In the case of Massachusetts Mutual Life Insurance Co. v. Ludwig, Administrator (1975), the U.S Supreme Court was tasked with determining whether a federal court in a diversity action should apply state law or federal common law when deciding if an insurance company can be held liable for punitive damages due to fraudulent misrepresentation by its agent. The lower courts had ruled that under Arkansas law, which governed this case, punitive damages could not be awarded against the insurer unless it participated in or ratified its agent's fraud. However, they also found that under federal common law principles of agency liability, such participation or ratification was not necessary and thus upheld an award of punitive damages against Massachusetts Mutual Life Insurance Company based on their agent’s actions alone. The Supreme Court reversed these decisions and remanded the case back to district court for further proceedings consistent with its opinion. It held that since there is no significant conflict between any substantive policy embodied in Federal Rule 17(b) and Arkansas' rule limiting corporate liability for punitive damages arising from an employee's fraud to cases where the corporation authorized or ratified his conduct; therefore state rather than federal rules must govern this issue.

In the dissenting opinion for Massachusetts Mutual Life Insurance Co. v. Ludwig, Justice William O. Douglas argued that the majority's decision to allow a state court to impose its own interpretation of an insurance policy over that of a federal court was incorrect and violated principles of federalism. He contended that when there is no clear state law on an issue, it should be left up to the federal courts to interpret based on their best judgment rather than deferring automatically to any subsequent interpretations by state courts. This approach would ensure uniformity in decisions across different jurisdictions and prevent forum shopping where parties choose specific courts because they believe those will rule favorably for them.