New Jersey’s entire controversy doctrine generally requires that a defendant assert in the same lawsuit any claims arising out of the same transaction or occurrence that is the subject of an adversary’s lawsuit. If a defendant fails to assert related counterclaims in an adversary’s lawsuit, the defendant’s inaction “shall result in the preclusion of the omitted claims.” N.J. Ct. R. 4:30A; see also N.J. Ct. R. 4:7-1 (“A defendant . . . either failing to comply with [N.J. Ct.] R. 4:30A (entire controversy doctrine) or failing to set off a liquidated debt or demand or a debt or demand capable of being ascertained by calculation, shall thereafter be precluded from bringing any action for such claim or for such debt or demand which might have been so set off.”).
On February 17, 2011, in Investor Savings Bank v. Waldo Jersey City, LLC, No. A-6201-09 (N.J. App. Div. Feb. 17, 2011), New Jersey’s Appellate Division held that a provision in a loan agreement precluding the borrower, in a lawsuit by the lender for breach of the agreement, from asserting any counterclaim against the lender, is “contrary to public policy” and, as a result, “unenforceable.”
More particularly, the Investor Savings Bank Court determined that a counterclaim waiver provision contained in a loan agreement is unenforceable “because it conflicts with the public policies of simplicity, efficiency, and fairness that are the bulwarks of our court rules.” New Jersey’s Appellate Division observed that these public policies, which the New Jersey Court Rules codify as the entire controversy doctrine, include the principle “that the judicial process chiefly consists of ‘a single and complete trial with a single and complete review.’ ”
The Investor Savings Bank Court explained that a counterclaim waiver provision undermines New Jersey’s entire controversy doctrine by “compel[ling] defendants to file a separate lawsuit rather than [their] otherwise appropriate counterclaim”; and that such compulsion “convolutes the proceedings and generates additional trouble and expense.”
In Investor Savings Bank, pursuant to a loan agreement between the parties, the plaintiff bank loaned the defendant entities — a limited liability company (an “LLC”) which owned property in Jersey City, New Jersey, and another LLC which was created to manage construction of residential condominiums on the property — nearly $8,300,000 to fund the construction of the residential condominiums. The first loan commitment letter contained a counterclaim waiver provision stating: “All documents relating to the Loan must and shall constitute legal, valid and binding obligations of Borrower, enforceable in accordance with their terms and conditions, and free from any right of setoff, counterclaim or other defense.”
The defendants allegedly defaulted on their obligations under the loan agreement. The bank brought an action seeking the foreclosure of its mortgage. Then the bank filed, against the defendant entities and the defendant individual guarantor, the present action seeking damages in the amount of the alleged outstanding balance of the loan.
The defendants filed a counterclaim alleging, among other things, that the bank materially breached the loan agreement by failing fully to fund the loan. The Superior Court of New Jersey, relying on the counterclaim-waiver provision contained in the first loan commitment letter, had entered an order granting the bank’s motion to dismiss the defendants’ counterclaim for failure to state a claim upon which relief can be granted.
On interlocutory appeal by the defendants from the Superior Court’s order dismissing their counterclaim, New Jersey’s Appellate Division reversed the Superior Court’s order in pertinent part and remanded for further proceedings. The Appellate Division held that the counterclaim waiver provision set forth in the loan documents was unenforceable.
Investors Savings Bank‘s holding preventing lenders from enforcing counterclaim waiver provisions has application beyond the commercial lending context. The Investor Savings Bank decision aids employees in the securities industry in employment-related arbitration proceedings against brokerage firms before The Financial Industry Regulatory Authority, Inc. (“FINRA”) involving promissory notes and governed by New Jersey law. Specifically, the Investor Savings Bank case appears to render unenforceable, in FINRA arbitrations governed by New Jersey law and brought by brokerage firms against brokers to collect amounts owing under promissory notes, provisions in the brokers’ employment agreements barring the brokers from interposing counterclaims against the brokerage firms.
The type of dispute most frequently arbitrated before FINRA between brokerage firms and brokers relates to “transitional compensation” payments to brokers whom the firms have fired within a predetermined period of time. These disputes are termed promissory note, forgivable loan, up-front bonus, or recruiting bonus cases.
In the securities industry, brokerage firms commonly offer account executives transitional compensation to aid the account executives’ lateral moves to those firms. A firm’s purposes for offering such compensation are both to entice the account executive to join the firm and to make sure that the executive won’t receive a windfall if he or she leaves the new firm soon after joining.
As a result, the up-front bonus or forgivable loan provision of a broker’s employment agreement typically provides that if the brokerage firm terminates the broker’s employment within a specified period for any reason, or if the broker elects to leave the firm, the balance outstanding on the loan immediately becomes payable to the firm. Further, the broker’s employment agreement frequently provides that, in any FINRA arbitration brought by the firm against a broker (who has not immediately repaid the loan) to collect the amount due, the broker waives his or her right to assert any counterclaim, setoff, or defense against the firm, other than proof of payment.
As stated, the Investor Savings Bank case appears to render invalid, in FINRA arbitrations governed by New Jersey law and brought by brokerage firms against brokers to collect amounts owing under promissory notes, provisions in the brokers’ employment agreements prohibiting the brokers from asserting counterclaims against the brokerage firms.