By statute, judgments of state courts are entitled to the same preclusive effect in subsequent federal litigation as they would have in subsequent state court litigation. 28 U.S.C. § 1738. A recent decision by the U.S. Court of Appeals for the Second Circuit provides a reminder that this rule is not limited to state law claims but can also bar assertion of federal claims, even if those claims had never been raised in the state court litigation. See Beijing Neu Cloud v. IBM Corp., No. 22-3132 (2d Cir. July 25, 2024).

In September 2021, Beijing Neu Cloud Oriental System Technology Co., a Chinese company that was a joint venture between IBM and another Chinese company, filed two suits against IBM, one in federal court based on the Defend Trade Secrets Act (DTSA) and the other in state court for breach of contract and related business torts based on IBM's alleged diversion of business to a different joint venture in which IBM was also a member.

The state court case proceeded rapidly, with that court granting IBM's motion to dismiss based in part on the grounds that 1) New York state law claims were a nullity because Chinese law applied and 2) they were untimely under the parties' contractual limitation period of two years.

About seven months later, the federal court granted IBM's motion to dismiss that case, holding in part that the DTSA claim was 1) time barred and 2) not plausibly pled. The plaintiff appealed both the federal court judgment and the state court judgment.

The federal appeal was decided first, while the state court appeal remained pending. At the Second Circuit, IBM argued in part that the judgment in the state court case barred the federal DTSA action on res judicata (claim preclusion) grounds. Although the federal district court had not decided the case on that basis, it is a truism of appellate procedure that a judgment may be affirmed on any ground supported by the record.

Because the Second Circuit affirmed based on res judicata, it did not have to reach the grounds on which the district court had ruled in IBM's favor. It rejected the principal basis on which the plaintiff, referred to as Neu Cloud, contended that res judicata did not apply – which was the notion that the contract claims raised in state court – and the DTSA claim asserted in federal court arose from different facts. Explaining that the governing New York standard asked if the claims arose from "the same transaction or series of transactions," the Second Circuit concluded that both cases "allege the same injury based on the same series of events," i.e., that IBM "created a competing joint venture that undermined" Neu Cloud's business.

The Second Circuit opinion also addressed at length the question of whether the state court would have had jurisdiction to hear Neu Cloud's federal DTSA claim. Unlike the grants of jurisdiction for patent and copyright cases, which provide that the federal courts have exclusive jurisdiction over such claims, the grant of jurisdiction in DTSA provides only that the federal district courts "shall have original jurisdiction of civil actions" brought thereunder. 18 U.S.C. § 1836(c). Surveying cases addressing similar language in other statutes and the legislative history of DTSA, the court concluded that there was no basis to depart from the presumption that federal claims can be heard in state courts.

A review of the parties' respective briefs on appeal shows that this issue – i.e., would the state court have had jurisdiction to hear the DTSA claim if Neu Cloud had asserted it in that case – was minimally argued. However, it appears that the Second Circuit had not previously addressed in a precedential opinion the question of whether the state courts have jurisdiction to entertain DTSA claims, and its discussion of the issue in this case cited several district court decisions holding to the contrary. A reasonable inference is that the Second Circuit took the opportunity presented by this case to make clear that the state courts do have jurisdiction to hear DTSA claims.

This case serves as a reminder that federal claims can often be heard by the state courts and hence, that concurrent pursuit of closely related claims in state court and federal court requires consideration of res judicata implications even when, as here, the claims are divided between state causes of action and federal causes of action. As summarized by the Second Circuit, "Neu Cloud could have raised its DTSA claim in the prior state court action. It did not, instead filing two complaints in separate judicial systems to challenge the same conduct committed by [IBM]. As a result, Neu Cloud is barred from bringing its DTSA claim."