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Supreme Court Decision Clarifies Diversity Statute’s Terminology

By Teresa Rider Bult, Litigation News Associate Editor – May 5, 2010

The U.S. Supreme Court decision in Hertz v. Friend [PDF] has been touted as an overdue clarification of the federal diversity statute’s definition of “principal place of business,” but critics say it erodes states’ rights, promotes forum-shopping, and unfairly benefits corporations.

Under the federal diversity jurisdiction statute, defendants may remove a case from state to federal court if they are citizens of another state. The purpose behind the statute is to ensure “foreign” defendants are not prejudiced by local bias.

Because corporations are somewhat of a unique legal entity, the diversity statute carved out a specific definition of citizenship for them. Early on, corporations were considered to be citizens of their state of incorporation. In 1958, to reduce the number of diversity cases and to prevent corporations from forum shopping, Congress added an additional component; it stated that corporations would also be considered citizens of those states where they maintained their “principal place of business.”

In 2007, Hertz removed a state-law based class action from a California Superior Court to federal court, alleging that the company’s headquarters were in New Jersey, ergo its principal place of business was in that state.

Relying on the Ninth Circuit’s established “business realities test,” the District Court remanded the case back to state court. Hertz appealed.

The Ninth Circuit maintained its established “business realities test” precedent, more specifically, that a corporation’s principal place of business is dictated not by corporate headquarters, but whether the business is “significantly larger” or “substantially predominates” in the state.

Because Hertz, by its own admission, conducted more business in California than any other state, the court found the company’s principal place of business to be in California.

The U.S. Supreme Court unanimously disagreed, rejecting the Ninth Circuit’s business realities test in favor of the Seventh Circuit’s “nerve center test.” The Court ultimately held a corporation’s “principal place of business” refers to its “nerve center,” or “the place where a corporation’s officers direct, control, and coordinate the corporation’s activities.”

It found this location will “normally be the place where the corporation maintains its headquarters—provided that the headquarters is the actual center of direction, control, and coordination . . . and not simply an office where the corporation holds its board meetings . . .”

In making this decision, the Supreme Court found the “business realities test” was unworkable and would likely require each state to perform a complicated statistical analysis of what constituted “substantially larger business.”

It noted the test could result in uneven findings, and that California could assert almost every corporation in America was a citizen for purposes of diversity jurisdiction, due to California’s large density and the amount of business resulting from its population.

The Court recognized that not every case analyzed under this standard would be easy and that it might “in some cases produce results that seem to cut against the basic rationale for the diversity statute.”

Even so, the Court found this anomaly was “the price the legal system must pay to avoid overly complex jurisdictional administration while producing the benefits that accompany a more uniform legal system.”

The Corporate Reaction
Corporations are calling the ruling a huge victory for companies all over the United States.

“The ruling provides a common-sense approach which simplifies this thorny procedural question, making it easier for lower court interpretation and enforceability,” says Frank B. Shuster, Atlanta, a member of the ABA Section of Litigation and one of the attorneys representing Hertz in the matter.

“And it provides corporations, who do business in many states, to be able to litigate in a more uniform manner, with federal court rules, which are more standardized and sometimes easier to administer, compared to state rules,” Shuster says.

Allowing corporations some control over the federal versus state forum provides more equality, because “there is a perception among some defendants that a state court may be biased in favor of a local company,” he notes.

Others Express Forum Shopping Concern
Some feel that is precisely the problem. “While the Supreme Court ruling certainly provides clarity, which was needed among the circuits, it arguably does so by allowing forum-shopping, which undermines the underlying purpose of the diversity statute,” says Alan G. Crone, Memphis, cochair of the Employment Law Subcommittee of the ABA Section of Litigation’s Class Actions and Derivative Suits Committee.

“The entire reason Congress added the term, ‘principal place of business’ into the statute in 1958 was to ensure that corporations that are actually ‘local’ cannot evade their home state courts,” Crone says.

The ruling puts at risk well-entrenched federal doctrines that favor allowing state courts to enforce state laws, Crone opines.

“The business community has an unjustified fear of state courts, but they are the best places to adjudicate state laws,” he adds.

“There is no justification to allow corporations that have a large economic impact on a state to ‘opt-out’ of state court. If a company wants the benefit of a particular state’s economy, then it should be subject to the jurisdiction of that state’s courts,” says Crone.

Keywords: Litigation, business law, federal diversity statute, Supreme Court, Hertz v. Friend

Related Resources
  • Diversity Timeline
  • »1787—Constitution provides basis for diversity jurisdiction (U.S. Const. Art III, § 2, “the judicial power shall extend . . . to Controversies . . . between citizens of different states; . . . and between a State, or the Citizens thereof, and foreign States, Citizens, or Subjects.”).

  • »1789—Diversity Statute passed.

  • »1809—Bank of United States v. Deveaux, decided by U.S. Supreme Court, finding that corporations could invoke the diversity jurisdiction of the United States.
  • »1854—In Marshallv. Baltimore & Ohio R. Co., Supreme Court found that for diversity purposes, a corporation would be considered a citizen of the state of its incorporation.
  • »1928—High Court made clear that the “state of incorporation” rule was virtually absolute—Black & White Taxicab & Transfer Co. v. Brown & Yellow Taxicab & Transfer Co., 276 U.S. 518, 522–525.

  • »1932—Movement begins to abolish diversity rule for corporations as abuse of federal procedure.

  • »1938—Supreme Court decides Erie Railroad v. Tompkins, holding federal courts exercising diversity jurisdiction must apply the same substantive law as their state court counterparts.
  • »1952—Congressional committee to analyze whether diversity jurisdiction should be abolished for corporations.

  • »1958—Term “principal place of business” added to diversity statute.

  • »1988—Amount in Controversy requirement increased from $10,000 to $50,000.

  • »1996—Amount in Controversy requirement increased to $75,000.
  • »2005—Class Action Fairness Act enacted, giving federal courts jurisdiction to hear certain class actions based on diversity of citizenship and where amount in controversy exceeds $5 million.

  • »2010—

  • Articles
  • »Marcia Coyle, Home Court Showdown at the Supreme Court, NAT’L L. J., Nov. 10, 2009.

  • »Marcia Coyle, Supreme Court Establishes “Nerve Center” Test for Corporate Jurisdiction, NAT’L L. J., Feb. 24, 2010.

  • »Robert Rothman, Supreme Court Gives Companies Weapon to Fend Off Plaintiffs, BUS. ETHICS, Apr. 5, 2010.

  • »Supreme Court Decision in Hertz Case a Small Victory for Federalism, Constitutional Patriots, Feb. 23, 2010.


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