Category: Constitutional Law

Employee’s Deactivation Of Facebook Account Leads To Sanctions

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The latest Facebook case highlights how courts now intend to hold parties accountable when it comes to preserving their personal social media accounts during litigation.  Recently, a federal court ruled that a plaintiff’s deletion of his Facebook account during discovery constituted spoliation of evidence and warranted an “adverse inference” instruction against him at trial.  Gatto v. United Airlines and Allied Aviation Servs., et al. , No. 10-CV-1090 (D.N.J. March 25, 2013).

The plaintiff, a ground operations supervisor at JFK Airport, allegedly suffered permanent disabling injuries from an accident at work which he claimed limited his physical and social activities.  Defendants sought discovery related to Plaintiff’s damages, including documents related to his social media accounts.

Although Plaintiff provided Defendants with the signed authorization for release of information from certain social networking sites and other online services such as eBay, he failed to provide an authorization for his Facebook account.  The magistrate judge ultimately ordered Plaintiff to execute the Facebook authorization, and Plaintiff agreed to change his Facebook password and to disclose the password to defense counsel for the purpose of accessing documents and information from Facebook.  Defense counsel briefly accessed the account and printed some portion of the Facebook home page.  Facebook then notified Plaintiff that an unfamiliar IP address had accessed his account.   Shortly thereafter, Plaintiff “deactivated” his account, causing Facebook to permanently delete the account 14 days later in accordance with its policy.

Defendants moved for spoliation of evidence sanctions, claiming that the lost Facebook postings contradicted Plaintiff’s claims about his restricted social activities.  In response, Plaintiff argued that he had acted reasonably in deactivating his account because he did know it was defense counsel accessing his page.  Moreover, the permanent deletion was the result of Facebook’s “automatically” deleting it.  The court, however, found that the Facebook account was within Plaintiff’s control, and that “[e]ven if Plaintiff did not intend to deprive the defendants of the information associated with his Facebook account, there is no dispute that plaintiff intentionally deactivated the account,” which resulted in the permanent loss of  relevant evidence.  Thus, the court granted Defendants’ request for an “adverse inference” instruction (but declined to award legal fees as a further sanction).

The Gatto decision not only affirms that social media is discoverable by employers, but also teaches that plaintiffs who fail to preserve relevant social media data will face harsh penalties.  Employers are reminded to specifically seek relevant social media (Facebook, Twitter, blogs, LinkedIn accounts) in their discovery requests since such sources may provide employers with sufficient evidence to rebut an employee’s claims.  This case also serves as a reminder and a warning to employers that the principles of evidence preservation apply to social media, and employers should take steps very early in the litigation to preserve its own social media content as it pertains to the matter.

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Warning to in-house Counsel: Be Careful When Responding to Demand Letters

Drinker Biddle & Reath LLP‘s Jerrold J. Wohlgemuth recently had an article, Warning to in-house Counsel: Be Careful When Responding to Demand Letters, featured in The National Law Review:

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It’s a common occurrence: counsel sends a demand letter to an employer explaining the basis for his/her client’s claim of discrimination or wrongful discharge, and threatening to sue, but offering to discuss settlement in advance of filing a complaint.  In-house counsel responds by explaining why the claim has no merit, but expressing a willingness to discuss settlement, with the understanding that in the event of litigation the correspondence would be inadmissible under Evidence Rule 408 as a communication concerning settlement.  It says so right in the Rule:  “a statement made during compromise negotiations about the claim” is inadmissible “to prove or disprove the validity or amount of a disputed claim.”  But the U.S. District Court for the District of New Jersey has reminded us that is not always the case.

In its recent decision in Bourhill v. Sprint Nextel Corp., the District Court affirmed the decision of the magistrate judge allowing the plaintiff in his cross-motion for summary judgment to rely on a portion of in-house counsel’s response to a demand letter.  In that case, the demand letter first described the factual basis for the contention that the employee’s discharge was unlawful under the New Jersey Law Against Discrimination, and then set forth counsel’s position that while he believed the case had merit, his client was willing to avoid litigation if the matter could be resolved by means of an “adequate compensatory settlement.”  In-house counsel wrote a two paragraph response under the subject line caption “Confidential/For Settlement Purposes Only.”  In the first paragraph in-house counsel denied that the discharge was unlawful and explained in factual detail that it had been made for legitimate non-discriminatory reasons.  The second paragraph expressed an interest in discussing an amicable resolution and requested a specific demand.  In the ensuing litigation, plaintiff’s counsel relied on the letter as an exhibit in his cross-motion for summary judgment, and defense counsel moved to strike.

Before moving on to discuss the decision of the magistrate judge it is important to recognize that in-house counsel responded in the normal, customary fashion when responding to a demand letter of this type.  It is the magistrate judge’s decision, and the subsequent decision of the District Court discussed in the next part, that should give every in-house counsel pause when responding to any demand letter.

