Royalty Alliance, Inc. v. Tarsadia Hotel, Slip Copy, No. 09CV2739DMS CAB, 10CV1231 DMS CAB, 2010 WL 3339202 (S.D. Cal. Aug 23, 2010).

A District Court in California remanded the action to state court holding that it cannot consider two similar actions together to see if CAFA requirements are met when there is a colorable basis for dividing up the lawsuits.

The plaintiff, Royalty Alliance, brought a class action in state court for alleged violations of California securities laws committed in connection with the sale of condominium units in the Hard Rock Hotel San Diego (“HRHSD”). (While we have not been to the Hard Rock Hotel San Diego, we have partied in other Hard Rock Hotels, and it is pretty cool).

Some defendants removed the matter to the federal court asserting diversity jurisdiction under CAFA and federal question jurisdiction under Securities Act of 1933.  The remaining defendants joined the removal.  

The plaintiff filed a motion to remand the action to state court. Some of the defendants filed a motion to consolidate this actionwith a similar action–Salameh v. Tarsadia Hotel, 09cv2739 DMS (CAB), which contained claims for both state and federal securities laws violations committed in connection with the sale of condominium units at HRHSD. 

The District Court granted the plaintiff’s motion and denied the motion to consolidate.

The defendants did not contend that Royalty Alliance had more than 100 plaintiffs or $5 million in claims.  Rather, the defendants argued the proposed class in Royalty Alliance was merely a subclass of the Salameh action, and that when considering the two actions together, the requirements of CAFA were met. (Clever argument).

The defendants, citing Freeman v. Blue Ridge Paper Prods., 551 F.3d 405 (6th Cir. 2008), argued that the plaintiffs were trying to “game the system” by artificially splitting their class action to avoid CAFA jurisdiction.  (Editors’ Note:  See the CAFA Law Blog analysis of Freeman posted on February 17, 2009).

In Freeman, the court determined that the five lawsuits having identical claims for $4.9 million each should be combined when examining CAFA jurisdiction because “CAFA was clearly designed to prevent plaintiffs from artificially structuring their suits to avoid federal jurisdiction.”  The Freeman court went on, however, to limit its holding “to the situation where there is no colorable basis for dividing up the sought-for retrospective relief into separate time periods, other than to frustrate CAFA.”

This Court observed that Royalty Alliance had, however, a different class of plaintiffs than Salameh.  In Salameh, the proposed class members were individuals who purchased a condominium unit in HRHSD, whereas, in Royalty Alliance, the proposed class members comprised individuals who attempted to purchase a condominium unit at HRHSD but, after putting down a deposit, were unable to complete the purchase.  Royalty Alliance also contained three state law claims not present in Salameh.  Thus, the Court concluded that while similarities existed between the claims, there was a colorable basis for dividing up the lawsuits as the plaintiffs had done. Accordingly, combining the two matters for purposes of determining CAFA jurisdiction was unwarranted.

Next, considering if it had federal question jurisdiction, the Court noted that although several allegations within the Royalty Alliance complaint referred to the Securities Act, the plaintiff did not assert a claim against the defendants for violation of the Securities Act, and all the seven claims asserted were state law claims.  Thus, the Court concluded that the allegations did not indicate that federal law formed the basis of the plaintiff’s claims.

The defendants further argued federal question jurisdiction existed under the “artful pleading” doctrine, under which “a plaintiff may not defeat removal by omitting to plead necessary federal questions in a complaint.” The defendants argued that the case necessarily implicated resolution of federal issues because federal securities laws were relied upon to support the plaintiff’s claims.  The defendants contended that the matter turned on the definition of a security, which is set forth in federal securities laws, that California courts apply federal law in determining whether a transaction is an investment contract, and the California securities laws are modeled on federal securities laws.

Rejecting the defendants’ arguments, the Court remarked that California has its own securities laws distinct from the federal laws.  In determining whether a transaction is an “investment contract” under California securities laws, courts use either the same test as that applied under federal law or a “risk-capital test,” a test established by the California Supreme Court.  Thus, the Court concluded that determination of whether the transaction here fell under the securities laws was not necessarily federal in character, nor did it turn on the resolution of a substantial, disputed federal question.