Spring 2023

Federal Courts Strengthen Corporate Disclosure Requirements

On November 2, 2022, Taylor Morse filed a negligence action in Mississippi state court arising from a trucking accident against Tod Wesley Newman and TW Newman Trucking, LLC. The defendants attempted to remove the case to the United States District Court for the Northern District of Mississippi on December 13, 2022. See generally Morse v. Newman, Case No. 4:22-CV-190-DMB-JMV, 2022 WL 17682644, at **1, 1 (N.D. Miss. Dec. 14, 2022). Parties to a legal dispute with complete diversity of citizenship and an amount in controversy in excess of $75,000.00 qualify for federal diversity jurisdiction under 28 U.S.C. § 1332(a). But satisfying this requirement was not as easy as the defendants in this case expected because of recent procedural changes strengthening corporate disclosure requirements.

Newly amended Federal Rule of Civil Procedure 7.1, effective as of December 1, 2022, imposes new provisions governing corporate disclosure. Subsection (a)(2) now mandates that parties submit disclosure statements identifying the citizenship of every individual or entity attributed to them. Fed. R. Civ. P. 7.1(a)(2). The district court in Morse accordingly ordered the defendants to disclose the citizenship of TW Newman Trucking, LLC’s members the very next day on pain of remand. Id. at *1. The parties agreed to dismiss the case shortly after.

Morse is only one recent example of how federal courts are employing Rule 7.1(a)(2) over recent months to enforce the requirements of diversity jurisdiction against unincorporated business associations more tenaciously. The official note commenting on the 2022 amendment to Rule 7.1 emphasizes that noncorporate business associations with “exotic” organizational structures must be transparent. Limited liability companies, for example, must disclose the citizenship of every one of their members. If one of the members is itself a limited liability company, the citizenship disclosure requirement extends to that “member’s members” and so on down to the root of the organizational tree.

Federal courts use at least three different approaches to enforcing Rule 7.1(a)(2) when a party initially fails to make complete corporate disclosures. First, a federal court may give the party the benefit of the doubt absent any opposition. See, e.g., Nat’l Salvage & Serv. Corp. v. Pristine Res., Inc., Case No. 3:21-cv-138, 2022 WL 17362016, at **1, 2 & n.4 (W.D. Pa. Dec. 1, 2022). Second, a federal court may order the party to promptly supplement their corporate disclosures or approve a period of jurisdictional discovery. E.g., Wells Advance, LLC v. Nicole L. Carpenter, Case No. 1:22-cv-09997-JLR, 2022 WL 17631813, at **1, 2 (S.D.N.Y. Dec. 13, 2022); Hans Moke Niemann v. Sven Magnus Oen Carlsen, Case No. 4:22-cv-01110-AGF, 2022 WL 17403157, at **1, 3 (E.D. Mo. Dec. 2, 2022). Title 28, Section 1653 of the United States Code permits federal courts to grant parties leave to amend to cure defective jurisdictional allegations. See Meyn Am., LLC v. Omtron USA, LLC, 856 F. Supp. 2d 728 (M.D.N.C. 2012). Third, a federal court may dismiss or remand the case without issuing a show cause order or granting leave to amend. Morris v. Das, Case No. 22-cv-1863-L-AHG, 2022 WL 17418638, at **1, 1 (S.D. Cal. Dec. 2, 2022).

The 2022 amendment to Rule 7.1 responds to a pattern of jurisdictionally defective federal litigation. Unincorporated business associations, especially secretive limited liability companies, had a tendency of slipping into federal court in the past without satisfying the requirements of diversity jurisdiction and remaining there unnoticed. On March 23, 2018, for example, the United States Court of Appeals for the Ninth Circuit remanded a case back to the United States District Court for the Western District of Washington to determine whether one of the parties, a limited liability company, satisfied the diversity of citizenship requirement. Stalwart Cap., LLC v. iCap Pac. Nw. Opportunity & Income Fund, LLC, 715 Fed. App’x 794 (9th Cir. Mar. 23, 2018).

