Kris Jen Ltd. Partnership v. Fairfax Savings, F.S.B.

WILNER, Chief Judge. This appeal arises, ultimately, from a foreclosure action filed in the Circuit Court for Harford County by appellee, Fairfax Savings, F.S.B. It involves the conflict, considered by the Court of Appeals in Rowland v. Harrison, 320 Md. 223 , 577 A.2d 51 (1990), between the preclusion principles embodied in the doctrines of res judicata, collateral estoppel, and collateral attack and Maryland’s permissive counterclaim rule. ²⁷ Procedural History In January, 1988, Kris Jen Limited Partnership borrowed $3,200,000 from Fairfax in order to finance construction of a housing development known as Wellington Woods. The loan was secured by a deed of trust on the property and by a guarantee signed by John Seisman, a general partner of Kris Jen, and his wife, Susan. On April 21, 1989, Fairfax sent a Notice of Default to Kris Jen and the Seismans, setting forth five alleged acts of default: (1) the Interest Reserve provided for in the loan documents had become depleted, and Kris Jen had failed to pay $30,637 in interest due, as demanded by Fairfax; (2) the loan matured on January 22, 1989; (3) the project had not been completed by January 22, 1989, as required by the Construction Loan Agreement; (4) Kris Jen had failed to provide additional funds for the project pursuant to the Construction Loan Agreement and as demanded by Fairfax; and (5) mechanics liens had been filed against the property.

When these defaults had not been cured to Fairfax’s satisfaction, the bank’s trustees, on April 25,1989, filed an action to foreclose the deed of trust. Fairfax purchased the property at the foreclosure sale for $1,500,000. On July 24,1989, Kris Jen filed an objection to ratification of the sale. In that objection, Kris Jen contended, essentially, that there had been no default.

It averred that, pursuant to an agreement entered into in December, 1988, Fairfax had agreed to “deduct” interest payments on the loan from funds available in the construction account and had, in fact, done so, so that no interest was then due. Kris Jen also alleged that, in accordance with the December agreement, Fairfax had agreed to pay invoices of subcontractors and materialmen directly, without holdback, and to reimburse the construction fund from the proceeds received from the sale of units constructed by Kris Jen. The December agreement, as alleged by Kris Jen, was in the nature of a “work out” agreement, modifying the terms of the loan documents. ²⁸ In further response to the notice of default that triggered the foreclosure, Kris Jen contended that the loan had not matured but rather had been extended by Fairfax, that the time for completion of the project had also been extended, that the provision in the December agreement for taking 100% of the proceeds from the sale of units satisfied the requirements of the Construction Loan Agreement for additional funds, and that mechanics liens had been filed only because Fairfax delayed making payments to the subcontractors and suppliers, in violation of its commitment. Additionally, Kris Jen complained that the price paid by Fairfax at the foreclosure sale was both unconscionably low and fraudulent to third-party creditors of Kris Jen and that $47,196 of the debt claimed by Fairfax was not due.

We assume that some of these allegations, if proved, would have caused the court to reject the report of sale, for they would have established that there was no act of default justifying the foreclosure and that the sale price was unconscionably low. They were never determined, however, for, over Fairfax’s protest, Kris Jen was allowed to withdraw its objection. The withdrawal came in the form of an amendment to the objection to ratification, stating that Kris Jen had no objection to the ratification. Suspecting, with good reason, that this move was not intended for its ultimate benefit, Fairfax (1) opposed the amendment, and (2) proposed, as an alternative, that, if inclined to allow Kris Jen to withdraw its objection, the court, in its order of ratification, make specific findings of fact that the deed of trust was valid, that the loan was in default for each of the reasons set forth by Fairfax in its notice of default, that Fairfax had acted properly throughout and did not breach any agreements with Kris Jen, that the sale price was fair, and that the full amount stated in the Statement of Debt was due and payable.

The court overruled Fairfax’s protest and declined to make any of the proposed findings. It allowed Kris Jen to withdraw its objection and then entered a simple order ratifying the sale. Thereafter, the auditor stated an account in the matter, which the court ratified. At some point, in a separate action ²⁹ at law that has since been stayed, Fairfax proceeded against the Seismans on their guarantee agreement.

