Sixth Circuit Blog

SLUSA Provision Authorizing Federal Courts to Stay State Court Discovery to Prevent "Circumvention" of PSLRA Discovery Stay Has No Practical Applications or Effect

The Private Securities Litigation Reform Act of 1995 (PSLRA), at 15 U.S.C. 78u-4(b)(3)(B), provides for a mandatory stay of "all discovery and other proceedings" in private securities actions:

In any private action arising under this chapter, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.

The Securities Litigation Uniform Standards Act of 1998 (SLUSA) added a provision to the PSLRA, at 15 U.S.C. 78u-4(b)(3)(D), entitled "Circumvention of Stay of Discovery" which reads, in its entirety:

Upon a proper showing, a court may stay discovery proceedings in any private action in a State court, as necessary in aid of its jurisdiction, or to protect or effectuate its judgments, in an action subject to a stay of discovery pursuant to this paragraph.

The difficulty arises when two lawsuits are pending at the same time -- one in federal court asserting federal securities claims and another in state court alleging different claims -- against the same defendant arising out of common or related facts or issues.  The defendant may contend that discovery in the state action should also be stayed because permitting discovery on those facts or issues the two cases have in common would "circumvent" the discovery stay in the federal case.

Thus, when a discovery stay is automatically imposed pending resolution of a defendant's motion to dismiss in a federal securities case, the PSLRA also explicitly authorizes the defendant, upon a "proper showing" to the court in that case, to seek an order staying discovery in pending state litigation "as necessary in aid of [the federal court's] jurisdiction, or to protect or effectuate [the federal court's] judgments."

But should this congressional language be construed as broadly as it may appear at first blush?  And if so, does this provision exceed the limits, rooted in the Supreme Court's well-entrenched principles of federalism and comity, on Congress' power to authorize federal courts to intrude so expansively on the prerogatives of state judges?

As the prerequisite for a federal court's exercise of the power to stay discovery in a state court case, SLUSA's circumvention provision adopts in identical language two of the three exceptions to the broad prohibition on enjoining state court proceedings found in the Anti-Injunction Act, 28 U.S.C. 2283.  By so doing, Congress was obviously trying to clothe federal discovery-stay orders in the traditional trappings of permissible federal court interference with state court litigation.

The "protect or effectuate its judgments" language has been interpreted in connection with the identical Anti-Injunction Act provision to authorize a stay or injunction when necessary to promote or effectuate an earlier judgment by a federal court.  It is usually referred to as the "relitigation exception" because it permits federal courts to issue injunction or stay orders only to ensure the preclusive effect of an earlier federal court judgment.  The relitigation exception thus applies only in situations where a state court should not hear a case because of res judicata principles but is proceeding to do so anyway.  Moreover, the exception only applies to federal court judgments on the merits, in which case the merits decision can be upheld by injunction if necessary.  If, on the other hand, the federal court dismissed a case on procedural grounds, or otherwise issued a ruling not on the merits, a state court is free to hear the matter.  See Atlantic Coast Line Railroad v. Brotherhood of Locomotive Engineers, 398 U.S. 281 (1970).

Therefore, this language authorizes federal intrusion in state court litigation only if a judgment on the merits has already been entered in the federal case that is in need of being "protect[ed] or effectuate[d]" by barring relitigation in state court.  But how does this operative context justify resorting to a federal stay of state discovery?  How can discovery in a state court lawsuit ever threaten the primacy or efficacy of a prior federal judgment on the merits?  And when would there even be a prior federal court judgment on the merits while a discovery stay in the federal action is still pending?  It would seem that the basis Congress chose for authorizing a federal stay of state discovery makes its use a logical and practical impossibility.

The second statutory justification for staying discovery requests in separate state court actions is if a stay is "necessary in aid of [the federal court's] jurisdiction.  Once again, the identical term "necessary in aid of jurisdiction" in the Anti-Injunction Act has been narrowly construed.  It applies in only two circumstances:  where a case is removed from state court to federal court, and where a federal court first acquires jurisdiction over a case involving the disposition of real property.

With respect to the first circumstance, if a case is removed from state court to federal court and the state court does not properly relinquish jurisdiction, the federal court may enjoin further state court proceedings.  See Reviser's Note to the 1948 revision to Section 2283 (the purpose of this exception is "to make clear the recognized power of the Federal courts to stay proceedings in State cases removed to the district courts");  Mitchum v. Foster, 407 U.S. 225, 234-37 (1972).  As to the second circumstance, it has long been established that whatever court initially acquires in rem or quasi-in-rem jurisdiction over a matter involving real property can enjoin all other courts from hearing the matter.  In fact, the only instance in which the Supreme Court has authorized the reverse situation, where a state court may enjoin parties from litigating in federal court, is where the state court first acquired jurisdiction over real property.  In other words, the general rule is that whichever court first gains jurisdiction in a case concerning the disposition of real property has exclusive jurisdiction to decide claims to that property and may enforce its jurisdiction with stays or injunctions if necessary.  See Donovan v. City of Dallas, 377 U.S. 408, 412 (1964);  Princess Lida v. Thompson, 305 U.S. 456, 465-68 (1939).  The Supreme Court has been firm in ruling that the "in aid of jurisdiction" exception applies only in real property situations and not in in-personam cases.  Atlantic Coast Line Railroad v. Brotherhood of Locomotive Engineers, 398 U.S. 281, 295-96 (1970) ("the state and federal courts had concurrent jurisdiction . . . and neither court was free to prevent either party from simultaneously pursuing claims in both courts . . .  Therefore the state court's assumption of jurisdiction . . . did not hinder the federal court's jurisdiction so as to make an injunction necessary to aid that jurisdiction").

There are few if any conceivable respects in which staying discovery requests in state litigation would be necessary to aid a federal district court in exercising or maintaining its jurisdiction over a federal securities action, especially in the limited sense in which the term-of-art has been consistently interpreted for decades by authoritative Supreme Court decisions.

