September 20, 2016

Diversity Jurisdiction and Unincorporated Entities: Recent Developments

There are many benefits to having a case in federal court as opposed to state court. For example, the Federal Rules of Civil Procedure create, for the most part, a streamlined process for a case throughout all stages of litigation. Moreover, in federal court there usually is one judge assigned to a case from start to finish, which allows for a more informed decision maker on the key factual and legal issues. Assuming the amount in dispute exceeds $75,000, a business organization may access the federal courts through diversity jurisdiction, which is dependent upon the organization’s ability to show that none of the plaintiffs share the same citizenship as that of any of the defendants. 28 U.S.C. § 1332. A natural person is a citizen of the state in which he or she is domiciled, and, by legislative act, a corporation is a citizen of its jurisdiction of incorporation and the jurisdiction in which it maintains its principal place of business. Within the last few years, the Supreme Court resolved the question as to which test should be utilized in determining the principal place of business, adopting the “nerve center” test. See Hertz Corp. v. Friend, 559 U.S. 77 (2010).

The situation is far more complicated for LLCs and other organizations that are not corporations. The rule for these entities is that the organization has the citizenship of each of its “members.” See Carden v. Arkoma Assoc., 494 U.S. 185 (1990) (holding that a limited partnership has the citizenship of each of its partners, whether general or limited). Compliance with this rule causes issues mostly with the access by LLCs and other unincorporated forms to federal courts on the basis of diversity jurisdiction. Several recent decisions provide guidance as to how those requirements may or may not be satisfied.

Americold Realty Trust v. ConAgra

The decision rendered by the Supreme Court in Americold Realty Trust v. ConAgra, No. 14-1382, 136 S. Ct. 1012 (Mar. 7, 2016), addressed how the Carden decision should be applied in the context of a modern business trust. In a 1980 decision, Navarro Savings Assn. v. Lee, 446 U.S. 458 (1980), the Supreme Court held that, where suit was brought on behalf of a traditional common-law business trust by and in the names of the individual trustees (a common-law trust lacks the capacity to sue or be sued in its own name), only the citizenship of those trustees is considered, not the citizenship of the trust’s beneficiaries.

In the decades since, there have been substantial changes in the law of business trusts. These organizations are now often organized pursuant to statutes that afford a business trust the capacity to sue and be sued in its own name. See, e.g., Del. Code Ann. tit. 12, § 3804(a); Ky. Rev. Stat. Ann. § 386A.3-060(1); Md. Corp. & Assns. Code Ann. § 8-301(2); Unif. Stat. Tr. Entity Act § 8-308, 6 (pt. 1) U.L.A. 675 (2015). In such a milieu, would Navarro or Carden control? The Americold decision considered and answer that question.

Americold was a real estate investment trust organized under Maryland law. ConAgra had been the plaintiff in state court. On the basis of diversity jurisdiction, the defendant removed to federal court. After it lost in trial court, ConAgra sought to set aside the verdict on the basis that diversity jurisdiction was lacking, thereby affording it another bite at the apple in state court. In support of its position, ConAgra argued that the citizenship inquiry should extend to all of its beneficial owners and not only the trustees. Not surprisingly, Americold, in reliance upon the Navarro decision, argued that its citizenship should be restricted to that of the trustees. The Tenth Circuit agreed with ConAgra and applied Carden to Americold. As the record lacked a listing of Americold’s shareholders and their citizenship, the Tenth Circuit held that there was a failure to show diversity of citizenship.

In a unanimous opinion authored by Justice Sotomayor, the Supreme Court restricted the Navarro decision to trusts that in and of themselves lack the capacity to sue and be sued. In contrast, because Americold was organized under a statute enabling it to sue and be sued in its own name, the rule of Carden was applied, and the citizenship of every beneficial owner in the trust will be attributed to it for purposes of assessing diversity jurisdiction.

Even as clarity has been added as to business trusts, there is no consensus as to whether, in the context of a common-law donative trust, citizenship is determined by reference to the trustees alone or to the beneficiaries as well.

