Frank v. Bear Stearns & Co

REVISED
United States Court of Appeals,
Fifth Circuit.
No. 96-21019.
Robert S. FRANK, Plaintiffs-Appellants,
v.
BEAR STEARNS & CO., Defendants-Appellees.
Nov. 26, 1997.
Appeal from the United States District Court for the Southern
District of Texas.
Before REYNALDO G. GARZA, HIGGINBOTHAM and DAVIS, Circuit Judges.
REYNALDO G. GARZA, Circuit Judge:
The defendants-appellees in this case are the underwriters for
one or more securities offerings made by the Federal Home Loan
Mortgage Corporation ("Freddie Mac") and the Federal National
Mortgage Association ("Fannie Mae"). Between 1991 and 1994,
Freddie Mac, a federally chartered, sponsored, and regulated
corporation, see 12 U.S.C. §§ 1451-1459 (1997), issued securities
described as Multiclass Mortgage Participation Certificates and
Multiclass Mortgage Securities ("Collateralized Mortgage
Obligations"). During the same time period, Fannie Mae, another
federally chartered, sponsored, and regulated corporation, see 12
U.S.C. §§ 1716-1723h (1997), issued securities described as
Guaranteed REMIC Pass-Through Certificates ("REMIC Certificates").
As underwriters, each defendant then sold the securities to others
in arms-length transactions, who in turn sold these securities to
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other brokers or individuals.
One of the many purchasers that bought these securities
directly from the defendants was High Yield Management, Inc.
("HYM"). HYM then sold these securities directly to the
plaintiffs. HYM is now insolvent. The defendants never sold any
of the securities at issue to the plaintiffs. None of the
defendants maintained any accounts or acted as brokers for any of
the plaintiffs. The defendants did not have any contact or
communication with or make any statements to the plaintiffs, and
did not solicit the plaintiffs' purchases of the securities at
issue. The plaintiffs did not own, directly or indirectly, any
voting securities of HYM and none of the purchasers from which the
plaintiffs bought these securities, such as HYM, ever acted as
agents of the defendants in further transactions.
The plaintiffs ended up losing $8,687,323.60 on the securities
and on June 9, 1995 filed an original petition against the
defendants in the 129th Judicial District Court of Harris County,
Texas. The original petition alleged breach of contract and
violations of the Texas Securities Act. TEX.REV.CIV.STAT.ANN. art
581-33A(2), -33F. The plaintiffs asserted that the defendants
breached their alleged duty under the purchase agreements with
Fannie Mae and Freddie Mac to deliver disclosure documents to the
purchasers of the securities. On August 2, 1995, the defendants
removed the case to federal court on the grounds that (1) the
plaintiffs' claims that they were intended third-party
beneficiaries of contracts between the defendants and
2
federally-sponsored enterprises arose under federal law, and (2)
appellants had artfully pled federal securities law as state law
claims. Plaintiffs moved to remand the matter to state court, but
the district court denied the motion on October 6, 1995.
Plaintiffs appeal this denial.
On March 25, 1996, the magistrate judge signed an extensive
23-page memorandum and recommendation granting Paine Webber's
motion for summary judgment. The district court adopted the
recommendation on May 20, 1996. The magistrate judge then issued
recommendations to grant summary judgment for the remaining
defendants which, again, the district court adopted by orders
signed on September 24, 1996. The district court then signed a
final judgment on September 26, 1996. Our decision will not reach
plaintiffs' appeal of these decisions because we find that the
district court lacked subject matter jurisdiction to hear this case
and, therefore, should have remanded the case to the state court.
Accordingly, we reverse the district court's denial of the
plaintiffs' motion to remand.
