The Supreme Court recently held that a New York statute that prohibits class actions cannot be applied in federal court. The Court held that doing so would improperly restrict the scope of Rule 23 of the Federal Rules of Civil Procedure. Shady Grove Orthopedic Associates, P.A. v. Allstate Ins. Co.,559 U.S. ___ (2010). As a result, a class-action lawsuit against Allstate Insurance Company may proceed in the United States District Court for the Eastern District of New York.

The case involves Allstate’s alleged failure to timely pay insurance benefits to a medical facility and refusal to pay interest that accrued on the overdue benefits in violation of New York law.The medical facility filed a class action lawsuit against Allstate in federal court based on diversity jurisdiction. The district court dismissed the class action based on a New York law prohibiting an action to recover a statutory penalty from being maintained as a class action (see 466 F. Supp. 2d 467,472).

The Second Circuit affirmed the district court, noting that there was no conflict between the New York law and Rule 23 (see 549 F.3d 137). The Second Circuit held that, under the doctrine set forth in Erie R. Co. v.Tompkins, 304 U.S. 64 (1938), federal courts sitting in diversity must apply the New York law (where applicable) because it is “substantive.”

The Supreme Court reversed the judgment and remanded the case. Only Parts I and II-A of the opinion garnered a majority and are binding. The majority agreed that, not with standing the New York law, the case “may proceed as a class action”under Rule 23, which provides a “one-size fits all formula for deciding the class-action question.”

An upshot of Shady Grove is that plaintiffs will have far greater incentive to maintain certain class actions based on state law in federal court. Additionally, corporate defendants should carefully analyze the potential impact of this decision before removing a class action from state to federal court. Please contact Ashley Trehan for more information.