7th Cir. Rejects CAFA Removal Under ‘Internal-Affairs’ and ‘Home-State Controversy’ Exceptions

The U.S. Court of Appeals for the Seventh Circuit recently held that a putative class action removed to federal court under the Class Action Fairness Act lacked federal jurisdiction because it fell within CAFA’s “internal-affairs” and “home-state controversy” exceptions.

A copy of the opinion in Sudholt v. Country Mutual Insurance Company is available at: Link to Opinion.

Current and former policyholders filed a class action lawsuit in Illinois against a mutual insurance company and 46 of its current and former officers and directors. Every member of the proposed class was an Illinois citizen under the Class Action Fairness Act, 28 U.S.C. § 1332(d)(2), as were the insurer and 45 of the individuals. The 46th individual defendant was a resident of Massachusetts.

The policyholders alleged that the company accumulated and retained an excess surplus of over $3.5 billion from premium revenues exceeding the cost of claims and thereby failed to supply those policies at cost. They claimed breach of contract, violations of the Illinois UDAP statute, unjust enrichment, and breach of fiduciary duty.

Based on putative class size, the amount in controversy, and the minimal diversity created by the 46th individual defendant, the insurer removed the case to federal court. The policyholders then moved to remand, contending that the action satisfied at least one of three exceptions to the federal jurisdiction otherwise supplied by CAFA: the internal-affairs exception in § 1332(d)(9)(B), the home-state controversy exception in § 1332(d)(4)(B), and the local controversy exception in § 1332(d)(4)(A).

The federal trial court denied the motion to remand, concluding that no exception applied. The policyholders timely appealed.

On appeal, all parties agreed that the class action brought by the policyholders satisfied CAFA’s general requirements for federal jurisdiction. The question therefore was whether the action fit within either of two exceptions — the internal-affairs exception, or the home-state controversy exception — thereby requiring a remand to Illinois state court (the ruling on the local controversy exception was not appealed).

By its terms, the internal-affairs exception in § 1332(d)(9) requires determining whether the class action “solely involves a claim” pertaining to a corporation’s “internal affairs or governance.” § 1332(d)(9), (d)(9)(B).

The Seventh Circuit determined that the “solely involves” limitation means that, for the exception to apply, the class action cannot include a claim that does not “relate to” internal affairs or corporate governance. The Court reasoned that the exception encompasses claims concerning the governance of a corporate enterprise by directors and officers through the exercise of their fiduciary duties.

The Seventh Circuit concluded that the policyholders’ complaint “solely involves” claims that “relate to” the insurer’s “internal affairs” or “corporate governance”— that directors and officers exercised the discretion they have to set capital levels and determine dividend distributions in impermissible ways that benefited themselves and harmed policyholders. § 1332(d)(9)(B).

Therefore, because the internal-affairs exception applied, the Court held that federal jurisdiction was lacking, and the case must return to Illinois state court.

Additionally, the Seventh Circuit determined that the home-state controversy exception also provided an independent reason for remanding the suit to Illinois state court.

Under § 1332(d)(4), a federal court “shall decline to exercise jurisdiction” when “two-thirds or more of the members of all proposed plaintiff classes in the aggregate, and the primary defendants, are citizens of the State in which the action was originally filed.” § 1332(d)(4), (d)(4)(B).

All parties agreed that more than two-thirds of the members of the proposed class were citizens of Illinois. The point of contention was whether the 46th individual defendant, a citizen of Massachusetts and the defendant who supplied the minimal diversity for the insurer’s invocation of CAFA jurisdiction in federal court — was a “primary defendant” within the meaning of the home-state controversy exception.

The Seventh Circuit saw the spotlight of the complaint as shining foremost on the insurer. The insurer was the named defendant in three of the complaint’s four claims and the party alleged to have accumulated over $3.5 billion in excess surplus. Also, the Court reasoned that the insurer was the party from which the policyholders sought the lion’s share of any recovery.

Moreover, the Seventh Circuit was persuaded that the 46 directors and officers did not stand as equal defendants alongside the insurer when considering the plain objective of the class action — to exact a material financial recovery of billions of dollars of surplus alleged to be wrongfully withheld by a mutual insurance company from distribution to policyholders. Therefore, the Court concluded that the 46th individual defendant was not a “primary defendant,” so the home-state controversy exception did apply.

Accordingly, the Seventh Circuit held that this case fit within both the internal-affairs and home-state controversy exceptions of CAFA. Thus, the Court reversed the trial court’s denial of the policyholders’ motion to remand and remanded to the trial court with instructions to remand the case to state court.