Did the Supreme Court Open the Door for Class Action Lawsuits?

The Supreme Court's decision in Shady Grove Orthopedics Associates, P.A. v. Allstate Insurance Company, 130 S.Ct. 1431 (March 31, 2010) is of vital importance for any litigator or claims professional who handles class action lawsuits in federal court. It also may have a significant impact on the economics of writing coverage that includes defense costs in industries that are typically subject to class actions. In Shady Grove, the Supreme Court took on the issue of whether, in the context of a state law diversity action pending in federal court, Rule 23 of the Federal Rules of Civil Procedure, which generally permits a plaintiff to maintain a class action in federal court if certain preconditions are met, pre-empts a New York statute (N.Y. Civ. Prac. Law Ann. ' 901(b)) that prohibits a plaintiff from maintaining a class action suit seeking statutory penalties. In a 5-4 decision, the Court held that Rule 23 pre-empts the New York statute and permits the plaintiff to maintain a class action suit in federal court seeking statutory penalties, even though the plaintiff could not have maintained the same action in a New York state court.

Nevertheless, the Court could not agree on a single rationale for holding that Rule 23 pre-empted the New York statute, thus leaving an opening for defendants in other cases to distinguish their particular disputes from the New York statute. Another potential outcome is that state legislatures will attempt to amend their laws in order to potentially avoid the ruling in Shady Grove. More specifically, defendants can argue that other state laws are substantive, as opposed to the statute at issue in Shady Grove, which Justice John Paul Stevens (who gave the critical fifth vote in favor of pre-empting the New York statute) deemed to be procedural because it merely served to prohibit the procedural class action device in certain actions. Alternatively, state legislatures can amend existing laws to make them more “substantive” in nature, such as by tying them to particular substantive rights or expressly limiting the remedies available in certain actions, rather than procedurally barring the class action itself. While such arguments or amendments are not certain to withstand pre-emption in federal courts, Shady Grove leaves some room for that possibility.

This article discusses the Court's holding in Shady Grove, its implications for similar laws in other states, and the potential openings for defendants and state legislatures to distinguish other state laws from the New York law at issue in Shady Grove.

Background

The facts in Shady Grove were straightforward. The plaintiff, Shady Grove Orthopedic Associates, provided medical care to Sonia Galvez after a car accident. Allstate insured Galvez and paid Shady Grove, but not within the 30-day deadline required by New York law. Allstate nevertheless refused to pay Shady Grove the statutory interest that accrued on the overdue payments under New York law. Shady Grove sued Allstate in the U.S. District Court for the Eastern District of New York to recover statutory interest on behalf of itself and a class of all others to whom Allstate owed statutory interest on similar overdue payments.

The district court dismissed Shady Grove's lawsuit for lack of jurisdiction because the value of Shady Grove's individual claim was below the amount in controversy required to maintain a diversity lawsuit. Further, the court reasoned that New York law, ' 901(b), prohibited Shady Grove from maintaining a class action against Allstate for statutory interest. Shady Grove appealed, arguing that the class certification provisions of Rule 23 pre-empted ' 901(b) and permitted it to maintain its lawsuit as a class action. The Second Circuit disagreed, holding that ' 901 applied to bar Shady Grove from maintaining a class action for statutory interest in federal court.

With a 5-4 vote, the Supreme Court reversed the Second Circuit's decision and held that Rule 23 permitted Shady Grove to maintain a class action for statutory interest, notwithstanding ' 901. In that regard, the majority agreed that Rule 23 and ' 901 were in direct conflict because Rule 23 permitted a plaintiff to maintain a class action if certain preconditions were met, but ' 901 prohibited the maintenance of such an action for statutory penalties even if Rule 23's preconditions were met. The majority further agreed that Rule 23 controlled because it complied with the Rules Enabling Act, 28 U.S.C. ' 2072, which authorizes the Court to set procedural rules in federal courts.

The majority could not, however, agree upon a single rationale as to why Rule 23 complies with the Rules Enabling Act. On one hand, Justice Antonin Scalia, joined by Chief Justice John G. Roberts, Jr. and Justices Clarence Thomas and Sonia Sotomayor, focused on Rule 23 itself and concluded that Rule 23 complies with the Rules Enabling Act because it regulates procedure, i.e., “the judicial process for enforcing rights and duties recognized by substantive law.” Justice John Paul Stevens, on the other hand, focused on ' 901 and concluded that Rule 23 complies with the Rules Enabling Act because ' 901 regulated procedure and, therefore, Rule 23 did not “abridge, enlarge, or modify any substantive right” under New York law. Thus, Justices Scalia and Stevens differed with respect to whether the Court should focus its attention on the procedural or substantive nature of Rule 23 or the conflicting state law to determine whether Rule 23 complies with the Rules Enabling Act. The four dissenting justices, led by Justice Ruth Bader Ginsburg, concluded that ' 901 did not conflict with Rule 23 because ' 901 only limited the remedies that a plaintiff could recover in a class action under New York law, rather than setting forth the preconditions for the maintenance of such an action in federal court, which is the province of Rule 23. Thus, Justice Ginsburg opined that federal courts must apply ' 901 in state law diversity actions under the Rules of Decision Act, 28 U.S.C. ' 1652 and Erie R. Co. v. Tompkins, 304 U.S. 64 (1938).