The magistrate judge granted the defendant’s motion to strike with respect to the second paragraph inasmuch as it clearly invited plaintiff’s counsel to make an offer to settle, but denied it as to the first.  In this regard, the magistrate judge determined that the two parts of the letter were not “logically connected” and could therefore be evaluated separately because the first was addressed to the merits of the claim articulated in the demand letter while the second concerned the offer to compromise.  The magistrate judge then found that the first paragraph did not implicate Rule 408 because it did not “contain an actual compromise or a suggestion of a genuine willingness to resolve the dispute.”

On appeal, defense counsel argued that the letter should be read in its entirety as a response to the settlement inquiry, that the first paragraph was designed to make clear that the company did not place a high monetary value on the claim, and that public policy requires that the parties be free to express their positions in settlement communications without fear they will be used to prove liability.  The District Court did not disagree, but affirmed the decision of the magistrate judge based on the conclusion that he had simply made a finding of fact – that the paragraphs were not “logically connected” – which could not be overturned on appeal.

This is not the first time a court has determined that a portion of a communication otherwise covered by Rule 408 may be admitted into evidence because it did not directly address the subject of settlement.  But the decision should serve as a reminder to in-house counsel to be extremely careful when responding to demand letters, to avoid including any facts, statements or admissions that could be difficult to explain in litigation and to make clear in each paragraph that it has been written in response to the demand letter for the limited purpose of exploring the possibility of settlement.

©2013 Drinker Biddle & Reath LLP

Restrictions on Digital Billboards Are Valid Under the First Amendment

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A municipal zoning ordinance that restricts the placement of digital billboards does not violate an advertiser’s right to free speech, according to a recent decision  by the U.S. District Court for the Western District of Michigan in Hucul Advertising, LLC v. Charter Township of Gaines, No. 1:11-cv-682 (Bell, J.).  The lawsuit follows an earlier, unsuccessful lawsuit by Hucul against the Township that was the subject of an earlier blog post.

The case involves the outdoor advertising company’s challenge of a Township ordinance under the First Amendment to the U.S. Constitution.  The ordinance requires that billboards be placed next to a local highway and that digital billboards be placed more than 4,000 feet apart from one another.  Hucul filed the lawsuit after the Township denied the company’s application to erect digital billboards that did not conform with the ordinance.

In granting summary judgment for the Township, the Court explained that a municipality may place valid limits on the “time, place, and manner” of speech provided:

(1) that they are justified without reference to the content of the regulated speech, (2) that they are narrowly tailored, (3) to serve a significant governmental interest, and (4) that they leave open ample alternative channels for communication of the information.

Applying this test, the Court found that the restrictions in the ordinance were valid.  The ordinance: (1) did not distinguish between commercial and non-commercial speech; (2) was “content neutral”—i.e. they didn’t depend on the message being displayed on the billboard; (3) furthered the Township’s interest in traffic safety and community aesthetics; and (4) was a reasonable fit with the Township’s goals.  Further, the Court emphasized the fact that the ordinance did not restrict Hucul from communicating its speech through alternate channels.

© 2012 Varnum LLP

Eleventh Circuit Strikes Down Provisions of Controversial State Immigration Laws

The National Law Review recently published an article by Natalia S. Ballinger of Greenberg Traurig, LLP regarding State Immigration Laws:

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On August 21, the U.S. Court of Appeals for the Eleventh Circuit struck down several provisions of Alabama and Georgia’s controversial immigration statutes, HB 56 and HB 87, respectively.

Specifically, the court blocked four provisions of HB 56, including the requirement that public schools investigate students’ immigration status and a provision that makes it a crime for illegal immigrants to solicit work. The court found that the statute impermissibly interfered with children’s constitutional right to education and further ruled against the state’s measure to criminalize the failure to carry immigration documents and the transporting or harboring of undocumented immigrants. In addition, the provision invalidating contracts with undocumented immigrants was also rejected by the court.

The court also struck down Section 7, a key part of HB 87 which criminalized harboring or assisting undocumented immigrants, on the grounds that it undermined federal law by “present[ing] an obstacle to the execution of the federal statutory scheme and challeng[ing] federal supremacy in the realm of immigration.”

Notably, the court upheld several provisions of both laws, including the right of police officers to check the immigration status of individuals who are suspected of a crime.

©2012 Greenberg Traurig, LLP

U.S. Supreme Court’s Affordable Care Act Decision: Impacts on Life Sciences

The National Law Review recently published an article by Robyn S. Shapiro of Drinker Biddle & Reath LLP, regarding the U.S. Supreme Court’s Affordable Care Act Decision:

The June 28, 2012 U.S. Supreme Court decision upholding the Patient Protection and Affordable Care Act (“Act”) impacts the life sciences industry in a number of ways, including impacts on innovation and compliance initiatives by medical device, pharmaceutical, and biotechnology companies.

