In all cases where a federal court is exercising jurisdiction solely because of the diversity of citizenship of the parties, the outcome of the litigation in the federal court should be substantially the same, so far as legal rules determine the outcome of a litigation, as it would be if tried in a state court.
In May 1930, a corporation issued notes in the amount of $ 30,000,000. Under an indenture of the same date, a guaranty company was named trustee with power and obligations to enforce the rights of the noteholders in the assets of the Corporation. The trustee, with other banks, made large advances to companies affiliated with the Corporation. In 1931, when it was apparent that the Corporation could not meet its obligations, the trustee cooperated in a plan for the purchase of the outstanding notes on the basis of cash for 50% of the face value of the notes and twenty shares of the Corporation's stock for each $ 1,000 note. In April of 1940, three accepting noteholders filed suit against the trustee for fraud and misrepresentation. The suit, instituted as a class action on behalf of nonaccepting noteholders and brought in a federal court solely because of diversity of citizenship, is based on an alleged breach of trust by the trustee in that it failed to protect the interests of the noteholders in assenting to the exchange offer and failed to disclose its self-interest when sponsoring the offer. The trustee moved for summary judgment, which was granted. On appeal, the Circuit Court of Appeals held that in a suit brought on the equity side of a federal district court that court is not required to apply the State statute of limitations that would govern like suits in the courts of a State where the federal court is sitting even though the exclusive basis of federal jurisdiction is diversity of citizenship. The case was elevated on certiorari to the Supreme Court of the United States.
Was the case barred by the state’s statute of limitations?
The Court concluded that a federal court sitting in diversity was not bound in equity by the state statute of limitations that barred the suit in the state court and were required to apply state law to determine the outcome of litigation, regardless of whether the remedy was in law or in equity. The court noted that under the Erie Doctrine, in all cases where a federal court had jurisdiction solely because of diversity of citizenship, the outcome of the litigation in the federal court should be substantially the same, so far as legal rules determine the outcome of a litigation, as it would be if tried in a state court. The doctrine required the federal diversity court to follow state law, and if the statute of limitations under state law barred recovery in a state court, the federal court could not afford recovery. The court reiterated that the source of substantive rights enforced by a federal diversity court was state law, and that this law determined the outcome regardless of the forum or whether the remedy was in law or in equity.