Justice Scalia's Approach

The first step in Justice Scalia's analysis was to determine whether Rule 23 governed the dispute before the Court. As he typically does, Justice Scalia utilized a plain language approach in determining whether Shady Grove's class action suit could proceed, noting that “Rule 23 unambiguously authorizes any plaintiff, in any federal civil proceeding, to maintain a class action if the Rule's prerequisites are met.” Shady Grove Orthopedic Associates P.A., 130 S.Ct. at 1442. Given the plain language of Rule 23, Justice Scalia wrote that the Court could not contort the text of the Rule even to avert a collision with a state law that might be pre-empted by the Rule.

Since Rule 23 governed the dispute, Justice Scalia next analyzed whether the Rule fell within the statutory authorization set forth by the Rules Enabling Act, 28 U.S.C. ' 2072(b), which holds that a federal rule applies when it conflicts with a state law on the same issue as long as the federal rule does not “abridge, enlarge or modify any substantive right.” Id. See also Hanna v. Plumber, 380 U.S. 460, 469 (1965). In that regard, Justice Scalia opined that, under the Court's precedent, the guiding light for the validity of a federal rule is whether the rule itself regulates procedure as opposed to whether the state law at issue regulates procedure. Justice Scalia disagreed with Allstate's argument that ' 901(b) involved a substantive right and argued that it is not the substantive or procedural nature or purpose of the affected state law that matters, but the substantive or procedural nature of the federal rule that must be addressed.

Notably, Justice Scalia acknowledged that the Court's precedent, which focused its attention on the federal rule rather than the conflicting state law, did not entirely square with the text of the Rules Enabling Act. Nevertheless, Justice Scalia opined that the Court should apply “settled law” in considering whether Rule 23 complied with the Rules Enabling Act and focus on whether Rule 23 itself regulated procedure, rather than considering whether ' 901(b) was substantive. Applying this framework to Rule 23, Justice Scalia found that it only altered how claims were processed and did not alter the rights themselves, the available remedies, or the rules of decision by which the Court adjudicated either. Accordingly, Justice Scalia opined that the New York law was pre-empted by Rule 23 and Shady Grove's lawsuit could proceed as a class action.

Justice Stevens' Approach

Writing only for himself, but nevertheless adding the critical fifth vote necessary to overrule the Second Circuit, Justice Stevens concurred with Justice Scalia in holding that Rule 23 pre-empted the New York state law regulating class action lawsuits. Critically, however, Justice Stevens adopted a different rationale to support his conclusion.

Like Scalia, Justice Stevens began his analysis by finding that Rule 23 was “sufficiently broad” to “control the issue” before the Court, “thereby leaving no room for the operation of seemingly conflicting state law.” Shady Grove Orthopedic Associates P.A., 130 S. Ct. at 1452. Although Justice Stevens ultimately agreed with Justice Scalia that Rule 23 pre-empted ' 901(b), he diverged significantly from Scalia as to whether federal Rule 23 would always trump a state law in a diversity action pending in federal court. According to Stevens, “an application of a federal rule that effectively abridges, enlarges, or modifies a state-created right or remedy” violates the Rules Enabling Act. Id. at 1454. Thus, in contrast to Justice Scalia's approach, Justice Stevens focused on whether the state law at issue, as opposed to the federal rule, regulates procedure. The vital determination, according to Justice Stevens, is whether the law actually is part of the state's framework of substantive rights or remedies. In some situations, procedure and substance become so interwoven that “rational separation becomes well-nigh impossible.” Id. at 1450 (citing Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541, 559, 69 S.Ct. 1221 (1949)). Justice Stevens stressed that there are some state procedural rules that federal courts must apply in diversity lawsuits because those rules are essentially part of the state's definition of substantive rights and remedies.

Although Justice Stevens' opinion reflects a strong respect for state sovereignty and the power of the states to define their own rights and remedies, he noted that the “bar for finding an Enabling Act problem is a high one” and to find such a problem there must be little doubt that the federal rule at issue would alter a state-created right. In Shady Grove, Justice Stevens ultimately found that ' 901(b) only regulated whether certain actions could proceed as class actions and did not abridge, enlarge, or modify any state substantive rights or remedies. Therefore, in the end, Justice Stevens ruled that ' 901(b) was pre-empted by Rule 23 and Shady Grove's lawsuit could proceed as a class action in federal court.

