Professional corporations are jurisdictional corporations

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A law firm organized as a professional corporation is a citizen, for diversity purposes, of its state of incorporation, and principal place of business, just like a traditional business corporation, the Seventh Circuit held on Sept. 22.

Donald Hoagland, as receiver for Midwest Transit, Inc., filed suit in an Illinois state court against Sandberg, Phoenix & von Gontard, P.C., a law firm incorporated, and having its principal place of business, in Missouri. The suit alleged legal malpractice.

The firm removed the suit to federal district court on the basis of diversity of citizenship. The district court entered judgment for the firm after determining that Hoagland had not proved the elements of legal malpractice under Illinois law, and Hoagland appealed.

The court directed the parties to address whether removal was proper, and before addressing the merits of the malpractice suit, the court addressed removal, holding that diversity jurisdiction was present, in a decision written by Judge Richard A. Posner, and joined by Judge William Bauer. Judge Frank Easterbrook wrote a separate, concurring opinion.

The court found that Hoagland is a citizen of Illinois, and notwithstanding the law firm’s connections to Missouri, three of its 22 shareholders are citizens of Illinois.

Thus, if the firm is not to be treated as any other corporation, but as a partnership or other noncorporate enterprise, complete diversity would be lacking and the suit must be dismissed for lack of federal jurisdiction.

The court noted, in Coté v. Wadel, 796 F.2d 981, 983 (7th Cir. 1986), it joined the Second Circuit, in the case of Saxe, Bacon & Bolan, P.C. v. Martindale-Hubbell, Inc., 710 F.2d 87, 89 (2d Cir. 1983), holding that for purposes of diversity jurisdiction, a professional corporation should be treated like any other corporation, rendering the members’ citizenship irrelevant.

Since Coté, every other jurisdiction to consider the issue has also held in accordance with that decision: Schneider ex rel. Estate of Schneider v Fried, 320 F.3d 396, 399, 400 (3d Cir. 2003); Ocean Ships, Inc. v. Stiles, 315 F.3d 111, 114, 115 n. 1 (2d Cir. 2002); Edell & Associates, P.C. v. Law Offices of Peter G. Angelos, 264 F.3d 424, 427 (4th Cir. 2001); and Duffey v. Wheeler, 820 F.2d 1161, 1162 (11th Cir. 1987).

In additon, the Seventh Circuit reaffirmed Coté in Saecker v. Thorie, 234 F.3d 1010 (7th Cir. 2000), and, in a case involving a nonprofit corporation, held that Coté stands for the rule that “for purposes of diversity jurisdiction a corporation is a corporation is a corporation,” CCS Information Services, Inc. v. American Salvage Pool Ass’n, 230 F.3d 342, 346 (7th Cir. 2000).

Nevertheless, the court expressed discomfort with the holding, stating, “we know that business entities that are functionally similar to corporations, but are not formally corporations, such as limited partnerships and limited-liability companies, are not classified as corporations for diversity purposes. Since professional corporations differ in certain respects from business corporations, perhaps in more respects than the entities involved in the cases just cited, we were led in Saecker v. Thorie, supra, 234 F.3d at 1012-13, to wonder whether the rule of Coté could be reconciled with these cases (cites omitted).”

Despite continued misgivings, however, the court concluded that it ought to continue to follow Coté. Besides the fact that reversing it would create an intercircuit conflict, the court found it would inject confusion into the determination of federal jurisdiction.

The court reasoned, “A salient consideration in favor of Coté is the easy applicability of a rule that treats any corporation as a corporation for diversity purposes.

Functional approaches to legal questions are often, perhaps generally, preferable to mechanical rules; but the preference is reversed when it comes to jurisdiction.

When it is uncertain whether a case is within the jurisdiction of a particular court system, not only is the cost and complexity of litigation increased by the necessity of conducting an inquiry that will dispel the uncertainty but the parties will often find themselves having to start their litigation over from the beginning, perhaps after it has gone all the way through to judgment. ‘Jurisdictional rules ought to be simple and precise so that judges and lawyers are spared having to litigate over not the merits of a legal dispute but where and when those merits shall be litigated.’ ‘The more mechanical the application of a jurisdictional rule, the better. The chief and often the only virtue of a jurisdictional rule is clarity’ (cites omitted).”

After delineating some of the different types of corporations, the court asked, “Would it be a sensible, or even a feasible, judicial undertaking to create and apply, case by case, a standard for deciding which of these should be classified as corporations for purposes of the diversity jurisdiction and which not? No court has thought so.

All the cases that discuss the citizenship of nonbusiness corporations hold that they are indeed corporations for diversity purposes.”

