Fifty years ago, the tragedy of the Thalidomide birth-defect crisis captured the attention of the world: Sold over-the-counter as a tranquilizer in some countries, Thalidomide was hailed as a wonder drug when it was released in the late 1950s. During its four years on the market, Thalidomide was also prescribed to millions of pregnant women as an antidote to morning sickness. Its maker, a small German company, marketed it aggressively throughout the world.
Richardson-Merrell was licensed to distribute the drug in the United States. It distributed more than 2.5 million Thalidomide tablets to more than 1,000 doctors as part of a clinical trial. The doctors prescribed Thalidomide to nearly 20,000 patients, several hundred of whom were pregnant women. Fortunately, the U.S. Food and Drug Administration never approved Thalidomide for general use. Although more than 10,000 children around the world were estimated to have been born with deformities caused by Thalidomide use, the damage in the United States was small by comparison. Yet at least 17 children born in the United States suffered serious deformities. This column focuses on the most recent fallout from the Thalidomide tragedy: litigation in the United States on behalf of those victims.
Several cases were filed recently on behalf of these plaintiffs in a Pennsylvania state court described by some as a “judicial hellhole.” The plaintiffs are likely to argue that a recently discovered FDA memorandum about the clinical trial should allow the statute of limitations to be tolled. The defendants swiftly removed to federal court, with the cases going to several different judges in the Eastern District of Pennsylvania. Differing in their analyses of one of the defendants’ corporate citizenship, most judges remanded; but the judge deciding the latest disagreed and denied the motion to remand.
The key issue was whether a particular defendant was a citizen of Pennsylvania, which would result in remand. All of the judges purported to apply the U.S. Supreme Court’s “nerve center” test for corporate citizenship for diversity jurisdiction purposes under 28 U.S.C. 1332(c), which was enunciated just two years ago in Hertz Corp. v. Friend, 130 S. Ct. 1181 (2010). There, in choosing among myriad tests adopted by the courts of appeals, the court adopted the nerve-center test because it not only best comported with congressional intent, but also because it would be the simplest to apply, opining that jurisdictional rules should be as straightforward as possible.
The leading opinion finding remand to be appropriate was Judge Timothy Savage’s opinion in Brewer v. SmithKline Beecham Corp., 774 F. Supp. 2d 721 (E.D. Pa. 2012). He began by stating that he was confronted with an “atypical factual scenario.” I am not sure how atypical the scenario is; corporate structures seem to become more complex by the day. But the facts here surely complicated the citizenship analysis. The courts all had to determine how a corporation’s status as a holding company factored into the jurisdiction analysis when the named defendant, GlaxoSmithKline LLC, formerly SmithKline Beecham Corp. (SKB), is an operating limited liability company whose sole member, GlaxoSmithKline Holdings (Americas) Inc., a Delaware corporation headquartered there, is a holding company that delegates its operational decision-making to the operating company.
The court began by detailing the relationship among the various defendants. SKB was converted from a Pennsylvania corporation to a Delaware LLC for business purposes: Delaware allows a corporation to convert to a limited liability company without liquidating or dissolving the corporation. Indeed, the defendant conceded that the LLC is “simply a continuation of what used to be SKB,” with the LLC having “the same rights and obligations that it always had.” Moreover, although the LLC was registered in Delaware, the limited liability company agreement listed its “business address” as One Franklin Plaza in Philadelphia. Its president described this address as the LLC’s headquarters or “principal place of business.”
The court then moved to the question at hand: What is the citizenship of the defendant LLC? Well, the first part of the answer is easy: An LLC’s citizenship is that of its members. But the LLC’s only member was a corporation, the holding company, and that was unquestionably incorporated in Delaware. Under 28 U.S.C. 1332(c), a corporation is a citizen of any state of incorporation as well as its principal place of business. The controlling issue was whether the holding company’s principal place of business was Delaware or Pennsylvania.
