Klaxon Co. v. Stentor Electric Manufacturing Co.

Background

A New York corporation transferred its business to a Delaware corporation under a contract made and begun in New York. Ten years later the New York company sued in federal court in Delaware, saying the Delaware company broke the agreement. A jury awarded money, and the New York company asked to add interest from the date the case began based on a New York statute that makes interest part of contract recoveries.

Reasoning

The Court addressed whether a federal court sitting in a state must follow that state’s conflict-of-law rules instead of independently applying some general rule. The Justices said the Erie principle — that federal courts must not create their own general rules that differ from state law — extends to conflict-of-law questions. Therefore the federal court in Delaware must follow the conflict rules that Delaware’s courts would use. The Court also explained that the full faith and credit clause did not force Delaware to apply the New York interest statute here because that statute concerned an incidental item of damages, not the contract’s validity.

Real world impact

The Supreme Court reversed the award of automatic New York interest and sent the case back so the lower courts can decide under Delaware law. Going forward, federal courts hearing cases with parties from different states must use the forum state’s approach to decide which state’s law applies, including rules about damages and interest. This reduces the chance that diversity of citizenship alone will produce different legal results between state and federal courts in the same place.