. This prior debt was evidenced by a promissory note executed by the Henrys on February 7, 1980.*fn1 Pursuant to the Letter of Direction, the Champaign National Bank proceeded to execute both a first and a second mortgage on the Henrys' business property in favor of the Farmer City State Bank.

The Henrys defaulted on both of the loans, and on April 14, 1982, the Bank filed a two-count complaint in Illinois circuit court seeking foreclosure of the two mortgages. A judgment of foreclosure was entered against the trustee and plaintiff Evelyn Henry on March 9, 1983, and against plaintiff John Henry on June 13, 1983. The property was sold to the Bank for $170,000 at a foreclosure sale on November 28, 1983. The Henrys moved to set aside the sale on the ground that John Henry failed to receive notice of the sale. Finding that the sale was in total compliance with the Illinois Mortgage and Foreclosure Act, Ill. Rev. Stat. ch. 95, P23 et seq. (1981), the court confirmed the sale and entered deficiency judgments against Evelyn Henry in the amount of $86,998.37 and against John Henry in the amount of $95,464.14.

The Henrys challenged both the foreclosure and the deficiency judgments on appeal to the Illinois appellate court, raising three specific arguments. First, they argued that the trial court erred in entering the deficiency judgments against them because (1) the complaint failed to allege the Henrys' personal liability, and (2) they were only guarantors, and not makers, of the promissory notes evidencing the two loans. Second, they argued that the trial court erred in confirming the foreclosure sale because the bank failed to notify John Henry of the impending sale. Finally, they argued that the trial court erred in calculating the amounts of the mortgage indebtedness. The Illinois appellate court rejected all of the Henrys' arguments and affirmed the judgments of the circuit court. Farmer City State Bank v. Champaign National Bank, 138 Ill. App. 3d 847, 486 N.E.2d 301, 93 Ill. Dec. 200 (4th Dist. 1985), petition for leave to appeal denied. At no time during the foreclosure proceedings, either at trial or on appeal did the Henrys ever claim that the second mortgage was a forgery or obtained through fraud.

On July 3, 1985, the Henrys filed a complaint, which was later amended on October 18, 1985, in federal district court. The thirty-count amended complaint alleged RICO and 42 U.S.C. § 1983 claims against twenty-nine defendants. The Henrys sued everyone even remotely connected with the mortgage foreclosures: the auctioneer who cried the foreclosure sale, the he moving company that confiscated and transported the Henrys personal property, the Sheriff and the State's Attorney of DeWitt County, the City of Farmer City and its Chief of Police, the Chevrolet dealer and dealership who leased the property after it was purchased by the Bank, the Champaign National Bank as land trustee, the Henrys' former attorney, and a former employee of John Henry, as well as the directors, officers, and attorneys of the defendant Farmer City State Bank. In a series of orders, the district court dismissed the peripheral defendants for lack of subject matter jurisdiction in December 1985.*fn2

The RICO claims against the Bank and its directors, officers, and attorneys alleged that the defendants had engaged in a purported scheme of racketeering activity to defraud the Henrys through use of the mails and interstate wires ni violation of 18 U.S.C. §§ 1341, 1343, and state laws making extortion and intimidation felony crimes. The Henrys claimed for the first time that the second mortgage in the amount of $345,000 was a forgery and that the underlying obligation to the Bank was unlawful. They further alleged that the defendants had knowingly filed forged and false documents and pleadings in the state court foreclosure action. On December 17, 1985, the district court dismissed the RICO claims against all of the defendants because the Henrys had alleged no pattern of racketeering, the Henrys had alleged no facts indicating that the underlying debt of $345,000 was false, and the Henrys had suffered no injury to their "business or property by reason of a violation of [RICO] § 1962." 18 U.S.C. § 1964(c).

The § 1983 claims against the City of Farmer City, its Chief of Police, and the Sheriff and the State's Attorney of DeWitt County alleged unspecified violations of the COnstitution and laws of the United States arising out of their actions in executing the foreclosure judgments. In a series of orders in December 1985, the district court dismissed the § 1983 claims against all of the defendants for failure to state a claim.*fn3

On December 27, 1985, and January 21, 1986, the Henrys filed notices of appeal with the district court. while these appeals were pending, the Henrys filed a complain on February 4, 1986, in Illinois circuit court. The complaint named eight defendants: the Bank, two of its officers and its attorney, Champaign National Bank, the Chevrolet dealer and dealership who took possession of the Henrys' property after the sale, and the Henrys' former attorney. The factual basis of the state court compliant was the same as that of the federal court complaint, but instead of alleging RICO violations, the complaint alleged common law fraud, conspiracy, trespass, and legal malpractice causes of action, seeking compensatory and punitive damages in addition to equitable relief.

To thwart the Henrys' attempt to carry on the litigation in state court, the RICO defendants petitioned the district court to issue an injunction enjoining the state court proceedings and prohibiting the Henrys from filing any further complaints against any of the original federal court defendants based on any set of facts arising out of the mortgage foreclosures.*fn4 The district court granted the requested injunction on March 10, 1986. The Henrys appeal the order issuing the injunction.

II. The RICO Claims

The district court concluded that the plaintiffs had failed to make out a cause of action under RICO and therefore dismissed the RICO claims against all of the defendants. Although we find no error in that conclusion, the district court should not have reached the merits of the RICO claims. We hold that plaintiffs' RICO claims are barred by the doctrine of res judicata because they failed to raise their fraud claims as a defense in the state court mortgage foreclosure proceedings initiated by the Bank.

The traditional doctrine of res judicata provides that "a final judgment on the merits of an action precludes the parties or their privies from relitigating issues that were or could have been raised in that action." Allen v. McCurry, 449 U.S. 90, 94, 66 L. Ed. 2d 308, 101 S. Ct. 411 . In determining the preclusive effect of a prior state court judgment, a federal court must give the same full faith and credit to the judgment that it would receive in the courts of the state in which it was rendered. Migra v. Warren City School Dist. Bd. of Educ., 465 U.S. 75, 85, 79 L. Ed. 2d 56, 104 S. Ct. 892 ; Allen, 449 U.S. at 96; 28 U.S.C. § 1738.

If federal preclusion law were controlling here, this case would be easily disposed by our recent decision in Rudell v. Comprehensive Accounting Corp., 802 F.2d 926 (7th Cir. 1986). In Rudell we held that the doctrine of res judicata bars a party from subsequently raising claims based on facts which could have constituted a defense or counterclaim to a prior proceeding if the "successful prosecution of the second action would nullify the initial judgment or would impair rights established in the initial action." Id. at 928 (quoting Restatement (Second) of Judgments § 22(2)(b)). Although recognizing that in most instances a defendant's failure to raise a defense or a counterclaim in a prior action will not bar him from raising a related claim in a subsequent proceeding, we nevertheless observed:

Both precedent and policy require that res judicata bar a counterclaim when its prosecution would nullify rights established by the prior action. Judicial economy is not the only basis for the doctrine of res judicata. Res judicata also preserves the integrity of judgments and protects those who rely on them.

Id. (quoting Martino v. McDonald's System, Inc., 598 F.2d 1079, 1085 (7th Cir. 1979), certiorari denied, 444 U.S. 966, 10 ...

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