The United States Supreme Court on the ‘Principal Place of Business’

Two earlier posts had discussed the issue and the oral arguments before the United States Supreme Court in Hertz Corp. v. Friend. Earlier this year, the Court delivered a unanimous verdict, holding that the ‘principal place of business’ of a corporation is its ‘nerve centre’, i.e. the headquarters of the corporation.

As discussed earlier, the issue came before the Court as part of a class action suit. Two Californian citizens filed a suit against Hertz Corporation in a California State Court. Hertz removed the claim to the Federal District Court, on the ground that it was not a Californian citizen, since it was incorporated and headquartered in New Jersey. The Respondents urged that the principal place of business had to be determined with reference ‘first to the location of employees, tangible properties and production activities, and then second to income earned, purchases made and where sales take place’. Since a majority of Hertz’s operations were in California, and were ‘significantly larger than any other state in which the corporation conducts business’, it was a Californian citizen and the Californian State Court was the appropriate forum. The Federal District Court accepted this ‘place of operations’ test proffered by the Respondents, and was affirmed in appeal by the Ninth Circuit. However, this test was different from the test adopted by other circuit courts (the Seventh Circuit for instance), and it was relying on this disparity that Hertz filed an appeal with the Supreme Court.

The oral arguments saw Hertz emphasising the superiority of the nerve centre approach, while the Respondents stressed the policy of the class action law under consideration (Class Action Fairness Act of 2005). It was also argued that the term principal place of business owed its origins to bankruptcy laws, and had to be interpreted widely like it was in bankruptcy litigation. However, rejecting these arguments, Justice Breyer speaking for a unanimous Court, upheld Hertz’s contentions, equating the ‘principal place of business’ of a corporation to its ‘nerve centre’ or ‘headquarters’.

In a lucidly written opinion that repays study, Justice Breyer puts forth three reasons for adopting the nerve centre approach. First, on the text of the CAFA, the principal place of business is envisaged as being a single place, within a State. The place of operations test had led some circuit courts to conclude that an entire State was the place of operations. This inconsistency between the result of the ‘place of operations’ test, and the text of the provision was the first blow to its applicability. Secondly, the Court placed a premium on administrative simplicity, observing that the ‘nerve centre’ approach led to much greater predictability and stability than the ‘place of operations’ test, which would aid in conserving judicial resources, and enable corporations to make investment and business decisions. Finally, the Court examined the legislative history of the provision in aid of its interpretation. Interestingly, the legislative history had been relied on by the Respondents (to contend that it was intended to be broader than the place of incorporation). The Court examined the debates that preceded the introduction of the phrase ‘principal place of business’, which apart from emphasising the need for administrative simplicity showed that the ‘place of operations’ test had been implicitly rejected by the drafters. A 1951 Report revealed that one of the phrases which was considered was ‘any State from which it (the corporation) received more than half its gross income’. This is very similar to the ‘place of operations’ test, as argued by the Respondents. However, six months later, in response to criticisms, the proposal for this monetary test was replaced by the phrase ‘principal place of business’. This clearly showed that the principal place of business was something other than the place of operations.

That said, there still remained the concern that applying the nerve centre approach would allow corporations to ‘shop’ for favourable jurisdictions, which would go militate against the efficacy of class action suits. In equating the nerve centre to the headquarters, the Court introduced the caveat that it should be “the actual centre of direction, control and coordination … and not simply an office where the corporation holds its board meetings” (p. 14). If the record revealed ‘jurisdictional manipulation’, where the headquarters were “a mere mail drop box, a bare office with a computer, or the location of an annual executive retreat”, the nerve centre would be “the place of actual direction, control and coordination, in the absence of such manipulation” (pp. 18-9). The Court also accepted that there would be hard cases where even the nerve centre approach would be difficult to apply, and may, in some cases, “produce results that seem to cut against the basic rationale” of diversity jurisdiction. It also admitted that the test was imperfect, and not always simple to apply. However, it was the test’s superiority (inspite of its imperfection) and relative simplicity that rendered it appropriate to determine the principal place of business of a corporation.

Thus, the Court put to rest the concern voiced earlier that the decision may turn more on the policy underlying the CAFA, and inadequately address the corporate law principles involved in the dispute. Admittedly, even now, the decision has little to offer by way of direct judicial precedent in common law systems like India, especially when dealing with tax planning. However, by basing itself on the appropriate meaning of the principal place of business as opposed to policy concerns, the decision has left open the possibility of a ripple effect being observed in other jurisdictions in coming years.