The Supreme Court issued a decision last week that may be of concern to many corporate defendants hoping to benefit from state-level tort reform. The case of Shady Grove Orthopedic Associates, P.A. v. Allstate Insurance Co., No. 08–1008 (March 31, 2010) considered the scope of Rule 23, the federal rule that governs when a lawsuit seeking civil damages may be pursued as a class action. The question was whether plaintiffs could pursue a class action under Rule 23 for state-law claims for which New York statutes expressly precluded recovery on a class-wide basis. The Supreme Court voted narrowly to allow the federal class action to proceed. In reaching its decision, however, the Court was deeply divided on the governing principle – a fact that will likely limit (or at least complicate) the decision’s application.

The dispute began after Shady Grove provided medical care to Sonia Galvez following a car accident in Maryland. As partial payment for her care, Ms. Glavez assigned to Shady Grove her rights to insurance benefits under a policy issued by Allstate in New York. Allstate paid the claim, though allegedly not within the prescribed thirty-day time period. Shady Grove brought a suit in federal court and sought to pursue the case as a class action, representing all whose claims allegedly had not been paid on time. The putative class asserted state-law claims and demanded at least $5 million in statutory interest penalties. The district court, sitting in diversity, dismissed the case pursuant to a New York statute that precludes class-wide recovery for a “penalty” such as statutory interest. The Second Circuit affirmed based on the Supreme Court’s 1938 decision in Erie Railroad v. Tomkins, which stated that in diversity cases, federal procedural rules may govern how the case proceeds, but state substantive law controls the merits of the case.

A fractured Supreme Court reversed. Writing for himself, Chief Justice Roberts, and Justice Thomas (and, in part, Justice Sotomayor), Justice Scalia concluded that as long as the requirements of Rule 23 are met, a class action may proceed in federal court, stating that “Rule 23 unambiguously authorizes any plaintiff, in any federal civil proceeding, to maintain a class action if the Rules’ prerequisites are met. We cannot contort its text, even to avert a collision with state law that might render it invalid.” But while Justice Stevens contributed the fifth vote to support the result, he wrote separately to explain his reasoning and gave the federal rule a narrower sweep. He concluded that a federal rule could not govern a case when it would “displace a state law that is procedural in the ordinary use of the term but is so intertwined with a state right or remedy that it functions to define the scope of the state-created right.” The Rules Enabling Act, Stevens noted, stated that federal courts may not craft procedural rules if such a rule would conflict with, expand, or modify “any substantive right”.

In a lengthy dissent, Justice Ginsburg – joined by Justices Kennedy, Breyer and Alito – warned that the Court’s ruling strikes a blow against Erie and may undercut state regulatory regimes.

Given its fractured reasoning, this case may have a narrower impact than its outcome suggests. While Justice Scalia’s sweeping analysis of Rule 23 would widen opportunities for federal class action lawsuits to move forward regardless of contrary state laws, his opinion may not represent the Court’s controlling interpretation of Rule 23. Justice Stevens’s opinion reflected the narrowest view supporting the outcome and, under Supreme Court precedent, his view is arguably the controlling interpretation. But that narrower opinion does not dictate the result in future cases; instead, it sets forth general principles and instructs courts to analyze the particular nature and characteristics of the state law at issue and whether it operates to define the scope of a substantive right. In short, courts confronting similar issues in the future may find themselves analyzing not one but two complex issues: the nature of the particular state law limitation, and the proper interpretation of the Shady Grove decision itself.