Supreme Court Clarifies Diversity Jurisdiction Standard

In a unanimous decision on February 23, 2010 in Hertz v. Friend, et al., No. 08-1107, --- S.Ct. ----, 2010 WL 605601, the Supreme Court clarified the test federal courts should apply to determine a corporation’s citizenship for purposes of diversity jurisdiction, holding that corporations are citizens of the state of their ​“nerve center” – usually their corporate headquarters – not of any state where a plurality of their business activity occurs. The decision resolves great uncertainty amongst federal courts regarding the test for corporate citizenship and should give businesses greater peace of mind about where they are and are not subject to high stakes class action litigation in state court.

Background

Federal courts have ​“diversity” jurisdiction over any civil actions in which the amount in controversy exceeds $75,000 and the parties are citizens of different states, and any class actions in which the aggregated amount in controversy exceeds $5,000,000 and any member of the putative class is a citizen of a different state from any defendant. 28 U.S.C. § 1332. The federal diversity jurisdiction statute provides that a corporation is a citizen of its state-of-incorporation and ​“of the State where it has its principal place of business.” 28 U.S.C. § 1332(c)(1).

For years, federal courts have grappled with how to determine a corporation’s ​“principal place of business.” The 7th Circuit has applied the simplest test, known as the ​“nerve center” test, deeming corporations residents of any state in which the majority of its executive and administrative functions are performed. See Wisconsin Knife Works v. Nat’l Metal Crafters, 781 F.2d 1280, 1282 (7th Cir. 1985) (“The test in this circuit for principal place of business is ​‘nerve center,’ . . . we look for the corporation’s brain, and ordinarily find it where the corporation has its headquarters.”). Other circuits, including the 9th, have applied several variations of the ​“total activity” test, which assesses the amount of the corporation’s activity in each state and deems the corporation a citizen of any state in which its activity is ​“significantly larger” or ​“substantially predominates” over its activity in other states. These circuits have typically held that if there is no such state, the ​“nerve center” test should apply. See, e.g., Harris v. Black Clawson Co., 961 F.2d 547, 549 (5th Cir. 1992). Cf. Torres Vazquez v. Commercial Union Ins. Co., 417 F. Supp. 2d 227 (D.P.R. 2006) (“In the First Circuit, the ​‘nerve center test’ applies only to far-flung corporations or corporations without physical operations, while the principal place of business of a corporation that has the bulk of its physical operations in one state is to be determined under the ​‘locus of operations’ test even when the corporation’s executive offices are located in another state.”).

As the Supreme Court notes in Hertz, federal courts applying these various tests have looked to a growing number of different factors, with different cases highlighting different factors or emphasizing similar factors differently, and ​“different circuits (and sometimes different courts within a single circuit) have applied these highly general multifaceted tests in different ways.” Slip Opinion at 12.

The effect has been continued uncertainty for corporations about where they are subject to high-dollar or class action litigation in state courts, as well as the expenditure of countless litigation dollars spent on jurisdictional discovery in circuits where variations on the ​“total activity” test have been applied.

The Hertz Decision

In Hertz, the Supreme Court set out to resolve these differing interpretations. At issue was a class action filed against Hertz rental car company in California state court. Hertz attempted to remove the case to federal court on grounds that it was a citizen of New Jersey, where it is incorporated and maintains its headquarters. The district court, applying the Ninth Circuit’s ​“total activity” test, remanded the case to state court on grounds that a plurality of Hertz’s relevant business activity occurs in California, making Hertz a California resident. Friend v. Hertz Corp., No. C-07-5222 MMC, 2008 WL 7071465 (N.D. Cal., Jan. 15, 2008). The Ninth Circuit affirmed. Friend v. Hertz Corp., 297 Fed.Appx. 690 (9th Cir. 2008).

Recognizing the disagreement between the circuits on the issue and the need for clarity, the Supreme Court rejected the Ninth Circuit’s interpretation of the diversity jurisdiction statute and blessed the ​“nerve center” test for all diversity cases. Adopting and expanding on an approach articulated by the late District Judge Weinfeld in Scot Typewriter Co. v. Underwood Corp., 170 F. Supp. 862 (D.C.N.Y. 1959), and applied in the Seventh Circuit, the Court held that

‘[P]rincipal place of business’ is best read as referring to the place where a corporation’s officers direct, control, and coordinate the corporation’s activities. It is the place that Courts of Appeals have called the corporation’s ​‘nerve center.’ And in practice it should normally be the place where the corporation maintains its headquarters

Slip Op. at 14. The Court cautioned that the corporate headquarters will not be considered the principal place of business if it is not the actual center of direction, control, and coordination, such as if it were ​“simply an office where the corporation holds its board meetings.” Id.

The Court justified the opinion as best serving the legislative intent behind the diversity jurisdiction statute, administrative simplicity, and predictability.

Implications for Corporate Defendants

The Court’s decision should be welcome news to corporate defendants, as it will provide greater certainty and predictability about where corporations are subject to class action and other high-stakes state court litigation. Corporations can be sure that for purposes of diversity jurisdiction, they are residents only of their state-of-incorporation and their headquarter offices. As the Supreme Court noted, such predictability ​“is valuable to corporations making business and investment decisions. . . [and] also benefits plaintiffs deciding whether to file suit in a state or federal court.” Id. at 16. The decision should also put and end to disputes about where defendant corporations conducted a plurality of their business activity. For example, Hertz was required in the district court to disclose detailed facts and figures regarding the location of its employees, tangible property, production activities, sources of income, and sales, showings that will no longer be necessary to establish diversity jurisdiction as a result of Hertz.

Finally, the decision is good news for companies who find themselves subject to class action and other high-stakes litigation in populous states such as California. Given that states such as California have populations significantly larger than those of many others, the Court in Hertz noted that applying the ​“total activity” test could ​“award or decline diversity jurisdiction on the basis of a state’s population,” resulting in “‘nearly every national retailer—no matter how far flung its operations—[being] deemed a citizen of California for diversity purposes.’” Id. at 15 (quoting Davis v. HSBC Bank Nev., N.A., 557 F.3d 1026, 1029-30 (9th Cir. 2009)). This is no longer a problem after Hertz – companies will not be deemed residents of a given state simply because they cater to larger populations there or a plurality of their activities otherwise occur there. This is particularly good news for companies doing business in California, which is a hot-bed of consumer class action activity with state courts that can be unfavorable to corporate defendants.