Under the well-known rule of Erie Railroad Co. v. Tompkins, 304 U.S. 64 (1938), federal courts exercising diversity jurisdiction apply state substantive law and federal procedural law. Sometimes, however, it is difficult to determine whether a particular rule is substantive or procedural, and thus whether state or federal law controls a particular question. For example, it is not necessarily clear whether state laws prohibiting certain class actions are substantive or procedural in nature, and thus it is not clear whether federal courts exercising diversity jurisdiction are bound by such laws.

On March 31, 2010, in a deeply fractured but potentially important decision, the Supreme Court held that a federal court exercising diversity jurisdiction over a claim brought under New York law must apply Rule 23 of the Federal Rules of Civil Procedure, which governs the maintenance of class actions in federal court, rather than Section 901 of the New York Civil Practice Law and Rules (CPLR), which purports to prohibit certain types of class actions under New York law. Although the practical impact of the decision in Shady Grove may depend on how the lower courts interpret the majority, plurality, and concurring opinions, the decision will likely cause federal courts to entertain certain state-law class action lawsuits that could not have been brought in state court, and thus will likely lead to increased forum shopping.

In Shady Grove, the plaintiff filed a putative class action seeking statutory penalties under New York law against the defendant insurer for allegedly refusing to pay the statutory interest on overdue automobile insurance benefits. The district court dismissed the case, concluding that CPLR § 901, which prohibits class actions seeking statutory penalties, applies to diversity suits in federal court because it is “substantive” law within the meaning of Erie. Both the district court and the U.S. Court of Appeals for the Second Circuit, which affirmed the judgment, determined that Rule 23 did not trump Section 901 because the two provisions were not in conflict. The Supreme Court reversed and remanded.

Justice Scalia, writing in part for a 5-justice majority, concluded that because Rule 23, like Section 901, addresses whether a class action can be maintained, the two provisions are irreconcilable and the federal rule must govern. Slip op. 4-5. According to the majority opinion, it was error for the district court to have dismissed the plaintiff’s putative class action because “Rule 23 unambiguously authorizes any plaintiff, in any federal civil proceeding, to maintain a class action if the Rule’s prerequisites are met.” Id. at 11.

Although Justice Stevens joined that portion of Justice Scalia’s opinion, he also wrote a separate concurrence that could ultimately limit the impact of the Court’s decision. According to Justice Stevens, a court exercising diversity jurisdiction must apply Rule 23 rather than Section 901 because Section 901 “is a procedural rule that is not part of New York’s substantive law.” Concurrence at 1. Significantly, however, Justice Stevens emphasized that “not every” federal rule of procedure will “displace state law.” Id. at 3. According to Justice Stevens, “[a] federal rule . . . cannot govern a particular case in which the rule 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.” Id. at 11. Thus, if a lower court were to follow Justice Stevens’ approach, it could give effect to a state-law restriction on class actions notwithstanding Rule 23 if the court determined that the particular restriction at issue is an inextricable aspect of the particular state-law right that the plaintiff seeks to vindicate.

Justice Ginsburg wrote a dissenting opinion joined by Justices Kennedy, Breyer, and Alito. Characterizing Section 901 as embodying a substantive policy decision by the New York legislature to limit potentially ruinous liability, the dissenting justices argued that reconciling CPLR § 901 with Rule 23 is both possible and necessary in light of the federalism concerns that animate the Erie doctrine.

In particular, Justice Ginsburg noted a “large irony”—that when Congress enacted CAFA, it “sought to check what it considered to be the overreadiness of some state courts to certify class actions,” and therefore “envisioned fewer—not more—class actions overall.” Yet “Congress surely never anticipated that CAFA would make federal courts a mecca for . . . class actions seeking state-created penalties for claims arising under state law—claims that would be barred from class treatment in the State’s own courts.” Dissent at 24.