Articles Posted in Case Notes

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It is the rule in many jurisdictions that an insurer which assumes defense of its insured without issuing a reservation of rights can be estopped from later denying coverage based on rights or defenses in the insurance contract. This general rule was rejected by the Supreme Court of Wisconsin in Maxwell v. Hartford Union High School District, 814 N.W.2d 484 (Wis. 2012). The court in Maxwell held that an insurer which defends without reserving the right to deny coverage has not waived its ability to rely on coverage clauses in the policy allowing for such a denial.

In Maxwell, the policyholder – a school district facing a wrongful termination suit from an ex-employee – tendered a claim to its liability insurer which defended the school district in the ensuing litigation without issuing a reservation of rights letter. It was not until a judgment in excess of $100,000 was awarded against the school district that the insurer denied coverage based on language in the policy excluding liability for damages due under the employment agreement and for lost benefits or lost wages. That the policy indeed excluded coverage for the damages at issue was not in dispute. The issue presented to the court was whether, because the insurer failed to issue a reservation of rights, it had waived or could be estopped from asserting its defense of no coverage. In rendering its decision, the court held that waiver or estopped could not supply coverage to an insured that was not provided in the policy itself. Ruling otherwise, the court stated, would force an insured to pay for a loss for which it had not received a premium.

The court clarified that waiver or estoppel did not apply to the present case because it involved a coverage clause, as opposed to a forfeiture clause (such as a notice or cooperation clause). It noted that an insurer must act timely on a forfeiture defense and stated that providing a defense may be grounds for establishing waiver or estoppel regarding a forfeiture clause where the insurer fails to issue a reservation of rights. The court also made clear that its decision did not limit the damages applicable to an insurer which breaches its duty of good faith toward its insured. Such an insurer is liable for all damages resulting from its breach, and is not limited to damages contemplated by the contract.

The Maxwell court emphasized the importance of communication between insurers and insureds. Indeed, after Maxwell, policyholders should have increased motivation to engage in clear, detailed communications with their insurer regarding the insurer’s coverage position prior to entrusting the insurer with defense of a claim. If a policyholder cannot rely on a reservation of rights letter to explain the scope and limits of an insurer’s coverage position, it must seek such information through other means.

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The First Circuit has endorsed key principles that favor policyholders in insurance coverage disputes — principles that can frequently be used to help insureds in construction cases. So, this new case is worth a look. In Oxford Aviation, Inc. v. Global Aero., Inc., 2012 U.S. App. LEXIS 10101 (1st Cir. 2012), the U.S. Court of Appeals for the First Circuit vacated the district court’s decision which found that a carrier had no duty to defend claims involving alleged faulty workmanship. Relying on Maine law, the court held strong to the concept that even the remotest possibility of coverage triggers an insurer’s duty to defend.

The details, after the jump.

Airlarr hired Oxford to perform repairs and installations on its airplane. After picking up its restored plane, Airlarr sued Oxford for breach of contract, breach of express and implied warranties and various state-law claims. Airlarr alleged that, due to Oxford’s “negligence and faulty performance,” one of the plane’s side windows cracked on Airlarr’s flight home from Oxford’s Maine facility. Airlarr also listed a number of “defects and other substandard work,” including uncomfortable seats, leaking fuel injectors, a cracked turbocharger, and an improperly installed carpet. But the cracked window was central to the Court’s decision to overturn the district court’s ruling.

Oxford tendered the complaint to its CGL insurer, Global Aerospace, and requested that the insurer provide a defense. But Global disclaimed both coverage and its duty to defend Oxford in the Airlarr lawsuit. Oxford then sued Global in a Maine state court, and Global removed the case to federal district court. The district court granted summary judgment in favor of Global, holding that Global had no duty to defend because Airlarr’s claims fell within the CGL policy’s exclusions. The First Circuit disagreed and held that the district court should have considered the issue of initial coverage instead of relying solely on the policy’s exclusions.

Recognizing that Maine interprets coverage terms like “accident” and “occurrence” broadly – as opposed to courts that rely on these terms to exclude coverage for faulty workmanship – the First Circuit concluded that the damage to the plane’s side window should be considered an “accident” and an “occurrence” and be covered under Coverage A of the policy. The court, therefore, did not interpret these terms narrowly to exclude coverage for faulty workmanship.

