Argument preview: Avoiding removal by limiting damages?

On January 7, in Standard Fire Insurance Co. v. Knowles, the Court will hear its first Class Action Fairness Act (“CAFA”) case – to consider whether a state class action complaint can avoid removal by limiting the damages sought to less than the federal jurisdictional amount.

Factual and procedural background

Greg Knowles filed a class action in which he alleged that petitioner Standard Fire Insurance Company underpaid claims for real property loss or damage to Arkansas homeowners by refusing to pay for charges associated with retaining a general contractor.  Such charges, called general contractors’ overhead and profit (GCOP), typically amount to twenty percent of the estimated repair.  In his complaint, Knowles alleged only state-law claims, and he limited the class definition to residents of Arkansas, which both authorizes plaintiffs to limit their damages and provides that such declarations are binding.  Consistent with and citing to this provision, the complaint stated that no individual class member’s claim exceeds $75,000 (including costs and attorney’s fees), and that the aggregated damages of all class members do not exceed five million dollars (again including costs and attorney’s fees).  In his complaint (and an exhibit attached to it), Knowles also stipulated that he would neither seek damages for any class member in excess of $75,000 nor seek damages for the class in excess of five million dollars, including costs and attorney’s fees.

Standard removed the suit to federal court, but Knowles then timely moved to remand on the ground that the requisite amount in controversy had not been met.  The federal district judge rejected Standard’s challenges to the stipulation and granted Knowles’s remand motion; the Eighth Circuit denied Standard’s petition for permission to appeal.  Standard filed a petition for certiorari, which the Supreme Court granted on August 31, 2012.  Since then, more than a dozen amicus briefs have been filed with the Court, of which approximately three-quarters are from various insurance companies and other business-oriented entities in support of petitioner Standard.

Arguments

Standard challenges the stipulation as both invalid and not binding.  Standard argues that Knowles’s stipulation is useless because it cannot bind other class members.  Moreover, it contends, the stipulation does not adequately bind the plaintiff for two reasons:  (1) Knowles stipulated that he would decline to “seek” such damages rather than declining to “seek or accept” such damages; and (2) because class counsel did not sign the stipulation, attorney’s fees are not included within it.  Standard also argues that Knowles’s decision to limit damages to a two-year recovery period is fraudulent because the applicable statute of limitations is five years, and such a limitation on damages violates class members’ due process rights.

According to Standard, these deficiencies leave open the possibility that Knowles could amend the complaint to seek additional damages in the future.  Standard argues that because this stipulation – or any stipulation – is invalid and not binding, CAFA’s jurisdictional amount is satisfied in this case.  Standard’s calculations take twenty percent of the total damages purportedly owed to the class (the GCOP) – $3,054,961 – and add a twelve percent statutory penalty for breach of contract, an attorney’s fee award of forty percent, and pre-judgment interest, for a grand total of $5,024,150 – enabling it to cross CAFA’s jurisdictional amount threshold.

Knowles responds that the Supreme Court has long recognized that the plaintiff is the master of his complaint and accordingly may limit his damages claim.   Knowles additionally notes that the existence of federal jurisdiction is determined by the plaintiff’s pleadings at the time of removal, and that pursuant to CAFA, Standard may act upon any amendments or other subsequent changes by removing the action at that time – an action that is possible because CAFA eliminated the one-year limit on diversity-based removal.  Knowles also observes that if a class representative attempts to unreasonably restrict a class recovery, a remedy already exists within the federal class action rule:  in such a situation, the federal court should deny class certification for failing to satisfy Federal Rule of Civil Procedure 23(a)(4)’s adequacy of representation prerequisite.

