October 01, 2011

Locating a Corporation’s “Home”

John T. Mitchell


Home is where the heart is. So they say, but what if you are heartless? The Supreme Court has settled for brain activity, if you are a corporation. “Home is where the brain is,” to paraphrase the Supreme Court’s ruling in Hertz Corp. v. Friend, 130 S. Ct. 1181 (2010), in which Justice Stephen Breyer’s opinion laid out a new rule for determining a corporation’s citizenship for purposes of establishing federal diversity jurisdiction.

Specifically, the Supreme Court examined the “principal place of business,” because “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.” 28 U.S.C. § 1332(c)(1). Addressing a circuit split, the Court settled on the “nerve center” approach to determining the location of the principal place of business.

The facts of the case don’t really matter much. The general context is that, there you are, minding your own in-state business, filing suit against a major corporation in your familiar state court. Your local clients feel more at home in a state court, and you prefer a pool of home jurors to those strangers that populate the broader federal jurisdiction. The corporate defendant, however, uses its national law firm that reacts to state court lawsuits as if they’d been filed in Transylvania. Despite a huge volume of business conducted in your state, complete with warehouses, a manufacturing plant, a sales team, and a distribution network, your case gets bumped into federal court. Why? Because all these major activities are being carried out by the corporate tentacles that reach into your state but have no mind of their own—they are controlled by the corporate “nerve center” that lives elsewhere.

But where, exactly, is the corporation’s nerve center? The Court had little difficulty pinpointing it in Hertz v. Friend, but Justice Breyer, in his usual forward-looking style, admitted the new rule’s imperfection by flagging a few problems we might face in trying to apply it:

We recognize as well that, under the “nerve center” test we adopt today, there will be hard cases. For example, in this era of telecommuting, some corporations may divide their command and coordinating functions among officers who work at several different locations, perhaps communicating over the Internet.

Indeed, these days most of my corporate clients conduct several of their board meetings by teleconference, and it is quite common for top management to be based in multiple jurisdictions. Breyer went on to note that the new rule could produce anomalies that run counter to the rationale for the rule, particularly where the corporate headquarters in one state is dwarfed by principal corporate activity in another. The decision adopts this rule nonetheless, reasoning that it is the best they can do, but is it? Justice Breyer’s concern over future facts that may make it difficult to find the corporate nerve center is just the tip of the iceberg. We could have a lot of fun with where the corporation’s “brain”—the nerve center—really is. (I can see civil procedure law professors having a field day preparing exam questions.) It’s not just tele­conferences or even Cisco’s new holographic “Telepresence” that might make you uncertain whether the people participating in a meeting are sitting nine feet or 9,000 miles away from you.

Exactly where are the top managers, physically, when they conduct the nerve center activity? (And let’s not include absent-minded attendees.) Do we draw the line at the most significant management decisions, such as whether to begin a new product line, as opposed to who is going to lock up tonight? If the buck stopped in the engineering department on a choice pertaining to the safety feature at issue in a products liability case, would the nerve center change to the state where the engineering department is located for that case, yet remain at corporate HQ for the others?

Does management make the nerve center decisions while sipping single malts in their favorite bar across state lines? Consider the company where the most crucial decisions are made on the Bois de Sioux Golf Course—you may need discovery into whether most decisions are made on the front nine holes, located in North Dakota, or on the back nine, in Minnesota. What about a company whose CEO and CFO call the shots from the Regent Park Golf Course, which meanders between North Carolina and South Carolina?

Justice Breyer correctly predicts that the Supreme Court’s nerve center rule is not likely to be definitive. His review of the evolution of corporate citizenship for purposes of diversity jurisdiction, however, suggests that Congress and the courts have allowed corporations to be personalized in a manner that makes no logical sense for a non-human paper entity that is the fictional creature of the state. More than resolving the question of the corporation’s citizenship, they have succeeded in making corporations into super-human beings, forcing us to apply mind-bending rules for how to treat them.

It was not long ago, in legal years, that corporations held a tenuous existence. They were created by state law for very limited purposes and were subject to being “executed,” so to speak, by the same state that created them. They were the outgrowth of the need to amass capital, and the legal fiction of their “being” was simply a convenient artifice to organize and manage a collaborative enterprise. But in those early days, the notion that a corporation could be considered a “citizen” of any state was rather ludicrous. That a corporation could be considered to have a nerve center was just as far-fetched as suggesting it had a torso.

Back in 1787, when our Constitution was submitted for ratification, providing that the judicial power extended to “Controversies . . . between Citizens of different States,” Art. III, §2, there were fewer than 40 corporations operating in the United States, and they were not considered to be citizens at all. Chief Justice John Marshall, writing for a unanimous Court just over 200 years ago, described the corporation as an “invisible, intangible, and artificial being” which was “certainly not a citizen.” Bank of United States v. Deveaux, 5 Cranch 61, 86 (1809). How did we get from “certainly not a citizen” to conferring citizenship and nerve centers upon them?

When corporations were seen as mere intangible property, the first diversity jurisdiction questions were determined on the basis of the citizenship of all the corporate shareholders. That was a simpler time, before day trading would make it impossible to establish the location of all the shareholders for any jurisdictionally significant moment. But there was—and still is—a simple elegance to that approach: Corporations are mere personal property of the shareholders, so if the corporation is given a right to sue and be sued, its citizenship, for diversity purposes, can be no more or less than the citizenship of every real person who owns the property.

