In theory, it seems simple: for diversity purposes the citizenship of a LLC is determined by the citizenship of all of its members. In practice, however, many attorneys treat LLCs like corporations by alleging the entity’s state of incorporation and principal place of business. This practice is not only wrong, but a survey of breach of contract/diversity cases filed in the Northern and Southern Districts of Texas shows that the error is widespread.
As stated by the Fifth Circuit in Harvey v. Grey Wolf, an LLC’s “citizenship must be traced through however many layers of members or partners there may be.” “[F]or each member of an LLC that is itself an LLC or partnership, its members and their citizenship must be identified and traced up the chain of ownership until one reaches only individuals and/or corporations.” Cavender Enterprise Leasing Family LLC v. First States Investors 4200 LLC, No. 10-1667, 2011 WL 3664563 *2 (W.D. La. July 21, 2011). This can be a difficult task because many states do not require LLCs to identify their members, and many LLCs have complex ownership structures. For example, in Mullina v. TestAmerica Inc., No. 08-11224. 2009 WL 807458 *9 (5th Cir. March 30, 2009), the membership of one LLC included a general partner, 31 limited partners, 16 individuals, six corporations, three trusts, four general partnerships, a limited partnership and a limited liability company.
A survey of 76 breach of contract/diversity cases filed in the Northern and Southern Districts of Texas during the first six months of 2012 was conducted. Of the 38 actions filed in the Northern District, 84 percent used the wrong standard when alleging the diversity citizenship of an LLC. The error rate in the Southern District was only slightly lower at 76 percent. Just as startling as the number of pleading errors, however, is the fact that only two parties recognized that the wrong standard had been used and sought either dismissal or remand for lack of subject matter jurisdiction. To be fair, this last number could have been higher because there were a number of cases in which the Court noted the error and ordered the plaintiff/removing defendant to replead or have its case dismissed or remanded.
The consequence of using the wrong diversity standard can be far more serious than simply having to replead. For example, in Bellville Catering Co. v. Champaign Market Place, L.L.C., 350 F.3d 691 (7th Cir. 2003), the error was not caught until the case was on appeal. The Seventh Circuit laid blame on the plaintiff (the case should not have been filed in federal court), the defendant (the answer should have pointed out a problem) and the Magistrate Judge who presided at trial (he should have inquired whether the court had jurisdiction). Noting that “[f]ailure to perform these tasks has the potential, realized here, to waste time (including that of the put-upon jurors) and run up legal fees,” the Court held that “[t]he best way for counsel to make the litigants whole is to perform, without additional fees, any further services that are necessary to bring this suit toa conclusion in state court, or via settlement. That way the clients will pay just once for the litigation.”
The bottom line is that in those instances in which you cannot determine an LLC’s membership, remember the Seventh Circuit’s advice to “accept the inevitable and proceed to state court.”