The Supreme Court is considering an amendment to Federal Rule of Civil Procedure 7.1 “designed to facilitate an early and accurate determination of jurisdiction” in actions based on diversity jurisdiction (the Proposed Rule). Memorandum From the Comm. on Rules of Practice and Procedure to Scott S. Harris, Clerk, Sup. Ct. of the U.S. (Oct. 18, 2021) (SCOTUS Package), at 126-28. This Proposed Rule aims to resolve questions of diversity before time and resources are wasted litigating claims that have no constitutional basis for being heard in federal court. Beyond the surface of its sensible purpose, however, lies genuine cause for concern for noncorporate entities like limited liability companies (LLCs) and limited partnerships (LPs), which take on the citizenship of each of their partners, members, or owners.
The Proposed Rule would require all parties to an action based on diversity jurisdiction to file a disclosure statement with the names and citizenship of every individual or entity whose citizenship is attributed to that party. SCOTUS Package at 126-27. Consistent with current Rule 7.1, this disclosure statement would be filed with each party’s first appearance, pleading, petition, motion, response, or other request addressed to the court.
In theory, the Proposed Rule is well intentioned. In practice, however, the Proposed Rule’s flaws are likely to far outweigh its benefits.
First, the Proposed Rule is unlikely to resolve complex questions that arise concerning the citizenship of noncorporate entities or unincorporated associations. For diversity purposes, LLCs and LPs are citizens of states of each of their partners, members, or owners. If an LLC has several members, each of which are LPs, each of those LPs’ partners’ ( jurisdictional) citizenship must be determined, and so on up the corporate chain until the terminus is, in most cases, a corporation or individual. Thus, it may be necessary to wade through many, many layers of corporate structures to determine citizenship.
The Advisory Committee on Civil Rules rightly recognized that “more elaborate LLC ownership structures may make it difficult, and at times impossible, for an LLC to identify all of the individuals and entities whose citizenships are attributed to it, let alone determine what those citizenships are.” SCOTUS Package at 154. And the Committee Note acknowledges that the Proposed Rule “does not address the questions that may arise when a disclosure statement or discovery responses indicate that the party or intervenor cannot ascertain the citizenship of every individual or entity whose citizenship may be attributed to it.” SCOTUS Package at 111. This significant flaw could be so pervasive that it undercuts the purpose of the Proposed Rule.
Take, for example, a defendant start-up LLC that has funding from several third-party LLC or LP members. The start-up may not have comprehensive upper-tier ownership information concerning each of its investors, but would nevertheless be compelled to disclose the names of its members without the benefit of fully answering the citizenship question. Not only is the process of attempting to determine citizenship likely to be time consuming, but it may also interfere with the LLC’s business relationships with its third-party investors, all while failing to satisfy the Proposed Rule’s goal.
Second, the Proposed Rule requires disclosure vastly in excess of that which is necessary to meet its objective. The names of an entity’s members, owners, or partners have no bearing on its citizenship. Complete diversity requires that “all plaintiffs must be citizens of states diverse from those of all defendants.” Tagger v. Strauss Grp. Ltd., 951 F.3d 124, 126 (2d Cir. 2020) (citation omitted). Accordingly, once a plaintiff’s citizenship is known, the narrow question should be whether any defendant shares citizenship with that plaintiff. If a New York plaintiff sues an LLC, a simple disclosure stating that the LLC has a New York member—signed by an attorney subject to Rule 11— should be sufficient to establish that diversity jurisdiction is defeated. The names and citizenship of the rest of its members (or its members’ members, and so on) is superfluous. Indeed, the Committee Notes suggest “[d]isclosure might be cut short when a party reveals a citizenship that defeats diversity jurisdiction,” SCOTUS Package at 111, but the Proposed Rule nevertheless mandates that the burden of disclosure, or seeking a protective order, be borne not by the party invoking federal jurisdiction, but by the party haled into court.