In January, 1990—some 10 months before the auditor’s report was ratified, and thus while the foreclosure proceeding was still open—Kris Jen and John Seisman, appellants here, filed against Fairfax what eventually became a 10-count second amended complaint for compensatory and punitive damages and for injunctive and declaratory relief. For the most part, the underlying bases for this action are the same as those set forth in Kris Jen’s initial objection to the report of sale. Appellants allege that, pursuant to the December, 1988 agreement, the parties restructured the loan to provide that interest payments would come initially from the construction fund and that Fairfax would pay all outstanding invoices of subcontractors and materialmen directly and without retain-age. They aver that in February or March, 1989, Fairfax stopped paying those invoices in violation of the agreement and that caused numerous mechanics’ liens to be filed.

They contend, as they did in the initial objection, that the notice of default sent by Fairfax was inaccurate in each of its particulars but that, despite notice of the inaccuracies, Fairfax proceeded to foreclose. One new allegation, not set forth in the objection to the sale, is that, by its silence, Fairfax had agreed to allow Kris Jen to use certain funds collected in advance from buyers to finance the construction, and that Fairfax later demanded that Kris Jen place those funds in escrow until construction was complete, thereby causing a significant shortage of money available to Kris Jen. As part of this allegation, appellants aver that a substantial part of the sale price (and construction cost) for the homes arose from optional features that were not part of the basic house but could be ordered at extra cost by the buyers and that, under the individual home sales contracts, the price for those options was to be paid by the buyers in advance. Appellants were expecting to use those advanced funds to supplement the construction financing, and they complain that Fairfax, by its agents, required the escrowing of those funds, thereby making them unavailable to help defray ³⁰ the cost of construction.

That shortfall, they aver, contributed significantly to their financial problems. Upon these assertions, appellants charged Fairfax with breach of a fiduciary duty owed to Kris Jen by failing to keep its various promises and commitments (Count I); breach of its duty of good faith and fair dealing to Seisman by inducing him to guarantee Kris Jen’s obligation upon the sub silentio promise that Kris Jen could use the advance collections for optional improvements to help finance the construction, by doing the other things previously noted, and by forcing a default on the loan and foreclosing on the property, thereby increasing Seisman’s risk as a guarantor (Count II); breach of its duty of good faith and fair dealing to Kris Jen and Seisman by misleading them as to Fairfax’s willingness to approve certain unspecified “work out terms” with Wellington Woods’s creditors and by forcing a default (Count III); negligent supervision of its loan officers (Count IV); tortious interference with Kris Jen’s contractual relations with its home-buying customers (Count V); fraud with respect to the use of the money collected in advance for optional additions to the houses being constructed (Count VI); negligent misrepresentation with respect to that money (Count VII); breach of the December, 1988 agreement (Count VIII); and defamation of Seisman by telling subcontractors and materialmen that there was no work out agreement when they knew that Seisman had made contradictory statements to those creditors (Count IX). In Count X, Seisman contends that, because Kris Jen was not in default, Fairfax had no ground on which to foreclose, and that it therefore had no basis for pursuing Seisman on his guarantee. He asked for a declaratory judgment to that effect and for an injunction restraining Fairfax from prosecuting its action against him on the guarantee agreement.

Fairfax moved to dismiss appellants’ second amended complaint on a number of grounds, including that it was barred by the coalescing doctrines of res judicata, collateral estoppel, and collateral attack because it sought to relitigate matters ³¹ that were either resolved by the ratification of the foreclosure sale or that could have been raised and resolved in that action. In a Memorandum Opinion and Order entered on May 12, 1993, the court concluded that most, though not necessarily all, of the causes of action and relief sought were indeed barred by those doctrines, as explained and applied by this Court in Klein v. Whitehead, 40 Md.App. 1 , 389 A.2d 374 (1978) and Shepard v. Nabb, 84 Md.App. 687 , 581 A.2d 839 (1990). Specifically, it held that appellants were barred from asserting that there was no default on the loan, that any default was induced or coerced by Fairfax, that the sale was illegal or fraudulent, that the price was inadequate, or that they suffered damages from the foreclosure. Those issues, the court concluded, had been resolved by the ratification order and could not be relitigated, even under the principles enunciated in Rowland v. Harrison, supra, 320 Md. 223 , 577 A.2d 51 .

The court observed that, although some of the allegations made in the complaint were not adjudicated in the foreclosure action and thus might not be barred under any of the preclusion doctrines, they might be susceptible to dismissal for other reasons. The overlap or inter-relationship between those matters that the court believed had been adjudicated and those that were new was such, however, that the court did not feel comfortable in dismissing the complaint outright, and it did not address the non-preclusion defenses. Instead, it dismissed the complaint but gave appellants leave to amend if they could do so without relying on allegations already deemed to be adjudicated or subject to res judicata. Appellants expressly declined to amend, so the court then entered a final order dismissing the complaint.