Moreover, in the context of discovery in multiple federal court cases (which avoids to added complication of federal-state federalism and comity concerns), federal courts have allowed discovery to proceed notwithstanding the PSLRA automatic stay regarding non-securities claims pending between the same parties in separate actions in the same court, or even in the same action.  For example, in In re FirstEnergy Shareholder Derivative Litigation, 219 F.R.D. 584 (N.D. Ohio 2004), the court observed that "[t]he PSLRA, by its terms, is limited to actions filed under the federal securities laws and does not apply outside this context."  The court specifically held that even though "the securities fraud claims [in one case] and the shareholder derivative claims [in other cases] include similar facts, this is insufficient to bring the state law derivative claims within the ambit of [the discovery stay of] the PSLRA. . . .  These claims fall outside the PSLRA's discovery stay."

Another district court has also rejected this same argument that Congress intended a PSLRA stay also to stay discovery in related litigation involving the same or similar parties.  In Tobias Holdings, Inc. v. Bank United Corp., 177 F. Supp.2d 162, 167 (S.D.N.Y. 2001), the court found no congressional intent to prevent discovery in non-securities-fraud cases simply because the cases share facts in common with securities fraud cases.  In that case the non-securities-fraud claims were combined with federal securities claims in the one action, and the court held that "permitting discovery [in connection with the state law claims] to proceed here would not represent an impermissible 'end run' around the PSLRA's automatic stay provisions."

The federal stay of state court discovery permitted by 15 U.S.C. 78u-4(b)(3)(D) requires an application and "proper showing" to the federal court.  Based on the statutory language requiring a stay to be "necessary in aid of [the federal court's] jurisdiction" or needed "to protect or effectuate its judgments," It would seem that there are few circumstances in which a party could make such a showing that it was entitled to a stay of otherwise proper state court discovery merely because of the pendency of a discovery stay in the related federal securities litigation.

Emerging Standards for Production of Electronically Stored Information

Although not strictly a matter of appellate law, there has been substantial controversy over the manner in which electronically-stored information (ESI) must be produced in discovery.  Requesting parties generally seek the production of ESI in native format with all metadata intact.  Metadata, described as "data about data," includes information embedded in an electronic document or file describing inter alia its creation, revision history, tracking and management that is generally not visible or retrievable when an electronic document is printed or converted to an image file.  Responding parties usually prefer to produce ESI in one of the static-image formats, PDF (portable document format) or TIFF (tagged image file format), so that the information is not electronically usable or searchable.  Which format is the correct one?  The December 1, 2006 amendments to the Federal Rules of Civil Procedure were designed to avoid or greatly reduce this controversy, but have achieved mixed results thus far.

Amended Fed.R.Civ.P. 34(b) provides in pertinent part:

The request [for production of documents] may specify the form or forms in which [ESI] is to be produced. . . .  If objection is made to the requested form or forms for producing [ESI] -- or if no form was specified in the request -- the responding party must state the form or forms it intends to use.

Unless the parties otherwise agree, or the court otherwise orders:  *    *    *

(ii)  if a request does not specify the form or forms for producing [ESI], a responding party must produce the information in a form or forms in which it is ordinarily maintained or in a form or forms that are reasonably usable;  and

(iii)  a party need not produce the same [ESI] in more than one form.

Thus, amended Rule 34(b) gives the requesting party the right and power to specify the form in which ESI is to be produced.  In the absence of such specification, the default position of Rule 34(b)(ii) is that ESI is to be produced in the form in which it is maintained and used in the ordinary course of business or some other form that is "reasonably usable."

In state court litigation, the Conference of Chief Justices approved and adopted on August 2, 2006, the Guidelines for State Trial Courts Regarding Discovery of Electronically Stored Information as a reference tool for state trial court judges facing e-discovery issues.  The Guidelines are available on the website of the National Center for State Courts.  Guideline 6, entitled "Form of Production," is based on FRCP 34(b)(ii) and (iii):

In the absence of agreement among the parties, a judge should ordinarily require [ESI] to be produced in no more than one format and should select the form of production in which the information is ordinarily maintained or in a form that is reasonably usable.

The principal difference between Amended Rule 34(b)(ii) and Guideline 6 is that, under the Federal Rule, a party may specify the form in which ESI is to be produced, whereas under the Guidelines, specifically Guideline 3(B)(7), the form of production "preferred" by the requesting party is merely one factor the judge should consider and take into account.

On August 3, 2007, the National Conference of Commissioners on Uniform State Laws approved and adopted Uniform Rules Relating to Discovery of Electronically Stored Information.  Rule 7 entitled "Form of Production" tracks the language of amended Rule 34(b), including allowing the requesting party to specify the form in which ESI is to be produced.  See Rule 7(a).  If a request for production does not specify a form for producing the ESI, "the responding party shall produce the ESI in a form in which it is ordinarily maintained or in a form that is reasonably usable."  Rule 7(c)(1).

The influential Delaware federal court Default Standards for Discovery of Electronic Documents similarly provides:

if a request for ESI does not specify the form of production, a responding party must produce the information in the form in which it is ordinarily maintained, or in an electronically-searchable form . . .

There are two common threads running through all these authorities:

(1)  three out of the four sets of rules cited above, including the Federal Rules of Civil Procedure, allow the requesting party to specify the form in which ESI is to be produced.  This means that a requesting party may specify that ESI is be produced in its native format (another way of saying the form in which it ordinarily maintained) with metadata intact.  This appears to be the requesting party's absolute right under these rules.  If the responding party has any objection, its bears the burden of demonstrating to the court why production in the specified form is objectionable.

(2)  even if the requesting party does not specify the form of production, the default standard is that the responding party must produce ESI in the form in which it is ordinarily maintained or in a form that is reasonably usable.  ESI kept in the ordinary course means in its native format, obviously -- the form in which it is used during the course of ordinary business.  That does not mean a PDF or TIFF image of a document.  Furthermore, a static image of a document, whether in TIFF or PDF format, is not a "reasonably usable" form.  Indeed, that is the whole point of those two formats, to make them not electronically usable by the recipient.  Neither are TIFF or PDF files "electronically-searchable."