Innovation

A number of provisions in the Act provide incentives and resources for product innovation.  First, it is expected that more than 30 million Americans will obtain health care coverage on account of the Act.  A bigger pool of Americans with health coverage to pay for treatment will yield growth in pharmaceutical sales and, perhaps, the ability to charge higher drug prices, which, in turn, could spur innovation.  In addition, the Act created the Therapeutic Discovery Project Program, through which $1 billion in new therapeutic discovery project grants and tax credits will be awarded.  In 2010, 2,923 companies specializing in biotechnology and medical research in 47 states and the District of Columbia received awards under the grant program.  Firms can opt to receive either a grant or a tax credit under the program, which allows both profitable companies and start-ups that are not yet profitable to benefit.  A third measure in the Act likely to have a positive impact on innovation is a provision that gives biotech companies a dozen years of exclusive rights to the data underpinning their products.

On the other hand, the ruling leaves intact a 2.3% excise tax on medical devices, which is estimated to cost the industry $20 billion over the next 10 years, and which manufacturers fear will burden innovation.  On the other hand, some believe that, as in the case of pharmaceutical manufacturers, expansion of health care coverage will increase the demand for medical devices and offset the effect of the tax.

The Supreme Court ruling affects not only the speed but also the direction of life sciences product innovation.  PricewaterhouseCoopers[1] has identified five broad pillars of medical technology innovation: financial incentives (such as reimbursement for adoption of new technologies), resources for innovation (such as academic medical centers), a supportive regulatory system, demanding and price-insensitive patients, and a supportive investment community of venture capitalists and other investors.  Various provisions in the Act promote the development of more cost-effective ways of delivering care, including a measure that calls for more real-world evidence of a new drug’s superiority over other treatments in order to qualify for reimbursement.  Such provisions may spur more definitive product innovation, as opposed to production of “me too” drugs and new devices that make only modest improvements to existing products.

Compliance

Certain provisions in the Act impact compliance initiatives in the life sciences industry.  The Act includes “Sunshine Provisions,” which require pharmaceutical and medical device manufacturers to track and report payments and other transfers of value greater than $10 to physicians and teaching hospitals.  While under prior laws improper industry-provider relationships primarily were uncovered by whistleblowers and government investigations, the Sunshine Provisions place the onus on life sciences manufacturers to disclose their relationships with providers, for review by others.  This enhanced transparency and data accessibility could result in sharper scrutiny by enforcement agencies of information about improper relationships and violations of fraud and abuse laws.  Moreover, other provisions in the Act enhance the government’s ability to pursue violations of existing fraud and abuse laws–e.g., revisions to the intent requirement of the Anti-Kickback Statute; and strengthening of fraud enforcement tools through changes to the False Claims Act, civil monetary penalty laws, sentencing guidelines and exclusion authority, and dedication of $250 million for fraud and abuse enforcement.  These changes will require life sciences companies to carefully structure and manage relationships with providers, and ensure that their compliance initiatives include efficient and effective operating procedures for tracking and reporting payments, educating and training sales and research personnel, and auditing and monitoring provider relationships.

[1] PricewaterhouseCoopers, Medical Technology Innovation Scoreboard: the Race for Global Leadership, January 2011.

©2012 Drinker Biddle & Reath LLP

Illuminating the “Invisible Branch” – the Supreme Court

The National Law Review recently featured an article by Health Government Relations Team of Drinker Biddle & Reath LLP regarding the Supreme Court:

While Congress’ deliberations over policy dominate the news, the Supreme Court often flies under the radar of the American people, unless there is a major case before it. Many Americans are not well-versed in the Supreme Court’s dealings; in fact, a Pew Research Center political knowledge survey found that in July 2010 only 28% of Americans polled could correctly identify John Roberts as the Chief Justice of the Court. As much of the health policy world’s attention is focused on the Supreme Court due to the Affordable Care Act case (Department of Health and Human Services, et al. v. Florida, et al.), below is a refresher on Supreme Court procedure and why there will be months of silence from the Court between the oral arguments and the announcement of the Court’s decision.

First, a few Supreme Court basics. The Supreme Court’s term begins on the first Monday in October and lasts for a year. The Court is typically in recess from late June or early July until the end of the term in October. The current term began on Monday, October 3, 2011, and will be wrapping up business for this term over the next two months. The next term will begin on Monday, October 1, 2012.

Each week when the Court is in session, the Justices hold a conference. Only the Justices are allowed in the room, and as a testament to the collegiality of the Court, each conference begins with each Justice shaking hands with every other Justice. During conferences, the Justices review petitions for certiorari or, in other words, decide which cases the Court will hear. The Justices then review the cases heard previously that week. Each Justice, beginning with the Chief Justice and going in order of seniority (who has been on the court the longest), is given time to state his or her views and raise any questions without interruption. Each Justice, in seniority order, then casts a preliminary vote on the case. In the case of the health reform arguments, which were heard March 26-28, the Justices met in conference to discuss the case and cast their votes on Friday, March 30.

So, if the votes have been cast and an outcome decided, why has there been no announcement of a decision yet? What has been going on since March 30?

