While state courts generally can hear almost any legal matter, federal courts are courts of limited jurisdiction. Litigating civil cases in federal court is usually permitted only when one of two conditions is met: (1) the case involves a federal law, regulation, treaty or the U.S. Constitution (which the courts refer to as a “federal question”); or (2) there is complete “diversity of jurisdiction” among the parties, and the amount in dispute exceeds $75,000.
The concept of “diversity jurisdiction” dates back to colonial times. In the late 18th century, the founders of our legal system were concerned that out-of-state defendants might get “home-turfed” by state court systems. After all, the U.S. started as a loose coalition of thirteen colonies that only gradually evolved into a strong united nation. To protect against local abuse, the founders created the concept of diversity jurisdiction, which permits an out-of-state defendant to transfer or “remove” an action from state court to federal court, as long as the plaintiff and defendant are residents of different states. Under the same principle, a plaintiff can bring an action in federal court in the first instance as long as the plaintiff and the defendant are residents of different states, and the case involves at least $75,000 in dispute.
Currently, more than two-thirds of civil cases are brought in federal court on the basis of diversity jurisdiction alone. Without diversity jurisdiction, these cases could not be litigated in federal courts. A recent case from the Seventh Circuit Court of Appeals details an important variable in determining a company’s access to the federal court system.
In 1989, the U.S. Supreme Court determined that a U.S. citizen who is “domiciled” abroad (meaning that person resides outside the U.S. and intends to remain outside the U.S. indefinitely) is not the citizen of any U.S. state, but rather is considered “stateless.” The Supreme Court also ruled that a “stateless” person cannot be sued under a theory of diversity jurisdiction. The idea is that a plaintiff from Georgia and a defendant who is a U.S. citizen domiciled in Scotland are not citizens of different states, because the U.S. citizen domiciled in Scotland is not the citizen of any state at all.
It is unusual for federal litigation to be initiated against a U.S. citizen living abroad, so the issue did not come up very often. However, the U.S. Supreme Court subsequently ruled that, for diversity jurisdiction purposes, a partnership has the citizenship of all of its partners. So, if partnership ABC has partners who live in Wisconsin, Idaho and Hawaii, the partnership is a citizen of all three states. Over time, courts have applied this doctrine to every type of business organization other than corporations (who have their own special rule). Just like partnerships, a host of entity types including limited liability companies, cooperatives, limited liability partnerships and others follow the same rule—their citizenship for diversity purposes is determined by the citizenship of each of their owners. A recent case by the Seventh Circuit Court of Appeals put the two rulings of the Supreme Court together and produced an important result for diversity jurisdiction purposes.
In Page v. Democratic Nat’l Comm., Page was a former advisor to the Donald Trump Presidential Campaign. In 2020, he brought suit in federal court in the Northern District of Illinois against the Democratic National Committee and several other entities, including a prominent law firm that is organized as a limited liability partnership. The basis of jurisdiction was complete diversity of citizenship. However, the law firm had three partners who are U.S. citizens domiciled in China. In a matter of first impression for the Seventh Circuit, the court determined that the presence of any “stateless” partner destroys complete diversity of citizenship, and thus the court dismissed the case because the federal courts lacked authority to hear it. Applied more generally, any non-corporate entity that has owners who are U.S. citizens domiciled outside the U.S. cannot sue or be sued in federal court on the basis of diversity jurisdiction.
While this result follows from the relatively straightforward application of two settled legal principles, this ruling potentially has large consequences, particularly given the diversity-heavy nature of federal civil cases.
For instance, many large companies have overseas offices where owners who are U.S. citizens work. Any such company that is organized as an LLC, LP or LLP cannot sue or be sued in federal court on the basis of diversity jurisdiction. Further, a company that wanted to avoid federal litigation whenever possible could bring on a U.S. citizen living abroad as a minority owner. Conversely, a company that wanted the ability to bring actions in or remove actions to federal court whenever possible could consider refraining from bringing on an owner who is a U.S. citizen domiciled in a foreign country.
Perhaps an even more interesting possibility would be for a non-corporate business to send an owner to a foreign country to reside there indefinitely (or to bring them back) if the business expected to bring or be the subject of litigation and wanted to influence whether the action could be litigated in federal court. Domicile is the place where a person resides and intends to remain indefinitely, and diversity jurisdiction is determined on the day a suit is filed, so such travel need not be for extended periods. In cases where the amount at stake dwarfs the cost of relocation of a single owner, and litigating in state or federal court is deemed mission-critical, it could make economic sense to send out or bring back a minority owner to make or break diversity jurisdiction.
More than two-thirds of federal civil cases are brought on the basis of diversity jurisdiction alone. Non-corporate entities have the power to control whether they can sue or be sued in federal court in the bulk of cases brought in the federal courts. Whether or not it makes sense to consider that potential tool in organizing a business or bringing in or removing owners, any party who seeks to bring a federal action or to remove a state action to federal court on the basis of diversity jurisdiction must pay careful attention to the current whereabouts of each owner whenever a non-corporate entity is involved.
The decision whether to litigate in state or federal court is a very important strategic choice that needs to be made at the outset of litigation. State and federal courts have different pros and cons depending on the facts of each individual case.
This column was originally published by Kohner, Mann & Kailas and is reposted here with permission.