## Facts

- Floyd Koch and other investors (plaintiffs) bought partnership interests connected to the acquisition, subdivision, and resale of Arizona real property.
- Plaintiffs claimed defendants made misrepresentations and omissions in selling the partnership interests and in carrying out the transactions.
- Plaintiffs first sued in the U.S. District Court, alleging violations of federal securities law (including § 10(b) and Rule 10b-5) and also pleading related state-law claims; plaintiffs asked the federal court to hear the state claims under pendent (supplemental) jurisdiction.
- The federal court declined to exercise pendent jurisdiction over the state-law claims and dismissed those state claims without prejudice to refiling in state court, while keeping the federal securities claim.
- Plaintiffs then filed an action in California superior court against some of the same defendants, asserting state causes of action for common-law fraud and legal malpractice arising out of the same investment transactions.
- After the state action was filed, the federal court granted summary judgment for defendants on the federal securities claim on the ground that plaintiffs had not purchased “securities” within the meaning of the federal statutes.
- Relying on the federal summary judgment, defendants in the California case sought to end the state action on res judicata grounds (claim preclusion and/or collateral estoppel). The trial court agreed and dismissed the state case.
- Plaintiffs appealed from the dismissal.

## Issues

1. Whether a federal court’s summary judgment on a federal securities claim—after the federal court dismissed related state-law claims without prejudice for lack of pendent jurisdiction—bars a later California action for fraud and legal malpractice arising from the same transactions.
2. Whether the federal determination that the partnership interests were not “securities” collaterally estops plaintiffs from litigating elements necessary to their state-law fraud and legal-malpractice claims.

## Decision

- The Court of Appeal reversed the dismissal and remanded.
- Claim preclusion did not apply because the federal court expressly dismissed the state-law claims without prejudice after declining pendent jurisdiction; the state claims were not adjudicated on the merits in federal court.
- Issue preclusion did not bar the state causes of action because the only issue necessarily decided in federal court was the federal-law classification question (no “security”), which did not decide the elements of common-law fraud or legal malpractice under California law.

## Legal Principles

- The preclusive effect of a prior federal judgment in a later state action is determined by federal preclusion rules.
- Claim preclusion generally requires a final judgment on the merits of the same claim between the same parties (or those in privity).
- When a federal court declines pendent (supplemental) jurisdiction over state-law claims and dismisses them without prejudice, that dismissal is not an adjudication on the merits of those state claims and does not bar refiling in state court.
- A plaintiff is not barred from pursuing state-law claims in state court when the federal court has refused to hear them; preclusion does not extend to claims the first court declined to decide.
- Collateral estoppel applies only to an identical issue that was actually litigated and necessarily decided, and that is material to the later action.
- A federal determination that an investment is not a “security” for § 10(b)/Rule 10b-5 purposes may preclude relitigation of that specific federal classification issue, but it does not resolve the broader factual and legal questions required to prove California common-law fraud or attorney malpractice (such as duty, breach, reliance, causation, and damages).

## Conclusion

Koch v. Hankins holds that a federal court’s summary judgment dismissing a federal securities claim on the ground that the investment was not a “security,” entered after the federal court dismissed related state claims without prejudice when it declined pendent jurisdiction, does not bar a later California action for common-law fraud and legal malpractice based on the same transactions; neither claim preclusion nor collateral estoppel warranted dismissal of the state case.


Koch v. Hankins, 223 Cal. App. 3d 1599, 273 Cal. Rptr. 442 (1990)