After the votes are cast, the Court must then produce documents that state the Court’s reasoning for deciding a certain way. If the Chief Justice is in the majority (generally an opinion five or more Justices join), he or she assigns who will write the opinion. If the Chief Justice dissents from the majority opinion, the senior-most associate Justice in the majority assigns the opinion. The Chief Justice or most senior Justice may choose to write the opinion him or her self. Likewise, the most senior Justice in the minority assigns who will write the dissenting opinion. Dissenting opinions carry no legal weight or precedent, but might lay groundwork for future cases. Additionally, any Justice may write a concurring opinion, and anyone can write a separate dissenting opinion should they agree with the ruling but for a different rationale. In the case of a tie vote, which might happen if there is a vacant seat or if a Justice recuses themselves from the case, the decision of the lower court stands. In this situation, the case is not considered to be binding precedent.

Once the opinions have been drafted, they are circulated to all the other Justices for comments and recommended changes. If a Justice in the majority agrees with the outcome expressed but disagrees with the argument in the drafted opinion, they may write their own concurring opinion or, at anytime before the Court’s opinion is handed down, they may switch their vote. In some controversial cases, the outcome of the case has actually reversed from what the original outcome would have been, due to Justices flipping their vote. Then once the draft has been revised, the opinion is signed by the author. Other Justices who are in agreement then “sign on” to the opinion, and the verdict is subsequently made public.

In regard to the timing of decision announcements, there are no rules other than it must be released by the last day of term (before the Court goes into recess in June or July). Unanimous or less contentious decisions generally take less time than cases on more controversial subjects. Given the weight and attention given to the health reform cases, a decision is not expected until late in the term, with most people predicting an announcement coming June 21st, 25th or 28th.

©2012 Drinker Biddle & Reath LLP

Are Bloggers’ Free Speech Rights Under Attack?

The National Law Review recently published an article by Jesse L. Jenike-Godshalk of Dinsmore & Shohl LLP regarding Blogger’s Free Speech:

A recent legal opinion has some concerned about just how broad free speech rights may be for bloggers who are not associated with institutional media, such as newspapers and television stations. In Obsidian Finance Group, LLC v. Cox, No. CV-11-57-HZ, slip op. (D. Or. Nov. 30, 2011), a federal judge ruled that a self-proclaimed “investigative blogger” was not “media” and, therefore, was not entitled to certain First Amendment protections that are reserved for the media.Despite the alarm that this case has generated, it actually is not a major setback for the free speech rights of bloggers.

The Case: Obsidian Finance Group, LLC v. Cox

From late 2010 to early 2011, Crystal Cox made numerous blog posts in which she accused Obsidian Finance, LLC and one of the company’s senior principals, Kevin Padrick, of corrupt, fraudulent, and illegal conduct. Obsidian and Padrick subsequently sued Cox for defamation. Rather than hiring an attorney, Cox chose to defend pro se.

In August 2011, before the case went to trial, the judge granted summary judgment to Cox with regard to all but one of her blog posts, because the posts were statements of opinion protected by the First Amendment. See Obsidian Finance Group, LLC v. Cox, No. CV-11-57-HZ, slip op. (D. Or. Aug. 23, 2011). A statement, such as a blog post, can be the basis for a defamation suit only if the statement is a provable assertion of fact. In contrast, statements of opinion are protected by the First Amendment. According to the judge, blog posts, by their very nature, are usually statements of opinion.

Prior to the trial, the judge still had several issues that he needed to resolve. Among these issues was Cox’s claim that she was “media” and therefore, based on U.S. Supreme Court precedent, the plaintiffs could not recover damages from her for defamation without proof that she was at least negligent in making the allegedly defamatory statements. The judge rejected that Cox was “media,” writing:

Defendant cites no cases indicating that a self-proclaimed “investigative blogger” is considered “media” . . . . Without any . . . authority on the issue, I decline to conclude that defendant in this case is “media” . . . .

Defendant fails to bring forth any evidence suggestive of her status as a journalist. For example, there is no evidence of (1) any education in journalism; (2) any credentials or proof of any affiliation with any recognized news entity; (3) proof of adherence to journalistic standards such as editing, fact-checking, or disclosures of conflicts of interest; (4) keeping notes of conversations and interviews conducted; (5) mutual understanding or agreement of confidentiality between the defendant and his/her sources; (6) creation of an independent product rather than assembling writings and postings of others; or (7) contacting “the other side” to get both sides of a story. Without evidence of this nature, defendant is not “media.”

Obsidian Finance Group, LLC v. Cox, No. CV-11-57-HZ, slip op. at 9 (D. Or. Nov. 30, 2011). Following this ruling, the case went to trial, and the jury found for the plaintiffs, awarding $2.5 million in damages.