There have already been two published decisions by federal courts applying the Supreme Court’s Americold decision. Specifically, in RTP LLC v. ORIX Real Estate Cap., Inc., Nos. 14-3671 & 15-1153, 2016 WL 3568090 (7th Cir. July 1, 2016), Americold was held to apply to certain pension-fund members of the plaintiff to the effect that they would be treated as members whose citizenship must be determined. In the second case, Wells Fargo Bank, N.A. v. Transcontinental Realty Investors, Inc., No. 3:14-cv-3565-BN, 2016 WL 357-0648 (N.D. Texas July 1, 2016), Americold was applied with respect to a securitization trust that was deemed the real party in interest.

In RTP LLC, ORIX loaned some $41,000,000 to RTP for the purchase of a commercial building in North Carolina. Although the loan was itself nonrecourse, RTP and an entity now named RSCD Opportunity Fund I, LLC, but previously named Inheritance Capital Group, LLC, executed conditional guarantees with respect thereto. Ultimately, the loan went into default, at which time ORIX accelerated the obligation and demanded that RTP and Inheritance satisfy their respective guarantees. Although it appears that they asserted the guarantees were invalid or on some other basis ineffective (the opinion does not address this point beyond a statement that they sought “a declaration that they do not owe ORIX anything beyond what can be paid out of the building’s assets”), the trial court held them liable to the tune of $30,000,000. This action before the district court had been brought on the basis of diversity jurisdiction.

It was also on this basis that the action would be largely set aside. RSCD Opportunity Fund I, LLC (formerly Inheritance Capital Group, LLC) has the citizenship of its members: two retirement plans, namely the General Retirement System of the City of Detroit and the Police and Fire Retirement System of the City of Detroit, each organized as a trust with the capacity to sue and be sued in its own name. In reliance upon, inter alia, Navarro, ORIX claimed that diversity jurisdiction should be assessed by looking only to the citizenship of the trustees of each of those trusts, ignoring for purposes of citizenship the citizenship of the beneficiaries of those trusts.

In reviewing the matter, the Seventh Circuit first held that two decisions, May Department Stores Co. v. Fed. Ins. Co., 305 F.3d 597 (7th Cir. 2002), and Hicklin Engineering, L.C. v. Bartel, 439 F.3d 346 (7th Cir. 2006), “did not survive Americold.” From there, the court observed, “the trusts themselves, not the trustees, are the members of the two LLCs. Detroit’s two pension funds contract (and litigate) in their own names. These trusts therefore have the citizenships of their own members.” The court also noted that the members of a trust of this nature include not only current participants who are paying into the trust fund, but also current beneficiaries thereof. Ultimately, in order to demonstrate diversity jurisdiction, ORIX, the party who sought removal in the first place, must investigate the domicile of each of the trusts that are in turn members of one of the guarantor parties. Specifically:

ORIX may think it pointless to conduct a detailed inquiry into the domiciles of the 59 persons who resided in these two states in 2013, especially because it would become necessary to consider the possibility that beneficiaries who then resided elsewhere (say, Oklahoma or Maryland) were domiciliaries of Texas or Delaware at the time. But ORIX may choose its own litigation strategy.

Ultimately, the judgment of the district court was vacated, and the case was remanded for further proceedings. It was specified that, if ORIX does not seek to determine the domicile of those trust beneficiaries as of 2013, “then the District Court must remand this litigation to state court.”

The second of these decisions, Wells Fargo, involved the treatment of a securitization trust. Wells Fargo initially filed this action in federal court on the basis of diversity jurisdiction. In doing so, it identified only its own citizenship, namely South Dakota, as the basis for diversity; Transcontinental is a Nevada corporation with its principal place of business in Texas. Transcontinental sought dismissal of the action on the basis that diversity did not exist. As summarized by the court:

Wells Fargo is the trustee of the Trust, and an unincorporated entity, and the Defendant argues that Wells Fargo cannot rely solely on its own citizenship for diversity jurisdiction. Instead, Defendant alleges, Wells Fargo must establish the diverse citizenship of all of the Trust’s members to establish diversity jurisdiction.

