Diversity Jurisdiction

Hertz Corp. v. Friend, 130 S. Ct. 1181, 559 US ___, 175 L. Ed. 2d 1029 (2010)

Federalism is the backbone of American government. The Constitution of the United States of America vests the federal government with limited power. By contrast, state governments have plenary power under each state's constitution. This post will focus on the limited power of the federal courts as related to civil procedure.

The U.S. Constitution established and empowered the Supreme Court of the United States. U.S. Const. Art. III, ‎§‎ 1. The same provision empowered Congress to "ordain and establish" the lower federal courts. Ibid. Thus, Congress created the circuit courts of appeal and district courts. Furthermore, Congress has authority to determine the jurisdiction of the lower federal courts.

The U.S. Constitution limits the power vested in the federal courts by allowing it to extend only to certain cases and controversies. U.S. Const. Art. III, ‎§‎ 2. One category where a federal court may exercise its judicial power applies to "Controversies . . . between Citizens of different States." Ibid. Exercising its constitutional authority to ordain, Congress enacted the diversity of citizenship statute. The U.S. Constitution gives federal courts limited power, preventing them from adjudicating a lawsuit between two citizens of the same state.

A problem arises, however, when one of the parties is a corporation. The issue is how a court should determine the citizenship of the corporation.

Early in American history corporate entities were not citizens. Bank of United States v. Deveaux, 5 Cranch 61 (1809). Under Deveaux, corporate citizenship was determined by the citizenship of its members.

This changed, however, in Louisville, C. & C. R. Co v Letson, 2 How 497 (1844)‎. There the Court determined a corporate entity is a citizen of the state of incorporation, separate and apart from the citizenship of its members. Importantly, only incorporated groups are considered as citizens for ‎diversity.

‎ The diversity statute enacted by Congress provides, 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) (emphasis added). Thus, a corporation may be a citizen of two separate states. For example, it may be a citizen of both Delaware and New Jersey when it has been incorporated under the laws of Delaware and its principal place of business is in New Jersey.

Until now, parties litigated the meaning of "principal place of business" either to assert or challenge the jurisdictional authority of the federal courts in civil matters. Federal case law on this issue had provided two distinct tests to determine the "principal place of business."
  • The "Nerve Center" Test. This test refers to the place where high level officers direct, control, and coordinate corporate activities.
  • The "Muscle Center" Test. This test refers to the place where most of the business activity occurs.

The following illustrates the confusion that ensued under this distinction:
  • The "Center Of Corporate Activities" Test. Developed by the Third Circuit, this test searches for the "headquarters of a corporation’s day-to-day activity."
  • A "Two Part Test." Developed in the Ninth Circuit, this test requires courts to:
    1. decide whether "a corporation’s activities are centralized or decentralized,” and
    2. apply either the “place of operations” or “nerve center” test.
In Hertz Corp. v. Friend the Supreme Court of the United States rejected the "muscle center" test to determine "principal place of business" and reaffirmed the "nerve center" test. The case arose in California state court but the defendants, asserting diversity of citizenship, sought to remove to federal court. The plaintiffs were from California (the Ninth Circuit) and the defendants had their corporate offices in New Jersey (the Third Circuit).

The plaintiffs probably urged the court to follow Ninth Circuit precedent, which applied both the "nerve center" and "muscle center" tests, while the defendants probably insisted on following Third Circuit precedent, which only applied the "nerve center" test.

Most likely the defendants hoped not only to prevail in the removal to federal court, but also planned to argue the California venue was an inconvenient forum, and to transfer the venue to a federal district court in the District of New Jersey.

Along the way to reaffirming the "nerve center" test, the Hertz Court reasoned this test was most appropriate based on the statute's plain language and its legislative history. This means the "nerve center" test comports with legislative intent. In addition, the Court reasoned the single test would serve the purpose of promoting administrative efficiency, and establishing uniformity of federal law.

Hertz Corp. v. Friend, 130 S. Ct. 1181, 559 US ___, 175 L. Ed. 2d 1029 (2010)