By: Stevan Bennett

Understanding Where Your Business can be Sued

 

On the day of incorporation/formation, no founder is immediately looking toward the day when someone sues their company. The reality is, however, that should the company reach some degree of success, this day is almost certain to come — be the claim meritorious or not. As such, it’s important for the startup founder to be prepared. One part of this preparation is understanding the idea of jurisdiction.

 

It’s easy to forget that not all cases can be heard in any court. In fact, for any given case, the vast majority of courts will not be able to hear it. This is because federal and state laws only grant courts certain jurisdiction. That is, they limit those cases which are properly heard in that court. In order to hear a case, a court must have personal jurisdiction over the parties and subject matter jurisdiction over that type of case. This post examines personal jurisdiction over a startup. Put differently: in which states can somebody properly sue your company?

 

From Where Does Personal Jurisdiction Come?

 

Courts may derive personal jurisdiction over an entity in a variety of manners relating to the entity’s place of formation, principal place of business, business endeavours, or even from the contracts to which the entity is a party. It’s crucial to keep all of these possibilities straight, less you find yourself litigating in a strange venue on the other side of the country.

 

General Personal Jurisdiction

 

The first type of personal jurisdiction is general personal jurisdiction — the fact that you may be sued for any incident in a court which sits in the state where you are “at home,” no matter the location of the incident in question. For a person, this is usually simple. For an entity, however, the analysis can be a bit more complex. Starting first with the states in which one can certainly sue an entity, be it an LLC or a corporation: the place of incorporation and the principal place of business — usually the company headquarters.[1] (Hyperlink: https://uslawessentials.com/general-specific-personal-jurisdiction/#:~:text=General%20jurisdiction%20means%20a%20state,the%20defendant%20is%20%E2%80%9Chome%E2%80%9D.)

 

For illustration, let’s take the two most common entities formed through our clinic: a Michigan LLC and a Delaware corporation, each with a principal place of business in Michigan. For the Michigan LLC with a principal place of business in Michigan, Michigan courts would be the only courts with general personal jurisdiction over the company. For the Delaware corporation, however, a potential plaintiff could properly bring suit in either Michigan or Delaware, even if the company did no business in Delaware, since it is the company’s place of incorporation. There is no question and no debate in this regard.

 

In addition to the above categories of general personal jurisdiction, a court may gain jurisdiction over a company which has operations so extensive in a given state that the company can be said to be “at home” in this state. For a long-time this threshold was set rather low. In a 2017 Supreme Court case, however, the Court held that a railroad company with substantial, if proportionally small, numbers of employees and miles of track in a state could not be sued in that state[2]. This represented a significant raising of the bar, and for the startup founder, while this test remains a bit amorphous, it does provide some confidence that mere shipment of goods into a state will not result in your being forced to litigate in the courts sitting in that state.

 

Specific Personal Jurisdiction

 

There is still, however, the issue of specific personal jurisdiction. Specific jurisdiction becomes an issue when a plaintiff is bringing suit in a specific state for defendant’s actions within that state. When this is the case, courts within that state may properly exercise personal jurisdiction over that entity.[3] (Hyperlink: https://www.law.cornell.edu/constitution-conan/amendment-14/section-1/suing-out-of-state-foreign-corporationsps://www.law.cornell.edu/constitution-conan/amendment-14/section-1/suing-out-of-state-foreign-corporations) Take, for instance, a Delaware C corporation called Computer Corp., which has headquarters in Michigan. Both Delaware and Michigan courts certainly have general personal jurisdiction over Computer Corp.. Now imagine Computer Corp ships only one laptop, through sales on its website, to a buyer in Oklahoma. This is the only contact Computer Corp. has ever had with Oklahoma. Unfortunately, said laptop explodes upon arrival and causes an injury. In the absence of an exclusive venue clause in the terms and conditions — the subject of this post’s next section — the jurisdictional result of this episode is Oklahoma courts gaining specific personal jurisdiction over Computer Corp. for any suits arising out of this incident, but not beyond that.