The court reiterated the basic principle that an insurer’s duty to defend is generally broader than its duty to indemnify. The court insisted that an insurer has a duty to defend even if the possibility of coverage is highly unlikely. After discussing the exclusions that Global relied on, the court concluded that, because the policy covers at least one of Airlarr’s claims, Global has a duty to defend the entire lawsuit: “Here, at least one scenario relating to the cracked window, occurring in flight and away from Oxford’s facilities, does fall within coverage and could plausibly avoid all cited exclusions.”

To determine whether any exclusion could negate the policy’s coverage of the damaged window, the court analyzed possible exclusions. The court held that exclusion (j)(4), which excludes from coverage “[p]roperty damage to … [p]ersonal property in the care, custody or control of the insured,” did not exclude the damaged window because the damage occurred after Oxford returned the plane to Airlarr. Additionally, in discussing exclusion (j)(6) (the “your-work” exclusion), which excludes a “particular part of any property that must be restored, repaired, or replaced because your work was incorrectly performed on it,” the court noted that this exclusion could conceivably apply to the damaged window. However, by its terms, the your-work exclusion does not apply to “property damage occurring away from premises you own or rent and arising out of your product or your work.” Because the damage to the window occurred in-flight and in Airlarr’s possession, the court concluded that the your-work exclusion did not exclude coverage of the cracked window.

The court quickly dismissed exclusion k (the “your-product” exclusion), which excludes “[p]roperty damage to your product arising out of it or any part of it,” since the cracked window was never alleged to be Oxford’s product.

The court also discussed exclusion l (the “products-completed operations hazard” exclusion), which excludes “[p]roperty damage to your work arising out of it or any part of it and included in the products-completed operations hazard.” The court noted, however, that the damaged window was not alleged to be, nor was there any indication that it was included in, Oxford’s work. Therefore, this exclusion also could not apply to the damaged window.

In concluding that the policy’s exclusions could not exclude coverage for the damaged window, the court held that Global had a duty to defend even though Global would likely be on the hook for little, if any, indemnification if Airlarr prevailed in the lawsuit: “If Airlarr proves its case, it seems unlikely that there will be much, if any, indemnification since most of the claimed injuries appear likely to be covered by exclusions. But the duty to defend is triggered by any realistic possibility of any damage that might be within coverage and outside the exclusions and the damaged window creates that prospect.” Notwithstanding the exclusions, therefore, the court held that Global had a duty to defend.

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Under the Texas code, the workers’ compensation exclusive remedy bar applies up and down: barring injured employees of subcontractors from bringing common law tort suits against a general contractor which provided workers compensation insurance, and also in reverse, barring injured employees of the general contractor from bringing suit against a subcontractor, even when the employees are covered under separate workers’ comp policies. So says the Texas Court of Appeals in Garza v. Zachry Construction Corp., 2012 WL 1864350 (Tex. Ct. App. May 23, 2012).

In Garza, an employee at DuPont’s Ingleside, Texas plant was injured when the railcar mover he operated came loose. He received workers’ compensation benefits through a policy provided by DuPont, and later brought common law tort claims against a subcontractor and two of its employees for negligence in causing the accident. The subcontractor, whose employees were covered by a separate workers compensation insurance procured by DuPont, successfully argued that DuPont was their deemed employer and the injured worker and subcontractor employees were deemed fellow employees. In this way, the subcontractor was shielded from such actions by the workers’ compensation exclusive remedy bar contained in Texas Labor Code section 408.001 as made applicable to subcontractors by Labor Code section 406.123. On appeal, the Court of Appeals agreed.

Garza, the injured employee, argued that the exclusive remedy bar could not apply where the subcontract specified that the subcontractor’s employees were not employees of DuPont, Garza’s employer. But even if they were deemed employees for purposes of statutory workers compensation benefits, the bar could not apply where the subcontractors were covered under a separate workers’ compensation policy than that covering DuPont’s employees. Lastly, if the statute does immunize the subcontractor, then it violates the open courts guarantee (assuring that a person bringing a well-established common-law cause of action will not suffer unreasonable or arbitrary denial of access to the court) in the Texas constitution.