Justice Ginsburg's Dissenting Approach

Justice Ginsburg, joined by Justices Anthony M. Kennedy, Stephen G. Breyer, and Samuel Anthony Alito, Jr., disagreed with the majority's conclusion that ' 901(b) conflicted with Rule 23. Instead, Justice Ginsburg concluded that ' 901(b) governed the remedies that a plaintiff could seek in a class action under New York law, rather than the preconditions for class certification, which is the province of Rule 23. Thus, Justice Ginsburg found that ' 901(b) and Rule 23 did not conflict, and that federal courts were bound to apply the New York statute under the Rules of Decision Act and Erie. In that regard, Justice Ginsburg was particularly troubled by the fact that the majority permitted Shady Grove to “transform a $500 case into a $5,000,000 award, although the State creating the right to recover has proscribed this alchemy.” Id. at 1582. Justice Ginsburg also criticized the majority for disregarding the Erie doctrine, which she characterized as “one of the modern cornerstones of our federalism” and ignoring important state prerogatives underlying ' 901(b) in the process. Id.

Impact of the Shady Grove Ruling

The Shady Grove decision will have a number of far-reaching repercussions. First, there will likely be an increase in the number of class action lawsuits brought in federal court, particularly in states that have enacted laws prohibiting the maintenance of certain class actions in state court. For example, New York's antitrust law, N.Y. Gen. Bus. Law ' 340, and its Consumer Protection Act, N.Y. Gen. Bus. Law ' 349, both allow the recovery of statutory penalties, so an uptick in class action lawsuits based on these laws can be expected. Plaintiffs' lawyers can also be expected to challenge state laws from a number of other jurisdictions outside of New York that also limit class action lawsuits in one fashion or another. At this time, 23 states have laws specifying that certain claims are categorically ineligible for class certification. For example, Pennsylvania law provides that a class action lawsuit may not be brought for violating the Pennsylvania Mortgage Satisfaction Act, 21 Penn. Stat. ' 721-6(d)(3), and the Pennsylvania Plain Language Consumer Contract Act, 73 Penn. Stat. ' 2208(d).

Whether the various state laws regulating class action lawsuits will be pre-empted in federal court under Shady Grove will largely depend on the specifics of the state law at issue. In that regard, the lower federal courts will struggle with the applicable test, given the splintered majority opinion in Shady Grove. Courts will likely view Justice Stevens' approach as determinative, however, since he cast the fifth and deciding vote in favor of holding that Rule 23 pre-empted ' 901(b). Thus, courts will likely analyze whether the state law at issue is procedural, rather than substantive, in nature to determine whether Rule 23 pre-empts the state law. In that regard, defendants must attempt to show that other state laws restricting the availability of class actions are truly “substantive” in nature, rather than “procedural” by proving that such laws are inextricably tied to state substantive rights, much like a statute of limitations. Nevertheless, laws like ' 901(b) that categorically restrict plaintiffs from maintaining class actions will likely be pre-empted after Shady Grove.

Alternatively, state legislatures can amend existing laws in an attempt to avoid conflicts with Rule 23 or to emphasize the substantive nature of statutes prohibiting the prosecution of certain claims as class actions. In that regard, the majority rejected Justice Ginsburg's conclusion that ' 901(b) was merely a limitation on the types of remedies that could be awarded in class action lawsuits, rather than a blanket prohibition against the maintenance of class actions in certain cases. Nevertheless, the majority left open the possibility that state laws that truly limit the available remedies, rather than prohibiting the procedural class action device, might not conflict with Rule 23. Thus, states can amend their laws to make clear that they impose substantive restrictions on the availability of certain remedies in class action lawsuits, rather than prohibiting the maintenance of such lawsuits.

States can also amend their statutes to bolster the argument that they are “substantive” rather than “procedural” by tying them to specific state-created rights, rather than being blanket prohibitions on class actions. Justice Stevens seemed particularly persuaded by the fact that ' 901(b), by its terms, barred the maintenance of a class action for any claim that sought statutory penalties, regardless of whether such a claim was based upon a substantive right created by New York law. This was a key fact that persuaded Justice Stevens to conclude that ' 901(b) was truly a procedural law, rather than a law inextricably tied to any particular substantive right under New York law.