Not a Major Setback

Despite the concern that this case has generated, the case is not a major setback for the free speech rights of bloggers, and it can even be regarded as a pro-free speech case. First, some of the judge’s statements suggest that bloggers enjoy expansive First Amendment rights. In his ruling on summary judgment, the judge stated that blog posts, by their very nature, are usually “opinions” and not provable assertions of fact. Such “opinion posts” are protected under the First Amendment and are not actionable as defamation—regardless of whether the writer is “media.”

Second, the judge established a very low bar for what a blogger must do to enjoy the additional free speech protections that are reserved for “media.” To wit, a blogger must present some evidence that he or she is a journalist. Cox lost this issue because she presented no evidence.

The judge provided her with a list of seven types of evidence that she could have offered. This list does not create an exacting standard of proof for a blogger to meet. To be considered “media,” a blogger would not need to offer all seven types of evidence. In fact, a blogger would not necessarily need to offer any of the seven types of evidence. The list is not exhaustive, but is merely “[f]or example.” A blogger must present “evidence of this nature.” Thus, a blogger could prove that he or she is “media” by presenting types of evidence not on the list. In addition, most bloggers probably would be able to present some evidence of the types that are on the list—e.g., “proof of editing,” “keeping notes of conversations,” or “creation of an independent product rather than assembling writings and postings of others.”

Had Cox hired an attorney, the attorney almost surely would have been able to offer some evidence that Cox was “media.” Actually, had Cox hired an attorney, she might have won the entire case on summary judgment—and she would have entirely avoided the issue of whether she was “media.” Herein lies the real lesson from this case: If you are sued for defamation, get yourself an attorney.

© 2012 Dinsmore & Shohl LLP.

High Court: Police Tracking of Suspect Via GPS Requires Warrant

Recently found in The National Law Review an article by Rachel Hirsch of Ifrah Law regarding a recent High Court Decision Requiring a Warrant:

Last November, we discussed the U.S. Supreme Court’s oral argument in United States v. Jones, which posed the question of whether police need to obtain a warrant before attaching a GPS device to a suspect’s vehicle during a criminal investigation.

We noted that in this case, 21st-century technology had come face to face with the constitutional requirements of the Fourth Amendment. We were hoping that the high court would uphold the U.S. Court of Appeals for the D.C. Circuit and hold that this action is a search that requires a warrant, but we took a pass on predicting what the Court would actually do.

On January 23, 2012, the Court decided the case – unanimously against the government and in favor of defendant Antoine Jones. The decision is fairly gratifying for those of us who believe it desirable to curb prosecutors’ power by imposing restrictions upon it, including, where appropriate, the requirement of a judge-issued warrant.

It turns out that both the advocates of the original-intent approach to constitutional interpretation, epitomized here and in general by Justice Antonin Scalia, and those who prefer the doctrine of the “living Constitution,” led here by Justice Samuel Alito, agree that the use of a GPS device by the government constitutes a search and requires a warrant.

Scalia, writing for a majority of the Justices, observed that prosecutors had intruded upon Jones’ property in way that would have been a “trespass” under common law.

Prosecutors “physically occupied private property for the purpose of obtaining information,” Scalia wrote. “We have no doubt that such a physical intrusion would have been considered a ‘search’ within the meaning of the Fourth Amendment when it was adopted.” And for Scalia, that fact alone was enough to decide the case.

Alito, joined by three Justices who concurred in the result, used quite a different line of reasoning and sharply criticized Scalia’s majority opinion, saying that ironically, it relied upon 18th-century tort law to decide a case involving 21st-century technology.

“This holding, in my judgment, is unwise,” Alito wrote. “It strains the language of the Fourth Amendment; it has little if any support in current Fourth Amendment case law; and it is highly artificial.”

Instead, Alito wrote, he “would analyze the question presented in this case by asking whether [Jones’] reasonable expectations of privacy were violated by the long-term monitoring of the movements of the vehicle he drove.” Alito observed that for decades, the Court has invoked the concept of “reasonable expectations of privacy” in a number of cases to define the nature of a “search” under the Fourth Amendment and to expand the definition of “search” to actions that do not involve a trespass to someone’s property.

Even though Alito is often identified with the pro-prosecution, conservative wing of the Court, he took the defendant’s side in this case. As our blog post last November noted, at oral argument Alito expressed concern about how easy it is these days “to amass an enormous amount of information about people” by the use of today’s technology.

Alito’s opinion followed similar lines. In the absence of legislation about police use of GPS tracking, he wrote, “The best that we can do in this case is to apply existing Fourth Amendment doctrine and to ask whether the use of GPS tracking in a particular case involved a degree of intrusion that a reasonable person would not have anticipated.”

This is good news for constitutional rights and for defendants. Whatever approach one takes to the Fourth Amendment, it’s clear that prosecutors can’t attach a GPS to a suspect’s car without a warrant.