The plaintiff in Stalwart Capital filed suit on July 24, 2014. A civil jury returned a verdict for the defendants on all counts except the defendants’ counterclaim on November 20, 2015. The Ninth Circuit’s order to remand therefore presented a litigator’s worst nightmare—it raised the possibility that the entire lifespan of a hard-fought lawsuit, including a favorable final judgment, was jurisdictionally invalid from the get-go. From the standpoint of the judicial system, it was a recurring nightmare that the United States Supreme Court’s administrative wing—the United States Judicial Conference—needed to address. The Judicial Conference’s Standing Committee on Rules of Practice and Procedure has coordinate advisory committees for the purpose of developing amendments to rectify problems like this.

The district court judge presiding over Stalwart Capital, the Honorable Thomas S. Zilly, dispatched a letter on May 31, 2018, to the Honorable John D. Bates, Chair of the Advisory Committee on the Federal Rules of Civil Procedure. That letter, containing a proposal designated “18-CV-S,” recommended stronger corporate disclosure requirements, especially for limited liability companies. The Civil Rules Advisory Committee anticipated Judge Zilly’s proposal to some extent as far back as November 2017 in the context of discussions about strengthening third-party financing disclosures. The Civil Rules Advisory Committee noted, for example, that fourteen federal district courts had local civil rules requiring corporate disclosures and financial statements beyond Rule 7.1’s requirements. See generally Nimitz Tech.’s, LLC v. CNET Media, Inc., Case Nos. 21-1247-CFC, 21-1362-CFC, 21-1855-CFC, 22-413-CFC, 2022 WL 17338396, at **1, 2 (D. Del. Nov. 30, 2022).

Judge Bates’ referred Judge Zilly’s letter to the Honorable David G. Campbell, Chair of the Standing Rules Committee, in a memorandum dated December 4, 2018. The Civil Rules Advisory Committee then proceeded to draft an amendment to Rule 7.1 responding to Judge Zilly’s proposal. The draft amendment went through the required public notice and comment period. The Civil Rules Advisory Committee was especially mindful during the drafting process of the timing of corporate disclosures relative to the tight thirty-day window for removing cases from state court to federal court under diversity jurisdiction. See generally 28 U.S.C. § 1441. The Civil Rules Advisory Committee therefore incorporated into its note for the 2022 draft amendment a disclaimer that counsel may submit disclosures “upon information and belief” at the pleading stage so long as they promptly provide supplemental disclosures when they confirm their clients’ corporate details.

The 2022 amendment to Rule 7.1 ultimately cleared the multi-layered interbranch review process instituted by the Rules Enabling Act of 1934: It entered force after obtaining approval from the Standing Rules Committee, the Supreme Court, and the United States Congress. Those institutions, in approving this amendment, effectively nationalized local efforts by some district courts to improve corporate disclosures years before. The judicial amendment process in this case therefore showcases how district court local rules authorized under Rule 83 create a feedback loop between local and national rulemaking bodies that optimizes the federal judicial system as a whole.

Business associations initially seeking federal jurisdiction in litigation must carefully contemplate Rule 7.1(a)(2)’s corporate disclosure requirements going forward. Failure to consider organizational structure will, at best, result in a prompt dismissal that wastes time, energy, and money. Failure to do so will, at worst, result in the nullification of years of litigation, sanctions for bad faith, and even attorney discipline proceedings for lack of candor to the courts. See Model Rules of Prof’ Conduct R. 3.3 (2022); cf. Domain Protection, LLC v. Sea Wasp, LLC, 23 F.4th 529 (5th Cir. 2022). As Judge Bates noted in his memorandum to Judge Campbell on December 4, 2018, “Ignorance may be bliss if a diversity-destroying citizenship is never uncovered, but it can lead to waste, and perhaps great waste, if it is uncovered – or revealed after a deliberate cover-up – after substantial proceedings have been had.”

Written by associate Joshua T. Carback