In rejecting these arguments, the appellate court first ruled that the subcontract at issue required DuPont to procure workers’ compensation coverage for Zachry’s employees, “thereby, creating the legal fiction of DuPont as the ‘deemed employer’ and Zachry and its employees as ‘deemed employees'” under Entergy Gulf States, Inc. v. Summers, 282 S.W.3d 433, 438 (Tex.2009) and HCBeck, Ltd. v. Rice, 284 S.W.3d 349, 352 (Tex.2009). The subcontract, however, did not provide these same “deemed employees” with the other more traditional employee benefits enjoyed by DuPont’s actual employees. Secondly, the court ruled that nothing in the workers compensation statute, section 406.123, “specifies that when a general contractor purchases a workers’ compensation policy for its own employees and also purchases a second policy for its subcontractors, then its own employees and its “deemed” employees may freely sue each other simply because they receive their coverage under different policies, albeit from the same “employer” for work performed at the same job site.” According to the court, such an interpretation would be contrary to the purpose of the legislation – which is to encourage coverage of employees. Finally, the court concluded that Garza’s rights under the open courts provision are not violated because “[t]he workers’ compensation benefits he receives from his employer, which also provides those same benefits to its subcontractors, is an adequate substitute for his right to bring his tort claims against those subcontractors.”

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A federal court in Louisiana denied a subcontractor’s coverage action against Ace Insurance because the subcontractor did not enroll in the Contractor Controlled Insurance Program. The case is Williams v. Traylor-Massman-Weeks, LLC, et al., EDLA No. 10-2309 and you can look at the pdf of the opinion here: Williams v. Traylor-Massman-Weeks.pdf

The Corps of Engineers entered into a contract with Shaw, which had a Contractor Controlled Insurance Program (known as a “CCIP” which is a type of “wrap up” because its “wraps up” various types of insurance into one place. Shaw entered into a contract with Eustis and at the time, Shaw planned to sponsor a CCIP, but had not created it yet. So, Shaw’s subcontract directed Eustis to enroll — presumably when the CCIP was created.

The trouble was, Eustis didn’t enroll. And wouldn’t you know it, of all the projects where they forgot to enroll in the CCIP, that was the one where they had a lawsuit? Eustis came up with several creative theories for coverage, but couldn’t escape its fundamental problem: It simply didn’t enroll in the CCIP.

Aside from the obvious lesson here — if you are a potential enrollee on a wrap up, make sure you have actually enrolled — there are other less obvious lessons. If you sponsor a CCIP, do two things: (a) try to make sure your subs get their paper work in; and (b) structure your contracts so that if they don’t, the risk to you is minimized.

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On March 30, 2012, New Jersey’s Appellate Division issued a ruling in the case of New Jersey v Perini Corp. which explains how New Jersey’s 10 year statute of repose applies to projects using phased construction.

New Jersey’s statute of repose essentially provides that no action may be brought to recover damages for any deficiency in the “design, planning, surveying, supervision or construction” of a project “more than 10 years after the performance or furnishing of such services and construction.” Earlier cases have already established that the statute of repose runs from the date that one’s services for the project are substantially complete. So, the statute of repose will prohibit a claim against an early trade subcontractor once 10 years has elapsed after that subcontractor completed its work on the project even though the entire project may not yet be substantially complete for more than 10 years. However, the general contractor will remain on the hook until 10 years has elapsed from the date of substantial completion for the entire project.

The Perini case required the court to apply these concepts to phased construction. The state sued the general contractor, designer and pipe supplier for problems that developed with the underground hot water piping at a new state prison. The suit was filed on April 28, 2008. By contract, the prison was constructed in three separate phases – each with its own contractual substantial completion date. By April 27, 1998, 10 years before the state filed suit, the state had issued substantial completion certificates for the entirety of the first two phases of the project and for all but two buildings included in the third phase – a garage and a housing unit located outside the main perimeter. However, no certificate of substantial completion was issued specifically for the hot water system.

