Establishing Diversity When a Trust Is Involved

06 June 2018 Law360 Publication
Authors: Andrew T. McClain

A recent Third Circuit opinion confirms the test of citizenship for traditional trusts for diversity purposes and highlights the importance of fully and accurately determining the citizenship of litigants. In GBForefront LP v. Forefront Management Group LLC,[1] the U.S. Court of Appeals for the Third Circuit held that, for purposes of diversity jurisdiction, the citizenship of a traditional trust — in contrast to the citizenship of a business trust — is determined solely on the citizenship of the trustee and not on the citizenship of the beneficiaries. The Third Circuit based its holding on the U.S. Supreme Court’s decision in Americold Realty Trust v. Conagra Foods Inc.,[2] which differentiated between traditional trusts and business trusts for purposes of diversity jurisdiction. In Americold, the court held that the citizenship of a business trust includes the citizenship of all its members. In GBForefront, the Third Circuit held that the citizenship of a traditional trust is based solely on the citizenship of the trustee.

GBForefront filed suit against several defendants for breach of contract and unjust enrichment. GBForefront is a limited partnership composed of a general partner, GBForefront General LLC (or GG LLC), and a limited partner, WPF2 LP (or WPF). Warren Weiner, a Pennsylvania resident, was the sole member of GG LLC. WPF was composed of a general partner, Weiner 2 General LLC, and a series of five trusts as limited partners. Warren Weiner was the sole member of Weiner 2. Warren Weiner was also the trustee of the five trusts, which were established for Weiner’s grandchildren, at least three of whom resided in New Jersey at the time the lawsuit was filed.

After lengthy litigation, the parties entered into a settlement agreement. Sometime later, GBForefront filed a diversity suit for default under the settlement agreement and sought entry of a consent judgment, which was part of the settlement agreement. The defendants moved to dismiss the case for lack of subject matter jurisdiction, claiming complete diversity was lacking. The district court granted the motion, finding that at least three of the beneficiaries of the trusts were citizens of New Jersey and one of the defendants was also a citizen of New Jersey. GBForefront appealed.

The critical question for diversity, thus, was whether the citizenship of the trust beneficiaries had to be taken into account — in which case diversity would be lacking — or whether only the citizenship of the trustee had to be considered — in which case diversity would exist. To answer that question, the Third Circuit focused on whether the citizenship of a “traditional trust” is determined differently than that of a “business trust.” The Third Circuit concluded that traditional trusts and business trusts are treated differently for diversity purposes. The court’s analysis focused on three Supreme Court cases: Navarro Savings Association v. Lee,[3] Carden v. Arkoma Associates[4] and Americold.

In Navarro, the court stated that when a trustee sues or is sued on behalf of the trust, citizenship of the trust is based solely on that of the trustee. In such instances, the trustee may claim diversity based on its own citizenship, without consideration of the citizenship of the beneficiaries. There, the trustees were expressly granted the right to sue or be sued in the name of the trust. Although the trust in Navarro resembled a business trust, the court noted it was an express trust in which the trustees had the power to hold, manage and dispose of the trust assets for the benefit of others. The court also stated that since it was the trustees who initiated the lawsuit in their own names, the court should consider only the citizenship of the trustees, the real parties in interest, for purposes of diversity jurisdiction.

In Carden, by contrast, the court held that when an artificial business entity other than a corporation sues or is sued in its name, the entity’s citizenship is determined by the citizenship of each of the entity’s members. There, the citizenship of a limited partnership was at issue, and the court held that the limited partnership’s citizenship was based on the citizenship of all its partners, as compared to a corporation, which is a citizen of its state of incorporation or principal place of business. In its ruling, the court reiterated its position declining to extend to artificial entities the well-established rules treating corporations as “citizens.” The court also declined to extend its reasoning in Navarro to the facts in Carden, stating that the holding in Navarro had nothing to do with the citizenship of a trust because Navarro involved a suit by trustees in their own names.

Finally, in Americold, several corporations sued a warehouse owner, which was a real estate investment trust. The REIT removed the lawsuit to federal court on diversity grounds, and diversity was subsequently challenged. The Supreme Court held that the citizenship of an artificial business entity, including a REIT that sues or is sued in its name, includes the citizenship of each of its members. The Supreme Court compared the REIT to other unincorporated business associations, such as joint-stock companies or partnerships, each of which has a citizenship based on each of its members.

