Estop right now, thank you very much: Supreme Court clarifies the test for cause of action estoppel

Res judicata exists to prevent abuse of the judicial process by balancing a litigant’s interest in fairness with society’s interest in the conclusion of disputes and the finality of judicial decisions. In Patrick Street Holdings Limited v. 11368 NL Inc.¹, the Supreme Court of Canada outlined the boundaries of cause of action estoppel (a branch of res judicata) and the requirements for its application. Critically, res judicata must be raised at the earliest opportunity by the party asserting it.

What you need to know

• Raising (and pleading) res judicata early is critical. Res judicata must be raised at the earliest opportunity: at the pleadings stage, if possible, or at a hearing. The obligation to plead res judicata early is functional and favours substance over form: the failure to explicitly reference “res judicata” or “estoppel” is not fatal if the material facts giving rise to res judicata are pleaded. The question of whether a proceeding was decided on the basis of res judicata is not determinative, as long as the party raised the matter.
• A separate and distinct cause of action. One of the key elements for establishing cause of action estoppel is that the cause of action is not separate and distinct from the cause of action in the subsequent proceeding. The Supreme Court clarified that this element of the test will be satisfied where the subsequent action arises out of the same relationship between the parties and the same subject matter as the initial litigation.
• The “reasonable diligence” qualifier. The test also requires a party seeking to apply cause of action estoppel to establish that the basis of the cause of action and of the subsequent action were argued in the prior action, or could have been argued if the parties had exercised reasonable diligence. The Supreme Court clarified that the test will not be met where circumstances such as fraud, dishonesty, or the discovery of new evidence explain why a party did not raise a matter in the first proceeding.

Background

In 2016, 11368 NL Inc. defaulted on a mortgage held by Patrick Street Holdings Limited. Patrick Street commenced power of sale proceedings under the defaulted mortgage and purchased the property. Patrick Street prepared an accounting regarding the sale in which it set out allocations to pay out several mortgages on the property that were held by Patrick Street and its affiliates, including a $4 million collateral mortgage. The sale generated insufficient proceeds to pay out all creditors who had encumbrances on the property.

The same year, two creditors brought applications which challenged Patrick Street’s accounting and sought payment of their claims by Patrick Street. Both 11368 and Patrick Street were respondents in these proceedings. The application judge reduced the amount Patrick Street had claimed on several mortgages, excluded the $4 million collateral mortgage from the accounting, and ordered Patrick Street to pay out the challenging creditors’ claims.

In 2019, 11368 filed an application seeking to be paid the residue of the proceeds from the sale of the property. Patrick Street argued that the $4 million collateral mortgage remained a valid contract between Patrick Street and 11368 even if it had been excluded from the accounting in the 2016 applications and that, in any event, the 2016 applications had not addressed the situation as between Patrick Street and 11368.

The application judge rejected Patrick Street’s arguments and ordered that the residue of the sale proceeds be paid to 11368. The Court of Appeal agreed, holding that 11368 had properly raised the doctrine of res judicata and that cause of action estoppel, issue estoppel, and the doctrine of abuse of process all operated to prevent Patrick Street from relitigating its claim.

The majority decision

The majority of the Supreme Court dismissed the appeal (per Wagner CJC)². In doing so, it emphasized that res judicata must be pleaded.

Since the 1800s, courts have shifted away from the technical and complex rules that historically applied to pleadings. Instead, modern pleadings must contain a statement of material facts that a party will rely on instead of identifying all causes of action or rules of law pleaded. This approach is functional and favours substance over form.

As such, a party need not explicitly use the term res judicata. While evidentiary rules are generally not pleaded, the requirements of fairness—and the avoidance of surprise—require a party to give notice of its reliance on res judicata. The question of whether it is properly pleaded is therefore focused on the question of fairness.

Importantly, not all parties will have the opportunity to plead res judicata at first instance (for example, in an administrative proceeding, or in a case where a plaintiff cannot anticipate a defence). There is therefore an obligation to plead res judicata when there is an opportunity to do so.

Here, the majority concluded that 11368 had properly pleaded res judicata in its written submissions and before the application judge in the 2019 proceeding, despite not having referenced the doctrine by name.

The majority then found that all four elements of the test for cause of action estoppel were satisfied:

1. there must be a final decision of a court of competent jurisdiction in a prior action;
2. the parties to the subsequent litigation must have been parties to the prior action;
3. the cause of action in the prior action must not be separate and distinct from the cause of action in the subsequent proceeding; and
4. the basis of the cause of action and of the subsequent action must have been argued or could have been argued in the prior action, if the parties had exercised reasonable diligence.

In particular, the majority offered guidance on the last two components of the test for cause of action estoppel.

On the requirement that the cause of action is not separate and distinct from the cause of action in the subsequent proceeding, the majority defined the basis of a cause of action as the theory that explains how the set of facts entitles a party to relief. Determining whether a cause of action raised in a prior proceeding is “separate and distinct” therefore requires an assessment and comparison of the facts in the prior and subsequent proceedings. Cause of action estoppel will operate to bar subsequent proceedings that arise out of the same matter and the same relationship between the parties, even if the subsequent proceedings are based on a different legal description or conception of the issues.

On the requirement that the basis of the cause of action and of the subsequent action were argued in the prior action—or could have been argued if the parties had exercised reasonable diligence—the majority affirmed that cause of action estoppel bars re-litigation of any matters that were raised or could have been raised with reasonable diligence in the prior proceeding. The majority held that the “reasonable diligence” qualifier was sufficient to ensure that litigants would not be held to an unrealistic standard. Cause of action estoppel will not bar further litigation where a party could not reasonably have advanced a particular theory, such as where evidence relevant to the theory did not exist or could not reasonably have been discovered at the time of the prior proceeding.

Finally, the majority also reiterated and endorsed the existence of a residual discretion to not apply res judicata. Even where a party has established all elements of the test for applying cause of action estoppel, courts maintain a narrow discretion to decline to apply estoppel where doing so would cause an injustice—for example, where the stakes in the first proceeding were too low to generate a full and robust response or where the first proceeding was tainted by procedural unfairness.

The dissents

There were two dissents, both of which would have allowed the appeal and found that the test for cause of action estoppel had not been met.

Both dissents turned on whether res judicata was previously pleaded. Justice Martin (with Justice Karakatsanis concurring) disagreed with the majority that res judicata had not been raised at first instance but held that this should not necessarily bar a party from raising the issue on appeal. However, Justice Martin concluded that, even if res judicata did apply, discretion should be exercised to let Patrick Street’s claim proceed on its merits, because of a “lack of clarity” in the record about what had been decided in the 2016 application.

In her dissenting reasons, Justice Côté concluded that because res judicata was not pleaded, raised, or decided in the 2019 application, 11368 was estopped from arguing the issue on appeal.

The takeaway

Patrick Street Holdings reinforces the importance of pleading the material facts at first instance, including facts wholly related to legal theories like res judicata. Parties should think early and often about the legal theories and strategies grounding a claim or defence, to avoid the conclusion that they are precluded from raising a critical (but late-breaking) theory.

While this obligation is particularly significant for defendants in the context of res judicata (because plaintiffs will not be expected to anticipate in their pleadings what defences a defendant or respondent may raise), the plaintiffs or applicants may in appropriate circumstances also have an obligation to plead res judicata.

Finally, parties should carefully consider the applicability of res judicata in the context of administrative proceedings, where the Supreme Court noted that the differing “structures, mandates, and procedures of administrative decision makers” requires a “necessarily broader” discretion to decline to apply cause of action estoppel in that context.