Responding parties typically refer to two decisions, Pace v. International Mill Service, Inc., 2007 WL 1385385 (N.D. Ind. 5-7-2007), and Wyeth v. Impax Laboratories, Inc., 2006 WL 3091331 (D. Del. 10-26-2006), as authority for the proposition that static-image files of electronic documents constitute legally-sufficient production.

Pace was decided after amended Rule 34(b) took effect but, since the conduct at issue occurred prior to the amendment, "the court addresse[d] the motion [to compel] in terms of the rule's prior version."  The court in Pace cited another pre-amendment case, Williams v. Sprint/United Management Co., 230 F.R.D. 640 (D. Kan. 2005), for its statement that, "[a]bsent a special request for metadata," a production of documents in PDF or TIFF images "complies with the ordinary meaning of [pre-amendment] Rule 34."  The court then denied the motion to compel "[b]ecause [the requesting party] has not shown that he made a request that called for any specific format."

Wyeth also predates the ESI amendments to the Federal Rules and relies on the pre-amendment version of the Delaware Default Standards.  It selectively quotes from the Williams v. Sprint decision, denying the motion to compel because the requesting party "has not demonstrated a particularized need for the metadata . . . it has requested."

It is important to carefully examine Williams v. Sprint, the pre-amendment decision on which both Pace and Wyeth expressly rely.  Magistrate Judge Waxe based his decision in Williams on the then-current version of Rule 34 and on Principle 12 and Comment 12.a of the Sedona Principles for Electronic Document Production (July 2005).  230 F.R.D. at 648, 650-52.  Sedona Principle 12 states that "[u]nless it is material to resolving the dispute, there is no obligation to preserve and produce metadata absent agreement of the parties or order of the court."  Comment 12.a provides that "there should be a modest legal presumption in most cases that the producing party need not take special efforts to preserve or produce metadata."  Finding the Sedona Principles and comments to be "particularly instructive," the Court in Williams noted that "emerging standards of electronic discovery appear to articulate a general presumption against the production of metadata" unless it is "relevant to the dispute."  Id. at 652.  This is the part of the Williams decision that Pace and Impax Laboratories quoted and referred to.

However, what Williams actually held was very different:

Based on these emerging standards, the Court holds that when a party is ordered to produce electronic documents as they are maintained in the ordinary course of business [or as an "active file" or in their "native format"], [or when a party requests ESI be produced as they are maintained in the "ordinary course of business," as an "active file," or in their "native format,"] the producing party should produce the electronic documents with their metadata intact, unless that party timely objects to the production of metadata, the parties agree that the metadata should not be produced, or the producing party requests a protective order.  The initial burden with regard to the disclosure of the metadata would therefore be placed on the party to whom the request or order to produce is directed.  . . .  Placing the burden on the producing party is further supported by the fact that metadata is an inherent part of an electronic document, and its removal ordinarily requires an affirmative act by the producing party that alters the electronic document.

Id. (footnotes omitted)(emphasis in original).  Thus, Williams fully supports the proposition that production of ESI as maintained in the ordinary course of business, which amended Rule 34(b) requires in the absence of any request for a specified format, means producing ESI in native format with metadata intact.

Parenthetically, the draft commentary to the Guidelines established by the Conference of Chief Justices specifies that the Guidelines deliberately rejected the Sedona Principles' rebuttable presumption against the production of metadata.  Instead, the Guidelines assume that ESI in the standard format in which it is ordinarily maintained must necessarily be "reasonably usable" or else it would not be kept that way in the first place.

I have found four other federal court decisions bearing on a responding party's obligation to produce ESI in native format with metadata intact when specifically requested:

1.   Most recently, on June 12, 2007, the Southern District of Ohio (i) observed that under amended FRCP 34(b) a party may specify the form in which ESI is to be produced, (ii) noted that the responding party contended its production was proper because the request for production of documents made no such specification, and (iii) denied the motion to compel without prejudice and ordered the parties to meet and confer to resolve the dispute.  Scotts Co. LLC v. Liberty Mut. Ins. Co., 2007 WL 1723509 (S.D. Ohio 6-12-2007).

2.   In Lorraine v. Markel American Ins. Co., 241 F.R.D. 534 (D. Md. 5-4-2007), a case involving the authentication of ESI for summary judgment purposes, Chief Magistrate Judge Grimm noted that recently-revised Rule 34(b) permits a party "to identify the form or forms in which it is to be produced.  A party therefore can request production of ESI in its 'native format' which includes the metadata for the electronic document."  The court went on to hold that metadata is a distinctive characteristic of all electronic evidence that will properly authenticate ESI under Rule 901(b)(4) of the Federal Rules of Evidence.

3.   In Nova Measuring Instruments Ltd. v. Nanometrics, Inc., 417 F. Supp.2d 1121 (N.D. Cal. 2006), the court granted a motion to compel and ordered ESI to be produced "in their native file format, with original metadata" over the defendant's objection.

4.   In In re Verisign Inc. Sec. Litig., 2004 WL 1445243 (N.D. Cal. 3-10-2004), the responding party objected to a discovery order entered by the magistrate judge to produce responsive documents that specified that "[p]roduction of TIFF version alone is not sufficient" and that "[t]he electronic version must include metadata as well as be searchable."  The district judge overruled the objections and found that the order directing defendants to produce responsive electronic documents in their native format including metadata was not clearly erroneous or contrary to law, even based on the pre-amendment version of Rule 34.  The district court also rejected defendants' arguments that production of ESI in its original format (e.g., PST format for e-mails) would be overly burdensome, prejudicial, extremely time consuming and expensive.

