Despite the mandate in section 34 of the Judiciary Act of 1789 that federal courts apply state law in diversity cases, the U.S. circuit courts in the antebellum years gradually developed their own set of rules governing commercial transactions, particularly with respect to the negotiability of commercial instruments. In Swift v. Tyson, a case involving a bill of exchange through which a resident of New York was indebted to a resident of Maine, the Supreme Court held that only state statutes, and not the decisions of the New York state courts, constituted the “state law” that federal courts were bound to apply in diversity cases. With respect to questions not governed by statute, the Swift decision held that federal courts possessed the authority to interpret and apply general commercial law, thus dramatically expanding federal judicial power. In the decades that followed, many plaintiffs involved in interstate commerce viewed this “federal common law” as more sympathetic to their interests and a further incentive to invoke diversity jurisdiction and file suit in federal court.

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Cases that Shaped the Federal Courts: Erie Railroad Co. v. Tompkins (1938)