By the mid-1800s, perhaps tired of the “herding cats” aspects of establishing the citizenship of all shareholders at a given moment in time, the courts developed the idea that, because corporations are artificial entities created by individual states, the state of incorporation should be the state of citizenship for diversity purposes. For more than a century, that rule—that the state of incorporation determines the state of citizenship—remained firmly entrenched. Although it was a practical and efficient solution, it marked a watershed for corporations, as their existence as legal fiction became vested with “real” properties.

The long-standing “state of incorporation” rule might as well have said that “the state of birth” determines citizenship (just as it does in many nations, with regard to humans). By recognizing direct corporate citizenship (in contrast to citizenship derivative of the corporation’s owners), the new rule placed us on the path to creating super-humans—citizens that, unlike mere humans, possess a potentially everlasting life right here on earth. The eventual step of conferring constitutional rights to corporations might not seem so far-fetched.

But there was one more step to humanoid status, for corporations needed not only a state of “birth” to enjoy human rights, but also needed a state of being. Congress delivered that element in 1958, when it codified the courts’ traditional “place of incorporation” test of citizenship, and also enacted the modern “principal place of business” language found in 28 U.S.C. § 1332(c)(1). Unlike their human counterparts, corporations could be dual citizens by being born in one state and conducting their principal business in another. The good people of Delaware may not be troubled if a corporate child misbehaves in California, where most of its operations are.

The final step came with the Hertz decision, recognizing a corporate self-awareness of sorts. Corporations need not bother to move their major physical activity from one state to another if they desire a more favorable citizenship—just change the corporate “state of mind” by moving the place where management is housed. For some, it may mean just a change of golf courses!

This personalization is not limited to the jurisdictional question. Parallel with the development of corporate consciousness blessed in Hertz, the Supreme Court has given that old non-human paper entity civil rights as well, vesting it with the First Amendment right of freedom of speech. If you substitute “megaphone” for “corporation,” the Supreme Court’s ruling in Citizens United v. Federal Election Comm’n, 130 S. Ct. 876 (2010), is the equivalent of saying that if you own a megaphone, not only do you, as an individual, have the right to freedom of speech (including the right to speak using your megaphone), but now we will give your megaphone an independent right to freedom of speech. (Indeed, if you are a minority shareholder in your megaphone, your megaphone can shout you down, and the courts will protect its right to do so!)

The Citizens United decision would not have been feasible had it not been for the evolution of the legal fiction of the corporation, and the diversity jurisdiction “citizenship” question, in particular, has enabled us to convert a convenient device of legal fiction into a full-blown citizen protected by the Bill of Rights, despite being, fundamentally, mere property that can, at the stroke of a pen, belong to a Saudi prince or Chinese investor.

Even today, no one would seriously argue with Chief Justice Marshall’s observation, over two centuries ago, that the corporation is an “invisible, intangible, and artificial being.” If we begin again from that premise to reach the self-evident conclusion that it is “certainly not a citizen,” it is not hard to envision taking a different path concerning the right to sue and be sued—a right derivative of the human properties of the owners.

As a First Amendment attorney, whenever I claimed that a censorship law or proposed bill would abridge First Amendment rights, I previously argued from the point of view of the humans, such as the customers of the corporate bookseller. It seemed too big a stretch to argue that the civil rights of an invisible, intangible, and artificial being were abridged. In cases involving membership lists of labor unions or the National Association for the Advancement of Colored People (NAACP), it has been the rights of the individual members, as humans, that drove the analysis, rather than the rights of, say, “NAACP, Inc.” That is, freedom of association was not a right claimed by the NAACP qua corporation, but merely in a capacity representative of its members. Today, Hertz and Citizens United have clearly created supermen: The fictional characters of convenience are endowed with the rights to more control over their state of citizenship than mere mortals, have the right to participate in political debate over democratic decisions that is in addition to the rights of their mortal handlers, and can have a very substantial physical and economic presence in all 50 states, unlike any mere mortal. And they get all this without the downside. A corporation can build a new housing development without having to worry about whether the infrastructure can handle it or whether its children will be attending overcrowded schools. The corporate factory can pollute the air and the corporation will not suffer from more headaches or asthma attacks. The corporation will never need to see a neurologist about its new nerve center.

Just as children playing “telephone” get a good laugh when the final transmission of a message is compared to the one first delivered, Congress and the courts would do well to revert to first principles. Otherwise, it may not be long before members of the human race will seek redress for race-based discrimination favoring of super-human corporations. (Already, the Copyright Act treats corporations more generously than humans.)

When corporations were first given “citizenship” for purposes of determining diversity jurisdiction, the point was not to put them on the road to equality with mortal humans, but to have a rule for deciding federal court jurisdiction—a simple housekeeping or administrative rule. That rule had its genesis back in the day when few corporations had a national (or global) reach, and states could (and did) revoke the corporate charter of a misbehaving corporation. Given the modern corporation’s reach today, when even a business set up in the garage can have a 50-state customer base of online purchasers, and corporate executions are practically unheard of, a better rule for diversity jurisdiction might simply be to treat all corporations as citizens of each state in which they do more than de minimis business, and leave the human qualities to us mortals.











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