As any award of relief would be to the benefit of the trust, and not Wells Fargo alone, it was found that “a careful review of the complaint makes clear that Wells Fargo is only a nominal or formal party suing on behalf of the trust, which is the real and substantial party to the controversy with Defendant.”

Without parsing the particular characteristics of the trust at issue, the court held, inter alia, that it is not a traditional, donative trust, but rather a trust for which the citizenship of all of the beneficiaries are attributed that determines citizenship.

Here, unlike a human trustee suing in her own name on her own behalf as in Navarro, the Trust is the plaintiff and real party in interest, and, as an unincorporated entity, the Trust is a citizen of the states in which its members are located. Because Wells Fargo has not established the citizenship of each of the Trust’s members, Wells Fargo has failed to properly invoke federal diversity jurisdiction.

On that basis, Transcontinental’s motion to dismiss was granted, and the action was dismissed for lack of subject-matter jurisdiction.

Lincoln Benefit Life Co. v. AEI Life, LLC, et al.

As noted above, federal diversity jurisdiction under 28 U.S.C. § 1332 requires that the dispute involve more than $75,000 and that there be complete diversity, i.e., that no defendant be a citizen of any state of which a plaintiff is a citizen. Section 1332 provides some clarity (and simplicity) for corporations and explains that a corporation “shall be deemed” a citizen of any state in which it is incorporated and of the state in which it has its “principal place of business.” In the case of partnerships, limited partnerships, or LLCs, the courts have determined that they are citizens of the states in which the organization’s partners or members are citizens. See, e.g., Mut. Assignment & Indem. Co. v. Lind-Waldock & Co., LLC, 364 F.3d 858, 861 (7th Cir. 2004) (“Lind-Waldock is a limited liability company, which means that it is a citizen of every state of which any member is a citizen; this may need to be traced through multiple levels if any of its members is itself a partnership or LLC.”). A plaintiff bringing an action in federal court, or a defendant seeking to remove an action to federal court, is required to plead facts demonstrating that diversity exists. See, e.g., Hale v. M.J.J.K., LLC, Civil Action No. 12–1515, 2013 WL 6287823, *2 (E.D. La. 2013) (“Accordingly, the party invoking federal jurisdiction ‘must list the citizenship of each member of each limited liability company to properly allege diversity of jurisdiction.’”).

Under the Federal Rules of Civil Procedure, a party filing suit in federal court must include a short and concise statement in the complaint (or notice of removal) describing the basis of the federal court’s jurisdiction. See F.R.C.P. 8. In other words, the party must show in its pleading (either a complaint or notice of removal) that none of the plaintiffs share the same citizenship as that of any of the defendants. Thus, in order for a plaintiff to bring an action in diversity against an LLC or other unincorporated organization, the plaintiff must know the citizenship of each member of the LLC or unincorporated association. This information may not be available publicly, however. Parties are therefore often stymied in accessing the federal courts because they are unable to ascertain the citizenship of each member of the LLC or unincorporated association and are consequently unable to plead that all plaintiffs are citizens of different states from all defendants. How, then, can either the plaintiff or the defendant seeking to enlist diversity jurisdiction adequately plead its existence?

In an attempt to resolve this problem, some courts have permitted a party seeking to establish diversity jurisdiction to take limited discovery into the citizenship of an unincorporated association’s members. See, e.g., Dougherty Funding, LLC v. Gateway Ethanol, LLC, No. 08-XC-2213-JWL, 2008 WL 2354965 (D. Kan. June 5, 2008) (permitting defendant to take written discovery of the plaintiff’s citizenship in order to ascertain if diversity jurisdiction exists). Other courts, however, have been less receptive to this approach. See, e.g., MCP Trucking, LLC v. Speedy Heavy Hauling, Inc., Civ. Act. No. 14-CV-02427-PAB, 2014 WL 5002116 (D. Col. Oct. 6, 2014) (denying jurisdictional recovery and remanding action to state court even as it was acknowledged that further discovery in that forum could demonstrate that diversity exists, leading to a subsequent removal); Osborn & Barr Comm., Inc. v. EMC Corp., Inc., No. 4:08-CV-87 CAS, 2008 WL 341664 (E.D. Mo. Feb. 5, 2008) (denying motion for jurisdictional recovery and collecting cases).