© 2012 Ifrah PLLC

Ford Motor Credit Company v. Chesterfield County: Reading Constitutional Fairness And Supply Side Economics Into The Virginia Tax Code

Recently posted in the National Law Review, Winner of the Winter 2011 Student Legal Writing Contest, Adam Blander of Brooklyn Law School wrote an article regarding the recent decision of Ford Motor Credit Company v. Chesterfield County:

In the recent decision of Ford Motor Credit Company v. Chesterfield County,[1] the Virginia Supreme Court held that the gross receipts of a taxpayer’s local business branch reflected activity generated outside of the branch itself, and was therefore not taxable to Chesterfield County as a licensing privilege. This Note argues that despite the rather case-specific and constrictive holding of the decision (which was decided on state-statutory grounds), the facts of the case actually confronted the Court with a much broader, yet more delicate constitutional and public policy determination — what constitutes “fair” tax apportionment of large multi-state businesses?

I. Background: Constitutional Boundaries of State Tax Apportionments

Tax apportionment is the attempt by a governing body to levy taxes based on a corporation’s earned income in that jurisdiction.[2] Almost by definition, “[a]ny state tax apportionment formula will be inaccurate – either overstating or understating the portion of a corporation’s income that should be subject to tax.”[3] Consequently, any formula, at some level, is unfair. In Complete Auto Transit, Inc. v. Brady, the Supreme Court held that the U.S. Constitution required all state taxes affecting multi-state businesses to be, among other things, “fairly apportioned.”[4] In Container Corp. of America v. Franchise Tax Board, the Court explained that a “fairly apportioned” tax must be both “internally” and “externally consistent.”[5] Container directed courts to test for “internal inconsistency” through engaging in a hypothetical exercise: if more than 100 percent of the business’s income would be taxed if every jurisdiction applied the challenged apportionment formula, then formula was internally inconsistent.[6]Internal inconsistency is a facial challenge – the taxpayer need only prove that he faces a “theoretical risk of multiple taxation.”[7] The more elusive element of externalinconsistency, on the other hand, requires the challenged formula to “actually reflect a reasonable sense of how income is generated.”[8]  As such, the taxpayer must show by “clear and cogent evidence that the income attributed to the State is in fact out of all appropriate proportions to the business transacted in that State” or that it “has led to a grossly distorted result.”[9] In Goldberg v. Sweet, the Court clarified that that “[t]he external consistency test asks whether the State has taxed only that portion of the revenues from the interstate activity which reasonably reflects the in-state component of the activity being taxed.”[10]

The practical effect of these Supreme Court decisions is that state courts have been entrusted with the daunting task of determining what constitutes “fair apportionment.” State courts have analyzed challenges to tax schemes utilizing these Supreme Court directives, but have also taken cues from their state’s common law tradition, the state’s own statutory code, and, when possible, the legislative intent of the state’s taxing body. Patrolling for constitutional defects presents an interpretative and political challenge to any court adjudicating tax disputes- how should it reconcile a taxpayer’s right to be free from unfairly apportioned taxes (even if the “unfairness” is entirely theoretical), while at the same time, faithfully interpret the tax systems passed by the legislative body, whose purpose is to collect vital revenue from all taxpayers in its jurisdiction?  This dilemma becomes all the more problematic when the taxpayer is a complex interstate business, which may organize its corporate make-up or accounting scheme in an attempt to avoid payingthese taxes. The Virginia Supreme Court faced such a dilemma in Ford Motor Credit Company.

II. Ford Motor Credit Company v. Chesterfield County: The Facts

In February 2007, Ford Motor Credit Company (FMCC), filed in Virginia circuit court an “Application for Correction of Erroneous Assessment of Business, Profession and Occupation License [“BPOL”] Tax,”[11] claiming it had mistakenly overpaid Chesterfield County, Virginia for the tax years of 2001, 2002, 2003, and 2004. FMCC asserted that its BPOL payments to Chesterfield County, which was based on “the entire gross receipts of loans related to its Richmond branch,”[12] did not actually “reflect the limited contribution of the Richmond Branch to [its] nationwide business.”[13] As such, FMCC sought a refund of $1,515,935.05.[14]

FMCC, a subsidiary of Ford Motor Company, is a “financial services provider, primarily to the automobile purchase or loan lessee environment,” headquartered in Dearborn, Michigan, with hundreds of sales branches throughout the Country, the Richmond branch being one of them.[15] The FMCC headquarters provided the Richmond branch with the capital needed to provide loans, and dictated to the branch “the policies and criteria governing loan approval, contract terms, and other management issues.”[16]

Roughly 75 percent of the branch’s revenue came from “retail and lease contracts,” in which the branch would provide financing to customers wishing to purchase or lease a vehicle from a Ford Motor Company dealership. While the Richmond branch provided the administrative duties necessary to effectuate a loan, such as reviewing the loan application, collecting paperwork and forwarding account information, [17] it generally “did not process funds, receive payments, engage in collection or other customer service activities, or handle delinquent debts.”[18] Upon approval of the loan, the paperwork was forwarded to a service center, in charge of taking title to the vehicle,[19] and the “branch had no further involvement in the loans.”[20] FMCC would then record these loans as receivables in its internal “management, analysis and performance system” (“MAPS”).[21] FMCC would also “book” as revenue any payments due to FMCC. In the event of default on a loan, FMCC would record revenue once the “principle was satisfied on the note.”[22] FMCC paid BPOL taxes based on the gross receipts that MAPS attributed to the Richmond Branch.