In the meantime, however, defendants can no longer rely on laws like ' 901(b) to protect them from class actions in federal court. Defendants who previously believed that such laws shielded them from class actions will now face hugely increased exposures. As in Shady Grove, lawsuits that would normally lead to an exposure of a few hundred dollars can be transformed into multi-million dollar class action lawsuits in federal court, even if such actions could not be maintained in state courts. As Justice Ginsburg noted, one of the New York legislature's purposes behind enacting ' 901(b) was to avoid “annihilating punishment of the defendant.” 130 S. Ct. at 1464. If federal courts hold that Rule 23 pre-empts state laws across the country that regulate or limit the availability of class action lawsuits, the results that New York and other states have sought to avoid will become the reality for many defendants and their insurance carriers.

Forum shopping by class plaintiffs in federal court is another expected result of the Shady Grove decision as plaintiffs try to side-step state laws regulating class action lawsuits by filing suit in federal court arguing that the state laws are pre-empted by Rule 23. Justice Scalia even recognized that forum shopping would likely result from the Supreme Court's ruling in Shady Grove, but noted that this was “the inevitable (indeed, one might say the intended) result of a uniform system of federal procedure.” Id. at 1448.

Ironically, however, the Shady Grove holding arguably subverts the purpose of the Class Action Fairness Act (“CAFA”) that was recently enacted in 2005 and which lowered the jurisdictional threshold for class actions in federal court, 28 U.S.C. ” 1332(d), 1453, and 1711-1715. When Congress enacted CAFA, one of its main purposes was to allow defendants to remove a class action lawsuit to federal court to avoid state courts noted for being favorable to plaintiffs, (See Progressive West Ins. Co. v. Preciado, 479 F.3d 1014, 1015-18 (9th Cir. 2007) (noting that the clear purpose of CAFA is to provide class action litigants with access to federal courts). By doing so, Congress certainly did not intend to increase the number of class actions, and many saw the enacting of CAFA as a victory for businesses fighting class action lawsuits. The Shady Grove decision may turn CAFA on its head by rendering federal courts a haven for class action lawsuits that would have been dismissed at the pleading stage if they were filed or remained in state court. With many class action lawsuits now being brought into federal court under CAFA, a conflict exists between a multitude of state laws regulating class action lawsuits and Rule 23. The Shady Grove decision will therefore create more litigation and many follow-up decisions by lower federal courts as to whether Rule 23 pre-empts the state law at issue.

Interesting Alignment

As an interesting aside, the decision in Shady Grove is a confusing and contradictory case for those who believe the justices' political ideologies determine the Court's voting. Chief Justice Roberts and Justices Scalia and Thomas are generally considered to be conservative and very sympathetic to states' rights. Even so, they joined in an opinion that undermined the states' authority to protect businesses from potentially devastating class action lawsuits based upon technical violations of the law. (For example, in Shady Grove, Allstate paid its insured's medical bills, but did not do so within the statutory 30-day deadline. Thus, Allstate was exposed to a claim for approximately $500 in statutory interest. By permitting Shady Grove to sue Allstate on behalf of a class, however, which Shady Grove could not do in state court, the Supreme Court increased Allstate's exposure 10,000-fold, from $500 to $5 million.) In contrast, Justices Ginsburg and Breyer are generally considered to be liberal and sympathetic to federal authority, but they concluded that the New York statute restricting plaintiffs' use of the class action device should apply in federal court proceedings.

Where Do We Go from Here?

With the author of the controlling opinion now retired (Justice Stevens), many commentators are asking how the Supreme Court will address similar pre-emption issues in the future. The deciding vote will now rest with Justice Stevens' replacement, Elena Kagan. Predicting how Justice Kagan will rule if faced with a pre-emption issue in the future is complicated by the fact that she has never previously served as a judge and does not have any prior opinions from which to glean any leanings on this topic. Despite this uncertainty, there is no doubt that it will be easier for plaintiffs to maintain class action lawsuits in federal courts sitting in diversity. Cases that would have never survived a motion to dismiss will now be given life and allowed to proceed as a class action. As a result of the Shady Grove ruling, there will be significantly more challenges to similar state laws as plaintiffs will argue that these laws are pre-empted by Rule 23. The lower courts will now be faced with the challenging task of sorting through these various state laws and determining whether they are truly part of the state's framework of substantive rights or remedies.

Chris Wadley is a partner and Justin Lessner is an associate in the Chicago office of Walker Wilcox Matousek LLP. Wadley's practice is nationwide, litigating matters at both the trial and appellate levels. His cases have involved, among other things, insurance coverage and bad faith lawsuits, business and commercial disputes, and tort litigation. He has also counseled insurance companies on various coverage matters and other business clients on issues pertaining to compliance with federal and state laws and regulations. Lessner handles a wide variety of lawsuits throughout the country, litigating insurance coverage matters, commercial disputes, professional liability claims and tort claims.

