A Trade Secret Case Study-Application of "Res judicata" Across the U.S. Federal and State Court Systems

There are two court systems in the United States, one is the federal court system, and the other is the local court system in each state. The federal court system and the state court system each have their own jurisdiction, but they are not completely independent of each other.

Some cases are only under the jurisdiction of the federal court, such as patent cases; some cases are only under the jurisdiction of the state court, such as contract cases; and some cases may be under the concurrent jurisdiction of both the federal court and the state court, such as the trade secret case analyzed below. When certain cases are under the jurisdiction of both the federal court and the state court, the principle of res judicata (derived from Latin meaning 'a matter judged' – this is a doctrine created to prevent parties relitigating a matter that has already been judicially decided) may apply across different court systems.

Beijing Neu Cloud Oriental System Technology Co., Ltd. vs. IBM, IBM WTC, IBM China

In this recent case decided on 24 July 2024, Neu Cloud first sued IBM, IBM WTC and IBM China (collectively referred to as IBM) for misappropriation of trade secrets under the Defend Trade Secrets Act of 2016 (DTSA) in the United States District Court for the Southern District of New York (federal court), and then sued IBM in the New York Supreme Court (state court) for unfair competition, unjust enrichment, breach of fiduciary duty, breach of contract and tortious interference. Neu Cloud’s claims were dismissed by The New York Supreme Court first and then dismissed by the United States District Court for the Southern District of New York. The federal court however declined to hold that the earlier judgment of the New York Supreme Court barred Neu Cloud's DTSA claim.

Neu Cloud appealed the decision of the federal district court to the United States Court of Appeals for the Second Circuit. During the appeal process, IBM argued that Neu Cloud should be barred from filing a DTSA lawsuit in the federal court based on the principle of res judicata. The appellate court agreed with IBM's argument, holding that the decision already made by the state district court barred Neu Cloud from asserting a DTSA lawsuit in other proceedings, thus upholding the decision of the federal district court.

The focus of the dispute is whether a state district court 's ruling on unfair competition, unjust enrichment, breach of fiduciary duty, breach of contract and tortious interference can trump a trade secret misappropriation case before a US federal court, so that the federal case can be dismissed right away on the grounds of res judicata. The appellate court said yes.

Under New York preclusion law, “a party may not litigate a claim where a judgment on the merits exists from a prior action between the same parties involving the same subject matter” - In re Hunter, 827 NE 2d 269, 274 (NY2005).

In this case, the appellate court held that although Neu Cloud's federal DTSA claim was not raised in the New York district court action, it could have been done so in one single district court action. In making this judgment, the appellate court mainly took into consideration whether the facts involved in the two lawsuits were sufficiently related, and whether the latter case was subject to the jurisdiction of the court that adjudicated the earlier case.

In deciding whether the cases were sufficiently related, the court primarily considered whether the subsequent claim arose from the same transaction or series of transactions with the adjudicated claim.

It was held that Neu Cloud's state law claim and federal law claim arose from "the same transaction or series of transactions." The appellate court found that both claims were based on the same series of events: IBM violated state and federal laws in establishing a joint venture that competed with Neu Cloud, which harmed Neu Cloud's business interests. Besides the same factual basis, even the language used for the two complaints was the same.

Although Neu Cloud claimed different damages in the two court proceedings, and the standards of proof in the two actions might also have been different, the appellate court said these were subtle differences and were not sufficient to overcome the overall similarities that rendered the two complaints sufficiently related so as to trigger res judicata.

The court found that although the DTSA stipulates that the federal district court has original jurisdiction over such cases, it does not explicitly say such jurisdiction is exclusive. Considering that state courts have inherent authority to adjudicate federal claims, the appellate court held that state courts are presumed to have jurisdiction over such cases.

In summary, the appellate court held that Neu Cloud could have, but failed to, file its DTSA claim in the previous state court lawsuit, and chose to initiate a separate lawsuit in a federal court instead to challenge the same conduct by IBM's. Neu Cloud was barred by the legal doctrine of res judicata from bringing a DTSA claim in the federal court. As a result, Neu Cloud’s federal claim should be dismissed.

Read the full text of the appellate court’s decision.

Comment

There may have been reasonable consideration behind Neu Cloud's decision to sue IBM in both a state court and a federal court. Such an approach, however, could pose significant legal risks. In this case, it directly caused the appellate court to affirm the district court’s dismissal decision without hearing Neu Cloud's appeal of the trade secret claim, on the ground that the earlier district court's decision was barred because of res judicata, which actually stripped Neu Cloud of the right to appeal.

Through this case, we can also see the "long arm" effect of the res judicata rule under New York law, which covers not only "prior claims that have actually been adjudicated", but also "claims that should have been made in the prior litigation". This undoubtedly raises the bar of building up a case on the plaintiff’s side. For causes of action arising from related factual bases, the plaintiff should, as much as possible, bring all the claims in one action to avoid the application of the res judicata doctrine between each other if those claims were litigated separately.