FMCC argued that MAPS, in fact, was not an “an activity based system,” but merely a “contract revenue-based system.”[23] In other words, MAPS tracked revenue via the branch in which the loan was originally processed, but was unable to verify which office was actually responsiblefor the specific revenue-generating activities.[24] An FMCC accounting expert testified that it would be “very difficult” to design a system which actually “attribute[d] revenue based on where services are performed.”[25]Accordingly, the BPOL tax assessment, which was based on the gross receipts of “all loans originating in the Richmond Branch” failed to consider the role of other offices in the administering of these loans, including, in particular, the Dearborn headquarters. Because reliance on the gross receipts did not actually reflect revenue collected based on the Richmond branch’s activities, FMCC argued that the BPOL tax, as administered, violated the “fair apportionment prong” for local taxation set forth in Brady.[26] The expert proposed that a BPOL tax based on payroll apportionment would more accurately reflect “all the activities [of the Richmond branch] thatgeneratedrevenues” which, incidentally, would entitle FMCC to a sizable refund.[27]

Unmoved, the circuit court dismissed FMCC’s application with prejudice, finding that the “MAPS figures accurately reflect the gross receipts generated as [a] result of the distinct efforts of the Richmond Branch” and consequently, was not “‘out of all appropriate proportion’ to the business transacted in the locality,” thus satisfyingBrady’s fair apportionment requirement.[28]

III. Ford Motor Credit Company: The Decision

On appeal, the Supreme Court of Virginia reversed the circuit court’s decision, and found for FMCC. Writing for the majority, Chief Justice Cynthia D. Kinser declined to directly address the constitutional challenges under Brady, and instead held that the assessment contravened the Virginia Taxation Code. Nonethless, this Note contends that the decision was not an exercise in “constitutional avoidance”: while the Court did not state so explicitly, it read into the state Tax Code its own value-laden interpretation of what constitutes “fair apportionment,” regardless of whether such an interpretation was a faithful interpretation of the actual legislation.  In so doing, the Court hinted that any alternate interpretation of the Code faced the risk of being challenged on constitutional grounds as well.

The Virginia Tax Code allows the “governing body of any county” to collect “liscence taxes” (BPOL taxes) upon any person, firm, or corporation “engaged” in any business or trade “within the county.”[29] The question, therefore, was whether “gross receipts [] falls within a locality’s statutory power to tax.”[30] Citing a prior Virginia case, City of Winchester v. American Woodmark (Woodmark I), the Court noted that additional tax burdens “are not to be extended by implication beyond the clear import of the language used. Whenever there is just doubt, that doubt should absolve the taxpayer.”[31] The Code provides that local BPOL taxes may only tax “those gross receipts attributed to the exercise of a privilege subject to licensure at a definite place of business within this jurisdiction.”[32] With regards to service businesses in particular, gross receipts should be “attributed to the definite place of business at which the service is performed…directed, or controlled.”[33] Nonetheless, if the licensee  “has more than one definite place of business and it is impractical or impossible to determine to which definite place of business gross receipts should be attributed under the general rule,” then gross receipts are to be “apportioned based on payroll.”[34]

The Court, relying upon its prior holding in City of Winschester v. American Woodmark Corp. (Woodmark II), which itself relied upon the language of the Supreme Court decision, Goldberg v. Sweet, concluded that the gross receipts werenotattributable solely to FMCC services rendered in the County.[35]Woodmark II held that a BPOL tax may be levied “only to the portion of the revenues from the interstate activity which reasonably reflects the in-state component of the activity being taxed.”[36] In Woodmark II, American Woodmark, a furniture manufacturer with 24 facilities in different states, alleged that city’s imposition of BPOL taxes on 100% of its revenue constituted “unfair apportionment” because only its corporate headquarters were located in Winchester. Woodmark argued that an assessment of the gross receipts was not “attributable to [its] business activities within the city.”[37] The Court determined it a matter of “common sense” that the value by the headquarters alone could “not possibly produce 100% of the revenues.”[38] It thus held that American Woodmark had presented “clear and cogent evidence” that the “assessments attributed to operations conducted in Winchester [were] out of all appropriate proportions to…the business transacted in Winchester.”[39]