 

Choice of Venue Clauses

 

            The final way that a court often gains personal jurisdiction over an entity is if that entity consents to suit in a court which would not otherwise have personal jurisdiction over it.[4] (Hyper Link: https://www.law.cornell.edu/constitution-conan/amendment-14/section-1/suing-out-of-state-foreign-corporations) For startups and other companies, one extremely common method of consenting to personal jurisdiction in a given court is through a choice of venue clause in a commercial contract.

 

Such clauses, common in many contracts and usually accompanied by a choice of law provision, establish the venue in which the parties will resolve disputes relating to that contract.[5] (Hyperlink:https://www.law.cornell.edu/wex/forum_selection_clause) As such, in these cases, all parties are giving their consent that a certain court should have personal jurisdiction over them. The founder should be careful, therefore, that they are not opening themselves up to litigation in a distant forum through their various contracts. Of course, the threat of litigation is reciprocal, and choice of venue provisions can have preclusive effects to go along with the inclusive effects. Put simply, while a choice of venue clause can allow suit to be brought in a specific court, it likely also establishes that court as the exclusive venue for dispute resolution.[6] (Hyperlink:https://www.americanbar.org/groups/business_law/publications/blt/2014/01/keeping_current_duffee/)This possibility was affirmed by the Supreme Court in 2013, holding that when a contract specifies a forum, and a party brings suit elsewhere, then another party to the contract and the suit may seek to transfer the case to the specified venue.[7]

 

Conclusion

 

In order for a court to hear a suit, that court must have personal jurisdiction over the parties. The startup founder should be aware of the various ways that a court may gain personal jurisdiction over them. First, any court sitting in the company’s state of incorporation or principal place of business will almost certainly have general personal jurisdiction over the entity. That is, the entity may be sued in those states for any incident, no matter where it occurs. Next, an entity may be sued in states in which it has operations “so extensive” that it can be said to be “at home” in that state. In 2017, however, the Supreme Court raised this bar significantly. So while this test remains gray, it should provide the startup founder some security that they will not be hauled into a far-off forum because of a small number of business contacts in a state.

 

Next, turning to specific personal jurisdiction. Put simply, assuming there is no exclusive forum clause, an entity can always be sued over an incident in the courts sitting in the state in which an incident occurred, even if the entity is not said to be “at home” in that state. Depending on the product, this could prove to be a factor for founders considering e-commerce.

 

Lastly, choice of venue provisions, common in commercial contracts, serve as an entity’s consent to suit in a specific court, even if personal jurisdiction could not be established in any other manner. Further, if a contract carries a choice of venue clause, the parties will likely be precluded from bringing suit over that contract in any other venue, even if it would be otherwise proper.

 

Of course, the hope is to avoid litigation completely. The reality is, unfortunately, that as companies grow, litigation is often a matter of when and not if. By carefully considering issues of incorporation and venue selection, however, the diligent founder may at least be able to control and prepare for the “where” of litigation.

 

 

 

[1]Ihttps://uslawessentials.com/general-specific-personal-jurisdiction/#:~:text=General%20jurisdiction%20means%20a%20state,the%20defendant%20is%20%E2%80%9Chome%E2%80%9D.

[2]BNSF Ry. Co. v. Tyrrell, 137 S. Ct. 1549, 198 L. Ed. 2d 36 (2017)

[3]https://www.law.cornell.edu/constitution-conan/amendment-14/section-1/suing-out-of-state-foreign-corporations

[4]https://www.law.cornell.edu/constitution-conan/amendment-14/section-1/suing-out-of-state-foreign-corporations

[5]https://www.law.cornell.edu/wex/forum_selection_clause

[6]https://www.americanbar.org/groups/business_law/publications/blt/2014/01/keeping_current_duffee/

[7]Atl. Marine Const. Co. v. U.S. Dist. Court for W. Dist. of Texas, 571 U.S. 49, 134 S. Ct. 568, 187 L. Ed. 2d 487 (2013)