The Supreme Court's decision in Shady Grove Orthopedics Associates, P.A. v. Allstate Insurance Company , 130 S.Ct. 1431 (March 31, 2010) is of vital importance for any litigator or claims professional who handles class action lawsuits in federal court. It also may have a significant impact on the economics of writing coverage that includes defense costs in industries that are typically subject to class actions. In Shady Grove, the Supreme Court took on the issue of whether, in the context of a state law diversity action pending in federal court, Rule 23 of the Federal Rules of Civil Procedure, which generally permits a plaintiff to maintain a class action in federal court if certain preconditions are met, pre-empts a New York statute (N.Y. Civ. Prac. Law Ann. ' 901(b)) that prohibits a plaintiff from maintaining a class action suit seeking statutory penalties. In a 5-4 decision, the Court held that Rule 23 pre-empts the New York statute and permits the plaintiff to maintain a class action suit in federal court seeking statutory penalties, even though the plaintiff could not have maintained the same action in a New York state court.

Nevertheless, the Court could not agree on a single rationale for holding that Rule 23 pre-empted the New York statute, thus leaving an opening for defendants in other cases to distinguish their particular disputes from the New York statute. Another potential outcome is that state legislatures will attempt to amend their laws in order to potentially avoid the ruling in Shady Grove. More specifically, defendants can argue that other state laws are substantive, as opposed to the statute at issue in Shady Grove, which Justice John Paul Stevens (who gave the critical fifth vote in favor of pre-empting the New York statute) deemed to be procedural because it merely served to prohibit the procedural class action device in certain actions. Alternatively, state legislatures can amend existing laws to make them more “substantive” in nature, such as by tying them to particular substantive rights or expressly limiting the remedies available in certain actions, rather than procedurally barring the class action itself. While such arguments or amendments are not certain to withstand pre-emption in federal courts, Shady Grove leaves some room for that possibility.

This article discusses the Court's holding in Shady Grove, its implications for similar laws in other states, and the potential openings for defendants and state legislatures to distinguish other state laws from the New York law at issue in Shady Grove.

Background

The facts in Shady Grove were straightforward. The plaintiff, Shady Grove Orthopedic Associates, provided medical care to Sonia Galvez after a car accident. Allstate insured Galvez and paid Shady Grove, but not within the 30-day deadline required by New York law. Allstate nevertheless refused to pay Shady Grove the statutory interest that accrued on the overdue payments under New York law. Shady Grove sued Allstate in the U.S. District Court for the Eastern District of New York to recover statutory interest on behalf of itself and a class of all others to whom Allstate owed statutory interest on similar overdue payments.

The district court dismissed Shady Grove's lawsuit for lack of jurisdiction because the value of Shady Grove's individual claim was below the amount in controversy required to maintain a diversity lawsuit. Further, the court reasoned that New York law, ' 901(b), prohibited Shady Grove from maintaining a class action against Allstate for statutory interest. Shady Grove appealed, arguing that the class certification provisions of Rule 23 pre-empted ' 901(b) and permitted it to maintain its lawsuit as a class action. The Second Circuit disagreed, holding that ' 901 applied to bar Shady Grove from maintaining a class action for statutory interest in federal court.

With a 5-4 vote, the Supreme Court reversed the Second Circuit's decision and held that Rule 23 permitted Shady Grove to maintain a class action for statutory interest, notwithstanding ' 901. In that regard, the majority agreed that Rule 23 and ' 901 were in direct conflict because Rule 23 permitted a plaintiff to maintain a class action if certain preconditions were met, but ' 901 prohibited the maintenance of such an action for statutory penalties even if Rule 23's preconditions were met. The majority further agreed that Rule 23 controlled because it complied with the Rules Enabling Act, 28 U.S.C. ' 2072, which authorizes the Court to set procedural rules in federal courts.

The majority could not, however, agree upon a single rationale as to why Rule 23 complies with the Rules Enabling Act. On one hand, Justice Antonin Scalia, joined by Chief Justice John G. Roberts, Jr. and Justices Clarence Thomas and Sonia Sotomayor, focused on Rule 23 itself and concluded that Rule 23 complies with the Rules Enabling Act because it regulates procedure, i.e., “the judicial process for enforcing rights and duties recognized by substantive law.” Justice John Paul Stevens, on the other hand, focused on ' 901 and concluded that Rule 23 complies with the Rules Enabling Act because ' 901 regulated procedure and, therefore, Rule 23 did not “abridge, enlarge, or modify any substantive right” under New York law. Thus, Justices Scalia and Stevens differed with respect to whether the Court should focus its attention on the procedural or substantive nature of Rule 23 or the conflicting state law to determine whether Rule 23 complies with the Rules Enabling Act. The four dissenting justices, led by Justice Ruth Bader Ginsburg, concluded that ' 901 did not conflict with Rule 23 because ' 901 only limited the remedies that a plaintiff could recover in a class action under New York law, rather than setting forth the preconditions for the maintenance of such an action in federal court, which is the province of Rule 23. Thus, Justice Ginsburg opined that federal courts must apply ' 901 in state law diversity actions under the Rules of Decision Act, 28 U.S.C. ' 1652 and Erie R. Co. v. Tompkins , 304 U.S. 64 (1938).

