LLCs as Nominal Parties in Dissolution Cases: An Uncertain Portal to Federal Court Jurisdiction
October 21, 2019
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In general, federal courts have subject matter jurisdiction to hear cases in which the opposing litigants have diverse citizenship or the suit involves claims arising under federal law.
Lawsuits seeking judicial dissolution of incorporated and unincorporated business entities arise under state law, leaving diversity jurisdiction as the only possible entrée to federal court in such cases.
The rules dictating the citizenship of incorporated and unincorporated entities differ. A corporation is deemed a citizen of its state of formation and its principal place of business. An unincorporated entity, including a limited liability company, is deemed a citizen of every state of which a member of the entity is a citizen.
Thus, if the shareholder-petitioner seeking judicial dissolution of a corporation is a citizen of State X, the corporation is a citizen of State Y, and a named respondent shareholder is a citizen of State Z (or any state other than X), there is complete diversity of citizenship and the federal court has subject matter jurisdiction.
At that point, even with jurisdiction secured, a possible, further impediment to a federal venue in dissolution cases is the so-called Burford abstention doctrine. Some but not all federal courts have applied Burford abstention to dismiss the case without prejudice to re-filing in state court, in deference to state court primacy in an area of comprehensive state regulation. (Read here, here, and here prior posts about Burford abstention in dissolution cases.)
LLCs as Nominal Parties
As to dissolution cases involving an unincorporated LLC, at first glance it would appear that achieving diversity jurisdiction is impossible where, as the law provides, the LLC whose dissolution is sought is deemed a citizen of the state of the member seeking its dissolution.
However, there may be a pathway to federal court jurisdiction in LLC dissolution cases if the LLC can be categorized as a “nominal” party to the suit. (See Navarro Savings Ass’n v Lee, 446 U.S. 458, 461  [“a federal court must disregard nominal or formal parties and rest jurisdiction only upon the citizenship of real parties to the controversy”]).
Are LLCs considered real or nominal parties to dissolution cases?
My quick research has turned up seven cases decided since 2005 in which federal courts have ruled on subject matter jurisdiction to hear state law claims for LLC dissolution based on the petitioner’s assertion that the LLC is a nominal party.
In four of them, the courts found the LLCs to be nominal and upheld jurisdiction. In three of them, the courts came to the opposite conclusion and dismissed the cases for lack of jurisdiction.
Cases Upholding Jurisdiction
Polak v Kobayashi. Decided in 2005 by the Delaware U.S. District Court on a motion to remand to state court an action subsequently removed to federal court based on diversity jurisdiction, the court in Polak concluded that the LLC was a nominal party because the party seeking dissolution, not the LLC, “would benefit from the dissolution.” As the court further explained,
this action arises out of a strictly internal conflict between [the LLC’s] members, both of whom will be before the Court. Because [the party seeking dissolution] has failed to establish that [the LLC] itself has any interest distinct from the interests of [the two members], the Court concludes that [the LLC] is not a real party to the dissolution issue and should remain a nominal defendant.
Roskind v Emigh. Decided in 2007 by the Nevada U.S. District Court, the court in Roskind cited Polak in holding that “the real dispute in this case is between [the two LLC members] over the dissolution and distribution of the assets of [the LLC].” The court added: “[The LLC] is a necessary party to the dispute, but is only present to effectuate the relief sought by the parties. It has no stake in the controversy.”
Gambel v Tullis. Decided in 2017 by the Louisiana U.S. District Court, the issue in Gambel was whether the LLC, which was not named as a party in the dissolution action, was a necessary party whose addition would destroy jurisdiction. The court held that the LLC was not a necessary party and “would be a nominal party here because the real parties in interest would be the company members, not the company.”