Analysis
We review a district court's denial of a motion to remand de
novo. Carpenter v. Wichita Falls Indep. Sch. Dist., 44 F.3d 362,
365 (5th Cir.1995). The party invoking the removal jurisdiction of
federal courts bears the burden of establishing federal
jurisdiction over the state court suit. Id. The federal removal
statute, 28 U.S.C. § 1441 (1997), is subject to strict construction
because a defendant's use of that statute deprives a state court of
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a case properly before it and thereby implicates important
federalism concerns. Id. The removal statute ties the propriety
of removal to the original jurisdiction of the federal district
courts. Id. Absent diversity of citizenship, removal is
appropriate only for those claims within the federal question
jurisdiction of the district courts. 28 U.S.C. § 1331 (1997).
Under the "well pleaded complaint" rule, as discussed in
Franchise Tax Bd. v. Construction Laborers Vacation Trust, 463 U.S.
1, 103 S. Ct. 2841, 77 L. Ed. 2d 420 (1983), a movant may not remove
a case to federal court unless the plaintiff's complaint
establishes that the cause of action arises under federal law. 463
U.S. at 10-11, 103 S.Ct. at 2846-47. Courts will, however,
typically look beyond the face of the complaint to determine
whether removal is proper. Villarreal v. Brown Express, Inc., 529
F.2d 1219, 1221 (5th Cir.1976). A federal court may find that a
plaintiff's claims arise under federal law even though the
plaintiff has not characterized them as federal claims. Aquafaith
Shipping Ltd. v. Jarillas, 963 F.2d 806, 808 (5th Cir.), cert.
denied, 506 U.S. 955, 113 S. Ct. 413, 121 L. Ed. 2d 337 (1992); see
also Uncle Ben's Intern. Div. of Uncle Ben's, Inc. v. Hapag-Lloyd
Aktiengesellschaft, 855 F.2d 215, 217 (5th Cir.1988) (removal was
proper notwithstanding pleading that made no reference to federal
statutes). The plaintiffs' state court petition alleged only
breach of contract claims and violations of state securities laws.
As the petition did not allege violation of any federal statute, we
are left with the defendants' contention that the case arises under
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federal common law, which we find to be without merit.
Federal question jurisdiction extends to "all civil actions
arising under the Constitution, laws, or treaties of the United
States." 28 U.S.C. § 1331 (1997). It is well established that the
"arising under" language of section 1331 has a narrower meaning
than the corresponding language in Article III of our Constitution,
which defines the limits of the judicial power of the United
States. See U.S. CONST. art. III, § 2, cl. 1 ("The judicial Power
shall extend to all Cases, in Law and Equity, arising under this
Constitution, the Laws of the United States, and Treaties made, or
which shall be made, under their Authority...."). Federal question
jurisdiction under section 1331 extends to cases in which a
well-pleaded complaint establishes either that federal law creates
the cause of action or that the plaintiff's right to relief
necessarily depends on resolution of a substantial question of
federal law. Franchise Tax Bd., 463 U.S. at 27-28, 103 S.Ct. at
2855-56. Here, the parties are not diverse and the complaint
alleged state law causes of action, therefore, removal to federal
court depends on the existence of a federal question. See Sam L.
Majors Jewelers v. ABX, Inc., 117 F.3d 922, 924 (5th Cir.1997)
("Absent diversity of citizenship, federal question jurisdiction is
required to support removal."). Although the plaintiffs did not
literally allege federal claims in their original complaint, the
defendants' contention is that this case presents a federal
question because the plaintiffs' state law claims are based on
interpretation of a federal contract, thereby invoking federal
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common law issues.
Federal question jurisdiction may exist over claims arising
under federal common law. See Illinois v. City of Milwaukee, 406
U.S. 91, 100, 92 S. Ct. 1385, 1391, 31 L. Ed. 2d 712 (1972) (noting
"[w]e see no reason not to give "laws' its natural meaning, and
therefore conclude that § 1331 jurisdiction will support claims
founded upon federal common law as well as those of a statutory
origin."); Sam L. Majors Jewelers, 117 F.3d at 926 (same). In
such circumstances, where the cause of action is not itself created
by federal statutory law, the existence of federal question
jurisdiction depends on an evaluation of the nature of the federal
interest at stake. See Merrell Dow Pharm., Inc. v. Thompson, 478
U.S. 804, 814 n. 12, 106 S. Ct. 3229, 3235 n. 12, 92 L. Ed. 2d 650
(1986) (highlighting importance of nature of federal issue in
relation to existence of federal-question jurisdiction).
