August 31, 2016

Ninth Circuit Holds "Fraudulent Joinder" Doctrine Misapplied

John Austin

The Ninth Circuit recently overturned a district court’s application of the “fraudulent joinder” doctrine, where the party was properly joined because she had an interest in the real estate. In Weeping Hollow Avenue Trust v. Spencer, 13-16060 (9th Circuit), the court found that the “joined” party had a viable claim in the matter.

Weeping Hollow Avenue Trust purchased Ashley Spencer’s house a HOA foreclosure sale. Two months after the foreclosure sale, Wells Fargo Bank, NA filed a foreclosure action on the property under its deed of trust with Spencer. Weeping Hollow filed a quiet title action in Nevada state court, and Wells Fargo removed the case to federal court based on diversity jurisdiction. Weeping Hollow and Spencer were both citizens of Nevada. The district court concluded it could nonetheless exercise diversity jurisdiction because Weeping Hollow had fraudulently joined Spencer as a defendant where the court determined Spencer no longer had an interest in the property.

Under the fraudulent-joinder doctrine, “[j]oinder of a non-diverse defendant is deemed fraudulent, and the defendant’s presence in the lawsuit is ignored for purposes of determining diversity, ‘[i]f the plaintiff fails to state a cause of action against a resident defendant, and the failure is obvious according to the settled rules of the state.’” Morris v. Princess Cruises, Inc., 236 F.3d 1061, 1067 (9th Cir. 2001) (quoting McCabe v. Gen. Foods Corp., 811 F.2d 1336, 1339 (9th Cir. 1987)). A showing of actual fraud would be sufficient to invoke the doctrine; however, that is rare. In most cases, the focus will be on whether the plaintiff can “state a reasonable or colorable claim for relief under the applicable substantive law against the party whose presence in the action would destroy the district court’s subject matter jurisdiction.” 13f c. Wright & A. Miller et al., fed. Prac. & Proc. Juris. § 3641.1 (3d ed.). Courts employ a general presumption against fraudulent joinder.

Given that Weeping Hollow needed to show it had superior claim to all others, the Ninth Circuit concluded (as opposed to the district court) that it was reasonable for Weeping Hollow to join Spencer as a defendant. While the district court correctly determined that Weeping Hollow’s purchase of the property at the foreclosure sale extinguished Spencer’s property rights, Spencer could challenge the foreclosure sale from which Weeping Hollow gained title on grounds “of fraud, unfairness or oppression.”

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John Austin

Principal at John Austin Law Firm in Raleigh, North Carolina.