Third, this robust disclosure requirement may lead to abuse by parties seeking to uncover layers and layers of ownership structures of private entities. The Proposed Rule may invite the filing of specious lawsuits in federal court solely as a fact-finding tool in the search for deep pockets. In fact, the disclosure required by the Proposed Rule is far more invasive than that which would typically be countenanced through discovery. Yet this disclosure is required at defendants’ first appearance “unless the court orders otherwise.” SCOTUS Package at 108-09. The only guidance provided to Courts construing this Proposed Rule in the Committee Notes is that “the names of identified persons might be protected against disclosure to other parties when there are substantial interests in privacy and when there is no apparent need to support discovery by other parties to go behind the disclosure.” Id. at 111 (emphases added). But shifting the burden onto defendants is illogical and unjust, as there is no substantial interest in exposing hundreds of private entities’ ownership structures for the sole purpose of attempting to establish whether diversity jurisdiction exists.
Consider the case of a private equity fund structured as an LP or an LLC. If named in a federal lawsuit based on diversity jurisdiction, the fund would be required to publicly file a disclosure statement identifying the name and citizenship of each of its third-party investors. As a result, those passive investors—which may include pension funds, sovereign wealth funds, or individuals—may be joined in litigation unrelated to any act or omission on the part of such investor, bear the costs of meritless litigation, and shoulder increased reputational risk.
Lastly, contrary to nearly a century of precedent, the Proposed Rule effectively shifts the burden away from the party invoking federal jurisdiction. See McNutt v. Gen. Motors Acceptance Corp. of Indiana, 298 U.S. 178, 189 (1936) (“[T]he party who seeks the exercise of jurisdiction in his favor … must allege in his pleading the facts essential to show jurisdiction. If he fails to make the necessary allegations he has no standing.”). The Second Circuit has therefore “remanded [to state court] or dismissed cases when a plaintiff has invoked the original diversity jurisdiction of a federal district court but failed to include adequate allegations of diversity in the complaint and the record [has] not allow[ed] [the court] to determine the citizenship of one of the parties.” Platinum-Montaur Life Scis. v. Navidea Biopharmaceuticals, 943 F.3d 613, 617 (2d Cir. 2019) (collecting cases).
Under the Proposed Rule, defendants would be required to disclose their citizenship simultaneously with a motion to dismiss, potentially mooting any argument that plaintiff failed to meet its burden to adequately plead diversity jurisdiction. Plaintiff could simply incorporate defendants’ disclosures and amend its complaint as a matter of course pursuant to Rule 15(a)(1)(B). Although the Committee Note stresses that the Proposed Rule “does not relieve a party that asserts diversity jurisdiction from the Rule 8(a)(1) obligation to plead the grounds for jurisdiction,” SCOTUS Package at 110, the Proposed Rule would allow plaintiffs to file federal cases without the requisite diligence—without consequence—while defendants are compelled to do all the legwork.
Simply put, though well meaning, the Proposed Rule is flawed and unnecessary. As outlined above, the Propose Rule would require invasive, overbroad disclosures that may not even answer the narrow question as to whether complete diversity among the parties exists. Moreover, close to a century of precedent has guided courts—and plaintiffs—as to what is necessary to adequately plead diversity jurisdiction. In attempting to provide a needless solution, the Proposed Rule is likely to cause more problems than it solves.
Despite this, the Proposed Rule has maintained momentum throughout the extensive rule-making process and was presented to the Supreme Court for review on Oct. 18, 2021. See SCOTUS Package. It is now up to the Supreme Court to prescribe the Proposed Rule and submit it to Congress. 28 U.S.C. §§2072, 2074. If so submitted by May 1, 2022, and Congress does not act, the Proposed Rule will take effect as a matter of law on Dec. 1, 2022. See 28 U.S.C. §2074.
Therefore, businesses and the defense bar should brace themselves for what may be on the horizon: a Federal Rule of Civil Procedure that burdens them with naming and identifying the citizenship of all LP and LLC members, owners, and partners each time they are sued in federal court, while plaintiffs benefit from a fountain of private ownership information, regardless of whether the disclosures actually resolve complex diversity jurisdiction questions.
Reprinted with permission from the November 3, 2021, issue of the New York Law Journal. © 2021 ALM Media Properties, LLC. All Rights Reserved.Click here to view the full article