Thursday, September 10, 2015

Diversity Jurisdiction and Jurisdictional Discovery: The Third Circuit Holds That “Hiding The Ball” Will Not Work

Diversity Jurisdiction and Jurisdictional Discovery: The Third Circuit Holds That “Hiding The Ball” Will Not Work
      Federal diversity jurisdiction, 28 U.S.C. § 1332, requires that the dispute both involve more than $75,000 and that there be complete diversity, i.e., that no defendant be a citizen of any state of which a plaintiff is a citizen. While corporations, consequent to specific legislative designation, are deemed to be citizens of the jurisdiction of incorporation and the jurisdiction in which is located the corporation’s principal place of business, an unincorporated association such as a partnership, limited partnership or LLC is deemed to be a citizen in which any of its partners/members are citizens to the effect that, for example, if a member of an LLC is itself another LLC or a partnership, citizenship must be tracked through all layers until there are reached either natural persons or corporations. A plaintiff bringing an action in federal court, or a defendant seeking to remove an action to federal court, is required to plead facts demonstrating that diversity exists. This obligation can be at best difficult to satisfy when one considers that the membership of partnerships and LLCs is almost never of public record. How then, can either the plaintiff or the defendant seeking to enlist diversity jurisdiction adequately plead its existence?
      This dilemma was recently faced and addressed by the Third Circuit Court of Appeals. In this case, the plaintiff brought an action in federal court against defendants including LLCs. Those defendants moved to dismiss the action on the basis that diversity jurisdiction had not been adequately pled.  Of course, the information as to the membership of those defendant LLCs was uniquely within their control. As such, the plaintiff had pled diversity jurisdiction on the basis of “information and belief.” Ultimately, the Third Circuit would confirm that “information and belief” pleading is at least initially sufficient. Lincoln Benefit Life Company v. AEI Life, LLC, No. 14-2660, 2015 WL 5131423, ___ F.2d__ (3rd Cir. Sept. 2, 2015).

      Lincoln Benefit brought suit in order to have declared void two life insurance policies, alleging they were procured by fraud or for the benefit of third-party investors (i.e., “Stranger Originated Life Insurance” or “STOLI”). AEI Life, LLC and ALS Capital Ventures, LLC were identified as the record owners and beneficiaries of those two policies. In its Complaint, originally filed in New Jersey, Lincoln Benefit alleged that it is a citizen of Nebraska based upon its organization and principal place of business. It alleged, “upon information and belief,” that AEI Life, LLC and ALS Capital Ventures, LLC were citizens of, respectively, New York and Delaware. In response:
The defendants filed motions to dismiss for, among other things, lack of subject-matter jurisdiction. Their primary argument was that Lincoln Benefit failed to adequately plead diversity jurisdiction: an LLC’s citizenship is determined by the citizenship of its members, and Lincoln Benefit had not alleged the citizenship of the members of the LLC defendants.

      Lincoln Benefit, in response, pointed out that none of the defendants had asserted that it was a citizen of Nebraska and further that, as information as to the membership of an LLC is not publicly available, it should be allowed to proceed on a “information and belief” basis or, in the alternative, it should be afforded the opportunity to undertake limited discovery for the purposes of confirming that diversity did exist. The trial court held against Lincoln Benefit, holding (a) that pleading diversity on the basis of information and belief is insufficient and (b) that allowing jurisdictional discovery would be inappropriate when it was not clear that the federal court did not already have jurisdiction. It was from these determinations that Lincoln Benefit appealed to the Third Circuit Court of Appeals.

      The Third Circuit, after providing a brief review of the rules of diversity jurisdiction, noted that there are two bases for challenging jurisdiction. First, there is a “facial attack,” which, as was done in this case, alleges a deficiency in the pleadings. There is as well a “factual attack,” which challenges whether the alleged facts justify jurisdiction. Distinguishing, in the setting of this dispute, a facial from a factual attack, the Court, wrote:
If the defendants here had challenged the factual existence of jurisdiction, Lincoln Benefit would have been required to prove by a preponderance of the evidence, after discovery, that it was diverse from every member of both defendant LLCs. Instead, however, the defendants mounted a facial challenge to the adequacy of the jurisdictional allegations in Lincoln Benefit’s complaint. 2015 WL 5131423,* 3.