Based on all these authorities, it is clear the emerging standard for the discovery of ESI is that production should be in the format specifically requested or, absent a specific request, in the form in which the ESI is maintained and used in the ordinary course of business.

I would welcome hearing from readers about other case decisions bearing on this developing topic.

On Rehearing En Banc, Sixth Circuit Affirms Panel Decision and Dismisses Removed Case for Want of Substantial Federal Question Under Grable Doctrine

A rare event.  An uncommon or unusual occurrence.  Isolated.  Extraordinary.  Virtually unheard of.  Once in a blue moon.

All of these terms accurately describe the Sixth Circuit's en banc decision filed on August 21 in Mikulski v. Centerior Energy Corp., et al., Case No. 03-4486.  The Court held by an 8-5 majority (Judge Cook was recused) that state law claims for fraudulent tax accounting and breach of contract that turn on the interpretation of a provision of the Internal Revenue Code do not state a "substantial federal question" supporting the exercise of federal removal jurisdiction under the Grable doctrine despite the presence of the embedded federal issue.  In so doing, the en banc Court affirmed the decision of a divided panel, 435 F.3d 666 (6th Cir. Jan. 26, 2006), rehearing en banc granted, opinion vacated Apr. 26, 2006.

In the absence of diversity, a civil action filed in state court may be removed to federal court only if the claim is one "arising under" federal law.  Beneficial National Bank v. Anderson, 539 U.S. 1 (2003), citing 28 U.S.C. 1441(b).  Whether a claim arises under federal law must be determined by applying the "well-pleaded complaint" rule.  Caterpillar Inc. v. Williams, 482 U.S. 386, 392 (1987).  Thus, a claim "arises under" federal law for jurisdictional purposes only if the plaintiff's statement of his own cause of action on the face of his properly-pleaded complaint affirmatively shows that it is based upon federal law.  Beneficial National Bank, 539 U.S. at 7;  Caterpillar, supra.  However, the "substantial federal question" doctrine is a recognized exception to the well-pleaded complaint rule.  It deals with the thorny issue of whether federal "arising under" jurisdiction attaches to state law claims that raise accompanying questions of federal law.

In its recent comprehensive treatment of the substantial federal question doctrine, Grable & Sons Metal Products v. Darue Engineering, 545 U.S. 308 (2005), the Supreme Court reaffirmed the principle that a state-law claim for relief which "necessarily raise[s] a stated federal issue" will confer federal-question jurisdiction (originally under 28 U.S.C. 1331 or on removal pursuant to 28 U.S.C. 1441) only where the federal issue is "actually disputed and substantial" and only where a federal forum may entertain it "without disturbing any congressionally-approved balance of federal and state judicial responsibilities."  Thus, even where a state action contains a contested and substantial federal question, "the presence of a disputed federal issue and the ostensible importance of a federal forum are never necessarily dispositive."  Instead, federal jurisdiction should be exercised "only if [it] is consistent with congressional judgment about the sound division of labor between state and federal courts governing the application of section 1331."  But no federal jurisdiction exists, even if the disputed issue of federal law is deemed to be "substantial," where its exercise would "herald[] a potentially enormous shift of traditionally state cases into federal courts."

Grable sets forth a three-part conjunctive test for removal jurisdiction based on the presence of a federal issue in state-law claims for relief.  A state-law claim can give rise to federal question jurisdiction only if:

1.  the "state-law claim necessarily raise[s] a stated federal issue";

2.  the federal issue must be "actually disputed and substantial";  and

3.  the exercise of federal jurisdiction would not "disturb[] any congressionally-approved balance of federal and state judicial responsibilities" nor herald a "shift of traditionally state cases into federal courts."

Grable, 545 U.S. at 314, 319.  Even before Grable, the Sixth Circuit had consistently held that federal questions raised by state law claims must be substantial to support federal removal jurisdiction.  In the immediate aftermath of the Supreme Court's decision in Merrill Dow Pharmaceuticals, Inc. v. Thompson, 478 U.S. 804 (1986), the Sixth Circuit held in Miller v. Norfolk & W. Ry. Co., 834 F.2d 556, 562 (6th Cir. 1987), that the alleged violation of "a federal statute as an element of a state cause of action may or may not raise a substantial federal question depending upon the nature of the federal interest at stake in the case."  In order to support jurisdiction, the "federal interest at stake" must have "great significance."  More recently, in order to confer jurisdiction, the Sixth Circuit required the federal question raised by a state law complaint to be "substantial, disputed and of great federal interest," and the resolution of such federal question to be "necessary" to the resolution of the state law claim.  Long v. Bando Mfg. of America, Inc., 201 F.3d 754, 757-59 (6th Cir. 2000).

Thus, in accordance with the reasoning of Miller and Long v. Bando, "the mere presence of a federal statute as an element of the complaint does not necessarily confer jurisdiction under the [substantial federal question] doctrine."  Mikulski v. Centerior Energy Corp., 435 F.3d 666, 676 (6th Cir. 2006)(panel decision vacated by grant of rehearing en banc), citing Long v. Bando and Miller.

The Supreme Court similarly emphasized in Grable the "commonsense notion that a federal court ought to be able to hear claims recognized under state law that nonetheless turn on substantial questions of federal law," because doing so justifies "resort to the experience, solicitude, and hope of uniformity that a federal forum offers on federal issues."  545 U.S. at 312.  This does not mean, however, that the "mere need to apply federal law in a state-law claim will suffice to open the 'arising under' door."  Id. at 313, discussing and limiting Smith v. Kansas City Title & Trust Co., 255 U.S. 180, 199 (1921).  The question whether to exercise federal-question jurisdiction over a state-law action raising an embedded federal issue "calls for a 'common-sense accommodation of judgment to [the] kaleidoscopic situations'" in which such federal issues can be presented -- which the Court described as "'a selective process which picks the substantial causes out of the web and lays the other ones aside.'"  Id., quoting Gully v. First National Bank in Meridian, 299 U.S. 109, 117-18 (1936).