Justice Scalia's Approach

The first step in Justice Scalia's analysis was to determine whether Rule 23 governed the dispute before the Court. As he typically does, Justice Scalia utilized a plain language approach in determining whether Shady Grove's class action suit could proceed, noting that “Rule 23 unambiguously authorizes any plaintiff, in any federal civil proceeding, to maintain a class action if the Rule's prerequisites are met.” Shady Grove Orthopedic Associates P.A., 130 S.Ct. at 1442. Given the plain language of Rule 23, Justice Scalia wrote that the Court could not contort the text of the Rule even to avert a collision with a state law that might be pre-empted by the Rule.

Since Rule 23 governed the dispute, Justice Scalia next analyzed whether the Rule fell within the statutory authorization set forth by the Rules Enabling Act, 28 U.S.C. ' 2072(b), which holds that a federal rule applies when it conflicts with a state law on the same issue as long as the federal rule does not “abridge, enlarge or modify any substantive right.” Id. See also Hanna v. Plumber , 380 U.S. 460, 469 (1965). In that regard, Justice Scalia opined that, under the Court's precedent, the guiding light for the validity of a federal rule is whether the rule itself regulates procedure as opposed to whether the state law at issue regulates procedure. Justice Scalia disagreed with Allstate's argument that ' 901(b) involved a substantive right and argued that it is not the substantive or procedural nature or purpose of the affected state law that matters, but the substantive or procedural nature of the federal rule that must be addressed.

Notably, Justice Scalia acknowledged that the Court's precedent, which focused its attention on the federal rule rather than the conflicting state law, did not entirely square with the text of the Rules Enabling Act. Nevertheless, Justice Scalia opined that the Court should apply “settled law” in considering whether Rule 23 complied with the Rules Enabling Act and focus on whether Rule 23 itself regulated procedure, rather than considering whether ' 901(b) was substantive. Applying this framework to Rule 23, Justice Scalia found that it only altered how claims were processed and did not alter the rights themselves, the available remedies, or the rules of decision by which the Court adjudicated either. Accordingly, Justice Scalia opined that the New York law was pre-empted by Rule 23 and Shady Grove's lawsuit could proceed as a class action.

Justice Stevens' Approach

Writing only for himself, but nevertheless adding the critical fifth vote necessary to overrule the Second Circuit, Justice Stevens concurred with Justice Scalia in holding that Rule 23 pre-empted the New York state law regulating class action lawsuits. Critically, however, Justice Stevens adopted a different rationale to support his conclusion.

Like Scalia, Justice Stevens began his analysis by finding that Rule 23 was “sufficiently broad” to “control the issue” before the Court, “thereby leaving no room for the operation of seemingly conflicting state law.” Shady Grove Orthopedic Associates P.A., 130 S. Ct. at 1452. Although Justice Stevens ultimately agreed with Justice Scalia that Rule 23 pre-empted ' 901(b), he diverged significantly from Scalia as to whether federal Rule 23 would always trump a state law in a diversity action pending in federal court. According to Stevens, “an application of a federal rule that effectively abridges, enlarges, or modifies a state-created right or remedy” violates the Rules Enabling Act. Id. at 1454. Thus, in contrast to Justice Scalia's approach, Justice Stevens focused on whether the state law at issue, as opposed to the federal rule, regulates procedure. The vital determination, according to Justice Stevens, is whether the law actually is part of the state's framework of substantive rights or remedies. In some situations, procedure and substance become so interwoven that “rational separation becomes well-nigh impossible.” Id. at 1450 ( citing Cohen v. Beneficial Industrial Loan Corp. , 337 U.S. 541, 559, 69 S.Ct. 1221 (1949)). Justice Stevens stressed that there are some state procedural rules that federal courts must apply in diversity lawsuits because those rules are essentially part of the state's definition of substantive rights and remedies.

Although Justice Stevens' opinion reflects a strong respect for state sovereignty and the power of the states to define their own rights and remedies, he noted that the “bar for finding an Enabling Act problem is a high one” and to find such a problem there must be little doubt that the federal rule at issue would alter a state-created right. In Shady Grove, Justice Stevens ultimately found that ' 901(b) only regulated whether certain actions could proceed as class actions and did not abridge, enlarge, or modify any state substantive rights or remedies. Therefore, in the end, Justice Stevens ruled that ' 901(b) was pre-empted by Rule 23 and Shady Grove's lawsuit could proceed as a class action in federal court.