The Brewer court carefully applied the Supreme Court’s nerve-center test, finding that the test was qualitative, not quantitative. Foreshadowing where its analysis would lead, the court then picked up on language from the Hertz opinion: A corporation’s nerve center is “not simply an office where the corporation holds its board meetings.” Id. at 1192. It also noted the Supreme Court’s admonition that if “the alleged ‘nerve center’ is nothing more than a mail drop box, a bare office with a computer, or the location of an annual executive retreat,” this would reveal “attempts at manipulation.” Id. at 1195. In that case, the court “should instead take as the ‘nerve center’ the place of actual direction, control, and coordination, in the absence of such manipulation.” Accordingly, the court examined the holding company’s center of direction, control and coordination in the context of its dual role as a holding corporation and as the sole member of the LLC: The directors and officers of the holding company, both before and after SKB’s conversion to an LLC, have been the same and almost all of them worked out of Philadelphia.
Not much happens in Delaware. Yes, the holding company’s board of directors meet quarterly in Wilmington. But at the meetings, which last between 15 and 30 minutes, the three directors vote on a limited number of financial issues on an agenda prepared in Philadelphia.
The Brewer court then noted that when the sole member of a limited liability company is a holding company, there is an anomaly in applying the nerve-center test. In this situation, the Hertz nerve-center test and the limited liability company citizenship test meld.
Here, as the LLC’s sole member, the holding company had the exclusive right and power to control, direct, run, manage and operate the LLC. It elected to make the LLC a manager-managed company. It delegated the management, direction and control of the business and affairs of the LLC to the LLC’s officers and directors, i.e., the former officers and directors of SKB were to be the LLC’s “managers.” Having delegated the direction, control and coordination of the LLC to managers who operate from Philadelphia, the holding company “had effectively transplanted the vast majority of its ‘brain’ or ‘nerve center’ to its managers in Philadelphia, leaving only a small part of its ‘brain’ in Delaware, Philadelphia and London, where its investment decisions and strategy are made.” Id. at 729-30. Thus, the court concluded that the “nerve center” of the holding company is Philadelphia.
The court then suggested that the LLC was formed to manipulate jurisdiction. It noted that what the holding company does in Wilmington is done to simply comply with Delaware law. Thus, according to the court, it fits the description of a company described in Hertz as “an artifice to manipulate jurisdiction.” Although the LLC was formed to accomplish a legitimate business purpose, its post-discovery conduct in the removed cases “smacks of jurisdictional manipulation.” Id. at 7. For example, after the deposition testimony of its president and its vice president — and documents it had produced — reflected that Philadelphia was its headquarters, the holding company amended its bylaws to change its general place of business and the location of its books and records from Philadelphia to Wilmington.
Judge Paul Diamond presented the counterpoint to Savage’s opinion. In Johnson v. SmithKline Beecham Corp., 853 F. Supp. 2d 487, 490 (E.D. Pa. 2012), using the same factual record analyzed by Savage, he denied the plaintiff’s motion to remand, finding that the LLC’s principal place of business was Delaware. In essence, Diamond disputed that the holding company had any role other than carrying out the limited duties that Savage had identified in Brewer. Like Savage, he distinguished between holding companies and operating companies, but Diamond said that holding companies do not operate — they “hold.” He decided that the high court in Hertz was addressing operating companies, not holding companies.
Moreover, applying a sort of hybrid rule to holding companies would contravene the Supreme Court’s condemnation of complex jurisdictional rules. Indeed, while Savage made persuasive use of the Supreme Court’s admonition regarding forum manipulation, Diamond makes a compelling point in that Savage’s approach would seem to be the kind of nuanced, fact-specific test, rather than a simple bright-line test, that the high court rejected. The holding company’s nerve center is not in Philadelphia simply because its investment (the LLC) operated there. Rather, its nerve center is where its unique, though limited, ownership decisions are made.
Both opinions have much to commend them, and judges on both sides of the fence have certified the issue to the U.S. Court of Appeals for the Third Circuit under 28 U.S.C. 1292(b). In contrast to the emotional merits of the cases, we will are likely to see a complex and technical exploration of Hertz. In turn, the determination of the forum for the Thalidomide litigation may have a major impact on the value of the plaintiffs’ claims.
Georgene Vairo is the David P. Leonard Professor of Law at Loyola Law School, Los Angeles. She serves as a member of the board of editors of Moore’s Federal Practice, for which she writes chapters on removal, venue and multidistrict litigation. She also serves on the Rand Institute for Civil Justice Board of Overseers.