Tuesday, September 22, 2015
This post is related to another great post from Tom Rutledge at the Kentucky Business Entity Law Blog, Diversity Jurisdiction and Jurisdictional Discovery: The Third Circuit Holds That “Hiding The Ball” Will Not Work. Tom's post is about Lincoln Benefit Life Company v. AEI Life, LLC, No. 14-2660, 2015 WL 5131423, ___ F.2d__ (3rd Cir. Sept. 2, 2015), which is available here.
Lincoln Benefit allows a plaintiff, after a reasonable inquiry into the resources available (like court records and public documents), to allege complete diversity in good faith, if there is no reason to believe any LLC members share the same state of citizenship. Thus, the diversity claim can be made on "information and belief." Tom explains that
While it may do nothing to address the fact that diversity jurisdiction may be unavailable consequent to de minimis indirect ownership . . . it does limit the ability of a defendant to “hide the ball” as to its citizenship while objecting that the other side has not adequately pled citizenship and therefore diversity.
This concern arises out of the fact that LLCs, as unincorporated associations, are treated like partnerships for purposes of federal diversity jurisdiction, meaning that an LLC is a citizen of every state in which it has a member. Thus, if an LLC has members that are partnerships or other LLCs, then a plaintiff would need to drill down all the way until they find get to natural people or corporations to know all the states in which the LLC is a citizen. (As a reminder, under 28 U.S.C. § 1332, federal diversity jurisdiction requires that the dispute both involve more than $75,000 and that there be complete diversity between all plaintiffs and all defendants.)
For corporations, the statute provides: "a corporation shall be deemed to be a citizen of every State and foreign state by which it has been incorporated and of the State or foreign state where it has its principal place of business . . . ."
Some may argue that LLCs, with the limited liability shield for all members, are just like corporations and should be treated as such for diversity purposes. I think there is instant appeal to treating LLCs as corporations in that setting, but after further thought, I don't think it's as simple as it looks (at least, not for me). As one who continues to argue that LLCs and corporations are distinct entities, I think there is a real (and valid) difference between "incorporated" as required under § 1332 and the more general term, "formed."
I would agree that one can make a reasonable argument (though I think contrary to § 1332, and not my choice) that where limited liability applies to all unit holders (or members), then the corporation rule for diversity should apply to all entities that are formed (not just incorporated). If so, though, then that would likely include LPs and LLLPs, too, because any entity that requires filing, (i.e., all limited liability entities) could then reasonably be views as "formed" under state law. That is okay, if that's the desired policy, but it's not limited to LLCs in that case.
Still, there are those who would argue that one can interpret "incorporated" in § 1332 to mean "formed," but I think that's wrong. "Formed" has its origins in partnership law. See, e.g., Uniform Partnership Act § 202 (1997) ("Formation of partnership."). Id.§ 202(c) ("In determining whether a partnership is formed, the following rules apply . . . ."). A legislature could make such a change, but it should be a legislative change.
Despite the best efforts of thousands of courts, LLCs are formed, not "incorporated." See Uniform LLC Act § 202(d): "(1) A limited liability company is formed when the [Secretary of State] has filed the certificate of organization and the company has at least one member, unless the certificate states a delayed effective date pursuant to Section 205(c)." As such, under current law for federal diversity, "incorporated" applies to corporations only.
Beyond that, as to LLCs specifically, I think there is a difference between member-managed LLCs and manager-managed LLCs in carrying out the corporate analogy. That is, a manager-managed LLC is (usually) quite comparable to a corporation and a member-managed LLC is more easily compared to a partnership. That raises the question: should there be a control test, if that's really the question, as to how diversity applies? There is no control test for close corporations, either, I would note, and instead a bright line is applied by entity, not control or risk of liability.
Furthermore, if it's just the concept of complete limited liability, I would argue that an LP with a corporate GP (that only operates for the purposes of that LP) is functionally similar to an LLC in terms of liability, yet there seems to be less of a question how we analyze the LP for diversity purposes.
It seems to me Lincoln Benefit got the test right, under current law. Let's see how that goes before we start conflating LLCs and corporations in yet another area.