Justice Ginsburg's Dissenting Approach

Justice Ginsburg, joined by Justices Anthony M. Kennedy, Stephen G. Breyer, and Samuel Anthony Alito, Jr., disagreed with the majority's conclusion that ' 901(b) conflicted with Rule 23. Instead, Justice Ginsburg concluded that ' 901(b) governed the remedies that a plaintiff could seek in a class action under New York law, rather than the preconditions for class certification, which is the province of Rule 23. Thus, Justice Ginsburg found that ' 901(b) and Rule 23 did not conflict, and that federal courts were bound to apply the New York statute under the Rules of Decision Act and Erie. In that regard, Justice Ginsburg was particularly troubled by the fact that the majority permitted Shady Grove to “transform a $500 case into a $5,000,000 award, although the State creating the right to recover has proscribed this alchemy.” Id. at 1582. Justice Ginsburg also criticized the majority for disregarding the Erie doctrine, which she characterized as “one of the modern cornerstones of our federalism” and ignoring important state prerogatives underlying ' 901(b) in the process. Id.

Impact of the Shady Grove Ruling

The Shady Grove decision will have a number of far-reaching repercussions. First, there will likely be an increase in the number of class action lawsuits brought in federal court, particularly in states that have enacted laws prohibiting the maintenance of certain class actions in state court. For example, New York's antitrust law, N.Y. Gen. Bus. Law ' 340, and its Consumer Protection Act, N.Y. Gen. Bus. Law ' 349, both allow the recovery of statutory penalties, so an uptick in class action lawsuits based on these laws can be expected. Plaintiffs' lawyers can also be expected to challenge state laws from a number of other jurisdictions outside of New York that also limit class action lawsuits in one fashion or another. At this time, 23 states have laws specifying that certain claims are categorically ineligible for class certification. For example, Pennsylvania law provides that a class action lawsuit may not be brought for violating the Pennsylvania Mortgage Satisfaction Act, 21 Penn. Stat. ' 721-6(d)(3), and the Pennsylvania Plain Language Consumer Contract Act, 73 Penn. Stat. ' 2208(d).

Whether the various state laws regulating class action lawsuits will be pre-empted in federal court under Shady Grove will largely depend on the specifics of the state law at issue. In that regard, the lower federal courts will struggle with the applicable test, given the splintered majority opinion in Shady Grove. Courts will likely view Justice Stevens' approach as determinative, however, since he cast the fifth and deciding vote in favor of holding that Rule 23 pre-empted ' 901(b). Thus, courts will likely analyze whether the state law at issue is procedural, rather than substantive, in nature to determine whether Rule 23 pre-empts the state law. In that regard, defendants must attempt to show that other state laws restricting the availability of class actions are truly “substantive” in nature, rather than “procedural” by proving that such laws are inextricably tied to state substantive rights, much like a statute of limitations. Nevertheless, laws like ' 901(b) that categorically restrict plaintiffs from maintaining class actions will likely be pre-empted after Shady Grove.

Alternatively, state legislatures can amend existing laws in an attempt to avoid conflicts with Rule 23 or to emphasize the substantive nature of statutes prohibiting the prosecution of certain claims as class actions. In that regard, the majority rejected Justice Ginsburg's conclusion that ' 901(b) was merely a limitation on the types of remedies that could be awarded in class action lawsuits, rather than a blanket prohibition against the maintenance of class actions in certain cases. Nevertheless, the majority left open the possibility that state laws that truly limit the available remedies, rather than prohibiting the procedural class action device, might not conflict with Rule 23. Thus, states can amend their laws to make clear that they impose substantive restrictions on the availability of certain remedies in class action lawsuits, rather than prohibiting the maintenance of such lawsuits.

States can also amend their statutes to bolster the argument that they are “substantive” rather than “procedural” by tying them to specific state-created rights, rather than being blanket prohibitions on class actions. Justice Stevens seemed particularly persuaded by the fact that ' 901(b), by its terms, barred the maintenance of a class action for any claim that sought statutory penalties, regardless of whether such a claim was based upon a substantive right created by New York law. This was a key fact that persuaded Justice Stevens to conclude that ' 901(b) was truly a procedural law, rather than a law inextricably tied to any particular substantive right under New York law.