Analysis

To a surprising degree, Standard’s arguments are not founded on the law created by CAFA, but instead are founded on the rhetoric surrounding CAFA’s enactment.  CAFA facilitated defendants’ ability to remove from state court to federal court certain large class actions – large in terms of both class size (requiring one hundred or more class members) and damages (requiring more than five million dollars).  For example, to remove such class actions on the basis of diversity, only minimal rather than complete diversity is required; removal is possible as long as there is just one class member who is a citizen of a state different from that of any defendant.  As another example, in most federal court lawsuits, claims may not be added together to satisfy the required jurisdictional amount, but CAFA authorizes precisely such aggregation to reach the five million dollar threshold.  CAFA class actions also are not subject to the traditional statutory limitations on diversity-based removal:  there is no outer one-year limit in which to effect removal; any defendant may remove without the consent of the other defendants; and removal is not precluded when a defendant is a citizen of the forum state.  Thus, CAFA defendants are uniquely entitled to diversity-based removal under circumstances denied to all other defendants.

CAFA’s removal provisions are not unrestricted.  CAFA necessarily is restrained by Article III – it cannot create federal jurisdiction where none exists.  However, Congress could, within the constraints of Article III, have extended more generous removal opportunities by, for example, requiring fewer class members (instead of one hundred or more) or requiring a lower jurisdictional amount (instead of in excess of five million dollars).  But it didn’t.

For all of the rhetoric surrounding CAFA’s enactment, the actual statutory language may not stretch as far as Standard would like.  Standard repeatedly references the allegedly notoriously plaintiff-friendly locale in which this class action was filed.  But despite broad platitudes in the legislative history, Congress made very specific statutory enactments.  Congress could have prohibited stipulations purporting to limit damages.  But it didn’t.  Indeed, CAFA’s failure to prohibit such stipulations is striking in light of the longstanding existence, and popularity, of the practice.

In traditional litigation, a plaintiff may elect to pursue only particular defendants, only particular claims, or only particular kinds or amounts of damages.  State court plaintiffs commonly elect such limitations precisely because, in the absence of such plaintiff-imposed restrictions, defendants would have a statutory right of removal.  When federal jurisdiction exists, a defendant is statutorily entitled to remove the suit to federal court unless the plaintiff is, quite literally, willing to pay a price.  The price is forfeiture:  forfeiting claims against a diverse defendant, a federal claim, or damages above a particular threshold.  There is nothing improper about this practice; “[i]f [a plaintiff] does not desire to try his case in the federal court, he may resort to the expedient of suing for less than the jurisdictional amount, and though he would be justly entitled to more, the defendant cannot remove.”

Moreover, Standard’s contentions often rest on speculation:  it asserts that remand was improper because Knowles and the class possibly could seek more damages in the future despite the stipulation, and the only way that Standard could reach CAFA’s jurisdictional threshold was by positing that class counsel might be awarded attorney’s fees of forty percent.  However, hypothetical, conjectural situations cannot support a determination of federal jurisdiction.

Finally, Standard asserts that the Court’s 2011 decision in Smith v. Bayer nullifies Knowles’s stipulation, arguing that proposed class members cannot be bound in any fashion until a class is certified.  However, the issue in Bayer was whether a federal court’s denial of class certification precluded a state court from considering a similar request for class certification by a different plaintiff.  Bayer had sought to come within the Anti-Injunction Act’s relitigation exception, which is based on the preclusion doctrines.  But Bayer lost, and there is no judgment on the merits in this case to invoke the preclusion doctrines.

Notwithstanding the extent to which the text of CAFA would seem to favor Knowles (or, alternatively, to go against Standard), the conventional wisdom among Court watchers is that the Court likely granted Standard’s petition to reverse the decisions below – particularly given the hostility of some Justices to what they perceive as class action abuses – and unquestionably the Court could reach that result by focusing on CAFA’s legislative history rather than its actual statutory language.  That approach would put the Court on a path that would invalidate a broader range of stipulations, but if the Court is persuaded by Standard’s legislative-intent-type arguments, it may be willing to take that path.  In any event, it will be interesting to see whether the class action context of this case causes the Court to retreat from well-established doctrines, including the maxim that federal courts are to construe removal statutes strictly.  And whatever the outcome, there is no question that the Court’s decision will generate extensive interest and coverage, and will have a genuine impact on class action practice.

Debra Lyn Bassett is the Justice Marshall F. McComb Professor of Law at Southwestern Law School.