Placer Mining Corp. v Atlas Mining Group, LLC. Decided earlier this year by the Idaho U.S. District Court, the court found the circumstances before it “identical” to Roskind and therefore sustained jurisdiction, writing:
The real dispute is between [the two LLC members]. [The LLC] is inactive and administratively closed by the State of Idaho, and is named only so that it can be judicially dissolved. Therefore, [the LLC] is a nominal party and its citizenship will not be considered for diversity purposes.
Cases Rejecting Jurisdiction
Masters v Harkleroad. Decided in 2008 by the 11th Circuit U.S. Court of Appeals (which covers Alabama, Florida, and Georgia), the case involved an appeal on jurisdictional grounds from the District Court’s order appointing a receiver in an action to dissolve a pair of realty holding LLCs. The plaintiff, defending the court’s jurisdiction, argued that the LLC’s were nominal-party “stakeholders” holding property to be divided between the members. Rejecting the stakeholder analogy, the court’s unpublished opinion dismissed the case for lack of jurisdiction, stating that “we have found no authority, and Petitioners cite none in their letter brief, holding that a LLC which a plaintiff seeks to put into receivership, dissolve, and enjoin from engaging in any business activity is merely a nominal party.”
R.C. Tway Co. v High Tech Performance Trailers, LLC. Decided in 2013 by the Kentucky U.S. District Court, the case involved a multi-count complaint brought by a voluntarily dissolved LLC and one of its members against the other member, seeking the orderly winding up and distribution of the LLC’s assets. Additional claims asserted in the name and right of the LLC sought damages against the defendant member. The plaintiffs argued that the LLC should be considered a nominal party and had no real interest in the outcome of this case because the pleadings merely seek division of the LLC’s assets, its dissolution, and the allocation of any funds to the other parties. The court disagreed and dismissed the case for lack of jurisdiction, holding that “[a]s a limited liability company retains the power under state law to enforce its rights in court until the company has finished winding up, there is no basis for disregarding its entity status and holding it to be merely a nominal party to an action simply because it has been dissolved.”
Tangshan Ganglu Iron & Steel Co. v Mapuche, LLC. Decided in 2014 by the Florida U.S. District Court, the case involved a suit to dissolve a two-member LLC brought by its China-based majority member which argued that the LLC should be considered a nominal party whose citizenship should be ignored in evaluating diversity. Citing Masters v Harkleroad, the court dismissed the case, finding that the LLC as “a legal entity distinct from its members” has a real interest in the litigation’s outcome. The court also observed that “[i]t is hard to imagine a case in which a limited-liability company would have a greater stake in the outcome” where the plaintiff member seeks to appoint a custodian to manage the LLC’s business and ultimately to dissolve the LLC.
There’s one other LLC dissolution case worth mentioning, In re Security First, LLC, decided earlier this month by the Louisiana U.S. District Court, in which the court addressed its jurisdiction upon removal of the case from state court. While leaning against jurisdiction and noting that the LLC “may have an interest in these dissolution proceedings,” the court did not reach a decision. Instead, it gave the removing member the choice to file a memorandum that presents argument and evidence in support of his contention that the LLC is a nominal party, or withdraw his removal notice “in light of the authority that appears to refute [his] argument.” Interestingly, the opinion does not mention the above-mentioned Gambel case, decided by another judge on the same court, in which the court upheld jurisdiction.
Can the Cases be Reconciled?
In a word: no.
The two sets of cases, albeit few in number and light on analysis, offer diametrically opposed, seemingly categorical holdings that, on the one hand, LLC dissolution is an internal affair between the members in which the LLC has no independent interest and, on the other hand, the LLC is a distinct legal entity with an independent interest in its dissolution and ancillary remedies such as receivership.
What does that mean for business divorce counsel choosing between state and federal court where the LLC’s members have diverse citizenship? Until we see more authoritative rulings at the appellate level, it means counsel must weigh carefully any potential benefits of proceeding in federal court against the risk of being booted either for lack of jurisdiction or under Burford, the potential loss of the client’s initial investment in litigation costs, and the risks associated with the passage of time spent unsuccessfully litigating choice of forum.