The court held that “multiple phases of a construction project that are clearly identified and documented can trigger separate periods of repose, even for the general contractor and other contractors that continue to work on the entire project.” However, the court rejected the notion that there can be “separate trigger dates of repose for components of a project, whether multi-phase or not, that are not clearly identified in the documentary record as distinguishable improvements.” In this case, the court found that the hot water system was not a clearly distinguishable component of the construction and was not substantially complete by April 27, 1998. As such, the state’s claim was not untimely under the statute of repose.

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Can anyone claim that they read their homeowner’s insurance policy before they had a claim to submit? That’s what I thought. I don’t know whether Larry Ward read his before he had a claim, but he’s read it now, and so have several judges and numerous lawyers. Based on a recent decision from the U.S. Court of Appeals for the Fourth Circuit, the judges and clerks of the Virginia Supreme Court will be reading it too.

Ward submitted a claim to his property insurance carrier when he discovered that his new home was suffering damage from Chinese Drywall. The carrier denied his claim and filed a declaratory judgment action in federal court for the Eastern District of Virginia (the “Rocket Docket” for those not familiar with it). The district court granted summary judgment in favor of the carrier and Ward appealed. The Fourth Circuit did not affirm or reverse. Instead, the court concluded that the case involved unsettled questions of Virginia law, and certified the question to the Virginia Supreme Court.

More, after the jump.

The policy is an all risk policy on a standard form. It covers all risk of direct physical loss to the property covered by the policy. Sounds easy, right? If your property is damaged, you’ve got coverage.

Not so fast, says the carrier. After issuing a broad coverage grant, the policy chips away at the coverage by excluding damage caused by several specific “causes of loss.” The district court agreed that the damage by Chinese drywall triggered these exclusions. The Fourth Circuit, noting Ward’s argument that they are ambiguous, concluded that Virginia law is unsettled on the point. The court accordingly asked the Virginia Supreme Court to answer this question:

1. For purposes of interpreting an “all risk” homeowners insurance policy, is any damage resulting from this drywall unambiguously excluded from coverage under the policy because it is loss caused by:
(a) “mechanical breakdown, latent defect,
inherent vice, or any quality in property that causes it to damage itself”;
(b) “faulty, inadequate, or defective materials”;
(c) “rust or other corrosion”; or (d) “pollutants,” where pollutant is defined as “any solid, liquid, gaseous or thermal irritant or contaminant, including smoke,
vapor, soot, fumes, acids, alkalis,
chemicals and waste?

For what it’s worth, an intermediate appellate court in Louisiana found that the exclusions apply under Louisiana law. You can see that opinion here.

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“Does an insurance broker, after procuring an insurance policy for a developer on a construction project, owe a duty to apprise a subcontractor that was later added as an insured under that policy of the insurance company’s subsequent insolvency?”

In this issue of first impression in California, the Fourth District Court of Appeals said “no.”  Pacific Rim Mechanical Contractors, Inc. v. Aon Risk Insurance Services West, Inc. — Cal.Rptr.3d —-, 2012 WL 621346 (Cal.App.4 Dist.).

A quick background: developer (Bosa) engaged insurance broker (Aon) to obtain insurance for a project in downtown San Diego.  Through Aon, BOSA created an OCIP from Legion.  Under the OCIP, Legion provided liability insurance to every contractor and subcontractor on the project.  Bosa later subcontracted with Pacific Rim (PacRim), who became an enrolled party on the OCIP.  After the project was complete, Legion became insolvent.  And apparently subcontractor PacRim was the last to find out. 

Six years after the project was completed, when the homeowner’s association filed a lawsuit for construction defects, a series of cross- and counterclaims followed.  At issue in this appeal were PacRim’s claims against Aon and Bosa begging the question:  who should have notified PacRim that the OCIP insurer became insolvent?

Insurance Broker’s Duty?

