Date: March 22nd, 2010
Categories: Corporate Law

It’s the question on every CEO’s or CFO’s mind:

“Which is my business’ state of corporate citizenship for purposes of federal diversity jurisdiction under 28 U.S.C. § 1332?”

Okay, maybe not.

Perhaps it’s far more accurate to say that most corporate executives aren’t concerned on a daily basis about issues of corporate citizenship and federal diversity jurisdiction. However, that all changes, or should change, when the process server shows up with a Summons and Complaint naming the company as a defendant in a State court lawsuit. If a company is headquartered in one State and does business in one or more other States, knowing the company’s state of corporate citizenship becomes important to litigation strategy if the company is sued in a state other than where its headquarters is located.

Why? Assume a hypothetical business that is incorporated and headquartered in Washington and has operations in Oregon, California, Idaho and Nevada. Assume further that the corporation is sued in a Nevada state court. The plaintiff claims the Nevada state court has jurisdiction over the corporation because the corporation does business in Nevada. For its own reasons, the corporation believes that the Nevada state court will be biased toward the Washington-based corporation. Because the plaintiff and defendant are diverse, meaning they are from different states, the defendant corporation now has the option to move the entire state court lawsuit into a federal court, where it might receive a more impartial hearing. This option is called “removal” and was created by the Judiciary Act of 1789 that granted federal trial courts jurisdiction in cases where the parties are diverse. This is called “diversity jurisdiction.”

Under 28 U.S.C. §1332(a)(1), a federal District Court has subject matter jurisdiction over civil cases between citizens of different states. ((The amount in dispute must also be in excess of $75,000.00 exclusive of interests and costs. 28 U.S.C. § 1332.)) The diversity in state citizenship grants the federal District Court “diversity jurisdiction” over the claim. This way, the out-of-state litigant can avoid the bias of the in-state jury. Pursuant to 28 U.S.C. §1332(c)(1), “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…” While it is easy to determine where a corporation has been incorporated, the process for determining a corporation’s “principal place of business” has long been widely debated, creating a multitude of competing and inconsistent legal standards among the federal Circuit Courts of Appeal.

Thanks to the U.S. Supreme Court’s February, 2010, ruling in Hertz Corp v. Friend, the relationship between corporate citizenship and federal diversity jurisdiction is much easier to understand for both business owners and lawyers. In Hertz, two California employees sued defendant-employer Hertz Corporation (“Hertz”), in California state court alleging violations of California’s wage laws. Claiming that its principal place of business was New Jersey, and hoping to avoid appearing in front of an all-California jury accused of being the evil foreign corporation harming California workers, Hertz removed the case to federal District Court based on diversity jurisdiction. Applying a standard not unlike the “Business Activities” Test ((The “Business Activities” Test generally focuses more heavily on where a competition’s actual business activities were centered.)) , the federal District Court (and later the Ninth Circuit Court of Appeals) found that California was Hertz’ “principal place of business ((The Court based it’s finding on the fact that Hertz Corporation, which operated in 44 states, had (1) 73 of its 1,606 car rental locations in California; (2) about 2,300 of its 11,230 full-time employees in California; (3) about $ 811 million of its $4.371 billion in annual revenue derived from California; and (4) about 3.8 million of its approximately 21 million annual transactions occurring in California.)), ” defeating diversity jurisdiction, and requiring the Court to remand the case to the California state court.

The Hertz decision overruled the lower courts, and may have finally put an end to the debate and the uncertainty surrounding corporate citizenship by officially endorsing the “Nerve Center” Test.” The Nerve Center Test requires that for purposes of establishing diversity jurisdiction under 28 U.S.C. § 1332, a corporation’s “principal place of business” is where “its officers direct, control and coordinate the corporation’s activities” or where its “core executive and administrative functions” are carried out.”

This test represents a drastic simplification of the corporate citizenship/diversity jurisdiction analysis, and likely represents a major victory for companies doing business in multiple states. It’s now easier to protect your business from the perceived prejudices of foreign jurisdictions through diversity jurisdiction, because the critical path to having litigation removed to federal court is much more certain and attainable. If a company’s management team carries out its core executive and administrative functions in a particular state and is sued in another state, removing the state court litigation to federal court is now a stronger option with much greater odds for success. With the emerging prevalence of doing business online and other forms of commercial globalization, more and more “local businesses” are engaged in transactions in every state across the nation, exposing them to the threat of litigation in those foreign jurisdictions. However, if the core executive and administrative functions are kept in-state, the Hertz ruling makes it far less likely that such businesses will face the local prejudices of out-of-state juries, and far more likely that they can rely on the protections of 28 U.S.C. § 1332.

Any business owner, CEO or CFO tasked with operating a business in multiple states should proactively work together with their corporate counsel to identify the best ways to avoid the problems and complexities of out-of-state litigation. Whether that’s through an analysis and revision of the governing law and venue provisions in standardized contracts, or through the thoughtful reorganization of where core executive and administrative functions are geographically based, the Hertz decision reminds us that it is wise to think proactively about issues of corporate citizenship so that an opponent in out-of-state litigation doesn’t have home court advantage.