There’s an interesting case that recently came down from the Third Circuit. In Lincoln Benefit Life Co. v. AEI Life, LLC, 800 F.3d 99 (3d Cir. 2015), the plaintiff insurer commenced a declaratory judgment in federal district court against two limited liability companies (LLCs), and it asserted federal diversity jurisdiction. The court was bound by the principle set forth in Carden v. Arkoma Associates, 494 U.S. 185  (1990). There, the Supreme Court held that the citizenship of all partners in a limited partnership must be taken into account in determining whether complete diversity exists between the parties. Based on this principle, federal courts have consistently held that the citizenship of noncorporate business organizations such as partnerships and LLCs is determined by the citizenship of their partners and members. In contrast, the citizenship of corporations have long been held to be the state of incorporation (see id. at 89-90, citing Marshall v. Baltimore & Ohio R. Co., 16 How. 314 (1854)). Not surprisingly, the Third Circuit held that the citizenship of an LLC for the purpose of diversity jurisdiction is the citizenship of its members (and not the state of filing as would be the case for a corporation), but in a twist the court further held that a complaint will survive a facial challenge to subject matter jurisdiction if a plaintiff avers in good faith, after a reasonable attempt to determine the identities of the members of the association, that it is diverse from all of those members. The plaintiff should consult the sources at its disposal, including court filings and other public records to satisfy diversity jurisdiction at the pleading stage, and the unincorporated entity may then mount a factual challenge by identifying any member who destroys diversity. Since the LLC filing requirement in most states do not require identification of members and that most other public sources of information may not contain a complete list of LLC members, the holding in Lincoln Benefit Life basically shifts the burden to disprove diversity jurisdiction to the defendant LLC, which the court properly notes “is in the best position to ascertain its own membership.”

The more interesting aspect of Lincoln Benefit Life is that the three-judge panel, which unanimously joined the court’s opinion, also wrote a separate, unanimous concurrence addressed specifically to the Supreme Court. The concurring panel argued that the rule on unincorporated entities is anachronistic and not servicing the policy needs of the modern business in which unincorporated entities, such as LLCs, are prominent. The three judges wrote: “What do these differences have to do with diversity of citizenship? Nothing. The kinds of business activities that can be carried on by LLCs are identical to those in which corporations may engage. And by picking corporate-style default rules in a membership agreement, an LLC could function in exactly the same way as a corporation for all purposes except diversity of citizenship.” The concurrence then suggested that the Supreme Court should revisit the principle in Carden.

The unusual concurrence makes a strong point that, in the modern world of business, Carden is unpersuasive and anachronistic. The Scalia opinion relied on a line of cases from Chapman v. Barney (1889) to Steelworkers v. R.H. Bouligny, Inc. (1965) for the proposition that, except corporations, the citizenship of business associations is determined by the citizenship of their partners. corporate option. Much has changed in the business world since the 1960s (the first LLC statute was enacted in the mid-1970s in Wyoming and the LLC has only in the recent two decades becomes prominent). Now, large scale and sophisticated business activities are commonly conducted through LLCs. Policy considerations applicable now could not have been contemplated at the time of Chapman and Steelworkers.

The citizenship of an LLC for the purpose of diversity jurisdiction is yet another iteration of the debate on whether a partnership is the aggregate of its partners and is a distinct entity. Modern statutes make clear that partnerships and LLCs are entities separate and distinct from their partners and members. See RUPA § 201(a) (“A partnership is an entity distinct from its partners.”); ULPA (2001) § 104(a) (“A limited partnership is an entity distinct from its partners.”); RULLCA § 104(a) (“A limited liability company is an entity distinct from its members.”); Delaware LLC Act § 18-201(b) (“A limited liability company formed under this chapter shall be a separate legal entity . . . .”). Indeed, modern non-corporate statutes, like corporation statutes, provide for derivative suits, which presupposes an entity for whose behalf one brings an action. The enabling statutes of most states are clear. Despite this clarity, courts have given business entities a chameleon’s adaptability that is malleable to the underlying policy preferences of owners, policymakers, and judges. Firms can be seen as aggregates of their owners, as was the case in Hobby Lobby where the Supreme Court held that the corporation can exercise religion. However, when the policy preference depends on the existence of a separate entity, such as the rule of limited liability, firms are said to be real entities who are responsible for their own debts and liabilities. Courts and policymakers have given non-corporate business entities a Rashomon effect, holding inconsistent conceptions of the firm for the purpose of advancing underlying policy preferences. On the issue of diversity jurisdiction, if courts prefer a restrictive policy on federal jurisdiction for cases involving non-corporate business entities for whatever reason, they simply disregard the entity and rely on antiquated precedent in face of modern business reality.

Robert Rhee

Professor Rhee’s legal experience includes positions as a law clerk on the U.S. Court of Appeals for the Third Circuit, and a trial attorney in the Honors Program of the U.S. Department of Justice. He also has significant investment banking experience. He was a vice president in financial institutions investment banking at Fox-Pitt, Kelton (then a unit of Swiss Re) in New York, a real estate investment banker at Deutsche Banc Alex. Brown, and an M&A investment banker at UBS Warburg in London. He has worked on public and private M&A assignments, distressed restructurings, private equity funding, and debt and equity issuances. He is an active writer and scholar. His articles have been published in leading journals including New York University Law Review, Michigan Law Review, Northwestern University Law Review, Vanderbilt Law Review, Notre Dame Law Review, Emory Law Journal, William & Mary Law Review, and Florida Law Review.

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