Your company gets sued in California state court by a plaintiff that resides in California, but your company is incorporated in Delaware. You opt to remove the case to federal court based on diversity jurisdiction. Up until a few days ago, removal based on party diversity was a sure thing. However, on February 23, 2010, in Hertz Corporation v. Friend, Case No. 08-1107, the United States Supreme Court changed that – laying down the law on the question of federal diversity for corporations once and for all.
Previously, lower federal courts have applied one of two tests in determining whether or not diversity jurisdiction exists: (1) looking at the total activity of the company nationwide, or (2) applying the "nerve center" test. The Supreme Court has finally, and definitively, opted for the latter.
Congress long ago authorized federal courts to exercise their jurisdiction over cases where the parties reside in different states - individual parties, that is. The original statute said nothing about corporations. In fact, it took a variety of cases dating back to 1809 before the law became somewhat clear with respect to corporations. By 1958, Congress finally codified the "place of incorporation" test as well as the "principal place of business" test. Over time the latter test proved more and more difficult to apply.
Historically, the "principal place of business" has been defined by some lower courts as a corporation's principal office, rather than its factory, mill, or mine. Other courts have held just the opposite. Ultimately, many circuits began following a rule that was later dubbed the "nerve center" test, which applied to businesses with headquarters in one state, but multiple operations in another. In Hertz, the Court recognized the wide variety of interpretations of business activities. This is due in no small part to the fact that corporations come in many different sizes, shapes, and forms.
When determining "principal place of business" many factors must be weighed, including locations of plants or factories, sales or servicing centers, where transactions occur, where payrolls are made, or where revenue is generated. Ultimately, the Supreme Court turned to an interpretation rendered by the 7th Circuit, concluding that:
"principal place of business" is best read as referring to the place where a corporation's officers direct, control, and coordinate the corporation's activities. It is the place that Courts of Appeals have called the corporation's "nerve center." And in practice it should normally be the place where the corporation maintains its headquarters – provided that the headquarters is the actual center of direction, control, and coordination, i.e., the "nerve center," and not simply an office where the corporation holds its board meetings (for example, attended by directors and officers who have traveled there for the occasion).
Why did the Court adopt the "nerve center" test, you ask? Three reasons. First, it recognized that the statutory language supports this approach. For example, the word "place" is singular, not plural. The word "principal" implies a main, prominent, or leading place. And the proximity of the words within the statute indicates that the location should be a place within the State, not the State itself. Second, the Court wanted an administratively simple interpretation. It hopes this simplicity will forestall unnecessary litigation over the issue of jurisdiction (as compared to litigating the actual merits of the case). It also thinks this interpretation will promote greater predictability. That is, corporations can take this test into account in making its business and investment decisions. Third, and finally, the Court recognized the statute's legislative history as mandating a "simplicity-related interpretive benchmark." The benchmark long ago sought an interpretation that was no more complex than one based on gross income of a company (i.e., the company's "principal place of business" was wherever it earned the most revenue). The "nerve center" test is just as simple.
The "nerve center" test points courts in a single direction, towards the center of the company's overall direction, control, and coordination. Courts will no longer have to weigh corporate functions, assets, or revenues different in kind. The "nerve center" approach provides a comparatively simpler, sensible test that is relatively easy to apply. That said, the Court recognized that its new test might occasionally produce apparently irrational outcomes (e.g., where a corporation's main business activities take place in New Jersey, while its top officials reside in New York, the principal place of business would be New York), yet the Court was willing to accept these possible anomalies in view of having a clear and simpler rule. Thus, the "nerve center" test now applies in all cases involving corporate federal diversity jurisdiction.
What does this mean for your corporation? It means that the place where your company's main control lies – that is, its officers, directors, primary management -- the ‘command center,' if you will, is the situs that will determine whether diversity exists that would merit removal of a case to federal court. Diversity jurisdiction will no longer, or necessarily, be based on the location of your company's headquarters, factories, distribution centers, or other centers of general business operations.
A partner with Nossaman, Janice Mock specializes in business litigation, including commercial business disputes, banking matters, constitutional rights, advertising and marketing and employment matters. She can be reached at 415.438.7284 or jmock@nossaman.com.