Defensive shield or tactical sword?

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Many litigators will tell you that the best defense is a good offense. As a result, it is always important for defense attorney to assess whether a cross-complaint should be filed when responding to any lawsuit filed against his or her client, asserting any counterclaims the defendant may have against the plaintiff whether related to the plaintiff’s claims or not. Often, bringing pressure down on the plaintiff with counterclaims will make the plaintiff reevaluate their commitment to prosecuting the case and may facilitate early settlement of the action. This may be especially true in cases where a plaintiff’s attorney is accepting a contingency fee (i.e. a percentage of any final monetary recovery), as many attorneys will not defend a counter suit without receiving an hourly fee for doing so (which some plaintiffs can’t or won’t pay). The attorney may also be forced to reconsider the “risk/benefit” of the contingency fee arrangement they had agreed to initially, assessing whether the amount of work involved in the case will be worth the potential payoff.

Of course, consideration of all possible counterclaims in response to a lawsuit is also important because many such counterclaims are in fact “compulsory” in that they relate to or arise out of the same transaction or occurrence as the causes of action brought by the plaintiff, and the failure to assert them in a cross-complaint would result in a waiver of such claims. (See CCP § 426.10 et seq.; see also Clark v. Lesher, 46 Cal.2d 874, 881-882 (1956)(“‘If the defendant omits to set up a counterclaim upon a cause arising out of the transaction set forth in the complaint as the foundation of the plaintiff's claim, neither he nor his assignee can afterwards maintain an action against the plaintiff therefor.’ This compulsory counterclaim statute has the obvious purpose of avoiding multiplicity of actions and conflicting judgments.”)

Unfortunately, in many instances, the possible counterclaims are already time-barred by the applicable statute of limitations because the defendant has waited too long to bring their own claims against the plaintiff. Indeed, some savvy plaintiffs may purposely wait to bring their own claims until the statute of limitations has passed on claims that could be brought against them by the defendant.

However, in such situations, not all is lost because the defendant can still raise even time-barred claims when responding to a lawsuit by asserting in their Answer to the lawsuit that they are entitled to an offset against any recovery by the plaintiff. The equitable doctrine of offset (sometimes instead referred to as a right of “setoff”) has been codified in California law as Code of Civil Procedure section 431.70: “Where cross-demands for money have existed between persons at any point in time when neither demand was barred by the statute of limitations, and an action is thereafter commenced by one such person, the other person may assert in the answer the defense of payment in that the two demands are compensated so far as they equal each other, notwithstanding that an independent action asserting the person’s claim would at the time of filing the answer be barred by the statute of limitations.”

In other words, where the plaintiff seeks monetary damages against the defendant, the defendant can respond by seeking monetary damages against the plaintiff even if the defendant would otherwise be too late to make such a claim through their own lawsuit. Such counterclaims could even date back decades if, for example, the parties involved had ongoing dealings for many years before the suit. The offset damages sought by the defendant could limit or even eliminate any recovery being sought by the plaintiff – even where the plaintiff’s claim for damages is legitimate. To the extent the defendant’s claims against the plaintiff would be otherwise time-barred, the only limitation in the California statute is that “the relief accorded [the defendant] under this section shall not exceed the value of the relief granted to the other party.” (CCP § 431.70 [emphasis added].)

For example, let’s say that Plaintiff and Defendant have been co-owners of an auto dealership for over twenty years, but the day-to-day operations of the dealership had been left to the plaintiff. Defendant discovered more than ten years ago that Plaintiff had been engaged in self-dealing, such as “loaning” himself money from the business without authorization or paying his personal expenses with company funds, which violated Plaintiff’s fiduciary duties to Defendant and reduced Defendant’s profit share. Defendant confronted Plaintiff, and got him to agree to repay the money he took but Plaintiff never did. Because the dealership was performing well, and the business relationship between the parties was otherwise profitable, Defendant never took any legal action against Plaintiff to recover the damages he had suffered because of Plaintiff’s prior wrongdoing and the claims became barred by the running of the statute of limitations. Later, Defendant entered into an agreement to buy Plaintiff out of the dealership with payments to be made over time. However, Defendant was less effective at running the dealership and he was unable to make enough revenue to pay Plaintiff as agreed. Plaintiff sued Defendant for breached of contract and sought recovery of the monies due on the buy sell agreement. Although Defendant’s claims from a decade ago were time-barred, Defendant asserted a defense of “offset” in his response to the suit and successfully reduced Plaintiff’s damages on the breach of contract claim by proving up at trial the damages Defendant had suffered from Plaintiff’s prior wrongdoing.

Notably, in the above scenario, the defendant didn’t need to have previously established the precise amount of injury he suffered as a result of the plaintiff’s prior wrongdoing. The defense of offset is available to a defendant even where the defendant’s claim has been unliquidated. (See Hauger v. Gates, 42 Cal.2d 752, 755 (1954)(the fact that a party’s offset “demand is an unliquidated claim for damages for breach of the contract … does not affect their right to the setoff” because the statute “does not require that the cross-demands be liquidated.”) Also, if the defendant’s damages from the plaintiff’s prior wrongdoing were equal to or greater than what the defendant owed the plaintiff at the time of his breach of the buy sell agreement, the defendant could not recover any excess damages but he could entirely eliminate the debt he owed to the plaintiff.

Like most rules, there are exceptions to the right of offset. For example, an employer may not use offset when defending an action brought by an employee for unpaid earnings, even if that employee owes money to the employer. (See, e.g. Barnhill v. Robert Saunders & Co., 125 Cal.App.3d 1 (1981)(An employer is not entitled to offset against unpaid wages the amount the employee owed pursuant to an unpaid promissory note because earnings are exempt from attachment under other statutes and allowing offset would let the employer “accomplish what neither it nor any other creditor could do by attachment and would defeat the legislative policy underlying that exemption.”)

In general, however, the right of offset even on time-barred claims of a defendant is a valuable tool in the defense arsenal that should not be overlooked. Like countersuits, the defense of offset can not only shield a defendant from part if not all of the damages sought by the plaintiff, but it can operate as an affirmative weapon against the plaintiff who might well be deterred from fully prosecuting his or her own suit against the defendant.