07 October 2008

LLC Status For Diversity Jurisdiction

For some purposes, limited liability companies (LLCs) are treated like corporations. Most notably, they are treated like corporations for most creditor-debtor liability purposes.

For other purposes, limited liability companies are treated like partnerships or sole proprietorships, as the case may be, for example, for federal income and in most states (but not all states), for state and local income tax purposes.

For purposes of federal diversity jurisdiction, limited liability companies are not treated like corporations (which are usually treated as domiciled in their state of incorporation and also in the state where they have their headquarters). Instead, "the purposes of diversity jurisdiction, the citizenship of an LLC is determined by the citizenship of all of its members." The practical effect of this rule is that for diversity jurisdiction, the state of organization or headequarters of the company is irrelevant; only the citizenship of the members (who are the owners of a limited liability company) mattters.

This position has been followed by the U.S. Courts of Appeals for the First, Second, Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, and Eleventh Circuits. Apparently, the U.S. Court of Appeals for the Third Circuit, and the U.S. Court of Appeals for the Tenth Circuit (which includes Colorado) have not yet ruled on this issue, despite the important and formative role that states in the Tenth Circuit have played in limited liability company law. Surely, however, there must be some district court level interpretation of the diversity jurisdiction rule for limited liability companies which has not risen to the appellate level (probably because it is in accord with existing precedents) even in the 3rd and 10th Circuits, because the issue comes up frequently in practice. One very much doubts that a contrary ruling will arise, however, given the strength of the established precedents.

This unaniminity follows rather naturally from a 1900 ruling of the U.S. Supreme Court in the case of Great Southern Fire Proof Hotel Co. v. Jones, 177 U.S. 449, 20 S.Ct. 690 (1900), which ruled likewise in a case involving a limited partnership association, which is similar in concept to a limited liability company (Colorado provides for them in the statute books, but very few have been formed).

The Fifth Circuit was not impressed with the law review article upon which the trial court based its determination that a limited liability company should be treated as a corporation for diveristy jurisdiction purposes.

The district court relied almost entirely on the reasoning of a law review article, which addressed the issue of determining a LLC’s citizenship for purposes of diversity jurisdiction. See Debra R. Cohen, Limited Liability Company Citizenship: Reconsidering An Illogical and Inconsistent Choice, 90 Marq.L.Rev. 269 (2006). The district court adopted the author’s conclusion that “28 U.S.C. § 1332(c) should be read ‘dynamically’ and ‘interpreted to include the LLC, an organization created after that statute was adopted and sharing the entity characteristics that are relevant to a diversity analysis.’”

While I sympathize with, and find logic in the position taken by Ms. Cohen in the article, since for all practical non-tax puropses vis-a-vis third parties a limited liability company is functionally much more like a corporation than a partnership, the life of law is not reason, it is experience. Precedents matter far more than what makes sense in American law.

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