Tuesday, May 8, 2018

Delaware Courts Should Do Better On Entities & LLC Diversity Jurisdiction Is Wrong

If I have learned anything over the years, it is that I should not expect any court to be immune from messing up entities. Delaware, as a leader in business law and the chosen origin for so many entities, though, seems like a place that should be better than most with regard to understanding, distinguishing, and describing entities.  Sometimes they get things rights, as I argued here, and other times they don't.  A recent case is another place where they got something significant incorrect. 

The case starts off okay:

Plaintiffs brought this action under federal diversity jurisdiction, 28 U.S.C. § 1332(a)(1), asserting that complete diversity of citizenship exists among the parties. In Defendants’ Motion to Dismiss, however, they argue that complete diversity of the parties is lacking. Federal jurisdiction under § 1332(a)(1) requires complete diversity of citizenship, meaning that “no plaintiff can be a citizen of the same state as any of the defendants.” Midlantic Nat. Bank v. Hansen, 48 F.3d 693, 696 (3d Cir. 1995); Exxon Mobil Corp. v. Allapattah Servs., Inc., 545 U.S. 546, 553 (2005). 

Cliffs Nat. Res. Inc. v. Seneca Coal Res., LLC, No. CV 17-567, 2018 WL 2012900, at *1 (D. Del. Apr. 30, 2018).
 
But, the court continues (my comments below): 
A natural person is a citizen of “the state where he is domiciled,”1 and a corporation is a citizen of the state where it maintains its principal place of business, as well as the state where it is incorporated. Zambelli Fireworks Mfg. Co. v. Wood, 592 F.3d 412, 418 (3d Cir. 2010). For purposes of § 1332, the citizenship of a limited liability corporation2 (“LLC”) is determined “by the citizenship of each of its members.” Id. Plaintiff Cliffs Natural Resources Inc. is incorporated in Ohio, and Plaintiff CLF Pinnoak LLC is incorporated3 in Delaware and maintains its principal place of business in Ohio. Third Am. Compl. ¶¶ 3–4, ECF No. 162. In moving to dismiss this action for lack of jurisdiction, Defendants assert that Seneca Coal Resources, LLC, a Delaware corporation,4 includes members who are Ohio citizens, thus destroying complete diversity as required for § 1332.
1 Or she? Is it that hard to note that the statute applies, regardless of gender?  
No. A citizenship of a "limited liability company" is determined by the citizenship of its members. 
3 Nope, again.  An LLC is formed, not incorporated. 
4 And one more time, no. It's a Delaware LLC.  There's a whole act just for LLCs
 
This is a rather run of the mill goof, and it appears the court when on to assess the issues before it correctly, even refering to LLCs correctly later in the opinion. I share it in part because this reminded me of another thing that bugs me: I still hate this rule for diversity jurisdiction of LLCs.  I know I am not the first to have issues with this rule. 
 
I get the idea that diversity jurisdiction was extended to LLCs in the same way that it was for partnerships, but in today's world, it's dumb. Under traditional general partnership law, partners were all fully liable for the partnership, so it makes sense to have all partners be used to determine diversity jurisdiction.  But where any partner has limited liabilty, like members do for LLCs, it seems to me the entity should be the only consideration in determing citizenship for jurisdiction purposes. It works for corporations, even where a shareholder is also a manger (or CEO), so why not have the same for LLCs.  If there are individuals whose control of the entity is an issue, treat and LLC just like a corporation. Name individuals, too, if you think there is direct liability, just as you would with a corporation. For a corporation, if there is a shareholder, director, or officer (or any other invididual) who is a guarantor or is otherwise personally liable, jurisdiction arises from that potential liability.
 
Okay, so I admit I am being a little lax in my civil procedure descritpions, but you get the point.  We should hold shareholders to the same standards as member or limited partners (or not). If we want a liability test or a control test, lets use that.  Or maybe I have missed something. I often reinforce the idea that LLCs, partnerships, and corporations are different entities, so different rules are often appropriate. Still, for this issue, I think the distinction between LLCs and corporations in this instance is false (or at least poorly justified).   I am open to other views, but for now, that's where I am on it right now.  
 
Lastly, it's Election Day here in West Virginia and in many places around the country.  I found my candidate -- I encourage you to find yours and go vote. Make your voice heard. 
 

http://lawprofessors.typepad.com/business_law/2018/05/delaware-courts-should-do-better-on-entities-llc-diversity-jurisdiction-is-wrong.html

Corporations, Delaware, Joshua P. Fershee, LLCs | Permalink

Comments

Josh, I suggest you have it backwards in suggesting that LLCs should be subject to the same rules of diversity jurisdiction as are applied to corporations. Corporations are the weird case consequent to special rules adopted in 1332 that apply only to entities that are incorporated. Consistency would entail removing the corporation’s special status and subjecting them to the same rules that apply to (nearly all) other business organizations.

Not that it matters what we think. Congress is not going to change the rule, And the courts, including the Supreme Court, have been very clear that nothing is going to be changed in this area unless and until Congress changes the rules.

Posted by: Thomas E. Rutledge | May 8, 2018 2:02:32 PM

Thanks for the comment, Tom. I don’t think we’re that far apart. My big picture view is the whatever the rule is, it should be consistent based on the rationale behind the rule. My suggestion above is consistent what I think is the practical reality that, as I think we agree, no one is going to change the rule as to corporations. As such, I’d be okay with bringing other entities in line, at least for similarly situated equity holders. If that runs amok, then maybe we’d actually see a legislative solution to address the real issue. Even writing that I see my suggestion is not much more likely to happen. Still, the inconsistency rubs me the wrong way.

Posted by: Joshua Fershee | May 8, 2018 2:20:57 PM

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