Changes to Federal Diversity Law for Liability Insurance Companies Raises Federal Jurisdictional Problems for the Insurance Bar

By John Armstrong

Congress made significant changes to the laws allowing the removal of actions filed in local state courts to be removed to federal court. Two kinds of cases have historically been allowed to proceed in federal court—even if filed and served in state courts, namely, “subject matter jurisdiction” where a federal law or policy is the gravamen of the claim and “diversity jurisdiction” where the dispute involves more than $75,000 and all of the plaintiffs and all of the defendants are residents of different states.

Congress changed what are known as the “removal statutes,” namely Title 28 U.S.C. § 1332 and § 1441. Section 1332 makes every corporate insurer, as a matter of law, a “citizen” of the state in which the insured resides, as well as the state of the insurer’s corporate incorporation, and where the insurer’s principal place of business. This is important because insurers can no longer bring declaratory relief actions against their insurers in federal court, and because insurers can no longer remove insurance bad faith actions to federal courts

Some states, like Louisiana,  allow a tort victim to sue the defendant’s liability insurer directly. In response to a large number of federal suits filed in the federal courts in Louisiana, Congress expanded the definition of “citizenship” for insurance companies. Liability Insurance companies are now a resident of the state in which they are incorporated, where their principal place of business [the corporation’s “nerve center” where its chief executive operations take place], and are deemed a resident of the same state that their insureds reside in if:

1) There is a “direct action” against a liability insurer; and

2) The insured is not joined as a party-defendant.

See the problem? “Direct action” is not defined. If the insured sues the insurance company directly for declaratory relief or for insurance bad faith, does this mean that the insurer can no longer remove to federal court? If the insurer cross-complains against the insured, is the insured now “joined” as a party-defendant? If an insurer sues in federal court first, can the insured move to dismiss for lack of diversity? The answer? Only time will tell. The answer will depend on how each court faced with these issues decides it.

A purely literal interpretation seems to preclude an insurer from removing the insured’s declaratory relief or insurance bad faith action since the insured is not a “party-defendant” at the time of the attempted removal, and the action would be a direct against an insurance company. Though the Congressional history shows that Congress intended to limit victims from suing insurers in federal court, the plain language in the Act does not contain such a limitation.

Oddly, if the insurer sues the insured first, the insured may not be able to dismiss for lack of diversity jurisdiction, since a literal interpretation of the Act only makes a liability insurer a citizen of the same state as its insured when the insured is “not joined as a party-defendant.”

If the changes to the Act are read in view of the Congressional history, a court should interpret the Act as defeating diversity jurisdiction only in actions where state law allows a victim to sue the wrongdoer’s insurer directly, which interpretation is consistent with the text’s reference to applying where insureds are not joined as party-defendants.

It’s worth noting that changes don’t apply to property insurers, i.e., “non-liability” insurers. Or do they? What if a property policy provides a defense or indemnity for a certain kind of liability claim? Would the court look to the type of policy issued or to the insuring provision? Again, only time will tell. Now, the insurance bar is free to argue either way until we get some judicial interpretation of these new changes.

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