      In reliance, at least in part, on the decision rendered in Lewis v. Rego, Co., 757 F.2d 66 (3rd Cir. 1985), and as well limiting Chem. Leaman Tank Lines, Inc. v. Aetna Cas. & Sur. Co., 177 F.3d 210, 222 n. 13 (3rd Cir., 1999), for the proposition that “rather than affirmatively alleging the citizenship of the defendant, a plaintiff may allege that the defendant is not a citizen of the plaintiff’s state of citizenship.” To the effect that:
A State X plaintiff may therefore survive a facial challenge by alleging that none of the defendant association’s members are citizens of States X. Id. at *4.
provided that the plaintiff has undertaken reasonable inquiry in support thereof. To that end:
[B]efore alleging that none of an unincorporated association’s members are citizens of a particular state, a plaintiff should consult the sources at its disposal, including court filings and other public records. If, after this inquiry, the plaintiff has no reason to believe that any of the Association’s members share its state of citizenship, it may allege complete diversity in good faith. The unincorporated association, which is in the best position to ascertain its own membership, may then mount a factual challenge by identifying any member who destroys diversity. Id.

Explaining the rationale for its holding, the Court wrote:
We believe that allowing this method of pleading strikes the appropriate balance between facilitating access to the courts and managing the burdens of discovery. District courts have the authority to allow discovery in order to determine whether subject-matter jurisdiction exists. Rule 8(a)(1), however, serves a screening function: only those plaintiffs who have provided some basis to believe jurisdiction exists are entitled to discovery on that issue. The corollary of this principle is that a plaintiff need not allege an airtight case before obtaining discovery.
Depriving a party of a federal forum simply because it cannot identify all of the members of an unincorporated association is not a rational screening mechanism. The membership of an LLC is often not a matter of public record. Thus, a rule requiring the citizenship of each member of each LLC to be alleged affirmatively before jurisdictional discovery would effectively shield many LLCs from being sued in federal court without their consent. This is surely not what the drafters of the Federal Rules intended.
Moreover, the benefits of such a stringent rule would be modest. Jurisdictional discovery will usually be less burdensome than merits discovery, given the more limited scope of jurisdictional inquiries. It seems to us that in determining the membership of an LLC or other unincorporated association, a few responses to interrogatories will often suffice. So long as discovery is narrowly tailored to the issue of diversity jurisdiction and parties are sanctioned for making truly frivolous allegations of diversity, the costs of this system will be manageable. Id. at * 5.

      This opinion was followed by a concurrence written by Judge Ambro that, while not specifically commenting upon this dispute, urged the U.S. Supreme Court to in effect abandon the rule of Carden v. Arkoma Associates, 494 U.S. 185 (1990), and allow at least limited liability companies, notwithstanding the fact that they are unincorporated, to proceed under the rules for determining citizenship that are applicable to corporations.
      Assuming the reasoning employed in the Lincoln Benefit decision is followed by the other circuits, this could be a most important decision. First, it significantly undercuts the large number of decisions that, to date, have held that citizenship must be pled specifically and not on information and belief.  See, e.g., Principle Solutions LLC v. Feed.Ing BV, Case No. 13-C-223 (E.D. Wisc. June 5, 2013) (“It is well-settled that a plaintiff claiming diversity jurisdiction may not do so on the basis of information and belief, only personal knowledge is sufficient.”); Pharmerica Corp. v. Crestwood Care, LLC, No. 13C 1422, 2015 WL 1006683 (E.D. Ill. March 2, 2015) (“[I]t is not sufficient to assert jurisdiction based on information and belief.”); MCP Trucking, LLC v. Speedy Heavy Hauling, Inc., 2014 WL 5002116 (D. Colo. Oct. 6, 2014) (denying jurisdictional discovery and remanding action to state court even as it acknowledged that further discovery in that forum could demonstrate that diversity exists, leading to subsequent removal); Lake v. Hezebicks, 2014 WL 1874853 (N. D. Ind. May 9, 2014) (allegations of subject matter jurisdiction must be based on personal knowledge and may not be based upon information and belief and collecting cases to that effect). Further, it stands in direct challenges to those decisions that have held that citizenship must be affirmatively pled and that negative statements as to citizenship are insufficient. See, e.g., D.B. Zwirn Special Opportunities Fund, LP v. Mehrotra, 661F.3d. 124 (1st Cir. 2011), citing Cameron v. Hodges, 127 U.S. 322 (1888). While it may do nothing to address the fact that diversity jurisdiction may be unavailable consequent to de minimis indirect ownership (see, e.g., Fadal Machining Centers, LLC v. Mid-Atlantic CNC, Inc., 2012 WL 8669, 2012 U.S. App. LEXIS 48 (Jan. 3, 2012), Alphonse v. Arch Bay Holdings, L.L.C., 2015 WL 4187585 (5th Cir. July 13, 2015)), it does limit the ability of a defendant to “hide the ball” as to its citizenship while objecting that the other side has not adequately pled citizenship and therefore diversity.

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