Lincoln Benefit faced this diversity dilemma in 2013 as it sought to challenge two life-insurance policies owned by a pair of LLCs. Lincoln Benefit’s complaint, filed in the United States District Court for the District of New Jersey, sought a declaration that the two life-insurance policies were void, alleging that they were procured by fraud or for the benefit of third-party investors (i.e., Stranger Originated Life Insurance or STOLI). AEI Life, LLC and ALS Capital Ventures, LLC were identified as the record owners and beneficiaries of the two subject policies. In preparing the complaint, including the required statement establishing diversity, Lincoln Benefit researched the background of each LLC and scrutinized all records that were publicly available concerning the LLCs and their respective members, but it was unable to determine the citizenship of each of the LLC’s respective members. The information Lincoln Benefit found, however, indicated that neither LLC (nor any of the members of either LLC) had any connection with Nebraska, the state in which Lincoln Benefit is incorporated and has its principal place of business. Accordingly, Lincoln Benefit pled that diversity jurisdiction existed “upon information and belief.” Specifically, Lincoln Benefit alleged upon information and belief that AEI Life, LLC and ALS Capital Ventures, LLC were citizens of, respectively, New York and Delaware.

The LLC defendants moved to dismiss Lincoln Benefit’s complaint on the basis that diversity jurisdiction had not been adequately pled because Lincoln Benefit had not alleged the citizenship of the members of the LLC defendants. Notably, the LLC defendants did not move to dismiss the complaint on the basis that there was no diversity between plaintiff and defendants; rather, the LLC defendants asserted a facial claim that Lincoln Benefit’s complaint failed to adequately plead diversity. Of course, the information critical to the LLCs’ position—the citizenship of each LLC member—was uniquely and solely within the LLCs’ control.

Lincoln Benefit, in response to the LLC defendants’ motions, pointed out that none of the defendants had asserted that it had members who were citizens of Nebraska. Lincoln Benefit also explained that information concerning the citizenship of the LLCs’ members was not publicly available; therefore, Lincoln Benefit should be permitted to proceed on an information-and-belief basis. Alternatively, Lincoln Benefit requested the opportunity to take limited discovery for the purpose of confirming that diversity indeed existed. The district court dismissed Lincoln Benefit’s complaint for lack of subject-matter jurisdiction, holding that (a) pleading diversity on the basis of information and belief is insufficient; and (b) allowing jurisdictional discovery would be inappropriate when it was not clear that the federal court did not already have jurisdiction. Lincoln Benefit thereafter appealed to the Third Circuit.

On September 2, 2015, the Third Circuit issued a precedential decision. See Lincoln Ben. Life Co. v. AEI Life, LLC, 800 F.3d 99 (3d Cir. 2015). The court began by providing a brief review of the rules of diversity jurisdiction. It also noted that there are two bases for challenging jurisdiction. First, there is the “facial attack,” which alleges a deficiency in the pleadings. Second, there is the “factual attack,” which challenges “the factual existence of jurisdiction.” The court described that, “[i]f the defendants here had challenged the factual existence of jurisdiction, Lincoln Benefit would have been required to prove by a preponderance of the evidence, after discovery, that it was diverse from every member of both defendant LLCs.” The court pointed out that the defendants had instead solely mounted a facial challenge to the adequacy of the jurisdictional allegations in Lincoln Benefit’s complaint.

