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Supreme Court Decision in Hertz Case a Small Victory For Federalism

A unanimous Supreme Court this morning, in Hertz Corp. v. Friend, No. 08-1107 (U.S. Feb. 23, 2010), held that a corporation’s “principal place of business” under the federal diversity-jurisdiction statute and the Class Action Fairness Act (CAFA)

refers to the place where the corporation’s high level officers direct, control, and coordinate the corporation’s activities. Lower federal courts have often metaphorically called that place the corporation’s “nerve center.” … We believe that the “nerve center” will typically be found at a corporation’s headquarters.

At first blush, while Justice Breyer’s opinion is of great practical interest to commercial litigators, it would seem to be little more than a routine dispute over the construction of a federal statute governing the jurisdiction of the federal courts. But buried within is a small victory for horizontal federalism or what I have long referred to as “federalism’s edge,” i.e., protecting the balance of federalism from being upset by a single state’s efforts to assert jurisdiction over the nation as a whole. Stay with me for just a bit of background and you’ll see why.

The Hertz case reached the Supreme Court because the Ninth Circuit had refused to apply the “nerve center” test used by other federal courts. The plaintiff brought an employment class action composed of California citizens under California law in California state court. Hertz, which is headquartered in New Jersey, took advantage of a federal statute that has existed in one form or another since 1789 that permits “diversity” cases to be removed from state court to federal court. To simplify, diversity jurisdiction, which derives from the explicit language of Article III of the Constitution, gives the federal courts jurisdiction over lawsuits between citizens of one state and citizens of another state. The idea is that federal courts are a more neutral forum and less likely to be biased against out-of-staters. The statute does not, however, allow a defendant to remove a case from the courts of the state in which the defendant is a citizen, the theory being that a defendant won’t be harmed by local prejudices in its own home state.

(I’ll leave aside here the ways in which this statutory scheme was altered by the 2005 enactment of CAFA, governing nationwide class actions, as the Court’s decision didn’t turn on its jurisdictional idiosyncracies; the case also involved some procedural issues under CAFA).

A simple enough legal issue where human beings are involved, but as such things often do, the diversity rules get complicated to apply when one of the “citizens” involved is a corporation. The Constitution is silent on the issue, but Congress by statute has provided that a corporation is to be treated as a citizen of the state it’s incorporated in (often Delaware) and the state where it has its “principal place of business.”

What’s a “principal place of business”? Well, courts in New York, Chicago and elsewhere had used the “nerve center” definition defined by the respected District Judge Edward Weinfeld in the 1950s, but the Ninth Circuit instead used a different rule – they let the plaintiff treat Hertz as having its principal place of business in California because that’s where it had the most retail car rental locations and employees. You see the problem: California’s the most populous state, so almost any company with operations distributed evenly across the country could be treated as a California corporation and denied recourse to federal court, even if the company was very obviously headquartered and identified with some other state.

The Supreme Court saw it too, and didn’t buy it; the Court unanimously endorsed the “nerve center” rule, mainly because it was easier to apply in practice, but also mentioning how California’s population could skew the question.

Some knee-jerk observers of battles over federal and state court jurisdiction tend to regard anything that expands federal jurisdiction as an affront to federalism, and concededly an employment class action composed solely of California residents is in the usual case less of a threat to expansion of California law over the nation than the kinds of nationwide class actions CAFA was aimed at. But then, the Hertz rule doesn’t prevent California state law from being applied by the federal courts. What it does is simply put California back on the same footing as other states in balancing the interests of out-of-state corporations sued by its residents. That balance of power among the states in applying the law within their borders to national enterprises is, too, part of the delicate balance of federalism.

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