Turning first to the insurance broker, the court held that Aon had no duty to inform PacRim of Legion’s insolvency.  Under well-settled California law, insurance brokers owe a limited duty “to use reasonable care, diligence, and judgment in procuring the insurance requested by an insured.”  The court declined to create and impose on the insurance broker a new legal duty of notification after the policy is procured.  According to the court, PacRim’s claims against Aon failed as a matter of law because “PacRim’s claims are based entirely on the allegation that Aon failed to satisfy a duty that California law does not recognize.”

The court rejected PacRim’s argument that public policy considerations warranted imposing such a duty on Aon.  Noting that other states have enacted statutes imposing such a duty on brokers – and California has not – the court agreed with Aon that it should remain the province of the Legislature.

The court further observed that PacRim was not merely seeking to impose a “narrow duty” on insurance brokers to notify insureds when the broker has actual knowledge of insurer’s insolvency.  Instead, PacRim asked the brokers to notify an insured of “any adverse changes in its financial condition.”  This would necessarily include a duty of monitoring insurers and would present uncertainty as to when the broker’s duty arises.  This would fundamentally change the relationship between brokers and their insureds – a step the court refused to take.

The court cited to a California Insurance statute and noted that “if anyone had a duty to inform PacRim of Legion’s insolvency, it was Legion.”  For obvious reasons, pursuing Legion for violating this statute would have likely been a dead end for PacRim.  In a brief two paragraphs, the court agreed with the lower court that Bosa breached its contractual duty to inform PacRim of Legion’s insolvency. 

California Stands its Ground

In a lengthier portion of the opinion, the court rebuffed PacRim’s assertion that the court should “join with every other state to consider the issue by recognizing an insurance broker’s duty to share its actual knowledge of the insurer’s insolvency with the insured.”  First, the court cited examples of other states that have refused to impose such a duty on a broker after it procured the insurance policy.  Further, the court distinguished the cases that PacRim cited, because in almost all of those cases, the plaintiff insured was the broker’s client.  Here, Bosa was Aon’s client – PacRim was not.  Accordingly, the court declined to follow the out-of-state authority.

Why is This Important to You?

Back to our original question: where does that leave you if you find yourself in a position of needing to rely on your insurer, only to find out your insurer is insolvent?  At the risk of stating the obvious, you will be in the best position if you have advanced notice of your insurer’s pending insolvency.  That way, you can do like PacRim alleged it would have done – procure alternate insurance.  But since you may not always (or ever) have such advance notice, you need to find another way to protect yourself.  Because – at least in California – you cannot rely on your insurance broker to notify you of adverse changes in your insurer’s financial condition.

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New York State’s Appellate Division, First Department, in VOOM HD Holdings LLC v. EchoStar Satellite L.L.C., recently adopted strict federal standards with respect to a party’s obligations to preserve documents prior to litigation. These standards were derived from the landmark Zubulake and Pension Committee opinions of Judge Shira Scheindlin of the United States District Court for the Southern District of New York. This is the first time that a New York appellate court has applied these standards to sanction a litigant for failing to suspend automatic data destruction practices once it “reasonably anticipated” litigation. The decision provides important clarity in the timing and scope of the preservation obligation. It also raises the bar for companies subject to the jurisdiction of New York state courts, many of whom had previously viewed the obligation to preserve as being triggered only by the commencement of litigation.

To learn more about this, click here to read the client alert that was written by Wayne Matus, John Davis and Aubrey Charette.

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On January 17, 2012, the Supreme Court of the State of New York, Appellate Division, First Department, declined to follow and expressly overruled the insurance rule adopted in DiGuglielmo v. Travelers Prop. Cas., 6 A.D.3d 344 (N.Y. App. Div. 1st Dep’t 2004). The DiGuglielmo rule stated that “[a]n insurer is not required to disclaim on timelines grounds before conducting a prompt, reasonable investigation into other possible grounds for disclaimer.” Id. at 346.

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Article Co-Authored with Christian Henel
The United States Supreme Court has settled a long-standing split among lower courts on the definition of a corporation’s “principal place of business” for purposes of diversity jurisdiction in federal court.

The Court held a corporation has a single principal place of business for purposes of diversity jurisdiction and that place is defined as the state where the corporation’s headquarters is located. Hertz Corp. v. Friend, No. 08-1107 (Feb. 23, 2010).