In suits between private parties, federal common law exists
in the narrow class of cases where federal rules are necessary to
protect uniquely federal interests which the application of state
law would frustrate. Miree v. DeKalb County, Georgia, 433 U.S. 25,
31, 97 S. Ct. 2490, 2494-95, 53 L. Ed. 2d 557 (1977); Jackson v.
Johns-Manville Sales Corp., 750 F.2d 1314, 1327 (5th Cir.1985)
(citing Miree for proposition that "[d]isplacement of state law is
primarily a decision for Congress....").1 According to the United
1
Federal common law also exists where necessary to protect
federal proprietary interests in suits involving the United
States or its officers, Clearfield Trust Co. v. United States,
318 U.S. 363, 366-67, 63 S. Ct. 573, 574-75, 87 L. Ed. 838 (1943),
and where Congress has given the courts the power to develop
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States Supreme Court, these instances are "few and restricted."
Wheeldin v. Wheeler, 373 U.S. 647, 651, 83 S. Ct. 1441, 1444-45, 10
L. Ed. 2d 605 (1963). In Texas Indus., Inc. v. Radcliff Materials,
Inc., the Court explained this restriction:
[A]bsent some congressional authorization to formulate
substantive rules of decision, federal common law exists only
in such narrow areas as those concerned with the rights and
obligations of the United States, interstate and international
disputes implicating the conflicting rights of States or our
relations with foreign nations, and admiralty cases. In these
instances, our federal system does not permit the controversy
to be resolved under state law, either because the authority
and duties of the United States as sovereign are intimately
involved or because the interstate or international nature of
the controversy makes it inappropriate for state law to
control.
451 U.S. 630, 641, 101 S. Ct. 2061, 2067, 68 L. Ed. 2d 500 (1981)
(footnotes omitted). The Fifth Circuit more recently restated this
rationale in MCI Telecomm. Corp. v. Credit Builders of Am.,
endorsing a "cautious approach with respect to the recognition of
federal common law." 980 F.2d 1021, 1022-23 (5th Cir.)
(criticizing and declining to follow Ivy Broadcasting Co. v.
American Tel. & Tel., 391 F.2d 486 (2d Cir.1968)), cert. granted
and judgment vacated, 508 U.S. 957, 113 S. Ct. 2925, 124 L. Ed. 2d
676, orig. opinion reinstated on remand, 2 F.3d 103 (5th Cir.),
substantive law. See, e.g., Texas Indus., Inc. v. Radcliff
Materials, Inc., 451 U.S. 630, 642, 101 S. Ct. 2061, 2067-68, 68
L. Ed. 2d 500 (1981) (explaining that "[f]ederal common law also
may come into play when Congress has vested jurisdiction in the
federal courts and empowered them to create governing rules of
law."). In addition, admiralty and maritime cases are governed
by federal common law because of the strong federal interest in
such matters. See, e.g., Kossick v. United Fruit Co., 365 U.S.
731, 81 S. Ct. 886, 6 L. Ed. 2d 56 (1961); Chelentis v. Luckenbach
S.S. Co., 247 U.S. 372, 38 S. Ct. 501, 62 L. Ed. 1171 (1918);
Southern Pac. Co. v. Jensen, 244 U.S. 205, 37 S. Ct. 524, 61 L. Ed.
1086 (1917).
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cert. denied, 510 U.S. 978, 114 S. Ct. 472, 126 L. Ed. 2d 424 (1993).
