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Diversity Jurisdiction and the LLC

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  • Posted on: Aug 20 2018

The simplest misstep has the potential to derail years of litigation and result in a massive financial sanction, as happened here. It is in everyone’s best interest, both the litigants’ and the courts’, to verify that diversity jurisdiction exists before proceeding with the case. Everyone involved in this case trusted that diversity jurisdiction existed, but no one verified it.

Purchasing Power v. Bluestem Brands, 851 F.3d 1218, 1220 (11th Cir. 2017).

Recently, the foregoing scenario played out in three cases pending before Judge Denis R. Hurley of the United States District Court for the Eastern District of New York.  As discussed below, Judge Hurley dismissed each action for the failure to plead diversity jurisdiction.

What is an LLC?

A limited liability company (“LLC”) is a hybrid legal structure that provides the limited liability features of a standard corporation and the tax efficiencies and operational flexibility of a sole proprietorship or partnership. Its members can include one or more individuals, corporations, partnerships or LLCs. With so many possible layers of membership, bringing a claim in federal court can be challenging, especially with respect to alleging diversity jurisdiction. (Federal question jurisdiction rarely exists in cases involving the internal affairs of an LLC – state law typically governs such disputes.)

Diversity Jurisdiction Explained

The federal courts are given diversity jurisdiction pursuant to the U.S. Constitution. Article III, § 2, clause 1 of the Constitution provides, in pertinent part, that “The judicial power shall extend to all cases . . . between citizens of different states.” The U.S. Supreme Court has interpreted this provision to mean that there must be complete diversity — that is, each party to a case cannot be a citizen of the same state. Strawbridge v. Curtiss, 7 U.S. (3 Cranch) 267 (1806).

Since diversity jurisdiction concerns the court’s subject matter jurisdiction over the matter, it cannot be waived by the parties and can be considered by the parties and the court at any time in the litigation.

Diversity is determined “upon the state of things at the time of the action brought.” Mollan v. Torrance, 22 U.S. (9 Wheat) 537, 539 (1824). Thus, a party cannot cure a diversity defect by changing his/her/its citizenship after filing the lawsuit. However, a party can cure a jurisdictional defect by dismissing a nondiverse party from the action. Grupo Dataflux v. Atlas Global Group, LP, 124 S.Ct. 1920, 1924-25 (2004). But, if that party is indispensable – that is, dismissal will unduly prejudice either the dismissed party or the remaining parties – dismissal will be deemed inappropriate.

To determine a party’s state citizenship, the courts look to the party’s domicile (i.e., the place a person considers his/her permanent place of residence). When the party is an individual, the analysis is straightforward. The court determines the domicile of each party, and if any plaintiff shares a domicile with any defendant, the court lacks subject matter jurisdiction over the action. If that happens, “the case shall be remanded” to state court.  28 U.S.C. § 1447(c).

When the party is a corporate entity, like an LLC, the analysis can become more complicated.

Diversity Jurisdiction: Corporations and Limited Liability Companies

When a party is a traditional corporation, 28 U.S.C. § 1332(c) governs the diversity jurisdiction analysis. Section 1332(c) provides that “a corporation shall be deemed to be a citizen of every State and foreign state by which it has been incorporated and of the State or foreign state where it has its principal place of business.”

There is no statutory rule governing the citizenship of an LLC.  For this reason, litigants often believe, albeit mistakenly, that the rules applicable to a corporation also apply to an LLC.

The citizenship of an LLC is determined by the citizenship of each of its members. See, e.g., Bayerische Landesbank, New York Branch v. Aladdin Capital Management LLC, 692 F.3d 42, 49 (2d Cir. 2012). “A complaint premised upon diversity of citizenship must allege the citizenship of natural persons who are members of a limited liability company and the place of incorporation and principal place of business of any corporate entities who are members of the limited liability company.” New Millennium Capital Partners, III, LLC v. Juniper Grp. Inc., 2010 WL 1257325, at *1 (S.D.N.Y. Mar. 26, 2010) (citation omitted). The state of incorporation for the LLC itself is, therefore, irrelevant.

The analysis becomes more complex when the lawsuit involves the LLC and/or its members. When the LLC itself is a litigant in a suit against any of its members, diversity jurisdiction will not exist because the parties are not diverse – the LLC has the citizenship of the adverse member. A lawsuit among LLC members can qualify for diversity jurisdiction only if the litigating members are diverse and the LLC is not an indispensable party to the lawsuit.