The ruling expanded upon and clarified the traditional notion of a business’s “nerve center” as applied in tests used by the 7th Circuit and sporadically in other circuits. It reverses tests in the 3rd, 4th, 5th, 6th, 7th, 8th, 10th and 11th Circuits that permitted courts to consider the extent of a corporation’s business activity in a given state as determinative of citizenship in that state. Perhaps most important, it reversed the standard in the 9th Circuit under which a corporation had a principal place of business in any state where the corporation conducted “significantly larger” operations or where its operations “substantially predominate.” Under that standard, a corporation could be considered a citizen of all 50 states – as long as it conducted significant operations in all 50 states.

By clarifying that a corporation can have only one principal place of business, the Hertz decision reduced the number of states in which a corporation is a citizen and therefore increased the likelihood that the corporation can obtain federal court jurisdiction for legal disputes.

Businesses often prefer federal courts over state courts. Among the reasons for this are predictable rules and the perceived higher quality of federal judges, on average, compared to state court judges. Anecdotally, some corporations claim to have experienced somewhat “fairer” treatment in federal court, especially in cases in which the corporation finds itself in the “home state” of its adversary.

But, federal courts have limited subject matter jurisdiction. Under 28 USC §§1331 and 1332, federal subject matter jurisdiction exists only when: (1) the lawsuit asks the court to decide a federal question or (2) the lawsuit asks the court to resolve a dispute between citizens of different states and the amount in controversy exceeds $75,000. This second type of jurisdiction is known as diversity jurisdiction. Most business contract disputes do not involve federal questions, so the only basis for federal court jurisdiction is diversity.

Thus, for a federal court to exercise diversity jurisdiction, the underlying dispute must be between citizens of different states, i.e., no plaintiff in the lawsuit may be a citizen of the same state as any defendant in the lawsuit. For individuals, it is easy to determine citizenship; but courts have struggled in deciding in which state a corporation is a citizen, particularly when the corporation does business in multiple states.

Diversity jurisdiction is rooted in Article III, Section 2 of the Constitution, and ever since the Judiciary Act of 1789, Congress has authorized federal courts to use it. Beginning in 1844 and continuing for more than 100 years, a corporation was deemed to be a citizen solely of the state in which it was incorporated. In 1958, Congress modified the statute. It codified the courts’ traditional “place of incorporation” test but also provided that a corporation is a citizen of “the State where it has its principal place of business.” This change meant that corporations could be citizens of at least two states: The state of incorporation and, if different, the state where the corporation maintains its principal place of business.

But in the 60 years since the statute was changed, the circuits created a patchwork of different tests to determine where a corporation’s principal place of business was. Many of the tests were vague and were prone to outcome-determinative analyses in which a trial court could choose facts to fit the outcome it desired. The patchwork of vague tests had two negative impacts on corporations. First, it made it very difficult to predict where the corporation might be able to secure diversity jurisdiction. Consider some of the different tests:

The 3rd Circuit adopted a “center of corporate activities” test under which the corporation’s principal place of business was the state where its day-to-day headquarters was located, with day-to-day headquarters defined based on a totality of the circumstances.

The 6th, 8th and 10th Circuits adopted a version of the “total activity” test, a highly fact-specific test that does not limit principal place of business to the state containing the corporation’s headquarters.

The 2nd, 5th and 11th Circuits applied either the “nerve center” or “place of activity” test, depending on whether the court found the business to be “centralized” or “decentralized.”

The 4th Circuit applied either the “nerve center” or the “place of operations” test, depending on whether the court found the corporation to be managed actively or passively from headquarters.

The 1st Circuit applied as many as three tests, primarily employing a “nerve center test,” sometimes in combination with a “center of corporate activity” test and a “locus of operations” test.

The 9th Circuit held that a corporation’s principal place of business was located in the state where it conducted a “significantly larger” amount of its business activity or where its business activity “substantially predominates,” resorting to a “nerve center” analysis only when it cannot be said that activity predominates in a particular state.

The second negative impact for corporations was that under many of the tests, a corporation could have its principal place of business in more than one state. This meant that the corporation was a “citizen” of multiple states for diversity jurisdiction purposes: The more states in which the corporation was a citizen, the fewer states in which it could seek federal diversity jurisdiction.

