The crucial difference between claim preclusion and issue preclusion is that while claim preclusion can bar a party from raising a claim he or she failed to raise in a prior action, issue preclusion can bar only matters argued and decided in a prior lawsuit. As Justice Harlan noted in Southern Pacific Railroad Co. v. United States, 168 U.S. 1, 48-49 (1897):
The general principle announced in numerous cases is that a right, question, or fact distinctly put in issue and directly determined by a court of competent jurisdiction, as a ground of recovery, cannot be disputed in a subsequent suit between the same parties or their privies; and, even if the second suit is for a different cause of action, the right, question, or fact once so determined must, as between the same parties or their privies, be taken as conclusively established, so long as the judgment in the first suit remains unmodified.
For an issue to be precluded in a future lawsuit, it must meet certain benchmarks. First, the issue in the new lawsuit must be the same issue as was decided in the previous lawsuit. Of course, what constitutes an "issue" is ambiguous, and there has been much litigation over what constitutes the "same issue." Second, as for claim preclusion, the issue must have been valid, final and on the merits (though note that the issue needn't be "on the merits" if it is exclusively a procedural issue). Third, the issue in the new lawsuit must have been actually litigated in the previous lawsuit. And finally, the determination must have been necessary to the court's judgment.
Some courts distinguish between "direct" and "collateral" estoppel. Direct estoppel can be invoked when the two suits involve the same cause of action. Collateral estoppel can be invoked when a new claim or cause of action is brought.
Section 27 of the Restatement (Second) of Judgments (1982) adopts the "actually litigated" requirement. Consider Professor Vestal's criticism of that requirement:
[Those in favor of an "actually litigated" requirement argue that] an action may involve "so small an amount that litigation of the issue may cost more than the value of the lawsuit." [Restatement] This is a rather curious rationale. It does not support the "actually litigated" requirement; rather it supports a rejection of issue preclusion under any circumstances. If there is insufficient incentive to litigate a matter, then there should be no issue precusion. Litigation in small claims courts or prosecutions for misdemeanors cannot give rise to issue preclusion because often those actions provide litigants with inadequate incentive to litigate.
[A second argument in favor of an "actually litigated" requirement is that] "the forum may be an inconvenient one in which to produce the necessary evidence or which to litigate at all." [Restatement] If a valid judgment is going to be handed down, then this forum must have jurisdiction over the defendant and it is the forum of choice of the plaintiff. As the forum of choice of the plaintiff, it is proper to hold that the plaintiff should be bound by any adverse decision reached by the court. It is only in the case of the defendant that he might be able to assert that he should not be bound because it is inconvenient.
In light of (a) the present consitutiotnal limitations on the exercise of jurisdiction over defendants, (b) the fact that the suit by definition involves a substantial interest, and (c) the availability of procedures to get and present the relevant evidence, this justification is not very persuasive. Would it not be better to hold for issue preclusion, and then permit the apparently precluded party to explain why preclusion should not apply?
The [Restatement's] Comment also gives as a reason for the "actually litigated" rule that a rule to the contrary "might serve to discourage compromise, to decrease the likelihood that the issues in an action would be narrowed by stipulation, and thus to intensify litigation." [But i]f compromise is going to be discouraged, it probably will be by the size of the present suit. If there is going to be a refusal to stipulate and thus narrow issues, in all probability it will be because of the importance of the instant suit and not because of the issue preclusion that may flow from the decision.
The Restatement (Second) of Judgments: A Modest Dissent, 66 Cornell L. Rev. 464, 473 - 74 (1981).