Thus, the Supreme Court refuses to "treat[] 'federal issue' as a password opening federal courts to any state action embracing a point of federal law."  545 U.S. at 314.  Instead, "federal jurisdiction demands not only a contested federal issue, but a substantial one, indicating a serious federal interest in claiming the advantages thought to be inherent in a federal forum."  Id. at 313, citing Chicago v. International College of Surgeons, 522 U.S. 156, 164 (1997);  Merrill Dow, supra, 478 U.S. at 814 & n.12;  Franchise Tax Bd. of Calif. v. Construction Laborers Vacation Trust, 463 U.S. 1, 28 (1983).

Moreover, the Court in Grable explicitly held that "the presence of a disputed federal issue and the ostensible importance of a federal forum are never necessarily dispositive" of federal jurisdiction.  There must always be an assessment of whether exercising federal jurisdiction in a case would upset the federal-state line drawn or assumed by Congress.  This is so because "the appropriateness of a federal forum to hear an embedded issue can be evaluated only after considering the 'welter of issues regarding the interrelation of federal and state authority and the proper management of the federal judicial system.'"  545 U.S. at 314, quoting Franchise Tax Board, supra, 463 U.S. at 8.

Therefore, even if an embedded federal issue in a state-law claim for relief were deemed to constitute a "substantial" federal question under the Grable test, it qualifies for a federal forum "only if federal jurisdiction is consistent with congressional judgment about the sound division of labor between state and federal courts governing the application of section 1331."  Id. at 313-14.

Less than a month after the January 2006 panel decision in Mikulski, the Sixth Circuit again applied the Grable factors to hold that federal removal jurisdiction did not exist over a state-law retaliatory discharge claim alleging that the plaintiff's discharge violated public policies based on federal statutes.  In Eastman v. Marine Mechanical Corp., 438 F.3d 544, 552 (6th Cir. 2006), the Court cited the fact that Congress had withheld a private right of action from the federal statutes identified in the plaintiff's complaint "as an important signal to its view of the substantiality of the federal question involved."  The Court concluded that the reference to federal statutes in the complaint did not create a substantial federal question.  Id. at 553.  Even more importantly, the Sixth Circuit in Eastman found that accepting jurisdiction over the state-law employment suit "would be disruptive of the sound division of labor between state and federal courts envisioned by Congress."  In contrast to Grable where the Court saw little danger in accepting jurisdiction because it would "portend only a microscopic effect on the federal-state division of labor" (545 U.S. at 315), the Sixth Circuit concluded that accepting jurisdiction "would distort the division of judicial labor assumed by Congress under section 1331."  Id., quoting Grable.

A year after Grable, the Supreme Court confirmed in Empire HealthChoice Assurance, Inc. v. McVeigh, 547 U.S. __, 126 S.Ct. 2121, 2136-37 (2006), that the Grable doctrine had created only a "special and small category" of federal jurisdiction.  The Court sharply distinguished McVeigh from Grable -- "[t]his case is poles apart from Grable" -- and dramatically limited the scope and application of Grable's holding and rationale.  In contrast to Grable, which centered on whether the actions of a federal agency (the IRS) had violated a federal statute (section 6335 of the Internal Revenue Code), and presented a nearly "pure issue of law" the resolution of which would be both dispositive of that case and controlling in numerous other tax sale cases, Empire's state-law reimbursement claim arose from the actions of private litigants in a state court forum rather than from the acts of any federal agency, service or department, and were "fact-bound and situation-specific."  The Court in McVeigh did not think "a proper 'federal-state balance' would place [the state-law issue] under the complete governance of federal law, to be declared in a federal forum."  It held that "[t]he state court in which the [tort] suit was lodged is competent to apply federal law . . . and would seem best positioned to determine" the state law issues arising out of the state tort action.  Although the Court recognized that the Government had a legitimate interest in protecting the federal workforce, it concluded that those interests did not warrant turning a straightforward state law contract claim into a costly "federal case."  The Court in McVeigh summed up its holding and the proper interpretation and application of Grable as follows:

Grable emphasized that it takes more than a federal element "to open the 'arising under' door."  This case cannot be squeezed into the slim category Grable exemplifies.

126 S.Ct. at 2137.

The sole federal issue in Mikulski -- whether FirstEnergy Corp. violated the effective date provision of Section 312(n)(1) of the Internal Revenue Code -- arises from the company's alleged false reporting to its shareholders that they had received taxable dividends when, in fact, the shareholders had merely received the tax-free return of their own capital.  The complaint in Mikulski alleges that FirstEnergy's predecessor and its two electric-utility subsidiaries employed fraudulent tax accounting practices to manipulate their corporate "earnings and profits" in order to make the companies look more profitable than they really were.  As a result, the complaint accuses FirstEnergy of misinforming its shareholders that they had received more taxable dividend income than they actually had.  The measure of the alleged damages is the amount by which the shareholders overpaid their federal and state income taxes for the years in question.

As of December 31, 1984, FirstEnergy's subsidiaries had spent over $1.5 billion on "construction in progress" -- i.e., construction costs for nuclear power plants and other facilities begun during the preceding decade but still unfinished.  Beginning with the 1985 tax year, corporations were required by Section 312(n)(1) of the Internal Revenue Code to capitalize their "construction period" interest expenses -- i.e., to include in the corporation's "earnings and profits" the amount of interest expense that could have been avoided if the amount spent on "construction in progress" after the effective date of Section 312(n)(1) had instead been used to reduce debt and avoid paying interest.

FirstEnergy included in its "earnings and profits" for 1985 and subsequent years the amount of interest expense (approximately $150 million per year) that it could have avoided if the $1.5 billion spent on "construction in progress" in 1984 and prior years had instead been spent on reducing its debt.  Section 61(e)(1)(A) of Pub. L. 98-369 (1984) provides that the requirements of Section 312(n)(1) apply to "amounts paid or incurred in taxable years beginning after September 30, 1984."  This effective date provision means that no construction expenses incurred before January 1, 1985 could be capitalized or considered in calculating a corporation's "earnings and profits."  FirstEnergy's alleged violation of the effective date of Section 312(n)(1) is the only federal issue involved in the state law claims for fraud and breach of contract alleged in the complaint.

