Six Years of Litigating Lost for Failing to Confirm LLC's Citizenship

Failing to fully track down the citizenship of a limited liability corporation can lead to enormous losses for lawyers and their clients. The U.S. Court of Appeals for the Eleventh Circuit spared the attorneys more suffering, though, and reversed a more than half-million-dollar sanctions order. The court found no bad faith, even if the parties naïvely relied on one another's unverified assertions.

Two LLCs involved in a contract dispute learned that although jurisdiction should be easy, it often is not. By failing to do due diligence on the LLC's citizenship, the two firms wasted nearly six years of litigation.

The decision represents a meaningful practice reminder on how to properly address and resolve LLC citizenship issues, say ABA Section of Litigation leaders. When dealing with LLCs, lawyers must remember that the citizenship of every member of the LLC counts. Often LLCs have other LLCs as their members; some members may be corporations whose citizenship may be in two states. The result can lead to citizenship that looks like a "factor tree." If lawyers representing, or suing, LLCs do not take the time to track down every branch of the tree, the result might be similar to the case here—a costly jurisdictional mistake.

Trusting Without Verifying
Purchasing Power LLC sued Bluestem Brands in Georgia state court in 2011. Bluestem removed the action to federal court: Bluestem is a citizen of Minnesota and Delaware while Purchasing Power appeared to be a citizen of Georgia. Yet, besides the Georgia members of Purchasing Power, the LLC also included several LLCs as its members. The client assured Purchasing Power's lawyers that none of its members were residents of Minnesota or Delaware.

Believing jurisdiction proper in federal court, the parties moved forward. Purchasing Power's lawyers may have sought to protect the identity of the LLCs' members from discovery. Or perhaps the client did not know its own citizenship. Not until the district court granted summary judgment in Bluestem's favor and the case appealed did either party fully investigate whether diversity existed.

Over two years after removal, the parties discovered that a corporation, set up for tax purposes in Delaware, actually owned one of Purchasing Power's LLC members. Because Bluestem was also a Delaware citizen, there was no complete diversity. "The moral of this story is to determine jurisdiction thoroughly from the beginning. Because, in the end, someone will notice and the issue can be raised at any time," explained Sonia Escobio O'Donnell vice chair of the ABA Section of Litigation's Appellate Practice Committee.

Appeals Court: "Result Was a Colossal Waste of Time and Effort"
The district court imposed sanctions on the attorneys for Purchasing Power even though they had not sought to remove the case. The district court focused on the fact that Purchasing Power's attorneys failed to check the citizenship of their client, instead relying on the client's assurances.

But the Eleventh Circuit pointed out that the burden is on the party trying to remove the case to federal court to prove diversity. Bluestem's removal petition stated that Purchasing Power was not a citizen of Delaware or Georgia. The truth, however, was that Purchasing Power had only told Bluestem it "believed" it was not a citizen of Delaware or Georgia.

The parties soon discovered that neither side fully investigated jurisdiction. "What both sides did in effect, although not necessarily intentionally, was to confer jurisdiction. One side was, according to the court, not totally thorough in verifying the jurisdictional facts. And the other side was not, according to the court, sufficiently specific in its responses to jurisdictional allegations and inquires," according to Escobio O'Donnell.

Although the Eleventh Circuit ultimately reversed the sanction order, it did so after noting the huge waste of time and effort. "The court sounded a warning bell reminder to litigants in federal court: When you see an LLC is involved, you have to run down the citizenship of every member or potentially face bad consequences," explained Robert J. Will, Saint Louis, MO, cochair of the Section of Litigation's Pretrial Practice & Discovery Committee.

The court noted that the attorneys for Purchasing Power worsened the problem by not fully complying with Bluestem's discovery requests. Still, Bluestem also deserved blame for assuming it knew the parties were diverse without verifying its allegations. No one should think the attorneys got off easy. The court wrote the "damage done to the parties' credibility, finances, and time is enough of a sanction to curb their conduct and to serve as a warning to future diversity jurisdiction litigants."

Inherent Power to Sanction Requires Bad Faith
The district court based its sanctions order on the court's inherent power to sanction and Rule 26(g)(3) rather than any statutory authority, such as 28 U.S.C. § 1927, or Rule 11. It incorrectly focused, however, on the recklessness of the attorneys' conduct.

On appeal, the Eleventh Circuit clarified that the standard for inherent sanctions was subjective bad faith. The court, emphasizing the importance of "restraint and discretion," explained that the focus of inherent power sanctions is on vindicating the court's own authority not for any litigation misconduct.

The court did not remand the case to the district court to decide if sanctions were appropriate under the proper standard. Rather, on its own initiative, the court found that none of the conduct of the attorneys involved met that standard.

"The Eleventh Circuit correctly noted that inherent power sanctions must be based on subjective bad-faith conduct. The court concluded that while this may have been bad lawyering, as both parties were to blame for the mistake, it was not bad faith. The damage to the firms' reputation—not to mention the wasted legal expense incurred by both parties—was sanction enough. The court's ruling essentially was 'A pox on both your houses!'" according to Will.

 

Stephen Carr is a contributing editor of Litigation News.

 


Keywords: sanctions, diversity jurisdiction, citizenship, inherent power

 

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