Choosing Procedure Over Substance - The Supreme Court Limits the Ability of States to Restrict or Prohibit Class Actions in Diversity Proceedings

On March 31, 2010, the Supreme Court issued its decision in Shady Grove Orthopedic Associates, P.A., v. Allstate Insurance Co., Docket No. 08-1008, on the question of whether class actions that are prohibited or limited under state law may nonetheless proceed in federal court. In a fractured decision that garnered five votes only with respect to two portions and the judgment, the Court held that a New York law (CPLR § 901(b)), which prohibits class actions in suits seeking penalties or statutory minimum damages, does not preclude federal courts sitting in diversity from allowing such class actions to proceed under Fed. R. Civ. P. 23 (“Rule 23”). In coming to this conclusion, the Court reexamined the concerns behind the Erie doctrine and the Rules Enabling Act – the balance between the power to “prescribe general rules of practice and procedure for federal courts” and the restriction that ”[s]uch rules shall not abridge, enlarge, or modify any substantive right.” 28 U.S.C. § 2072(b).

I. Background

Shady Grove Orthopedic Associates, P.A., provided medical care to an individual who was injured in an automobile accident and insured by Allstate Insurance Co. under a policy issued in New York. Allstate paid the claim late, but refused to pay the statutory interest that had accrued on the overdue benefits, which totaled $500. Shady Grove filed a diversity suit in the Eastern District of New York, seeking $5 million in relief on behalf of itself and a putative class of others who were similarly owed interest.

By filing in federal court, Shady Grove attempted to circumvent New York’s limitation on class actions in § 901(b), which provides that “unless a statute creating or imposing a penalty, or a minimum measure of recovery specifically authorizes the recovery thereof in a class action, an action to recover a penalty, or minimum measure of recovery created or imposed by statute may not be maintained as a class action.” This subdivision was “designed to discourage massive class actions for statutory violations where it would be difficult to identify the members of the class and where recovery of the statutory minimum by each class member results in ’annihilat[ing] punishment.’” CPLR § 901, cmt. C901:7 (McKinney 2005).

The United States District Court dismissed the suit for lack of jurisdiction, reasoning that § 901(b) applied in federal court because it did not contravene any federal rule. The district court rejected Shady Grove’s argument that § 901(b) was entirely procedural and thus inapplicable in a federal diversity action. The United States Court of Appeals for the Second Circuit affirmed, noting that Rule 23’s procedural requirements for class actions could be applied along with the substantive requirements of § 901(b).

Before the Supreme Court, Shady Grove argued that under Erie, a federal court should not apply a state procedural rule that would limit the use of a procedural device­­ that is otherwise available under the Federal Rules of Civil Procedure. The Second Circuit had rejected this argument, finding that § 901(b) did apply because it was substantive in nature as it limited the remedy available under a state law claim.

II. The Court’s Opinion

Justice Scalia, joined by Justices Roberts and Thomas, and in parts by Justices Stevens and Sotomayor, elucidated the two-step framework for “negotiat[ing] this thorny area.” The first step looks to whether the state rule conflicts with a federal rule. The Court found that there was a direct conflict between Rule 23 and § 901(b), as both rules purport to answer the same question: “whether Shady Grove’s suit may proceed as a class action.” The Court described that “Rule 23 provides a one-size fits all formula for deciding the class action question.”¹

If a conflict exists, the second step is to determine whether application of the federal rule violates the requirement of the Rules Enabling Act (28 U.S.C. § 2072(b)) that federal procedural rules may not “abridge, enlarge, or modify any substantive right.”² Justice Scalia observed that “the test is not whether the rule affects a litigant’s substantive rights,” as most procedural rules do so in some way. Instead, ”[w]hat matters is what the [federal] rule itself regulates: if it governs only the manner and the means by which the litigant’s rights are enforced, it is valid; it if alters the rules of decision by which the court will adjudicate those rights, it is not.” Under this approach, the nature of the affected state law does not matter; rather, it is simply a question of whether the federal law in question is substantive or procedural in nature.

The Court ultimately held that Rule 23, while having an “incidental effect upon state-created rights,” is a rule of procedure and therefore trumps the application of § 901(b). Accordingly, the Court reversed the judgment of the Second Circuit dismissing the case, and remanded the matter for further proceedings.

III. Justice Stevens’ Concurrence

Justice Stevens, concurring in part and concurring in the judgment, agreed that Rule 23 would trump the application of § 901(b), but articulated a narrower and more nuanced approach in coming to this conclusion. He departed from the plurality’s analysis by agreeing with the dissent that “there are some state procedural rules that federal courts must apply in diversity cases because they function as a part of the State’s definition of substantive rights and remedies.”

Justice Stevens articulated the two-step framework somewhat differently. He rejected the plurality’s interpretation that the “sole Enabling Act question is whether the federal rule really regulates procedure.” Instead, Justice Stevens wrote, the second step of the inquiry focuses on whether the state law is procedural or substantive in nature, and he noted that a seemingly procedural rule can be substantive (for instance, a statute of limitation). Justice Stevens warned, however, that there is a high bar for finding such “Enabling Act problem[s],” as ”[t]he mere possibility that a federal rule would alter a state-created right is not sufficient. There must be little doubt.” According to Justice Stevens, this approach better represents the “balance that Congress struck between uniform rules of federal procedure and respect for a State’s construction of its own rights and remedies.” Justice Stevens ultimately concluded that § 901(b) was procedural rather than substantive in nature, because it applies generally to claims based on New York, federal, and other state law.

IV. Implications Of Shady Grove

The decision in Shady Grove will likely encourage the filing of more class actions in federal courts. The Court observed that “Rule 23 unambiguously authorizes any plaintiff, in any federal civil proceeding to maintain a class action if the Rule’s prerequisites are met.” (emphasis in the original). Plaintiffs will unquestionably argue that, under this broad reading of Rule 23, there is little that a State can do to restrict or prohibit class actions filed in federal court. As the dissent noted, ”[t]he Court’s “one-size-fits-all” reading of Rule 23 likely prevents the enforcement of all of these statutes [that limit the use of class actions] in diversity actions.”

The Court’s reading of Rule 23 applies a strong presumption in favor of a uniform system of federal procedure at the expense of States’ ability to proscribe procedural rules that effectively regulate substance, potentially undermining the principles of federalism. Justice Stevens’ narrower approach, however, should provide some protection to state law provisions, as it recognizes the possibility that a state procedural rule can also be substantive and gives weight to such consideration. In order to improve the odds that a state law will not be trumped by federal law, state legislatures will likely begin drafting procedural rules with an eye towards spelling out their substantive nature.

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(1) The Court rejected the dissent’s and the Second Circuit’s assertion that § 901(b) does not conflict with Rule 23 because it “affects only the remedy [Shady Grove] may obtain if it wins.” The dissent argued that “Rule 23 describes a method of enforcing a claim for relief, while § 901(b) defines the dimensions of the claim itself.” The Court reasoned that the dissent’s approach does not avoid “a conflict between § 901(b) and Rule 23 but rather the invalidation of Rule 23 to the extent it conflicts with the substantive policies of § 901(b).” The Court hinged its analysis on the fact that a plain reading of the text of both rules demonstrates the inherent contradiction.
(2) If a conflict does not exist, then the traditional Rules of Decision Act analysis under Erie is applied. The dissent, like the Second Circuit, found that there was no conflict, and concluded that § 901(b) should apply in federal court because it was a rule of substance and it served Erie’s twin aims of discouraging forum-shopping and avoiding unequal administration of the laws.