DIVERSITY JURISDICTION AND “L” ENTITIES – THE IMPORTANCE OF GETTING IT RIGHT AND THE TRAUMA OF

GETTING IT WRONG  

Prepared for CT Corporation November 17, 2015

  

Thomas E. RutledgeStoll Keenon Ogden PLLC

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[I]N A DIVERSITY CASE, WHENEVER THERE IS AN UNCONVENTIONAL PARTY (THAT IS, SOMEONE OR SOMETHING OTHER THAN EITHER A NATURAL PERSON SUING IN HIS OWN RATHER THAN A REPRESENTATIVE CAPACITY, OR A BUSINESS CORPORATION), A JURISDICTIONAL WARNING FLAG SHOULD GO UP.

Cosgrove v. Bartolotta, 150 F.3d 729, 731 (7th Cir. 1998)

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Diversity JurisdictionFederal diversity jurisdiction is conditioned on two requirements – the amount in controversy must exceed $75,000, and there must be “complete diversity,” meaning that no defendant may have the same “citizenship” as any plaintiff.

Determining the citizenship of unincorporated business organizations, many of which are the recently incarnated “L” Entities such as the limited liability company, the limited liability partnership, the limited liability limited partnership and the limited cooperative association, is a far more involved task than is determining the citizenship of a traditional business or nonprofit corporation.

While not “L” Entities, this group includes as well the unincorporated nonprofit association and the statutory trust.

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Belleville Catering Co. v. Champaign Marketplace, LLC

Consider the following scene: an attorney is sitting at his/her desk, reading a just received appellate decision. The blood drains from his/her face as the first line is read, namely:

“Once again, litigants’ insouciance toward the requirements of federal jurisdiction has caused a waste of time and money.”

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Belleville Catering Co. v. Champaign Marketplace, LLC

Bringing us to the remedy ordered by the 7th Circuit:

“The costs of a doomed foray into federal court should fall on the lawyers who failed to do their homework, not on the hapless clients. Although we lack jurisdiction to resolve the merits, we have ample authority to govern the practice of counsel in the litigation. The best way for counsel to make the litigants whole is to perform, without additional fees, any further services that are necessary to bring this suit to a conclusion in state court, or via settlement. That way the clients will pay just once for the litigation. This is intended not as a sanction, but simply to ensure that clients need not pay for lawyers’ time that has been wasted for reasons beyond the clients’ control.”

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28 USC § 1332 - Diversity of citizenship; amount in controversy; costs.

A.The district courts shall have original jurisdiction of all civil actions where the matter in controversy exceeds the sum or value of $75,000, exclusive of interest and costs, and is between—1. citizens of different States.

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(c) For the purposes of this section and section 1441 of this title --5. 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.

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Corporate CitizenshipBy statute, a corporation is deemed a citizen of both (a) the jurisdiction of incorporation and (b) the jurisdiction in which the corporation maintains its principal place of business.

Where a corporation is incorporated is seldom going to be a challenge.

While there have over the years developed a variety of alternative (and sometimes conflicting) test as to where is the “principal place of business,” in Hertz Corp. v. Friend the US Supreme Court held that, for purposes of determining the “State where a [corporation] has its principal place of business” under 28 USC § 1332, it will utilize the “nerve center” test, directing that the focus be upon the “place where a corporation’s officers direct, control and coordinate the corporation’s activities.” 

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So What Is The Treatment Of Entities That Are Not “Corporations”?

In Carden v. Arkoma Associates, the Supreme Court held that a limited partnership, for purposes of diversity jurisdiction, has the citizenship of each of its partners, regardless of whether general or limited. The Carden majority rejected a “real party in interest” analysis of the limited partnership, and, although agreeing that it is “undoubtedly correct” that limited partnerships are “functionally similar to other entities that are treated as having their citizenship determined on a less restrictive basis than that of all the constituent owners,” rejected such a functional analysis as Congress had used the terms “corporation” and “incorporated” in 28 USC § 1332. In so doing, the Court held that the citizenship of the limited partners, as well as the citizenship of the general partners, would be assessed in determining the availability of diversity jurisdiction in a suit brought by or against a limited partnership.

Carden v. Arkoma Associates, 494 U.S. 185 (1990).

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Lets Be Clear – None of the Capacity to Sue and Be Sued Nor “Entity” Characterization

MatterMost modern unincorporated business organization acts expressly provide that the business organization, as an entity, may sue and be sued in its own name. Still, the ability of a business organization to sue or be sued in its own name does not alter the fact that none of these organizations is either a “corporation” or “incorporated” and does not indicate the characterization of the organization “incorporated” for purposes of 28 U.S.C. § 1332(c).