In the meantime, however, defendants can no longer rely on laws like ' 901(b) to protect them from class actions in federal court. Defendants who previously believed that such laws shielded them from class actions will now face hugely increased exposures. As in Shady Grove, lawsuits that would normally lead to an exposure of a few hundred dollars can be transformed into multi-million dollar class action lawsuits in federal court, even if such actions could not be maintained in state courts. As Justice Ginsburg noted, one of the New York legislature's purposes behind enacting ' 901(b) was to avoid “annihilating punishment of the defendant.” 130 S. Ct. at 1464. If federal courts hold that Rule 23 pre-empts state laws across the country that regulate or limit the availability of class action lawsuits, the results that New York and other states have sought to avoid will become the reality for many defendants and their insurance carriers.

Forum shopping by class plaintiffs in federal court is another expected result of the Shady Grove decision as plaintiffs try to side-step state laws regulating class action lawsuits by filing suit in federal court arguing that the state laws are pre-empted by Rule 23. Justice Scalia even recognized that forum shopping would likely result from the Supreme Court's ruling in Shady Grove, but noted that this was “the inevitable (indeed, one might say the intended) result of a uniform system of federal procedure.” Id. at 1448.

Ironically, however, the Shady Grove holding arguably subverts the purpose of the Class Action Fairness Act (“CAFA”) that was recently enacted in 2005 and which lowered the jurisdictional threshold for class actions in federal court, 28 U.S.C. ” 1332(d), 1453, and 1711-1715. When Congress enacted CAFA, one of its main purposes was to allow defendants to remove a class action lawsuit to federal court to avoid state courts noted for being favorable to plaintiffs, ( See Progressive West Ins. Co. v. Preciado , 479 F.3d 1014, 1015-18 (9th Cir. 2007) (noting that the clear purpose of CAFA is to provide class action litigants with access to federal courts). By doing so, Congress certainly did not intend to increase the number of class actions, and many saw the enacting of CAFA as a victory for businesses fighting class action lawsuits. The Shady Grove decision may turn CAFA on its head by rendering federal courts a haven for class action lawsuits that would have been dismissed at the pleading stage if they were filed or remained in state court. With many class action lawsuits now being brought into federal court under CAFA, a conflict exists between a multitude of state laws regulating class action lawsuits and Rule 23. The Shady Grove decision will therefore create more litigation and many follow-up decisions by lower federal courts as to whether Rule 23 pre-empts the state law at issue.

Interesting Alignment

As an interesting aside, the decision in Shady Grove is a confusing and contradictory case for those who believe the justices' political ideologies determine the Court's voting. Chief Justice Roberts and Justices Scalia and Thomas are generally considered to be conservative and very sympathetic to states' rights. Even so, they joined in an opinion that undermined the states' authority to protect businesses from potentially devastating class action lawsuits based upon technical violations of the law. (For example, in Shady Grove, Allstate paid its insured's medical bills, but did not do so within the statutory 30-day deadline. Thus, Allstate was exposed to a claim for approximately $500 in statutory interest. By permitting Shady Grove to sue Allstate on behalf of a class, however, which Shady Grove could not do in state court, the Supreme Court increased Allstate's exposure 10,000-fold, from $500 to $5 million.) In contrast, Justices Ginsburg and Breyer are generally considered to be liberal and sympathetic to federal authority, but they concluded that the New York statute restricting plaintiffs' use of the class action device should apply in federal court proceedings.

Where Do We Go from Here?

With the author of the controlling opinion now retired (Justice Stevens), many commentators are asking how the Supreme Court will address similar pre-emption issues in the future. The deciding vote will now rest with Justice Stevens' replacement, Elena Kagan. Predicting how Justice Kagan will rule if faced with a pre-emption issue in the future is complicated by the fact that she has never previously served as a judge and does not have any prior opinions from which to glean any leanings on this topic. Despite this uncertainty, there is no doubt that it will be easier for plaintiffs to maintain class action lawsuits in federal courts sitting in diversity. Cases that would have never survived a motion to dismiss will now be given life and allowed to proceed as a class action. As a result of the Shady Grove ruling, there will be significantly more challenges to similar state laws as plaintiffs will argue that these laws are pre-empted by Rule 23. The lower courts will now be faced with the challenging task of sorting through these various state laws and determining whether they are truly part of the state's framework of substantive rights or remedies.

Chris Wadley is a partner and Justin Lessner is an associate in the Chicago office of Walker Wilcox Matousek LLP. Wadley's practice is nationwide, litigating matters at both the trial and appellate levels. His cases have involved, among other things, insurance coverage and bad faith lawsuits, business and commercial disputes, and tort litigation. He has also counseled insurance companies on various coverage matters and other business clients on issues pertaining to compliance with federal and state laws and regulations. Lessner handles a wide variety of lawsuits throughout the country, litigating insurance coverage matters, commercial disputes, professional liability claims and tort claims.