Limited Liability Companies and Diversity Jurisdiction

If you’re a defendant and the plaintiff is a limited liability company and you get dragged into federal court based on diversity jurisdiction (28 U.S.C. § 1332), make sure you’re not there through crafty attempts at forum manipulation.

Many practitioners don’t pay much attention to the details regarding the treatment of an LLC versus a corporation when it comes to diversity jurisdiction. A corporation is a citizen of both the state of its incorporation and the state of its principal place of business.  So if you form a Delaware corporation in five minutes, you’ve got a Delaware corporation and can sue someone who lives in New York in federal court, provided other requirements are met (i.e., amount in controversy exceeds $75,000.00 etc.).

However many people like to form LLCs. Certain businesses are best operated as LLCs but not every type of business. Especially if you may use your business entity as a vehicle for litigation, it’s probably best not to form an LLC. This is because the LLC takes the citizenship of its members. So if a citizen of New York forms a Delaware LLC and that citizen of New York is the only member, you can’t sue another New York citizen in federal court.

Where things get tricky is when the plaintiff lacks scruples. LLCs are liked because of the supposed secrecy they operate in and the lack of records required by the formation states of choice  – Delaware, Nevada, Wyoming, etc. When you form an LLC, you don’t have to list any members. If the time comes and you need to show the court that the members of an LLC are citizens of different states, the only thing stopping a plaintiff and their attorney from pulling the wool over the court’s eyes is good conscience. In a subsequent post I’ll provide a subpoena to obtain records from various formation agents. These are the companies that exist which will form companies for you in five minutes. Most people think there is great secrecy that’s impenetrable but it’s actually quite easy to get the records from a formation agent with a subpoena. Whether the person listed with the formation agent is the “beneficial” member as opposed to a “nominee” or “nominal member” is a different story altogether.

Back to the topic.  Delaware’s Limited Liability Company Act doesn’t even require a written operating agreement. 6 Del. C. §18-101(7).  When you do need to produce an agreement, you can just claim that the agreement is oral. However if you don’t show the court any written documentation it will likely be suspicious of the legitimacy of such an entity.

The membership of an LLC can change based on the time of day or how the string puller is feeling. However, jurisdiction is analyzed by a court based on events at the time the case is brought. Grupo Dataflux v. Atlas Global Group, L.P., 541 U.S. 567, 124 S.Ct. 1920, 158 L.Ed.2d 866 (2004).

This means that an LLC will need to produce documents to the court showing that at the time the case was filed in federal court, its membership consisted of citizens who reside outside the state where the litigation is occurring.

If the LLC didn’t prepare for this, it will now have to backdate operating agreements and other documents. It’s likely that if the person behind the LLC didn’t do much planning, they will choose someone who is either a relative or a close friend who they think they can trust. However, that trust only goes so far when faced with a federal subpoena or a deposition. While in theory it’s easy to believe that your close friend or family member will have your back, a dogged attorney will do everything in his or her power to turn up evidence of forum manipulation.

Here’s a sample letter to a court to use when confronted with a “mysterious” LLC that refuses to divulge any information about who is behind it.

2014.08.01 Ltr to Judge Wexler – Word Document

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