Federal "Procedural" Rules Undermine Important State Interests in Shady Grove Orthopedic Associates. P.A. V. Allstate Insurance Co

Article excerpt

Since the Supreme Court's decision in Erie Railroad Co. v. Tompkins, (1) federal courts have attempted to apply state "substantive" law and federal "procedural" law when sitting in diversity. (2) Courts draw this distinction differently depending on whether a Federal Rule of Civil Procedure (Federal Rule) "directly conflicts" with the state law. (3) When a court determines that a Federal Rule does not govern a question, it then applies the "twin aims of Erie" test to determine whether state law should apply. (4) This test asks if applying state law is necessary to (1) avoid inequity between in-state and out-of-state litigants, and (2) avoid incentives for forum-shopping. (5) Courts often read a Federal Rule quite narrowly to avoid a conflict with "substantive" state law. (6) In Sibbach v. Wilson & Co., (7) however, the Court held that when a Federal Rule directly conflicts with state law, the Federal Rule must govern unless it is facially invalid for conflicting with the Rules Enabling Act. (8) The Act authorizes the Supreme Court to promulgate rules of procedure for federal courts, with the proviso that such rules not "abridge, enlarge or modify any substantive right." (9) This limitation has been construed as authorizing any federal rule that is "arguably procedural" (10) without regard for the nature of the substantive rights that may be modified by application of the rule in particular cases. Last Term, in Shady Grove Orthopedic Associates, P.A. v. Allstate Insurance Co., (11) the Supreme Court held that the Federal Rules permit a class action suit to go forward in federal court even though it would have been barred in state court. This ruling frustrates important state legislative objectives and exposes defendants to massive liability in diversity suits. The "arguably procedural" approach is at odds with the plain meaning of the statute and should be retired. In its place, the Court should adopt an "as applied" test for determining how Federal Rules apply in diversity suits.

Petitioner Shady Grove, a healthcare provider, alleged that Allstate Insurance was routinely late in paying out benefits and refused to pay the two-percent monthly interest penalty required by New York law. (12) Shady Grove filed a diversity suit in the Eastern District of New York "on behalf of itself and a class of all others to whom Allstate owes interest." (13) Under New York Civil Practice Law Section 901(b) (Section 901(b)), a class action "may not be maintained" to recover a "penalty" or statutory minimum damages, (14) thus limiting class certification to plaintiffs seeking only actual damages. There is no comparable prohibition in Federal Rule 23, which contains its own, apparently exclusive, criteria for class certification. (15) New York enacted its prohibition out of concern that combining statutory minimum penalties with the class action device could lead to "annihilating punishment." (16) A common purpose of both statutory penalties and the class action device is to incentivize lawsuits that might not otherwise be worth the time, effort, or cost; so combining the two devices would greatly magnify incentives to sue.

Both the Eastern District of New York and the Second Circuit held that Rule 23 and section 901(b) could be applied simultaneously. According to the Second Circuit, the New York statute creates a threshold inquiry--whether certain causes of action are even eligible for class treatment--that must be answered before the procedural criteria of Rule 23 can be applied. (17) Because the court found no conflict between the Federal Rule and the state statute, the court analyzed Section 901(b) under the "twin aims of Erie" test. The obvious conclusion was that a failure to apply the New York prohibition on class actions seeking penalties would create an enormous incentive for plaintiffs to choose the federal forum. (18) In so ruling, the Second Circuit followed "the overwhelming majority of district courts that have concluded that section 901(b) is a substantive law that must be applied in the federal forum, just as it is in state court. …