United States Supreme Court Invalidates State Limit on Class Actions in Federal Diversity Action

April 2, 2010

On March 31, 2010, the Supreme Court of the United States expanded the range of class action litigation in federal court by ruling that certain class actions barred by state law may nevertheless proceed in federal court.  In Shady Grove Orthopedic Associates, P.A. v. Allstate Insurance Co., No. 08-1008, the Court considered the effect of a New York statute that precludes class action suits to recover certain statutory minimum damages or penalties.  The Court held that the New York law conflicts with, and is superseded by, Federal Rule of Civil Procedure 23, which provides the general criteria for class action suits in federal court.  The Court’s ruling allows class actions in federal court for violations of certain New York statutes even when those class actions could not be brought in state court and are expressly proscribed by New York law.

Under the Class Action Fairness Act of 2005, federal courts have jurisdiction over class actions raising state law claims when the amount in controversy exceeds $5 million and the parties are minimally diverse.  28 U.S.C. § 1332(d).  In those cases–as in any federal case where subject-matter jurisdiction is based on the parties’ diversity of citizenship–the federal court must apply state "substantive" law and federal "procedural" rules.  See Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938).  Where both a federal procedural rule and a provision of state law would control a particular issue, federal courts sitting in diversity apply the federal rule so long as it does not violate the Rules Enabling Act, 28 U.S.C. § 2072, by abridging, enlarging or modifying any substantive right–including substantive rights guaranteed under state law.

In Shady Grove, the plaintiff sought relief on behalf of all parties who were allegedly owed statutory interest that had accrued on late payments from Allstate.  Although Federal Rule of Civil Procedure 23 authorizes class actions if certain requirements are satisfied, a New York statute explicitly forbids class actions in cases asserting violations of statutes that impose a "penalty" such as statutory interest.  N.Y. C.P.L.R. § 901(b).  The issue in Shady Grove was how courts should determine which of those rules should apply.

In a fractured decision, the Supreme Court held that Rule 23 trumps the New York anti-class action provision in federal court.  Although five Justices arrived at the same result, they disagreed on most of the rationale behind the ruling.  Justice Scalia’s opinion, on behalf of himself and three other Justices, advocated a categorical approach under which any federal rule that regulates procedure "is valid in all jurisdictions, with respect to all claims, regardless of its incidental effect upon state-created rights."  Slip op. at 16 (Opinion of Scalia, J.).  Such a framework would call into question numerous state law provisions, including those that limit class action remedies or prohibit class action treatment for certain types of claims.

Justice Stevens provided the fifth vote for the majority and filed a separate, narrower concurring opinion that ultimately controls the case.  His opinion preserves important arguments for defendants that state law provisions limiting class actions can still survive in federal court.  In Justice Stevens’ view, determining whether a federal rule applies in a diversity action requires a case-by-case assessment of the state rule with which the federal provision conflicts.  Under that approach, "federal rules must be interpreted with some degree of sensitivity to important state interests and regulatory policies," because some state laws, though nominally "procedural," are in fact "part of a State’s framework of substantive rights or remedies."  Slip op. at 3, 4 (Stevens, J., concurring) (internal quotation marks omitted).  Justice Stevens concluded that a federal procedural rule, as applied, can violate the Rules Enabling Act by effectively abridging, enlarging, or modifying a state-created right or remedy.  When a federal rule cannot be construed in a way to avoid such an outcome, "federal courts cannot apply the rule."  Id. at 8. 

Justice Stevens ultimately determined that Section 901(b) is not the sort of procedural rule that is sufficiently interwoven with substantive rights to avoid the application of Rule 23.  Importantly, however, he emphasized that each case must be addressed on its own merits: 

In some instances, a state rule that appears procedural really is not.  A rule about how damages are reviewed on appeal may really be a damages cap.  A rule that a plaintiff can bring a claim for only three years may really be a limit on the existence of the right to seek redress.  A rule that a claim must be proved beyond a reasonable doubt may really be a definition of the scope of the claim.  These are the sorts of rules that one might describe as "procedural," but they nonetheless define substantive rights.  Thus, if a federal rule displaced such a state rule, the federal rule would have altered the State’s "substantive rights."

Slip. Op. at 9 (Stevens, J., concurring) (citation omitted).

Some early commentary has suggested that Shady Grove automatically renders state anti-class action rules unenforceable in federal court.  A close reading of Justice Stevens’ controlling concurring opinion suggests that this will not be the case, and that each state restriction needs to be judged on its own merits under the framework Justice Stevens announced.  Time will tell how courts will respond to this apparent shift in the dynamic between state and federal rules.  What is clear today, however, is that the Court’s decision will result in additional scrutiny of state efforts to restrict large damage awards and coercive litigation mechanisms.  In addition, some state laws may benefit from revision to ensure that they remain effective in federal court as well as state court.

Gibson, Dunn & Crutcher LLP 

Gibson, Dunn & Crutcher’s Class Action and Complex Litigation Practice Group is available to assist in addressing any questions you may have regarding these issues.  Please contact the Gibson Dunn attorney with whom you work or any of the following members of the Class Action and Complex Litigation Group:

Gail E. Lees – Chair, Los Angeles (213-229-7163, glees@gibsondunn.com)
Andrew S. Tulumello – Vice-Chair, Washington, D.C. (202-955-8657, atulumello@gibsondunn.com)
G. Charles Nierlich – Vice-Chair, San Francisco (415-393-8239, gnierlich@gibsondunn.com)
Peter Sullivan – New York (212-351-5370, psullivan@gibsondunn.com)
Julian W. Poon – Los Angeles (213-229-7758, jpoon@gibsondunn.com)
Christopher Chorba – Los Angeles (213-229-7396, cchorba@gibsondunn.com)

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