Res Judicata Can Be Waived Through Stipulation

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On * * *, the district judge stayed the proxy tax matter for one year pending the outcome of administrative proceedings related to the UBIT tax examination. You anticipate that, when the stay period expires, * * * will request the district court to rule on the proxy tax refund claim cross motions, and will inform the court that the Service recently reopened the examination into * * *'s UBIT issues. Given that this examination was reopened and given that the proxy tax dispute has been pending for over three years, you do not think that the district judge will look favorably on a request to continue the stay pending further administrative proceedings. You believe that it is in the government's best interest to ask the district judge to rule on the pending cross motions and to enter a final, appealable order in the proxy tax case.

You think that the government should consider entering into a stipulation with * * * in which * * * would agree not to assert the defense of res judicata in a later action involving the UBIT issue. You also think that the stipulation should contain an agreement from * * * to waive the statute of limitations on assessment so that the Service can wait until after a final decision is entered in the proxy tax case before assessing any additional taxes based on the UBIT issue. You cite Hemmings v. Commissioner, 104 T.C. 221 (1995), as the reason for this stipulation.

The doctrine of res judicata, also referred to as claim preclusion, provides that "when a court of competent jurisdiction has entered a final judgment on the merits of a cause of action, the parties to the suit and their privies are thereafter bound `not only as to every matter which was offered and received to sustain or defeat the claim or demand, but as to any other admissible matter which might have been offered for that purpose.'" Commissioner v. Sunnen, 333 U.S. 591, 597 (1948) (quoting Cromwell v. County of Sac, 94 U.S. 351, 352 (1876)). We agree with the earlier advice issued by this office that res judicata does not apply when the first action involves the proxy tax and the second action involves the unrelated business income tax. "[T]he doctrine of claim preclusion bars litigation of all compulsory counterclaims of the defendant and any permissive counterclaims that are actually litigated." Hemmings v. Commissioner, 104 T.C. 221, 234 (1995). Our previous advice concluded that the UBIT issue was a permissive counterclaim, not a compulsory counterclaim, in the proxy tax litigation. In addition, because these causes of action are separate and distinct, a final judgment in one case does not preclude another court from hearing the second case. See, e.g., Towe v. Commissioner, T.C. Memo. 1992-689 (cases involving gift tax and income tax involve separate causes of action).

The doctrine of res judicata is an affirmative defense. Rule 8(c) of the Federal Rules of Civil Procedure provides: "In pleading to a preceding pleading, a party shall set forth affirmatively . . . res judicata . . . and any other matter constituting an avoidance or affirmative defense." If res judicata is not timely raised, it is considered waived. United States v. Shanbaum, 10 F.3d 305, 311 (5th Cir. 1994).

Issue 2

We have found one case in which the parties agreed to waive the defense of res judicata and the court found that this amounted to fraud on the court. We do not think this case has any application to the present litigation, however. In Cochran v. Celotex Corp., 123 F.R.D. 307 (C.D. Ill. 1988), an asbestos case, plaintiff's attorney voluntarily dismissed the case with prejudice on the eve of trial because he thought an impending trial would be unfair to defendant's newly appointed attorney. The parties entered into a side agreement whereby Celotex agreed, in exchange for the dismissal, not to raise a res judicata defense elsewhere if the cause of action were refiled. The court, referring to this action as "duplicitous and ethically suspect maneuvering," determined that the parties had committed fraud on the court. Id. at 311.

We do not think that stipulating that res judicata would not be raised in the UBIT action would fall within the parameters of Cochran v. Celotex Corp. We have determined that the action involving the proxy tax and the action involving the UBIT are separate causes of action. In Cochran v. Celotex Corp., the parties were agreeing not to raise the defense in subsequent litigation involving the same cause of action. That court noted that an extensive amount of resources had already been spent in preparing for litigation on the asbestos liability issue. That would not be the situation in the instant case. The preparation that has been done by the parties for the proxy tax litigation is not coextensive with the preparation that would have to be done for the UBIT litigation. Moreover, the judge involved in the * * * litigation is aware of the pending UBIT issue. That issue, however, is causing a delay in the litigation of the proxy tax issue. Waiting for the UBIT examination to end so that the parties can try these issues together is not promoting judicial economy. Arguably, it is wasting judicial resources.

Issue 3

The request for advice cites Hemmings v. Commissioner, 104 T.C. 221 (1995), as requiring the Service to wait until the district court has issued a final judgment in the proxy tax case before issuing * * * a notice of deficiency with respect to the UBIT issue. We do not read Hemmings this way. In Hemmings, the taxpayers filed a refund suit with respect to 1984 based on deductions related to losses incurred in commodity futures trading with ContiCommodity Services, Inc. (Conti). The district court found that the taxpayers were not entitled to any of the claimed refunds. Following the decision in that case, the Service issued to taxpayers a notice of deficiency for the 1983 and 1984 taxable years. The Service determined that taxpayers were not entitled to any deductions on their 1983 and 1984 returns related to the Conti trading. The Hemmings court presented a thorough background to I.R.C. § 7422(e). That section provides:

In Hemmings, the subject matter of the two proceedings was the same -- the income tax liability of the taxpayer. In the instant case, as discussed above, we do not think that the subject matter of the two proceedings would be the same. The district court case involves the proxy tax. The notice of deficiency would relate to the UBIT. Therefore, we do not think that I.R.C. § 7422(e) would apply. As a result, the two actions could proceed simultaneously, rather than seriatim.

You may prefer to exercise caution in this regard, however, and obtain a waiver of the period of limitations to assess the UBIT. We would not condone a stipulation to this effect, but would instead require that the government and * * * properly execute a Form 872 or Form 872-A.