The defendants' argument that federal common law governs all
contracts to which Freddie Mac or Fannie Mae is a party fails
because such contracts do not necessarily fall within the narrow
class of cases governed by federal common law. The plaintiffs here
sued as third party beneficiaries of the contracts between the
defendants and Fannie Mae and Freddie Mac. The defendants removed
the case to federal court, pinning their federal jurisdictional
hopes on the theory that these are government contracts which
necessarily involve interpretation of federal law. Fannie Mae and
Freddie Mac, however, are both shareholder-owned corporations in
which the United States has no ownership interests. See Mendrala
v. Crown Mortg. Co., 955 F.2d 1132 (7th Cir.1992) (noting that
government has no ownership interest in Freddie Mac, does not
control Freddie Mac, appoints only a minority of Freddie Mac's
directors, and makes no appropriations to Freddie Mac).2 As such,
2
In response to frequently asked questions, Freddie Mac has
posted the following on its world wide web home page:
5) Is Freddie Mac a government agency?
No. Congress chartered Freddie Mac with a special
mission, but the government has no ownership interest
in the company. Freddie Mac receives no federal funds.
In fact, we pay federal taxes. Freddie Mac is owned by
its shareholders and, like other corporations, is
accountable to its shareholders and a board of
directors. Freddie Mac's board of directors consists
of 18 members (13 are elected each year by
stockholders; the other five are appointed by the
President of the United States). Anyone can own
Freddie Mac stock, which is traded on the New York and
Pacific Stock Exchanges.
FAQ About Freddie Mac (visited Oct. 14, 1997)
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the defendants' contracts with Fannie Mae and Freddie Mac are not
"government contracts" because the United States is not a party to
those contracts. Consequently, this case does not concern rights
or obligations of the United States as required for the creation of
federal common law.
The defendants cite various district court cases from other
circuits for the proposition that federal common law governs all
contracts to which Freddie Mac or Fannie Mae is a party; however,
these cases are readily distinguishable from the present case. In
each of those cases, Freddie Mac was a party to the lawsuit,
whereas neither Freddie Mac nor Fannie Mae is a party to the
present case. See Dupuis v. Federal Home Loan Mortg. Corp., 879
F. Supp. 139 (D.Me.1995); Federal Home Loan Mortg. Corp. v. Dutch
Lane Assoc., 810 F. Supp. 86 (S.D.N.Y.1992); Federal Home Loan
Mortg. Corp. v. Nazar, 100 B.R. 555 (D.Kan.1989).3 Furthermore,
. Similarly, Fannie
Mae has posted the following on its home page:
The corporation's policies are established by an 18-
member board of directors. Thirteen of these directors
are elected by the shareholders and the remaining five
are appointed by the President of the United States.
The day-to-day management of Fannie Mae and its 3,400
employees is conducted by the corporation's
officers.... Fannie Mae is a tax-paying corporation,
owned entirely by private stockholders. Its stock is
traded on the New York Stock Exchange and other major
exchanges....
Fannie Mae—Housing America—Ownership and Management (visited
Oct. 14, 1997)
.
3
Although these cases involved Freddie Mac, the defendants
argue by analogy that the rationale of these cases is equally
applicable to Fannie Mae because both Freddie Mac and Fannie Mae
9
Congress explicitly vested jurisdiction in the district courts over
cases to which Freddie Mac is a party. See 12 U.S.C.A. § 1452(f)
(1997) ("[A]ll civil actions to which the Corporation is a party
shall be deemed to arise under the laws of the United States, and
the district courts of the United States shall have original
jurisdiction of all such actions, without regard to amount or
value...."). If Congress intended this jurisdictional grant to
extend to all cases that merely involve Freddie Mac securities
simply by virtue of that involvement and without regard to whether
Freddie Mac is a party, Congress would have said so.
Similarly, although some cases have found that federal
question jurisdiction exists where plaintiffs sue as third-party
beneficiaries of private contracts necessarily involving
interpretation of federal law, the cases that the defendants cite
distinguish themselves because they involved agreements entered
into directly pursuant to an Executive Order, see Terry v. Northrup
Worldwide Aircraft Svcs., 786 F.2d 1558, 1560-61 (11th Cir.1986)
("Since federal law controls the enforcement and construction of
executive order conciliation agreements, resolution of appellees'
cause of action, based on their status as third-party beneficiaries
of the agreement, will require interpretation and application of
federal law.") (quoting Eatmon v. Bristol Steel & Iron Works, 769
F.2d 1503, 1517 (11th Cir.1985)), or an Administrative Order on
Consent. See Amoco Chem. Co. v. Tex Tin Corp., 902 F. Supp. 730,
are federally chartered and highly regulated. We accept this
analogy for purposes of our analysis in this case.