Judge Hurley and the Trilogy of Dismissed Cases

In a one-month span, Judge Hurley dismissed three cases involving an LLC on diversity jurisdiction grounds. Each case involved the nightmare scenario described above: litigating a case for months or years only to learn that the court lacks subject matter jurisdiction over the action.

Sienna Ventures, LLC v. Halley Equipment Leasing

On April 2, 2018, Judge Hurley dismissed Sienna Ventures, LLC v. Halley Equipment Leasing, LLC, 18-cv-201 (E.D.N.Y Apr. 2, 2018) (DRH) (GRB) (here). In Sierra Ventures, the plaintiff, a New York limited liability company with a single member who is a citizen and resident of the State of New York, filed suit on January 11, 2018 against Halley Equipment Leasing, LLC, “a limited liability company organized and existing under the laws of the State of Texas, with its principal place of business located [in] Southlake, TX ….”  Sierra Ventures asserted claims for breach of an Aircraft Purchase Agreement, and alleged that the Court had jurisdiction over the matter pursuant to 28 U.S.C. § 1332. Sierra Ventures did not allege the citizenship and residency of the defendant’s members.

On January 17, 2018, the Court ordered Sierra Ventures to show cause why the action should not be dismissed for lack of subject matter jurisdiction. On February 6, 2018, Sierra Ventures filed an amended Complaint, which “again failed” to address the citizenship and residency of the defendant’s members.

The next day, Sierra Ventures responded to the Court’s order to show by simply stating that “subject matter jurisdiction exists in this case as Sienna Ventures, LLC [] is a New York Limited Liability Company and its sole member is a citizen and resident of New York, and Halley Equipment Leasing, LLC [] is a Texas Limited Liability Company.” The letter did not address the residency or citizenship of the defendant’s members.

Judge Hurley dismissed the action. In doing so, the Court noted that “Plaintiff has had three proverbial ‘bites at the apple’ to properly allege subject matter jurisdiction; in the Complaint, the Amended Complaint, and the Response to the Order to Show Cause. Plaintiff has failed to do so on all occasions.”

Courtyard Apartments Property 1, LLC, v. Rosenblum

On April 3, 2018, Judge Hurley dismissed Courtyard Apartments Property 1, LLC v. Rosenblum, 17-cv-2909 (E.D.N.Y Apr. 3, 2018) (DRH) (SIL) (here). Like the plaintiff in Sierra Ventures, the plaintiffs in Courtyard Apartments had three “bites at the apple” to properly allege diversity jurisdiction and failed to do so.

The plaintiffs, a group of Delaware LLCs, each “with its natural U.S. citizen or domestic corporation owner, with its same natural citizen sole owner” with a principal business or residential address in one of eight states, commenced their action against the defendants on May 12, 2017. One of the defendants, Harold Rosenblum, was alleged to be a “resident” of the State of Florida; his citizenship was not alleged. None of the plaintiffs claimed to be a citizen of Florida. The plaintiffs did not allege the citizenship of the other individual defendant. The remaining defendants are all companies allegedly formed by Rosenblum. The plaintiffs did not provide any allegations regarding their citizenship, instead stating only that they are “headquartered and doing business from the State of Florida.”

The plaintiffs alleged that the Court had jurisdiction pursuant to 28 U.S.C. § 1332 because the parties are diverse in citizenship and the amount in controversy exceeds $75,000.

On January 25, 2018, the Court ordered the plaintiffs to show cause why the action should not be dismissed for lack of subject matter jurisdiction. On February 7, 2018, the plaintiffs filed an amended complaint, “which again failed to address the citizenship of all of either Plaintiffs’ or Defendants’ members.” In the Amended Complaint, the plaintiffs alleged that “Defendant Rosenblum ‘formed, and solely owned, or controlled as Managing Member’ the corporate defendants.”  The plaintiffs made no other allegations concerning the citizenship of the defendants’ members and did not distinguish between “which of the defendant corporations Rosenblum solely owned and which he just controlled.”