Interestingly, Section 312(n)(1) does not apply to corporate "earnings and profits" calculations for years after 1986 because Section 263A of the Internal Revenue Code, enacted as part of the Tax Reform Act of 1986, requires the capitalization of interest expense to arrive at taxable income, eliminating the necessity of adjusting "earnings and profits" by the amount of avoided construction-period interest under Section 312(n)(1) for expenses incurred in years after 1986.  If costs are required to be capitalized under another Code provision, Section 312(n)(1) is not applicable.  Von Lusk v. C.I.R., 104 T.C. 207, 220 (1995).

Considering the first component of the tripartite Grable test, the Court in Mikulski had "little difficulty in concluding that there is a federal issue and it is actually disputed."  The second part, the substantiality of the federal interest, required a somewhat lengthier analysis.  The Sixth Circuit identified four aspects affecting the substantiality of a federal interest or issue raised by state-law claims for relief:  (i) "whether the case includes a federal agency, and particularly whether that agency's compliance with [a] federal statute is in dispute, (ii) whether the federal question is important (i.e., not trivial), (iii) whether a decision on the federal question will resolve the case (i.e., the federal question is not merely incidental to the outcome, and (iv) whether a decision as to the federal question will control numerous other cases (i.e., the issue is not anomalous or isolated)."  (Slip op. at 12, citing Grable, 545 U.S. at 313, and McVeigh, 126 S.Ct. at 2137.)  After analyzing each of the four factors separately and then considering them in the aggregate, and "acknowledging two unassailable truths -- (1) that state courts are fully competent to decide this question, and (2) that section 312(n)(1) does not control the collection of the plaintiffs' personal income taxes directly," the Court held that the federal interest in the issues presented were not so substantial as to compel or support a finding that the "traditional" state-law fraud and breach of contract claims alleged in this case actually "arise under" federal law, at least not without some express congressional determination to that effect.  (Id. at 14.)  Even a significant federal interest is not automatically "substantial" in the jurisdictional sense as defined by prevailing Supreme Court precedent.  As the Court concluded:  "If a case could be deemed to 'arise under' federal law . . . any time the litigation involves the interpretation of a provision in the federal tax code, then [prior Supreme Court] precedents -- particularly Grable -- would be meaningless . . ."  Neither Congress nor the Supreme Court "intended such an expansive or limitless view of federal jurisdiction."  (Id. at 15.)

Addressing the third and final Grable element, the Sixth Circuit found that "the exercise of jurisdiction over this type of lawsuit would impermissibly disrupt the congressionally-approved balance of federal and state judicial responsibilities."  (Id.)  But the Court sounded a cautionary note on resort to a "floodgates" argument:  "While we ultimately conclude that the possibility of encumbering the federal courts with these tax-code-related cases appears both real and significant . . . , we are at pains to avoid overstating our position.  We eschew predictions of any extreme outcome that may lurk in such phrases as 'flood of litigation' or 'overwhelm the federal courts,' and we have not succumbed to some eschatological trembling."  (Id.)

Biblical references aside, the Court concluded that if it "allow[ed] the present dispute over a relatively obscure provision of the tax code to be pursued in federal court," it would "extend federal jurisdiction not only to the question raised in this case, but to any dispute over the meaning or effect of virtually any provision in the entire federal tax code."  (Id.)  Finding a substantial federal question in this case "would open the door of the federal courts to significantly more than the solitary case asserting a constitutional challenge, as in Smith [v. Kansas City Title & Trust Co., supra], or the 'microscopic effect' portended by the quiet title action in Grable. . .  [E]ven if the actual number of cases proved not to be overwhelming, or even uncomfortably burdensome, it appears unlikely that Congress -- through its silence -- intended to open the federal court door quite so wide."  (Id. at 16.)

On en banc review, the Sixth Circuit upheld by a 13-0 vote the unanimous panel decision that (i) Section 7422 of the Internal Revenue Code does not preempt the plaintiffs' state law claims for fraudulent misrepresentation and breach of contract, and (ii) that the district court erred in concluding that plaintiffs' claims were completely preempted by federal law.  Section 7422(a)  precludes a suit for recovery of a federal tax alleged to be erroneously or illegally assessed or wrongfully collected unless a tax refund claim is filed with the IRS.  It provides taxpayers with the means to obtain relief from improper collections by federal tax collectors while also protecting government collection officials from being sued by taxpayers.  Although the so-called airline  passenger excise tax cases applied the protections of Section 7422 to airlines that act as tax-collection agents for the IRS by collecting excise taxes from the sale of airplane tickets, "that expansive application does not extend to the present case because [FirstEnergy] did not collect or withhold any taxes," nor was it "acting as a collection agent for or on behalf of the IRS."  (Id. at 8.)

Furthermore, the Sixth Circuit explicitly recognized that the "mere fact that the plaintiffs' damages are calculated in terms of overpaid income taxes does not necessitate the conclusion that the plaintiffs' claim must actually be one for a federal income tax refund. . . .  This is especially so for the claim of state income taxes -- the plaintiffs' alleged overpayment of state income taxes obviously does not assert a federal income tax refund claim.  Perhaps more to the point, however is that the plaintiffs are not seeking a tax refund inasmuch as they are not accusing the IRS of any wrongdoing.  Under the plaintiffs' theory, the IRS was an innocent third-party who, like the plaintiffs themselves, merely relied on the 1099-DIVs issued by [FirstEnergy]."  (Id., emphases in original.)