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735 (S.D.Tex.1995). In contrast, in the present case, the
government did not direct Fannie Mae or Freddie Mac to enter into
purchase and sale agreements with the defendants. Instead, the
Fannie Mae and Freddie Mac congressional charters merely enabled
Fannie Mae and Freddie Mac to enter into such contracts, thereby
detracting from the propriety of exercising federal question
jurisdiction in this case.
This case is not one of the "few and restricted" cases
involving a genuine federal question because it does not involve
the rights and obligations of the United States, interstate or
international issues implicating the conflicting rights of states,
or foreign relations. See Texas Indus., 451 U.S. at 641, 101 S.Ct.
at 2067; MCI, 980 F.2d at 1022-23. Although Congress chartered
Fannie Mae and Freddie Mac to establish secondary mortgage markets
subject to federal regulation, the mere fact that the United States
has an interest in regulating the secondary mortgage market does
not in itself justify federal question jurisdiction in every case
involving these federally regulated entities. See Miree, 433 U.S.
at 31, 97 S.Ct. at 2494-95 (refusing to create federal common law,
despite strong federal regulatory interest in aviation safety, due
to absence of "significant conflict between some federal policy or
interests and the use of state law.").4
4
In Miree, a victim of a plane crash and the survivors of
deceased passengers sought to recover from DeKalb County,
Georgia, as third-party beneficiaries of a contract between the
Federal Aviation Administration and DeKalb County, alleging that
the county had breached its contractual obligation to maintain a
safe environment for the airport. Miree, 433 U.S. at 26-27, 97
S.Ct. at 2492-93. Despite a strong federal regulatory interest
11
This Court's policy of taking a cautious approach to the
recognition of federal common law also supports our conclusion that
federal question jurisdiction does not exist in this case. See MCI
980 F.2d at 1022-23. That Congress has legislated in an area does
not, without more, confer subject matter jurisdiction on federal
courts regarding all matters requiring interpretation of that
legislation. Chuska Energy Co. v. Mobil Exploration & Producing
North America, Inc., 854 F.2d 727, 730 (5th Cir.1988). Finding
federal question jurisdiction under the circumstances presented
here would mean that any time Congress takes steps to regulate or
stabilize a particular market, federal question jurisdiction would
exist regarding any controversy related to that market, no matter
how far removed from federal rights and obligations. State court
is the proper forum for these private parties to adjudicate their
dispute. There is no reason to presume that the federal interest
in preserving a stable secondary mortgage market would be
threatened or frustrated by allowing the state courts to resolve
purely private disputes only tangentially related to those federal
interests. State courts routinely adjudicate actions involving
related federal issues, and there is no danger of erroneous or
inconsistent construction each time a state court adjudicates these
questions in common-law or state statutory actions. Id.
in aviation safety, the Court refused to create federal common
law because there was no evidence of a "significant conflict
between some federal policy or interests and the use of state
law." Id. at 31, 97 S.Ct. at 2495 (quoting Wallis v. Pan Am.
Petroleum Corp., 384 U.S. 63, 68, 86 S. Ct. 1301, 1304, 16 L. Ed. 2d
369 (1966)).
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Conclusion
The facts presented here are not appropriate for federal
question jurisdiction because the case does not arise under federal
law. This case is not within the narrow class of private disputes
appropriate for the creation of federal common law by virtue of
uniquely federal interests that would be frustrated by the
application of state law. Accordingly, we REVERSE the district
court's denial of plaintiffs' motion to remand to state court and
REMAND to the district court with instructions to remand the case
to the state court.
REVERSED and REMANDED.
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