The court relied, at least in part, on the decision rendered in Lewis v. Rego, Co., 757 F.2d 66 (3d Cir. 1985), for the proposition that “rather than affirmatively alleging the citizenship of a defendant, a plaintiff may allege that the defendant is not a citizen of the plaintiff’s state of citizenship.” Thus, “[a] State X plaintiff may therefore survive a facial challenge by alleging that none of the defendant association’s members are citizens of State X[,]” provided that the plaintiff has undertaken “reasonable inquiry” in support thereof. To that end, the court explained that a plaintiff should “consult the sources at its disposal, including court filings and other public records.” Then, if the plaintiff “has no reason to believe that any of the association’s members share its state of citizenship, it may allege complete diversity in good faith.” The unincorporated association may then mount a facial attack if necessary. The court recognized that the unincorporated association “is in the best position to ascertain its own membership[.]”

Explaining the rationale for its holding, the court wrote:

We believe that allowing this method of pleading strikes the appropriate balance between facilitating access to the courts and managing the burdens of discovery. District courts have the authority to allow discovery in order to determine whether subject-matter jurisdiction exists. Rule 8(a)(1), however, serves a screening function: only those plaintiffs who have provided some basis to believe jurisdiction exists are entitled to discovery on that issue. The corollary of this principle is that a plaintiff need not allege an airtight case before obtaining discovery.

Depriving a party of a federal forum simply because it cannot identify all of the members of an unincorporated association is not a rational screening mechanism. The membership of an LLC is often not a matter of public record. Thus, a rule requiring the citizenship of each member of each LLC to be alleged affirmatively before jurisdictional discovery would effectively shield many LLCs from being sued in federal court without their consent. This is surely not what the drafters of the Federal Rules intended.

Moreover, the benefits of such a stringent rule would be modest. Jurisdictional discovery will usually be less burdensome than merits discovery, given the more limited scope of jurisdictional inquiries. It seems to us that in determining the membership of an LLC or other unincorporated association, a few responses to interrogatories will often suffice. So long as discovery is narrowly tailored to the issue of diversity jurisdiction and parties are sanctioned for making truly frivolous allegations of diversity, the costs of this system will be manageable.

Assuming the reasoning employed in the Lincoln Benefit decision is followed by other circuits, this could be a most important decision. First, it significantly undercuts the large number of decisions that, to date, have held that citizenship must be pled specifically and not on information and belief. See, e.g., Principle Solutions LLC v. Feed.Ing BV, Case No. 13-C-223, 2013 WL 2458630 (E.D. Wisc. June 5, 2013) (“It is well-settled that a plaintiff claiming diversity jurisdiction may not do so on the basis of information and belief, only personal knowledge is sufficient.”); Pharmerica Corp. v. Crestwood Care, LLC, No. 13C 1422, 2015 WL 1006683 (E.D. Ill. Mar. 2, 2015) (“[I]t is not sufficient to assert jurisdiction based on information and belief.”); MCP Trucking, LLC v. Speedy Heavy Hauling, Inc., 2014 WL 5002116 (D. Colo. Oct. 6, 2014) (denying jurisdictional discovery and remanding action to state court even as it acknowledged that further discovery in that forum could demonstrate that diversity exists, leading to subsequent removal); Lake v. Hezebicks, 2014 WL 1874853 (N.D. Ind. May 9, 2014) (allegations of subject-matter jurisdiction must be based on personal knowledge and may not be based upon information and belief and collecting cases to that effect). But see Charles Alan Wright et al., Federal Practice and Procedure: Federal Rules of Civil Procedure § 1224 (3d ed. 2013) (stating that pleading on the basis of information and belief “is a practical necessity.”). Further, it stands in direct challenge to those decisions that have held that citizenship must be affirmatively pled and that negative statements as to citizenship are insufficient. See, e.g., D.B. Zwirn Special Opportunities Fund, LP v. Mehrotra, 661 F.3d 124 (1st Cir. 2011), citing Cameron v. Hodges, 127 U.S. 322 (1888). Although 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.

Conclusion

The implications of the choice-of-entity calculus impact not only obvious issues such as the rights of the participants vis-à-vis the organization and one another and the apparent agency of the organization’s agents, but also a multitude of oft-ignored implication, such as access to federal courts based on diversity jurisdiction. This is an area in which a great deal is happening.