The district court ruled that the plaintiffs' state-law claims were completely preempted by the Internal Revenue Code.  The doctrine of complete preemption applies where Congress intends the preemptive force of a federal statute to be so extraordinarily great that any state-law claim touching on the same field is deemed to be a federal claim arising under that federal law; in such circumstances, the federal statute provide the exclusive cause of action and the state-law claim is extinguished.  See, e.g., Caterpillar, supra, 482 U.S. at 393.  The Supreme Court has found complete preemption in only three classes of cases -- under Section 301 of the Labor Management Relations Act of 1947 (LMRA), 29 U.S.C. 185;  the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. 1001-1461;  and the National Bank Act, 12 U.S.C. 38.  See Beneficial National Bank v. Anderson, supra, 539 U.S. at 7-9.  The Supreme Court has not recognized complete preemption for damage claims alleging corporate misreporting to its taxpaying shareholders of their tax liability, nor under any other provision of the Internal Revenue Code.  Indeed, the district court seemed to be the first court in the country to find complete preemption in the Internal Revenue Code.  As the Mikulski panel noted, if the district court's analysis were correct, it would federalize most state law claims that remotely address tax issues, such as suing one's accountant or tax preparer.

The en banc Court rejected the conclusion that Section 7422 completely preempted the plaintiffs' state-law claims (slip op. at 7-8) and thereby prevented the expansion of the complete preemption doctrine into an area of law not intended by Congress or recognized by the Supreme Court.  This is consistent with the Sixth Circuit's previous cases acknowledging that complete preemption is a narrow doctrine.  Although in Gibson v. American Bankers Ins. Co., 289 F.3d 943, 947 (6th Cir. 2002), the Court held that the National Flood Insurance Act, 42 U.S.C. 4072, completely preempts state law because it expressly confers "original exclusive jurisdiction" on the federal courts, the Sixth Circuit has previously declined to extend complete preemption to various federal laws that lack similarly-explicit language.  See, e.g., Wellons v. Northwest Airlines, Inc., 165 F.3d 493, 496 (6th Cir. 1999)(Airline Deregulation Act);  Musson Theatrical, Inc. v. Federal Express Corp., 89 F.3d 1244, 1253 (6th Cir. 1996)(same);  Strong v. Telectronics Pacing Sys., Inc., 78 F.3d 256, 259 (6th Cir. 1996)(Medical Device Amendments to Federal Food, Drug & Cosmetic Act);  Gustafson v. Lake Angelus, 76 F.3d 778, 783 (6th Cir. 1996)(Federal Aviation Act).

So, after five years of federal litigation (four of which was on appeal), the Sixth Circuit is returning the Mikulski case back to the Ohio state court where it started in December 2001.

Which brings me back to the beginning of this post.  What did the Sixth Circuit do in its en banc decision in Mikulski that was so extraordinarily rare?  It affirmed the decision of the panel majority in all respects.  This is extremely unusual because, out of all the en banc cases decided by the Sixth Circuit between January 2000 and the Mikulski rehearing in September 2006, the full Court has reversed the panel majority in every case except two:  United States v. Koch, 383 F.3d 436 (2004), where the Court granted en banc review of the prior panel decision to consider whether the Supreme Court's decision in Blakely v. Washington, 542 U.S. 296 (2004), required the Court to invalidate the United States Sentencing Guidelines on Sixth Amendment grounds, and where the Court reinstated the judgment of the panel, adopted the panel opinion as its own, and added a further opinion regarding the validity of the Sentencing Guidelines;  and Dotson v. Wilkinson, 329 F.3d 463 (6th Cir. 2003), where en banc review was granted to resolve a conflict among panels regarding state prisoner claims.  Otherwise, as the active judges of the Sixth Circuit are currently constituted, the grant of rehearing en banc almost invariably means that the panel decision will be reversed in some significant respect.

Some other interesting facts about rehearings en banc in the Sixth Circuit are noteworthy.  Chief Judge Boggs has been in the majority of every en banc decision since he became chief judge in 2004.  In 2003 (the year before he became Chief), he voted with the majority of the more liberal judges of the Court in two out of three en banc cases.  There are two identifiable groups of judges that vote together in all en banc cases.  Judges Batchelder, Gibbons and Rogers have voted together in every en banc case.  Similarly, Judges Martin, Daughtrey, Moore, Cole and Clay have sided with one another in every en banc decision, whether in the majority or in dissent.  But the two groups have never voted the same way in any en banc case.  It is too soon to draw extensive conclusions about the newer judges of the Court, Judges Sutton, Cook, McKeague and Griffin, but as "Bush 43" appointees, one may expect them to be reliably conservative and to vote most often with the Batchelder-Gibbons-Rogers bloc.  Judge Gilman, and to a lesser extent Chief Judge Boggs, "swing" between the Court's liberal and conservative camps on a case-by-case basis, although Judge Gilman appears over time to vote increasingly frequently with his more conservative colleagues.  I will have further observations and empirical information about the ideological voting patterns of the Sixth Circuit, particularly but not exclusively regarding the judges' bitter divisions in death penalty cases, in a future post.

Disclaimer:  the author of this post (i) is one of the plaintiffs-appellants' counsel in Mikulski v. Centerior, and (ii) presented the oral argument for the petitioner-taxpayer to the Supreme Court in Grable.

The De-Value of Everything

This is a law site, but many of us see baseball as a metaphor for much of life, so on his historic occasion (or at least the day after), I hope you will indulge my brief reverie.

When contemplating the most hallowed record in all of American team sports, it is interesting to reflect on the fact that Babe Ruth held the lifetime major league home run record for 53 years, and then Hank Aaron held it for 33 years more, but Barry Bonds may enjoy being the record-holder for less than 10 years.  Neither Ruth nor Aaron had a legitimate challenger so close to their home run totals at such a young age as Alex Rodriguez is to Bonds' newly-minted record.

Although Lou Gehrig was only 32 years old when Ruth retired, he was 326 home runs behind Ruth at the time, and was fated to play for only three more seasons before being fatally stricken with ALS.  Both Jimmy Foxx and Mel Ott were in their mid-to-late 20s, but each was more than 400 home runs behind Ruth and thus too far removed to be considered a serious challenger to his record at that time.