The Supreme Court resolved this uncertainty by holding that a corporation’s principal place of business is located in a single state: the state where its day-to-day headquarters exists.

In Hertz, California citizens sued Hertz in a California state court. Hertz removed the case to federal court, asserting that it was not a citizen of California and that federal jurisdiction was proper. In support of this contention, Hertz submitted that its principal place of business was in New Jersey, where Hertz’s headquarters was located and where Hertz carried out all of its core executive and administrative functions.

The U.S. District Court disagreed. It applied the 9th Circuit’s test for principal place of business and concluded that Hertz’s business activity was “significantly larger” and “substantially predominated” in California. Based on this conclusion, the District Court held that Hertz was a California citizen. Because the plaintiffs also were California citizens, the District Court concluded that there was no diversity and remanded the case to state court. The 9th Circuit affirmed.

The Supreme Court reversed the 9th Circuit. After briefly describing the numerous and varied tests developed by circuit courts to identify a corporation’s principal place of business, the Supreme Court observed: “Not surprisingly, different circuits (and sometimes different courts within a single circuit) have applied these highly general multifactorial tests in different ways.”

To clarify the principal place of business issue once and for all, the Court concluded that a corporation’s principal place of business is best interpreted as “the place where a corporation’s officers direct, control, and coordinate the corporation’s activities.” The Court went on to hold that in practice, the principal place of business should be the corporate headquarters, “provided that the headquarters is the actual center of direction, control, and coordination, i.e., the “nerve center.” On the facts in the Hertz case, the Court concluded that because Hertz’s nerve center and corporate headquarters were in New Jersey, Hertz was a New Jersey citizen, and removal to federal court was proper.

In denominating the “nerve center” as a corporation’s discrete principal place of business and in providing a relatively administrable test for determining what constitutes the nerve center, i.e., corporate headquarters, the Hertz decision makes it much less likely that a corporation will be deemed a citizen of more than two places for diversity jurisdiction purposes. In turn, corporations that previously could not litigate in federal court because of diversity restrictions may find those restrictions lifted. Potential examples from the construction industry could include:

A California general contractor builds a project in California for a national developer that is incorporated in Delaware and that is headquartered in Illinois but which conducts a large part of its business in California. Assume a dispute arises and the California contractor would prefer a lawsuit in federal court. Under the previous 9th Circuit rule assigning citizenship based upon the significance of a corporation’s business activities in a state, the developer might be deemed a citizen of California on account of its substantial activity there, and the federal court would not have jurisdiction to hear the contractor’s claim. Under the new Hertz rule, the developer may only be considered a citizen of Delaware (its state of incorporation) or Illinois (its headquarters “nerve center”) but not California. Accordingly, California’s federal courts would have jurisdiction over the case.

An owner headquartered in Arizona seeks to avoid litigating a breach of warranty claim in federal court in New Mexico. It does so by arguing it is a citizen of New Mexico because it does business in New Mexico, has an office there and holds annual board meetings there. Under the 10 Circuit’s earlier “total activity” test, such activities may have been enough to confer citizenship on the owner. Under the new Hertz rule, the owner’s presence in New Mexico would not confer citizenship unless the owner was directing, controlling and coordinating its day-to-day work from the New Mexico office. Assuming these activities were instead performed in the owner’s Arizona headquarters, the owner will be deemed a citizen of Arizona, diverse in New Mexico and subject to federal court jurisdiction there.

A subcontractor in Michigan seeks to hale a Florida-based general contractor into state court in Michigan for breach of contract, and the Florida-based general contractor seeks removal to federal court. Under the 6th Circuit’s earlier “total activity” test, the subcontractor might attempt to characterize the general contractor as a Michigan citizen to defeat diversity and prevent removal. Under the new Hertz rule, the general contractor need only show that it is headquartered in Florida and its business is directed, controlled and coordinated out of Florida to establish Florida citizenship and permit removal.

The Hertz decision received little notice in the media. But for many businesses, it will prove to have been the most important decision of the year from the Supreme Court.