“Principal Place of Business”

Written by  //  August 17, 2010  //  Corporate Law and Business  //  Comments Off on “Principal Place of Business”

What is the “place of business” of a corporation? This answer to this question seems, at once, rather self-evident and unnecessary. In this context, it is interesting to note that the issue has invited substantial disagreement over the years, and goes back as far as the early twentieth century.  Its importance is explained by the fact that the place of business of a corporation is relevant to a diverse set of legal questions – for example, to ascertain its status as a taxable entity, under company legislation, for determining the applicable law, and so on.

Recently, the United States Supreme Court considered the meaning of this expression in Hertz Corporation v. Melinda Friend. The context was a US “diversity jurisdiction” statute that allows a defendant sued in a State court to have the case transferred to a federal court under certain circumstances. One of those circumstances is that the defendant and the plaintiff must be “citizens” of different States – the rationale being to obviate any possible prejudice local courts may have against an out-of-State defendant. The “citizenship” of a corporation, however, is not obvious, and the statute defines it as follows: “a corporation shall be deemed to be a citizen of any State by which it has been incorporated and of the State where it has its principal place of business”.

The first part of this definition creates no difficulty – the place of incorporation of a company is a question of fact. In simple cases, the second test also does not pose difficulty. However, in the case of a company whose business operations are “far-flung” or spread out over a few select States, it becomes important to identify the yardsticks on the strength of which its place of business is to be ascertained. Hertz v. Friend was such a case. Hertz, the well-known automobile renting company, was sued in state court by two residents of California for alleged contraventions of Californian labour law. Hertz claimed that it was entitled to remove the case to Californian federal court, since it was not a citizen of California. To prove that it was not a Californian citizen, Hertz relied on the fact that while it operated facilities in 44 States, and that its corporate headquarters were located in New Jersey, from where it made the corporate decisions that were implemented across the country.

The District Court had rejected this submission, holding that the amount of business activity Hertz had in California was “significantly larger”, applying precedent that instructed courts to apply this test. Hertz unsuccessfully appealed this order, and the Supreme Court granted a writ of certiorari to resolve wide disagreement between various Circuit courts in the country. Some courts applied the “significantly larger” business activity, while others held that the “nerve centre” of a corporation is the where its principal place of business is situate.

The Supreme Court began with an instructive analysis of historical developments on diversity jurisdiction. Diversity jurisdiction in the US goes back to 1789, but the statute was silent on corporate citizenship, and courts initially took the view that a corporation could claim the benefit of diversity jurisdiction only if its shareholders were citizens of a different State. Later, courts presumed conclusively that shareholders were citizens of the State of incorporation of the company, even if that was not in fact the case. This effectively meant that a corporation is a citizen of the State by which it is incorporated – the first limb of the present rule. This rule was widely criticised as inconsistent with the purpose of diversity jurisdiction and as an incentive for forum shopping – for a company incorporated in State “A” with no business activity there whatsoever is entitled to remove the matter from that State court to one in which it has substantial business activity, employees, advertisements etc. A Committee setup to inquire into the matter substantially agreed with this criticism, and proposed to make a corporation a citizen of both the State of incorporation and “any State from which it receives more than half of its gross income”.  Subsequently, this language was altered and the present language came into being.

The “nerve center” test was adopted by a court in 1959, and it referred to the place from which officers of the corporation “direct, control and coordinate all activities without regard to locale, in furtherance of the corporate objective”. This was easy to apply to a corporation that carried on business in several places, but harder to apply to one that confined its operations to a few States. For cases of this sort, courts began applying a “business activities” test, and had to decide which “factor” mattered more in this analysis – plant location, sales centers, employees etc.

The Supreme Court rejected the second approach, and held, for three reasons, that “principal place of business” refers to the place “where a corporation’s officers direct, control and coordinate the corporation’s activities”. It further held that this place is normally the corporation’s “headquarters”. The first reason the Supreme Court offered is that the word “place” used in the statute is used in “singular” indicating that a court is required to pick out the “main” or “predominant” place. Further, the words “the State where” precede “place”, indicating that the place is within a State, and not the State itself. This tends to militate against a business activity test, which finds, for example, that a State is itself the principal place of business on account of a large percentage of revenue being generated there. While this is an interesting point, it is submitted that it is not conclusive, because the correct application of a business activity test does not necessarily lead to a finding that a “State” is itself the place of business – it means, rather, that the place of business of a corporation in the State in which it has substantial business activity is “the” place of business of the corporation as a whole.

Secondly, the Court refers to “administrative simplicity” as a major virtue in a jurisdictional statute, and to the fact that complex jurisdictional provisions consume time and money. While these concerns are valid, it is submitted that they are of limited relevance in what is essentially a limited question before the court – what did the legislature intend by the words “principal place of business”? Thirdly, the court referred to legislative history to support the proposition that the legislature intended a “simple” rule by the expression “principal place of business”. Again, this is not entirely convincing for the court appears to have used a very broad conception of legislative history – to refer to the object of the legislature, rather than ascertain what it meant by the expression in question.

In sum, the Court may have arrived at the correct conclusion by virtue of the first reason it offered for it. It remains to be seen whether this is likely to influence more general conceptions of “principal place of business”, especially in other jurisdictions.

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