Supreme Court Opens Federal Courts to Class Actions Barred by State Law

April 07, 2010

The United States Supreme Court’s decision in Shady Grove Orthopedic Associates v. Allstate Insurance Company (“Shady Grove”) opens an avenue for potential class action claims that are expressly barred by state law to be pursued as class actions in federal court. As the Supreme Court acknowledges, its decision may encourage forum shopping and, with the advent of the availability of federal jurisdiction under the Class Action Fairness Act (“CAFA”), may void many states’ efforts to limit the ability to pursue certain statutory rights on a class-wide basis.

While the named plaintiff in Shady Grove had a damages claim in the range of $500, the class action complaint sought to recover potentially millions in aggregated statutory penalties under New York state law for overdue payments of no-fault auto accident benefits. The district court dismissed the complaint as barred by New York CPLR § 901(b), which prohibits lawsuits seeking statutory penalties from being brought as class actions. On appeal, the Second Circuit affirmed, concluding that Rule 23 of the Federal Rules of Civil Procedure, the federal rule governing class actions, addressed certifiability, whereas § 901(b) addressed the substantive issue of eligibility to bring a class action and thus prevailed over the procedural rule under Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938).

The Supreme Court granted certiorari to determine whether a state law prohibiting class actions in suits seeking penalties or statutory minimum damages prevents a federal court sitting in diversity from entertaining a class action under Rule 23. Resolution of the question required the court to determine whether New York’s class-action limitation is procedural in nature — and thus trumped by Rule 23 when the claim is brought in federal court — or whether § 901(b) is substantive in nature, in which case the New York law limiting class actions would prevail. While the district court and the Second Circuit viewed the answer as fairly straightforward, a divided Supreme Court ultimately held that the New York statute at issue was procedural in nature and thus superseded by Rule 23 in cases brought in federal court.

Justice Scalia delivered the opinion of the Court, concluding that § 901(b) does not preclude a federal district court sitting in diversity from entertaining a class action under Rule 23: “By its own terms Rule 23 creates a categorical rule entitling a plaintiff whose suit meets the specified criteria to pursue his claim as a class action.” The opinion notes that § 901(b) attempts to answer the same question as Rule 23, i.e., whether Shady Grove’s suit may be maintained as a class action, and holds that § 901(b) cannot apply in diversity suits unless Rule 23 was found to beyond the scope of authority provided by the Rules Enabling Act for the creation of federal court procedural rules. According to Justice Scalia, “Rule 23 unambiguously authorizes any plaintiff, in any federal proceeding, to maintain a class action if the Rule’s prerequisites are met.”

While Justice Stevens joined in the decision of the Court, there was only a plurality with respect to the broader implications of the decision. Citing the Rules Enabling Act, which permits the Court to promulgate procedural rules provided those rules do not abridge, enlarge or modify any substantive right, the plurality narrowed the relevant question to whether a rule governs only “the manner and the means” by which the litigants’ rights are enforced. If that is the function of the rule, the plurality deems the rule valid.  If a rule alters “the rules of decision by which [the] court will adjudicate [those] rights,” the plurality regards the rule as invalid. Justice Stevens agreed with the dissent that there are some state procedural rules that federal courts must apply in diversity cases because they function as part of the state’s definition of substantive rights and remedies. In Justice Stevens’ view, a federal rule “cannot govern a particular case in which the rule would displace a state law that is procedural in the ordinary sense of the term but is so intertwined with a state right or remedy that it functions to define the scope of the state-created right.”

The Shady Grove decision will foster more arguments concerning when class actions will be permitted in federal court under state statutes that contain provisions barring claims from being brought on a class action basis. At least 23 states have statutes that expressly prohibit certain types of claims from being brought as class actions. Shady Grove suggests that by forum shopping at the federal district court level, plaintiffs can circumvent these class action bars, a result expressly acknowledged in Justice Ginsburg’s dissent, where she notes the “large irony” that in enacting CAFA, Congress envisioned fewer — not more — class actions, yet the decision in Shady Grove will make federal courts “a mecca for…class actions seeking state-created penalties for claims arising under state law — claims that would be barred from class treatment in the State’s own courts.”

Shady Grove is, in essence, an open invitation to more class action lawsuits in federal court based on state statutory claims that were previously limited to individual claims. Given the divergence in views between the plurality decision and Justice Stevens’ opinion, however, it should be expected that extensive litigation will ensue as to whether other state statutes barring class action claims are procedural or substantive in nature and what standards the district courts need to apply to make that determination.

For more information, please contact any of the lawyers listed below:

William Berkowitz, Co-chair, Antitrust and Trade Regulation Group, 617.951.8375

Daniel Savrin, Partner, Antitrust and Trade Regulation Group, 617.951.8674

This article was originally published by Bingham McCutchen LLP.