Seventh Circuit Discusses “Nerve Center” Test for Diversity Jurisdiction as Applied to Corporate Subsidiaries

In Big Shoulders Capital LLC v. San Luis & Rio Grande Rd., No. 20-1503 (7th Cir. Sept. 3, 2021), the court remands a diversity action to determine whether the subsidiaries of a railroad – under the “nerve center” test – are citizens (1) of Illinois where the parent is headquartered, or (2) of Oregon, Delaware, and Colorado where they are incorporated or have operations.

“This case began when Big Shoulders sued SLRG [San Luis & Rio Grande Railroad Inc.] and Mt. Hood [Railroad Co.], alleging a breach of contract and more than $4.6 million in damages. That contract was a loan agreement between Big Shoulders, the defendants, and Iowa Pacific Holdings LLC, as well as several of its subsidiaries. Iowa Pacific is the ultimate parent company of SLRG and Mt. Hood, along with several other entities.” Iowa Pacific and Big Shoulders, it was undisputed, were citizens of Illinois for diversity-jurisdiction purposes. (There are a variety of other parties and an intervening bankruptcy in this complex case that, to simplify matters, are disregarded for this discussion.)

“In its complaint, Big Shoulders contended that federal jurisdiction existed because there was complete diversity of citizenship between the parties. See 28 U.S.C. § 1332. As a limited liability company, Iowa Pacific is the citizen of the states where its owning members are citizens . . . . One of its members is a citizen of Illinois, and Big Shoulders is also a citizen of Illinois. So if Big Shoulders sued Iowa Pacific, there would not be complete diversity. But according to Big Shoulders, the entities that it sued—SLRG and Mt. Hood—are citizens of Colorado and Delaware, and Oregon, respectively, making jurisdiction facially proper.”

Iowa Pacific’s general counsel submitted a declaration that, for relevant purposes, stated that there was no practical separation between the parent and subsidiaries. “The Michaud Declaration described the . . .  entities [SLRG and Mt. Hood] as a ‘single enterprise’ and averred that Iowa Pacific made all decisions for its subsidiaries. According to this declaration, these subsidiaries did not maintain separate books and records and did not transact with each other at arm’s length. Concerning corporate governance, the declaration stated that only the interests of Iowa Pacific were considered and not the individual interests of the subsidiaries.”

An intervenor, Sandton Rail Company LLC (Sandton), citing this declaration sought to dismiss the entire action by arguing (among other things) that there was a lack of subject matter jurisdiction because there was a lack of complete diversity between Big Shoulders and the subsidiaries. The district court found, nevertheless, that the parties were diverse. “Under Illinois contract law, the district court explained, a party suing for breach of contract may sue any one of the obligated parties and need not sue all of them. According to the district court, this meant that Big Shoulders could choose to sue SLRG and Mt. Hood but not Iowa Pacific. Sandton does not contest that holding on appeal.”

After resolving other jurisdictional disputes concerning standing and mootness of various parties, the Seventh Circuit reaches the issue of whether there was diversity jurisdiction. “Sandton brings the main appeal against Big Shoulders and claims the district court lacked subject matter jurisdiction based on lack of diversity.” Sandton argued that the subsidiaries were indistinguishable for diversity purposes from the Illinois-based parent.

The panel addresses, but declines to rule on, an alter-ego argument. “According to Sandton, the statements in the Michaud Declaration that the Iowa Pacific companies do not respect corporate separateness and that their holding company controls all decision-making demonstrate that the defendant subsidiaries in this case are alter egos of Iowa Pacific and its other subsidiaries.” The panel notes that this theory is one of “immense complexity” and ultimately it does not “see this case as the occasion to resolve this question with its subtle distinctions.”

Instead, it remands the action to be reconsidered under the “nerve center” test. By this theory, “we must determine the potentially separate principal places of business of Mt. Hood and SLRG. Sandton avers that they are both located in Illinois because that is where the Michaud Declaration alleged the ‘single enterprise’ of the Iowa Pacific companies is located.” The panel finds “tension” between “separate corporate forms deserve a presumption of validity” on the one hand, versus  a standard that “subsidiary corporations hav[e] the same principal place of business as their parent corporations, and as a result, weaken their separate corporate form.”

“The resolution is to apply the nerve center test by focusing only on the operations of the subsidiary. If the subsidiary is wholly owned by its parent corporation but also has its own executives in a different state, this other state should be the subsidiary’s principal place of business . . . . If, however, a subsidiary does not have any high-level operations outside of the state where its parent resides and it is ‘directed and controlled’ from the state where the parent has its headquarters, the subsidiary’s principal place of business should be in the same state as its parent.”

The panel “think[s] it is best here for the district court to apply the nerve center analysis in the first instance. Sandton did not present its nerve center argument in the district court. An analysis under the nerve center test is fact specific, and the district court is in the best position to make such determinations. In doing so, the district court can consider to what extent the Michaud Declaration addresses the location of the nerve centers of Mt. Hood and SLRG in Illinois.”

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