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Lets Be Clear – Tax Classification Does Not Matter

There has been rejected the notion that an LLC’s election to be classified for tax purposes as a corporation affects its treatment for purposes of diversity jurisdiction:

“Similarly, Spara’s elective decision to be treated as a corporation for tax purposes does not somehow transform its LLC status for purposes of evaluating diversity jurisdiction. The motivations behind a business entity’s choice to be taxed in a certain manner have no bearing on the rationale for evaluating the citizenship of each member of an LLC.”

Fairfield Castings, LLC v. Hofmeister, 2015 WL 4105027 (S.D. Iowa July 2, 2015)

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A Limited Liability Company (LLC) Is Unincorporated And Is Deemed To Have

The Citizenship Of Each Member

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A Limited Liability Partnership (LLP) Is Unincorporated And Is Deemed To Have

The Citizenship Of Each Of Partner

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Jurisdiction Of Organization And Principal Place Of Business Are Irrelevant

This is both counter-intuitive and crucial – in the realm of assessing the citizenship of an unincorporated organization, both jurisdiction of organization and principal place of business are irrelevant.

Certain early decisions such as Carlos v. Adamany which looked to the principal place of business of an LLC to determine its citizenship have now been soundly rejected and do not constitute good law. hence the rule for unincorporated organizations is entirely divorced from that for corporations as they look only to jurisdiction of incorporation and principal place of business.

Qualification To Transact Business Is Irrelevant

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With The General Rule Now In Hand, Let’s Talk About Some Wrinkles, Like A Citizenship

Of A Partnership With Non-US Resident Partners

Cresswell v. Sullivan & Cromwell

There is no diversity jurisdiction if a partner/owner of an unincorporated business organization is a U.S. citizen domiciled outside the United States.

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Partners Come And Partners GoProvident Energy Associates of Montana v. Bullington

“Where, pursuant to state law, an LLC member had ceased to be a member by reason of its bankruptcy, that member’s citizenship was not relevant for diversity purposes.”

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But Who Is A Partner?Morson v. Kreindler & Kreindler, LLP

The court considered whether a “contract partner’s” residency would be attributed to a partnership. The contract partner in question received a Form W-2, not a Form K-1, had no voting rights in the firm and did not share in its profits or losses. Ergo, he was not a partner but rather a mere employee.

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Don’t Stop Until You Are DoneIn a world of complicated, multi-layer structures, it is crucial that the diversity analysis be continued through all upstream layers until it reaches natural persons, corporations or other forms that have for themselves citizenship.

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There Is No De Minimis Member Exemption, And “I Don’t Know” Is Not An Excuse

Fadal Machining Centers, LLC v. Mid-Atlantic CNC, Inc.

In response to a de minimis argument, namely that “‘SP MAG Holdings, LLC’s Membership Interest should be disregarded for purposes of determining citizenship,’ because the company holds ‘only a severely fractionalized interest with no control over the day-to-day operations’ of MAG,” and that interest being as well non-voting, the Court stated that “the character of [SP MAG Holdings’] membership interests is irrelevant to the determination of its citizenship,” citing Carden v. Arkoma Assocs. “Scant though Mr. O’Shea’s interest in the Appellants, the rules governing subject matter of jurisdiction are ‘inflexible and without exception,’” again citing Carden.

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There Is No De Minimis Member Exemption, And “I Don’t Know” Is Not An Excuse

Alphonse v. Arch Bay Holdings, L.L.C.

Declaring as “unpersuasive” plaintiff’s argument that “an absurdity exists in this case because the non-diverse member is in fact a member of a member of one of Arch Bay’s members, is a limited partner with no managerial responsibilities, and was difficult to locate.”

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When Is Diversity Determined?Grupo Dataflux v. Atlas Global Group, L.P.

• At the time the action is filed or removed

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A Business Trust is Unincorporated, but Less SoNavarro Savings Ass’n v. Lee

•Suit by Trust or Suit by Trustees?

•Trustees or Trustees and Beneficiaries or Beneficiaries

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And There Is No Clear Rule As To Donative Trusts

Trustees v. Trustees & Beneficiaries

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Facial Attacks On Diversity Jurisdiction; Lincoln Benefit Life v. AEI Life, LLC

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Implications of Citizenship of Unincorporated Business Organizations

• Action Between Unincorporated Association and Any of Its Members

• Derivative Actions

• Nationwide “Partnerships” Are Not Subject to Diversity Jurisdiction

• Actions for an Accounting

• Action for Judicial Dissolution

• Publicly Traded Master Limited Partnerships

• Unincorporated Associations with Complicated, Multi-Level Ownership

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The ABA Proposal To Amend 28 U.S.C. § 1332