The court acknowledged that simplicity could be preserved by holding that only a corporation organized under a state’s business-corporation law is a co
rporation for purposes of the diversity jurisdiction. However, the court found such a rule would involve the courts in rewriting the diversity statute.

The court noted, “The statute states flatly that a ‘corporation’ is a citizen of the state in which it is incorporated and also the state in which its principal place of business is located. 28 U.S.C. 1332(c)(1). The word is not qualified.”

The court also noted that, in Carden v. Arkoma Associates, 494 U.S. 185 (1990), the U.S. Supreme Court refused to treat a limited liability company as a “corporation” for purposes of the diversity statute, and made no suggestion that the corporations of which the statute speaks are limited to business corporations.

Addressing Carden, the court mused, “Had the Court been minded to go down that road — had it thought there was some reason to think Congress had wanted to confine the corporate category to business corporations — it might have been expected to consider whether noncorporate business entities that were functionally similar to business corporations should be treated the same way in order to carry out Congress’s desire to give special treatment to businesses. Far from adopting a functional approach, one that might cast a shadow over Coté, Carden rejects such an approach in favor of drawing a bright line between corporations and all other associations. The Court said that ‘having established special treatment for corporations, we will leave the rest to Congress.’ Carden v. Arkoma Associates, supra, 494 U.S. at 197. We shall do likewise.”

Having found jurisdiction to be present, the court turned to the merits of the malpractice action, which it called “slight,” and affirmed the district court’s dismissal.

The Concurrence

Judge Easterbrook wrote a concurring opinion, going on at even greater length about the pros and cons of basing diversity solely on use of the word, “corporation.”
Easterbrook’s first objection is that the decision makes federal jurisdiction dependent upon state nomenclature: “My colleagues conclude that for purposes of 28 U.S.C. 1332(a) a ‘corporation’ is any entity on which a state bestows that label. Thus if a state renames a limited liability company as a ‘limited liability corporation,’ it becomes a ‘citizen’ with its own jurisdictional attributes, and the citizenship of its members no longer matters.”

Second, Easterbrook took issue with the observation that case law universally treats, as a “corporation,” any entity bearing that label under state law. Except for Coté, and Saxe, Bacon & Bolan, P.C., Easterbrook noted that none of the other cases actually discuss the jurisdictional question, and concluded that, therefore, they have not resulted in relevant holdings on the subject.

Third, Easterbrook cited Supreme Court precedent that has looked to the nature of the entity, rather than the label, such as Great Southern Fire Proof Hotel Co. v. Jones, 177 U.S. 449 (1900). The Supreme Court held that a joint stock company was only a “quasi” corporation, and must be deemed a partnership rather than a corporation under sec.1332, even though the Constitution of Pennsylvania provided that “all joint stock companies or associations having any of the powers or privileges of corporations not possessed by individuals or partnerships” were “corporations.”

Easterbrook asked, “If a joint stock company deserves a ‘quasi,’ why doesn’t a professional corporation, which like a joint stock company differs in many ways from a firm chartered under a state’s general corporate law?

Easterbrook suggested means of differentiating various entities labeled “corporations” from corporations under sec. 1332, such as the issuance of marketable stock, and separation of ownership and control. Easterbrook noted, “A professional corporation does not separate ownership from control even in principle, and it offers no opportunity for diversification either; a P.C. is scarcely different economically from a partnership.”

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Easterbrook observed, “No matter what feature one names as the potential dividing line, it is possible to find a decision of the Supreme Court on the other side. That makes life hard for an intermediate appellate court. We must choose between letting nomenclature control and trying vainly to identify which legal characteristics distinguish corporations from other entities. The former approach is wrong in principle, the latter untenable in practice.”

Nevertheless, Easterbrook concluded, “Forced to choose between these options, I join the majority in thinking that it is better to let names control than to set off on a snipe hunt. Carden, the Court’s most recent word, is essentially formal. A formal approach has at least the virtue of certainty, a desirable feature in a jurisdictional rule.

It also produces consistency. Professional corporations were created to permit lawyers, physicians, accountants and others to set up firm-wide tax-advantaged pension plans at a time when federal law restricted that opportunity to corporations. States created entities with the corporate name but the functional features of a professional partnership. If that gimmick opens the door to federal tax benefits, why not to citizenship under sec. 1332? (The federal rules for pensions were changed in 1992, which may explain why most professionals today opt for limited liability partnerships or other non-corporate forms of organization, but this does not affect the treatment of existing entities.) Either Con
gress or the Supreme Court can draw finer lines if a broad brush leaves states (and entrepreneurs) with too much discretion.”

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David Ziemer can be reached by email.