Online Exclusive: Hertz v. Friend May Add to Overburdened Federal Docket

Certain class action cases may be saved from courtroom limbo thanks to a recent Supreme Court opinion.

In Hertz v. Friend, the high court unanimously sided with Hertz Corp., agreeing that the rental car company’s principal place of business was not in California, as the plaintiffs had argued. Rather the court identified Park Ridge, N.J., where the company’s leadership is located, as the company’s principal place of business. In doing so it cleared up an issue that had remained unsettled up to that point.

“[I]n practice [a company's principal place of business] should normally be the place where the corporation maintains its headquarters–provided that the headquarters is the actual center of direction, control and coordination, i.e., the ‘nerve center,’” Justice Stephen Breyer wrote in the February opinion.

With that clarification, the Supreme Court has done away with the patchwork of tests used across the nation to determine a company’s citizenship and established a single, streamlined method. With the precedent in place, in-house counsel will have more certainty when removing class action cases to federal court based on diversity jurisdiction.

“You now have predictability,” says Frederic Giordano, a partner at K&L Gates. “Although a company’s principal place of business is not an issue in every case, this predictability can reduce litigation costs in cases where this would be an issue.”

Removal Rules

Filed in 2007, Hertz v. Friend is a fairly run-of-the-mill overtime lawsuit. Hertz employed plaintiff Melinda Friend in what the company claims was a managerial capacity. She worked in excess of 40 hours a week but was denied overtime because of her managerial classification. Along with a similarly situated class of Hertz employees, Friend filed suit in state court in California seeking overtime pay.

Hertz sought to remove the case to federal court.

“There is a uniform perception by members of the defense bar that federal district court is a more favorable forum than state court,” says Frank Shuster, a partner at Constangy, Brooks & Smith. Shuster was part of the defense team that represented Hertz.

Shuster says one advantage of a federal court’s much larger geographic area is that it provides a more diverse pool of jurors than a state court, which may only draw jurors from a single county. In addition, federal judges are appointed for life, unlike state court judges who may be subject to political pressure to ensure re-election or re-appointment.

Under the Class Action Fairness Act (CAFA), courts can remove state cases to federal court if certain criteria are met. Neither side in Hertz v. Friend disputed that the class action met some of these requirements, including the fact that the amount in controversy exceeded $5 million. However, what was in contention was the issue of diversity jurisdiction.

CAFA allows removal to federal court if any member of the class of plaintiffs is a citizen of a different state than a defendant. For removal purposes, there are two ways to determine a corporation’s citizenship. The first is to consider the state where the company is incorporated–in Hertz’s case, that is Delaware. The second is to consider the state where the company’s “principal place of business” is located.

“Before the Supreme Court’s opinion, different circuits were using different tests to determine a company’s principal place of business,” Giordano says.

The Hertz case fell in the 9th Circuit, which relied on a standard known as the substantial predominance test.

“The test applied by the 9th Circuit basically looked at where a corporation’s business was most concentrated,” Shuster says. “If there was a concentration in any given state, that state would serve as the corporation’s principal place of business for the purposes of removing a case.”

To determine a company’s concentration, the test considered six data points: the number of employees, the amount of tangible property, production activities, source of income, sales and purchases.

Under this test, the 9th Circuit sided with the plaintiffs and determined that Hertz was a citizen of California. Hertz appealed to the Supreme Court, citing the substantial predominance test as overly complex and flawed.

California Confusion

The defense argued that, by definition, a principal place of business should be a single location rather than an amalgamation of business operations throughout a state.

“The plain language of the term ‘principal place of business’ requires the conclusion that it means a single place,” Shuster says. “The substantial predominance test was flawed because it didn’t look at [just] one place.”

The Supreme Court agreed, citing many examples outside of the diversity statute where the phrase “place of business” is used to mean a specific business establishment.

“A number of federal statutes make sense only if the phrase ‘place of business’ refers to a particular business location rather than a State as a whole,” Justice Breyer wrote. “[C]ertain statutes require corporations to identify the ‘address’ of their ‘place of business.’ Related statutes provide for service on corporations by delivery or mail to a ‘place of business.’”

In addition, basing a company’s principal place of business on factors such as revenue could create inconsistent results. For example, if a drug manufacturer sells its products nationally, then the amount of revenue it earns per state could vary from year to year or month to month. In such a situation, determining the company’s principal place of business could depend on when the plaintiffs filed the complaint.

“If the principal place of business is dependent upon numbers that change all the time, it could be pretty costly and time-consuming to figure out these facts,” Giordano says.

However, even if these factors were unchanging, the 9th Circuit’s test could still present unnecessary and costly complexities, Hertz argued. Without prescribed methodology to calculate any of the data used in the test or guidance as to which data points are more important than others, parties were likely to get stuck litigating the finer details of the test.

Once again, the Supreme Court agreed. In his opinion, Justice Breyer called the substantial predominance test “complicated” and “unpredictable.”

“Almost all the other circuits in one form or another weighed where a company does the most business, owns the most property and employs the most people because of the legislative history on the subject,” says Robert J. Stein III, a partner at Adorno & Yoss and counsel for the plaintiffs. “But the Supreme Court’s opinion basically said they were going with a more pragmatic policy that would be easier to administer.”

Nerve Center

Hertz argued that the “nerve center” test the Supreme Court adopted was a simpler and more straightforward alternative. Implemented first by the 7th Circuit, the nerve center test defines the state where the company’s executive officers are located. The law defines that state to be the company’s principal place of business.

“The 7th Circuit’s test acknowledges the common-sense principal that litigating should be simple, ” Shuster says. “ We shouldn’t have to even get into these arguments about where a company is located.”

The nerve center test, unlike the substantial predominance test, pinpoints a single location from which a company conducts business, usually a company’s headquarters.

“The headquarters is the most important location because it bears responsibility for directing and controlling all of the corporation’s business activities in all states,” Justice Breyer wrote. “Thus, by definition, a corporation’s ‘headquarters’ is its ‘chief place of business.’”

Finally, the court reasoned that, based on 7th Circuit history, the nerve center test was an adequately “clear and easily administered” approach–an important point because the question of federal jurisdiction is so frequently litigated.

“Experience with the headquarters test demonstrates its simplicity and efficiency,” Justice Breyer wrote. “The 7th Circuit uses the headquarters test exclusively and finds it straightforward to administer.”

Experts agree with the Supreme Court that the nerve-center test will reduce time spent litigating jurisdictional issues. By making the question of a company’s citizenship easily predictable, companies will no longer have to delay litigating due to disagreement over data required by a complex place-of-business test.

“Now we won’t have to worry about being remanded, which can be very costly,” Shuster says. “This was [a case of] parties litigating over where to litigate, which in my opinion is a needless expense.”