In its analysis, the high court made clear that there are jurisdictional differences between a traditional trust and a business trust. The citizenship of a traditional trust is determined by the citizenship of its trustee and the citizenship of a business trust is determined by the citizenship of each of its members. This is so because a traditional trust embodies a fiduciary relationship, while a business trust is effectively an artificial business entity and only a trust by name. The court again reiterated that Navarro did not address citizenship of a trust; rather it addressed the trustees’ citizenship because the trustees were suing in their own names. Navarro and Americold are compatible because Navarro analyzed the citizenship of trustees suing in their own name pursuant to express authority and in furtherance of their trustee duties, while Americold analyzed the citizenship of an artificial business entity being sued in its own name.

Based on the holding and reasoning in Americold, the Third Circuit concluded that the citizenship of a traditional trust is based solely on that of its trustee. The Third Circuit did not ultimately determine whether diversity existed or whether the trusts were traditional or business trusts because the record before it was insufficient to reach such conclusions. However, the opinion makes clear that traditional trusts and business trusts are treated differently for diversity purposes. The citizenship of a traditional trust is only that of its trustee while the citizenship of a business trust is that of all its members.

A Business Trust Versus A Traditional Trust

GBForefront and the Supreme Court cases beg the question of how to differentiate between a business trust and a traditional trust for the purpose of determining diversity of citizenship.

The Restatement (Second) of Trusts states that a trust used for carrying on business is not within the scope of the restatement and “the business trust is a special kind of business association [that] can best be dealt with in connection with other business associations.”[5] The Supreme Court has previously described business trusts as an arrangement in which the object is not to hold and conserve property, but rather a medium to conduct business and share in its gains.[6] The business trust can also be described as an unincorporated business entity involving a bargained-for exchange.

In contrast, a traditional trust embodies a fiduciary relationship that facilitates a donative transfer. The restatement defines a trust as “a fiduciary relationship with respect to property, subjecting the person by whom the title to the property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intention to create it.”[7]

In determining whether a trust is a traditional or business trust, a court may consider two inquiries: (1) the state law of where the trust was formed to determine whether the trust has status of a juridical person and (2) the purpose of the trust. It must be noted that state law is not dispositive, only instructive, for trust classification for diversity purposes.

Takeaways From GBForefront

For diversity jurisdiction to exist under 28 U.S.C § 1332(a), no plaintiff may be a citizen of the same state as any defendant and the amount in controversy must exceed $75,000. Before commencing a lawsuit, the citizenship of all parties should be determined. GBForefront reminds us of the importance of drilling down the ownership structure of each litigant to ensure that diversity exists. The trusts at issue in GBForefront appeared at the second level of ownership in the plaintiff. If a trust is involved at any level, the most important task is determining what type of trust is at issue. GBForefront gives some guidance as to what courts may consider in making this determination. Courts may also consider the trustee’s right to sue or be sued; the trustee’s rights to hold, manage and dispose assets; the trust agreement; the nature of the trust’s assets; and voting rights or control rights of the beneficiaries. GBForefront also makes clear that the analysis of a trust’s citizenship does not change if the trust is buried in the ownership structure of a named party. Additionally, where a traditional trust contains multiple trustees, the citizenship of each trustee must be considered. As a general note, citizenship of the parties, not just residency, must be pled.

GBForefront highlights the importance of properly determining citizenship at all layers of ownership structure. Ensuring that diversity is properly established from the beginning of a case can avoid costly litigation down the road.

Endnotes

[1] GBForefront LP v. Forefront Mgmt. Grp. LLC, 888 F.3d 29 (3d Cir. 2018)
[2] Americold Realty Trust v. Conagra Foods Inc., 136 S. Ct. 1012 (2016)
[3] Navarro Savings Association v. Lee, 446 U.S. 458 (1980)
[4] Carden v. Arkoma Associates, 494 U.S. 185 (1990)
[5] Restatement (Second) of Trusts § 1 (1959)
[6] Morrissey v. Comm’r, 296 U.S. 344, 357 (1935)
[7] Restatement (Second) of Trusts § 2 (1959)

This article was originally published by Law360 here.

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