This appeal ensued, the single issue presented by appellants being whether the dismissal contravened this State’s permissive counterclaim rule, as explicated in Rowland v. Harrison. Discussion Until 1990, Maryland case law took a strict view against allowing a party to litigate in a second case issues that either ³² had been litigated or that could have been litigated in an earlier case. If the two causes of action were regarded as the “same”—i.e., if the evidence necessary to sustain a judgment for the plaintiff in the second case would have authorized a judgment for him in the first—the judgment in the first case was regarded as res judicata. As such, it served to preclude raising in the second case not only matters actually litigated in the first case but also those matters that could have been litigated in that case.

If there was not that identity of evidence, and thus the two cases were not regarded as the “same” cause of action, only those determinations of fact actually adjudicated in the first case were regarded as conclusive in the second. As we explained in Klein v. Whitehead, supra, these principles, denoted as “estoppel by judgment,” come into play when the plaintiff does not challenge the existence or validity of a judgment allegedly entered in an earlier case but rather questions the effect of that judgment or decree upon him: “Conceding that the judgment exists and is valid, he asserts that it does not apply to or settle the issues sought to be litigated in the subsequent proceeding.” Id., 40 Md.App. at 21 , 389 A.2d 374 . A third principle prevented a person from collaterally challenging the judgment itself in a subsequent proceeding—from attempting to impeach the judgment in an action other than the one in which the judgment was entered. Id. at 20 , 389 A.2d 374 .

Klein v. Whitehead is similar in many respects to the case now before us. There, too, a mortgagor/debtor allowed a foreclosure and other debt collection actions to proceed without defense and then, in a subsequent action, sued the mortgagee/creditor for wrongfully bringing those proceedings. We described the nature of the second action at 21-22, 389 A.2d 374 : “Appellant is not attempting here to vitiate the earlier proceedings—to recover the land or the chattels, to annul the deficiency decree or the confessed judgment, to expunge anything from the dockets or records of the Circuit Court for Wicomico County. He seems content to allow those ³³ judgments and decrees, and the actions taken in execution of them, to stand.

He does not challenge the jurisdiction of the court or the facial regularity of the prior proceedings. His contention is that the earlier proceedings were wrongfully—tortiously, fraudulently—brought; and, for that reason, he seeks civil damages against those whom he accuses as the tortfeasors—the successful suitors in the prior proceedings and their attorneys.” With the possible exception of the defamation claim (Count IX), this is almost precisely what appellants are doing here, and, in Klein v. Whitehead, we said that such a claim amounts to a prohibited collateral attack upon the prior judgment. Quoting from an Indiana case, which, in turn, was quoting from the then-current edition of Freeman on Judgments, we said, at 22, that “[t]he settled policy of the law forbidding that a matter once adjudicated shall be again drawn in issue while the former adjudication remains in force, does not permit the prosecution of an action for obtaining judgment by false and fraudulent practices, or by false and forced evidence.” The holdings announced in Klein v. Whitehead, which we believe fairly summarized and applied then-existing Maryland law, would certainly support the circuit court’s conclusions in this case. It is evident, however, that those holdings have been modified by Rowland v. Harrison, and what we now need to do is consider the extent of the modification.

That case arose from a transaction in which Ms. Rowland sent her horse to Dr. Harrison, a veterinarian, for boarding and treatment for a vaginal infection. When she retrieved the horse, Ms. Rowland found it suffering not only from the vaginal infection but from other maladies as well, and eventually it had to be destroyed. She therefore refused to pay Dr. Harrison’s bill, accusing him of malpractice. Harrison sued Rowland in the District Court to collect for the boarding and treatment.

Rowland had the case removed to the circuit court and, in a separate action, sued Harrison for malpractice. Failing in her attempt to have the cases consolidated, Rowland filed a counterclaim in the debt action but, ³⁴ when that action was called to trial before she had an opportunity to conduct discovery or otherwise prepare her malpractice case, she consented to a voluntary dismissal of the counterclaim -without prejudice and offered no evidence as to any malpractice. On that state of the record, the court gave judgment for Harrison without considering Rowland’s claim of malpractice. Harrison thereupon moved for summary judgment in Rowland’s separate malpractice action on the ground of res judica ta—that the allegation of malpractice could have been asserted as a