A feature of 28 U.S.C. § 1332, the diversity-jurisdiction statute, may make you scratch your head and wonder why it’s there. In the Seventh Circuit’s March 15, 2018 decision in Hyland v. Liberty Mutual Fire Ins. Co., No. 17-2712, Judge Frank Easterbrook explained the origin of § 1332(c)(1) and the role that Wisconsin law played in its adoption. The statute is an exception tacked onto the familiar rule that a corporation is deemed to be a citizen of every state by which it has been incorporated and of the state in which it has its principal place of business. But, the text continues:
in any direct action against the insurer of a policy or contract of liability insurance, whether incorporated or unincorporated, to which action the insured is not joined as a party-defendant
the insurer is also deemed to be a citizen every state of which the insured is a citizen. § 1332(c)(1)(A).
The Hyland case arose in Illinois. The plaintiff’s son (on whose behalf she sued), was a passenger in a vehicle driven by Smith and was severely injured when Smith drove into two parked cars. Plaintiff’s state court action against Smith resulted in a default judgment for $4.6 million. The uncollectible Smith—arguably entitled to a defense of the action by Liberty Mutual, which had insured the owner of the car Smith was driving—assigned any claim that she had against Liberty Mutual to the plaintiff. Plaintiff sued Liberty Mutual in federal court for failure to defend Smith, and the district court awarded judgment for the whole $4.6 million.
The Seventh Circuit, examining the jurisdiction of the district court, asked whether the plaintiff’s action against Liberty Mutual, a citizen of Massachusetts and Wisconsin, fell within the quoted exception to diversity jurisdiction as a “direct action” against the insurer in which the insured (a citizen, like the plaintiff, of Illinois) was not joined. Noting that in one sense this was certainly a “direct action,” because the insurer was the only defendant and the plaintiff sought money from it, Judge Easterbrook pointed out that in 1964, when the statutory exception was enacted, only Wisconsin and Louisiana permitted plaintiffs to sue an insurer directly, without seeking or obtaining a judgment against the insured. Commentators thought that these state laws permitted an unwise expansion of diversity jurisdiction, and Congress responded by enacting § 1332(c)(1). That, the court held, was the target of the “direct action” exception, not an action like Hyland by an insured’s assignee against the insurer.
The Seventh Circuit, applying Illinois law, reversed the $4.6 million judgment, ordering its reduction to one for the $25,000 policy limits.