The choice between federal and state court is often a difficult one to make, and different lawyers will give different preferences, for wildly different reasons, when asked to choose. It is often the first choice a litigant makes, and it can be one of the most important in any given case.
Article III, Section 2, of the United States Constitution authorizes Congress to pass laws granting federal court jurisdiction to consider, among other things, cases between citizens of different states. Congress has authorized federal court jurisdiction almost to the limits allowed by the Constitution. This article will discuss diversity jurisdiction – specifically, as it relates to corporations – and the recent changes in the interpretation of the statutory implementation of diversity jurisdiction.
The History of Diversity Jurisdiction
In 1789, Congress granted federal courts diversity-based jurisdiction. Congress’ first attempt at extending this diversity-of-citizenship jurisdiction was contained in Section 11 of the First Judiciary Act. It stated that the federal courts, concurrent with the courts of the states, shall have jurisdiction in actions “where the matter in dispute exceeds, exclusive of costs, the sum or value of five hundred dollars, and …the suit is between a citizen of the State where the suit is brought, and a citizen of another State.” It is interesting to note that, unlike the other potential grants of jurisdictions, Congress decided not to extend federal court jurisdiction to its fullest, as authorized in the Constitution. Federal courts could not hear all cases between citizens of different states, only those involving $500 or more.
In 1809, the Supreme Court of the United States was faced with the question of how to categorize the “citizenship” of a corporation for diversity-based jurisdiction. Writing for the Court, Chief Justice John Marshall reasoned that, because a corporation “is a collection of many individuals united into one body, under a special name…with the capacity of acting in several respects as an individual[,]” when determining jurisdiction, a court should consider the citizenship of the individual members. Bank of U.S. v. Deveaux, 5 Cranch 61, 64-65, 90-91 (1809). Interestingly, the Court, due to past rulings examining diversity jurisdiction, such as Strawbridge v. Curtiss, 3 Cranch 267 (1806), ruled that each of the shareholders of the corporation must be capable of supporting the diversity jurisdiction, i.e., there must be complete diversity among shareholders and other parties.
The Deveaux approach prevailed until 1844, when the Supreme Court decided Louisville, C. & C.R. Co. v. Letson, 43 U.S. 497 (1844). After an exhaustive discussion of the case law surrounding diversity-based jurisdiction, including Deveaux, and a discussion of agency and acts of a corporation, the Court stated, “[t]he residence of a corporation is not determined by the residence of its members, nor by that of the president and directors. A corporation created by a law of South Carolina, and for an object to be pursued in South Carolina, must have its location there, and nowhere else.” Letson, 43 U.S. at 535. The Court further stated, “[i]t is by no means clear that a corporation is held to reside where its principal office is.” Id. Thus, in Letson, the Supreme Court articulated a new rule – for the purposes of diversity jurisdiction, a corporation was a citizen of the state in which it was incorporated.
In 1958, Congress intervened to further clarify the citizenship of a corporation. It enacted what is now 28 U.S.C. § 1332(c)(1), which states, “a corporation shall be deemed to be a citizen of any State by which it has been incorporated and of the State where it has its principal place of business[.]” While Congress’ intent may have been to clarify the citizenship of a corporation, this new standard, the “principal place of business” standard, proved very difficult for many courts to apply consistently.
Courts have interpreted “principal place of business” in numerous ways. As the Supreme Court noted in Hertz Corp. v. Friend, citing Moore’s Federal Practice: 1) the First Circuit employs both the “center of corporate activities” test and the “locus of operations” test; 2) the Second, Fifth, Ninth, and Eleventh Circuits use different applications of a two part test that looks to whether a corporation’s activities are centralized or decentralized and applying either the “place of operations” or “nerve center” test; 3) the Third Circuit applies the “center of corporate activities” test which relies on the headquarters of the corporation’s day to day activities; 4) the Fourth Circuit applies both the “nerve center” and “place of operations” tests; and 5) the Tenth Circuit applies the “total activity of the company considered as a whole” test. 130 S.Ct. 1181, 1191-92 (2010).
Hertz v. Friend: The Supreme Court Defines “Principal Place of Business”
After allowing each Circuit Court to interpret “principal place of business” as it saw fit, in 2010, the Supreme Court intervened. Justice Breyer, writing for a unanimous court, issued the definitive opinion on the meaning of 28 U.S.C. § 1332(c)(1)’s use of the phrase “principal place of business.” Justice Breyer, after discussing much of the history cited above, wrote, “[w]e conclude that ‘principal place of business’ is best read as referring to the place where a corporation’s officers direct, control, and coordinate the corporation’s activities.” Hertz, 130 S.Ct. at 1192. This most closely approximates the “never center” test from several of the circuits.
The Court allowed for the fact that this may sometimes “produce results that seem to cut against the basic rationale for 28 U.S.C. § 1332[.]” Id. at 1194. In spite of that, the Court held, “in view of the necessity of having a clearer rule, we must accept them.” Id. An example the Court cited was a corporation that did the bulk of its business in New Jersey, while its “top officers direct those activities just across the river in New York.” Id. In such a case, pursuant to the “nerve center” test, the principal place of business would be New York. Id.
While lawyers can differ in preference for state or federal court (and it really should be a case to case determination), every lawyer should want the option. With a clear path going forward, corporations who foresee litigation (for whatever reason) now can make a plan. For purposes of diversity, the state of incorporation and the nerve center of the corporation are the relevant factors.
Corporations should give serious consideration to the first application of the “nerve center” test they encounter. Within a circuit, there could be collateral estoppel issues after that first determination.
By Will Helou