Third Circuit Rules That Traditional Trusts Are Citizens of the States of Its Trustees and Business Trusts Are Citizens of the States of Its Owners for Diversity Purposes

by Blank Rome LLP

The United States Court of Appeals for the Third Circuit recently determined that, for purposes of determining diversity of citizenship, the citizenship of a traditional trust is only that of its trustees, while the citizenship of a business trust is that of each of its constituent owners. GBForefront, L.P. v. Forefront Mgmt., LLC, No. 16-3905 (3d Cir. Apr. 19, 2018).

The case involved claims brought by GBForefront, a limited partnership whose membership included various trusts, against Forefront Management Group, LLC (“FMG”) and others, alleging that the defendants had defaulted on the terms of a settlement agreement. FMG moved to dismiss, arguing that complete diversity, the basis for subject matter jurisdiction in this case, was lacking. Between the filing of the motion and the District Court’s decision, the United States Supreme Court decided Americold Realty Trust v. Conagra Foods, Inc., 136 S. Ct. 1012 (2016), in which it held that the citizenship of a business trust includes the citizenship of all its members. The District Court ultimately granted the motion to dismiss because GBForefront’s membership included three trusts whose beneficiaries were citizens of New Jersey and FMG also had a member who was a citizen of New Jersey. The District Court reasoned that Americold Realty required it to look at the citizenship of all members and beneficiaries of GBForefront. GBForefront appealed.

The Third Circuit thoroughly reviewed the Supreme Court’s precedent on “jurisdictional citizenship when a trust is involved in a lawsuit.” First, when a trustee sues or is sued on behalf of a trust, the citizenship of the trust is based on that of the trustee alone. Navarro Savings Assoc. v. Lee, 446 U.S. 458 (1980). Second, when an artificial legal entity besides a corporation, such as a limited partnership, sues or is sued, diversity is determined by looking to the citizenship of each of the entity’s (general and limited) members. Carden v. Arkoma Assoc., 494 U.S. 185 (1990). Finally, under the Supreme Court’s recent decision in Americold Realty, the citizenship of a business trust includes the citizenship of all of its members. 136 S. Ct. 1012 (2016).

Based on this precedent, the Third Circuit determined that the citizenship of a traditional trust is only that of its trustees, while the citizenship of a business trust is that of each of its constituent owners. In determining whether an entity is a “traditional” trust or a “business” trust, a court should perform two inquiries: (1) Does the trust have the status of a judicial person under the laws of the state where it was formed (which would weigh in favor of finding a business trust)? and (2) Is the purpose of the trust to facilitate a donative transfer (weighing in favor of a traditional trust) or to implement a bargained-for exchange (business trust)? In GBForefront, the Third Circuit remanded the case to the District Court to allow it to determine if GBForefront’s trust members were traditional trusts or business trusts.

This case is important because it overturns the former rule in the Third Circuit, i.e., that it was unnecessary to distinguish between types of trusts when determining diversity jurisdiction. See Emerald Investors Trust v. Gaunt Parsippany Partners, 492 F.3d 192 (3d Cir. 2007). Businesses in New Jersey whose membership includes trusts should be aware of the new rule in the Third Circuit, as it could potentially foreclose them from taking advantage of the diversity jurisdiction of the federal courts.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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