Also on February 7, 2018, the plaintiffs responded to the Court’s order to show cause by arguing that “‘complete diversity is now properly alleged’ because the Complaint was amended to show that the corporate owners of the Plaintiffs LLCS incorporated in Delaware do not maintain their principal place of business in Florida and the sole owner of these same Plaintiff LLCs does not maintain his/her principal residence in the State of Florida.”

The Court dismissed the action, finding that the plaintiffs’ responses were “effectively nonresponsive to the Court’s order to show cause and [did] nothing to address the myriad deficiencies regarding subject matter jurisdiction in both the Complaint and the Amended Complaint.”

First, the Court rejected the blanket statement that each of the sixteen plaintiffs were limited liability companies “‘with its same natural citizen sole owner and same principal place of business and residential address [] listed as follows[.]’” Such a conclusory statement, said the Court, was “[in]sufficient to allege citizenship of each of the members of the sixteen limited liability companies.”

Second, the Court found that the plaintiffs failed to “allege the members, let alone the members’ citizenship, of certain of the Plaintiffs such as those of the David J. Keudell Revocable Trust.” Such a failure was “fatal to diversity jurisdiction” because a plaintiff is required to allege the citizenship of all members of an unincorporated entity, such as a trust. See Amerigold Logistics, LLC v. ConAgra Foods, Inc., 136 S. Cit. 1012, 1016–17 (2016) (explaining that for purposes of diversity jurisdiction, a trust as an unincorporated entity “possesses the citizenship of all of its members”).

Third, as to the defendants, the Court reiterated that the plaintiffs failed to plead “the citizenship of each of the Defendants’ members,” instead, choosing to “rely[] on confusing statements about Defendant Rosenblum’s involvement in the companies.”  The Court also noted that the plaintiffs failed to address the citizenship of non-defendants “who apparently have or had some stake in the Defendant companies at some point in time.”

Finally, the Court declined to provide guidance to the plaintiffs with regard to properly pleading diversity jurisdiction:

While Plaintiffs ask that the Court provide guidance or further directive as to its Order to Show Cause, the Court declines to do so here. Plaintiffs have had three proverbial “bites at the apple” to properly allege subject matter jurisdiction; in the Complaint, the Amended Complaint, and the Response to the Order to Show Cause. Plaintiffs have failed to do so on all occasions. It is not the Court’s responsibility to do research for Plaintiffs’ counsel on how to properly allege subject matter jurisdiction.

Encompass Group, LLC v. Oceanside Institutional Industries, Inc.

On May 3, 2018, Judge Hurley dismissed Encompass Group, LLC v. Oceanside Inst’l Indus., Inc., 16-cv-2560 (E.D.N.Y May 3, 2018) (DRH) (AYS) (here), the third case to be dismissed on diversity jurisdiction grounds. In doing so, Judge Hurley noted that there was a problem with litigants filing cases “in this Court in which diversity jurisdiction is not properly alleged,” which necessitated the issuance of “numerous orders to show cause pointing out the deficiencies in a pleading’s jurisdictional allegations and directing that the relevant party show cause why the action should not be dismissed for lack of jurisdiction.” Encompass Group was another example of the problem. “[A]fter nearly two years of litigation,” Judge Hurley dismissed the action “for lack of subject matter jurisdiction.”

The plaintiff, Encompass Group, LLC (“Plaintiff” or “Encompass”), commenced the action against the defendant, Oceanside Institutional Industries, Inc. (“Oceanside”), asserting claims for breach of contract and account stated arising out of Oceanside’s purchase of certain goods and services from Encompass. After the completion of discovery, which included a deposition in which Oceanside conceded that it owed Encompass $1,137,955.77, Encompass moved for summary judgment. That motion was unopposed.

In reviewing the motion, the Court concluded that Encompass failed to properly allege diversity jurisdiction. As a consequence, Judge Hurley issued an order to show cause directing Encompass to “file an amended complaint, on or before May 1, 2018, setting forth the citizenship of each of its members.” Encompass failed to file an amended complaint.

Given the threadbare allegation of jurisdiction in the complaint and the plaintiff’s failure to take “advantage of the opportunity afforded it to amend its complaint to correctly assert its citizenship for diversity purposes,” the Court dismissed the action.

Takeaway

As noted in the preface to this post, “[i]t is in everyone’s best interest, both the litigants’ and the courts’, to verify that diversity jurisdiction exists before proceeding with the case.” The trilogy of cases discussed in the post shows the consequence of not doing so.

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