Willie Mays was only 53 home runs behind Aaron at the close of the 1973 season, but that was his last season while Aaron played three more years and broke Ruth's record in the Braves' fourth game of the 1974 campaign.  When Aaron became the all-time home run champion in April 1974, Harmon Killebrew and Frank Robinson were at the end of their careers and each was more than 130 home runs behind Aaron.  Willie McCovey was 36 years of age at the time and had barely more than 400 home runs in his career (he would finish a few years later with 521).

By contrast, A-Rod is 32 years old and already has hit 500 home runs.  He will need to amass around 280 more home runs, give or take a few, in the remainder of his career to wrest the home run title from Bonds.  That is no sure thing to hit 40 home runs a year for 7 more years as he is approaching 40 years of age.  In fact, in the history of baseball, only two men have accomplished the feat of hitting 40 or more home runs in a season that ended after their 39th birthday -- Aaron once and Bonds twice.  But neither would I bet against A-Rod, the undisputed heir apparent.

One final note that has been lost for many to the dim mists of history.  Ruth became the all-time home run king in 1921, at the very beginning of his Yankee career as an everyday player, when he hit his 132nd career home run.   The old record was held by Hall of Fame first baseman Roger Connor who played in the last two decades of the 19th Century for the National League team in New York, the Gothams.  By virtue of Connor's great stature surpassing 6 foot 3 inches and 200 pounds, the New York Gothams became forever more known as the Giants.  Connor, who is now credited by modern baseball researchers with 138 career home runs, held the lifetime home run record for more than 25 years.

Sixth Circuit Judges on Tom Goldstein's (Not So) Short List

Two sitting Sixth Circuit judges, Deborah L. Cook and Jeffrey S. Sutton, are among Tom Goldstein's short-list of 30 potential nominees for a Supreme Court appointment if a Republican administration assumes office in January 2009.  Tom's commentary in Scotusblog and the entire list can be found here.

Is LaRue Moot After All?

On June 24 we reported that the Supreme Court had granted certiorari in an important ERISA case, LaRue v. DeWolff Boberg, Case No. 06-856, on June 18.  James LaRue is a former employee of DeWolff, Boberg & Associates, Inc. who was a participant in the company's 401(k) plan.  He alleged that the plan fiduciary had failed to invest the money in his account as directed, resulting in losses to his individual account (and consequently to the plan).  But it turns out that in July 2006, while his ERISA claims to recover such losses to his individual account due to the fiduciary breach were pending in the 4th Circuit, he withdrew the entire remaining $119,000 from his account.

On July 23, 2007, over a month after the Supreme Court granted cert., Defendant's counsel moved to dismiss the case as moot, arguing that he only recently learned of these facts and that LaRue's withdrawal of all funds from his 401(k) account means he is no longer a plan participant, and thus has "no legally cognizable interest in the outcome of the case."  But the motion suggests that, even if the fact LaRue is no longer a plan participant renders the two questions presented moot, the Court may wish to consider a slightly different question on which the lower courts are also divided:  can a former plan participant in an ERISA plan sue for damages measured by the lost value of his account?  The motion to dismiss the writ, filed by Crowell & Moring, can be found here.  Lyle Denniston's post for Scotusblog regarding the motion is here.

LaRue's counsel, Peter Stris and Jean-Claude Andre, have fired back in an opposition filed with the Court on Thursday, August 2.  They argue that the statutory definition of "participant" set forth in Section 3(7) of ERISA, 29 U.S.C. 1002(7), expressly includes a "former employee . . . who is or may become eligible to receive a benefit of any type" from an ERISA plan.  Plaintiff's counsel correctly point out that the Court has held this definition to include any "former employee" who has "a colorable claim that . . . he or she will prevail in a suit for benefits."  Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 117-18 (1989).  They note that while "participant" is a defined term, "former participant" is nowhere defined in ERISA.  Finally, they argue it is a false syllogism to equate a zero balance in an ERISA account with the loss of "eligibility" to receive further benefits, and maintain that LaRue's withdrawal of his funds over which there was no dispute does not mean he no longer has a personal stake or legally-cognizable interest in the outcome of the litigation.  Lyle Denniston covered petitioner's response in Scotusblog here.

I wish to emphasize another point raised in petitioner's opposition to the motion to dismiss.  Respondent's position -- that a former employee whose 401(k) account has been partially depleted through fiduciary breach must leave his remaining funds with the breaching fiduciary in order to continuing litigating to recover the monies already lost -- has been explicitly rejected by the United States Department of Labor and by every court of appeals to have addressed the issue.  See Graden v. Conexant Systems Inc., No. 06-2337, 2007 WL 2177170 (3rd Cir. 7-31-2007);  Harzewski v. Guidant Corp., 489 F.3d 799 (7th Cir. 6-5-2007).

It seems clear the Solicitor General's office will wish to weigh in on this topic since the SG urged the Court to grant cert. and rule on the Section 502(a)(2) and 502(a)(3) questions presented in part because they recur so frequently in so many cases.  The Court will take up the motion to dismiss at its "long conference" on September 24, 2007.

Follow-Up on Federal Tort Claims Act Sovereign Immunity

Jean-Claude Andre is counsel for a federal prisoner in Ali v. Federal Bureau of Prisons, Case No.  06-9130, on certiorari to the 11th Circuit, raising the question of whether the immunity attaching under the Federal Tort Claims Act applies only to law enforcement officers acting in a tax, excise or customs capacity.  The circuits are split 6-to-4 on the issue.  We thank Mr. Andre for informing us that he will be attempting to vindicate before the Supreme Court the 6th Circuit's position in Kurinsky v. United States, 33 F.3d 594 (6th Cir. 1994), a decision which is directly (and, he adds, correctly) contrary to the 11th Circuit's decision in Ali.