In a significant blow to business, the Supreme Court on Wednesday ruled that certain class actions barred or limited by state laws may proceed in federal courts.

In Shady Grove Orthopedic Associates v. Allstate Insurance Co., a 5-4 majority, led by Justice Antonin Scalia, held that the federal class action rule, Civil Procedure Rule 23, trumped a New York law prohibiting class actions that seek to recover statutory penalties or minimal recoveries.

“The Court’s decision is good for those who use class actions as a remedy to corporate wrongdoing,” said Scott Nelson of Public Citizen Litigation Group, who argued the case for Shady Grove. “The Court did the right thing today.”

But the decision will “upend” a large number of state statutes that limit remedies which can be sought by class actions or that outright prohibit certain class actions, said Archis Parasharami, cochair of Mayer Brown’s consumer litigation and class action practice.

“This is a major decision affecting statutory claims,” he added. “We now have cases that under controlling state law could never proceed as class actions in state court transformed into completely different litigation.”

In its Supreme Court brief, Allstate said at least 22 states limit remedies recoverable in class actions and at least 23 prohibit class actions for certain claims.

The issue before the justices stemmed from a federal class action filed by Shady Grove to recover statutory interest on overdue benefit payments by Allstate. Shady Grove alleged that Allstate routinely refused to pay interest on overdue benefits. The medical provider sought relief on behalf of itself and at least 100 other members of the class.

The federal district court dismissed the lawsuit after finding that statutory interest is a “penalty” under New York law and that law barred the action from proceeding. Shady Grove’s individual claim — roughly $500 — fell short of the amount that would have allowed its claim to remain in federal court. The U.S. Court of Appeals for the 2nd Circuit affirmed.

In the Supreme Court, the case presented a classic civil procedure conundrum that only law professors could love. And in the end, it produced splintered voting and unusual alignments of the justices.

Scalia rejected arguments by Allstate and the 2nd Circuit that Rule 23 and the New York law did not conflict because they addressed different issues. Allstate contended that Rule 23 is procedural, governing whether a class should be certified, while the New York law is substantive, determining whether a particular type of claim is eligible for class treatment. He called the “eligibility-certifiability” distinction “entirely artificial,” explaining that both are prerequisites for maintaining a class action.

“Rule 23 unambiguously authorizes any plaintiff, in any federal civil proceeding, to maintain a class action if the Rules’ prerequisites are met,” he wrote. “We cannot contort its text, even to avert a collision with state law that might render it invalid.”

He attracted a majority for the Court’s judgment that Rule 23 applies, but not all for the same reason. Scalia was joined in full by Chief Justice John Roberts Jr. and Justice Clarence Thomas, and in part by Justice Sonia Sotomayor, that the rule was valid because it regulates procedure.

However, Justice John Paul Stevens, concurring in part and concurring in the judgment, said that while he agreed that Rule 23 trumped the state’s procedural rule, he also agreed with Justice Ruth Bader Ginsburg’s dissent “that there are some state procedural rules that federal courts must apply in diversity cases” because they essentially are part of a state’s definition of substantive rights and remedies.

Ginsburg, joined by Justices Anthony Kennedy, Stephen Breyer and Samuel Alito Jr., said. “The Court today approves Shady Grove’s attempt to transform a $500 case into a $5,000,000 award, although the State creating the right to recover has proscribed this alchemy.”

She said there was no conflict between Rule 23 and the New York law, adding, “Sensibly read, Rule 23 governs procedural aspects of class litigation, but allows state law to control the size of a monetary award a class plaintiff may pursue.”

Andrew Tulumello, vice chair of the class action and complex litigation group at Gibson, Dunn & Crutcher, said, “I don’t think it’s fair to say the decision automatically blows up various state laws. It certainly casts doubt on them. Even to the extent it creates some doubt, that is a real problem from a defense standpoint, particularly with statutory damages. It’s very easy to generate a massive damages number by generating lots of penalties that have basically no connection to the actual amount of harm.’

Stevens’ concurrence, because it is narrower than the Scalia plurality, will control here, he added, explaining, “[Stevens] leaves the door open to looking at state laws that, in his view, would be more substantive than procedural. If a state says pretty clearly this is a damages cap or a remedy limitation, then I think, under Stevens view, that would be honored in federal court. You’re going to have a lot of detail-scratching as to laws on the books.”

State legislatures in the future, however, will have to be much more careful in enacting limitations “in order to get it right,” said Tulumello.

Public Citizen’s Nelson said, “You’re going to find there may be other types of laws where the result is going to be uncertain but as to one that says for X type of case you may not certify it as a class action, the majority opinion on Rule 23 is going to answer the question in 99.9% of the cases, as Justice Stevens’ concurrence indicates.”

Christopher Landau, head of Kirkland & Ellis’ appellate litigation practice, argued the case for Allstate. Michael Siemienas, an Allstate spokesman, said, “We are disappointed and respectfully disagree with the ruling. We believe New York law clearly specifies court cases involving statutory penalties cannot be brought as a class action. The case will now return to the U.S. District Court in New York. Today’s ruling does not affect the merits of the case and Allstate will continue to defend it accordingly.”

Marcia Coyle can be contacted at mcoyle@alm.com.