In a significant class action decision, Shady Grove Orthopedic Associates, P.A. v. Allstate Insurance Co., No. 08-1008, 559 U.S. -- (Mar. 31, 2010), the U.S. Supreme Court recently held that federal rules on class actions preempt state laws restricting a case from proceeding as a class action.

In the complaint, Shady Grove Orthopedic Associates, P.A. alleged that Allstate failed to pay or dispute claims within the time allotted, entitling it to statutory interest. Shady Grove filed a putative class action on behalf of all those who had not received the statutorily-mandated interest on late payments. Because New York CPLR § 901 prohibits class actions in suits seeking statutory damages, Shady Grove filed in federal court in the Eastern District of New York under diversity jurisdiction. The district court dismissed the action for lack of jurisdiction and the Second Circuit affirmed. The U.S. Supreme Court granted certiorari on the issue of whether a state statute restricting class actions can prohibit a case from proceeding under Rule 23 of the Federal Rules of Civil Procedure as a class in federal court under diversity jurisdiction. The Court held that it cannot. According to the plurality opinion written by Justice Scalia, Rule 23, which empowers a federal court to certify a class if certain conditions are met, cannot be limited by state laws. Because Rule 23 and New York CPLR § 901 are both “preconditions for maintaining a class action,” § 901 is validly pre-empted by Rule 23 where state law claims are brought in federal court.

The impact of Shady Grove is already being felt. This week, the Supreme Court applied Shady Grove in Holster v. Gatco, Inc., No. 08-1307, 559 U.S. -- (Apr. 19, 2010), another putative class action filed in the Eastern District of New York. There, the issue presented was whether New York CPLR § 901 divested federal courts of jurisdiction over a Telephone Consumer Protection Act class action brought under diversity jurisdiction. The Supreme Court vacated the judgment dismissing the suit for lack of jurisdiction, remanded the case to the Second Circuit, and instructed it to further consider its decision in light of Shady Grove.

Read expansively, this decision could be used as a way around other similar state laws that seek to limit class actions, potentially resulting in a wave of costly class actions being filed in federal court, rather than forcing individuals to sue for statutory damages one at a time.

U.S. Supreme Court Holds that State Law Does Not Bar Federal Courts from Using Class Action Device for State Law Claims