The FMCCcourt noted that “[a]lthough a statutory challenge was not presented inWoodmark II” the case nonetheless stood for the proposition that a locality, under the Code, may only tax the gross receipts “attributed to the exercise of a privilege subject to licensure at a definite place of business.”[40] Regarding the facts of this case, the court observed that service centers outside the County had refinanced loans (initially contracted into at the Richmond branch), assisted customers with administration changes, titled vehicle, and tracked the progress of loan payments. The court also recognized that FMCC headquarters directly provided the Richmond branch with capital. In light of these realities, the court held that FMCC had demonstrated “by clear and cogent evidence” that the gross receipts attributed to the Richmond Brach, were in fact, the product of “financial services provided in other jurisdictions.”[41] “In other words, the operation of the Richmond Branch did not produce 100 percent of the gross receipts that the County taxed.”[42] Therefore, a tax assessment based on these gross receipts was invalid. Finally, because MAPS only tracked revenues by contract, the Court determined it would be “impossible, or, at least, impractical” for FMCC to track the actual services performed over the lives of the approximately 20,000 loans which originated in the Richmond Branch. As such, the court concluded that the “BPOL tax assessment must be calculated using payroll apportionment.”[43]

IV. Possible Consequences

FMCC received a significant windfall from the ruling, which, as the dissent observed, was now entitled to recover approximately 93% of its past payments.[44] Still, the Court’s uncritical acceptance of FMCC’s contention that it would be “very difficult” to design an alternative accounting system may spawn unanticipated mischief in the near future. Without judicial incentives (punitive or otherwise), a complex interstate business, well aware of the financial stakes, will simply fail to create an accounting system which records revenue generated by each definite places of business. At that stage, the business will self-servingly insist to the taxing authority that redesigning the system would be “very difficult,” entitling itself to the more attractive BPOL based on payroll. In effect, a company may fleece itself from paying higher taxes simply through its own negligence, willful blindness, or lack of innovative impetus.

Perhaps more significantly, the court’s reliance on Woodmark II,  which was decided on non-statutory based grounds,  in interpreting the BPOL statutory provisions seems to be an effort by the court to inject constitutional principles of “fair apportionment” into the Tax Code itself. The FMCC court could have determined the extent of Chesterfield County’s authority to tax through utilizing the traditional maxims of statutory interpretation, in which the provisions dealing with the BPOL tax were analyzed within the context to the Code as a whole. Instead, the FMCC court relied onWoodmark II’s broad “reasonableness” standard of external inconsistency, set forth by the Supreme Court in Goldberg v. Sweet. Apparently, the court signaled that it would interpret the Code itselfto mandate that all assessments reasonably reflect the in-state component of the taxed activity in accordance with Goldberg. The Virginia Supreme Court, moreover, has set a considerably higher external inconsistency standard than Goldberg’s – Both Woodmark II and FMCC held that an assessment which taxed anythingmore than revenue attributed to that definite place of business constituted clear and cogent evidence that the assessments were out of all appropriate proportion. Proportionality was measured, not through any mathematical ratio or formula, but rather through an appeal to “common sense” (Woodmark II), or through realization that the revenue could not be quantified (FMCC). Both decisions’ reference to an opaque “100% of revenue” hypothetical exercise indicates that the Court has attempted to articulate a “reasonableness” standard which (rather coarsely) incorporates both internal and external consistency models.

V. Trending Towards a More Business-Friendly Virginia

To appreciate how far-reaching the FMCC decision is, it is crucial to highlight the actual holding in WoodmarkI, approvingly cited in FMCC. Woodmark Iheld that office equipment located at a manufacturer’s headquarters was sufficiently “used in manufacturing” under the Virginia Tax Code, thus exempting it from local property taxes.[45] The Virginia legislature thereafter amended the Code to codifyWoodmark’s broad interpretation of “manufacturing.”[46] The practical consequence of these actions was that anybusiness involved in manufacturing, however tangentially, could now claim exemptions for its personal property.[47] FollowingWoodmark I, the Virginia courts further broadened these exceptions to include, among other things, vending machines and advertising scoreboards used by a manufacturer, and even raises questions of whether the exemption may extend to property leased to a manufacturer which is owned by a non-manufacturer.[48] One scholar opined that Woodmark I’s interpretation of the Virginia Codeare  “convoluted” and “not easily categorized by [ ] theoretical rationales.”[49] She concluded that “on a more practical level, Virginia…seems willing to enlarge the tax breaks offered to manufacturing businesses.”[50]

FMCC’s reference to Woodmark I, regardless of its actual relevance to the facts of the case, evinces how broad Woodmark I’s holding has become. Instead of being constrained only to the manufacturing realm, Woodmark Iapparently has evolved into a judicial mandate to create additional tax breaks for interstate companies, even those engaged in distinctly non-manufacturing enterprises, such as financing loans. Seen in this light, Ford Motor Credit Company, inspired by Woodmark I (and to a degree, Woodmark II) is the latest incident of a growing trend in Virginia to resolve discrepancies in the tax code in favor of big business. The creation of these corporate “tax-loopholes,” either through judicial fiat or legislative codification, is likely an attempt to lure large businesses, particularly manufacturers, into locating or expanding their operations inside Virginia. As the Circuit Court in Woodmark I put it, “the term manufacturing is to be construed liberally because ‘the public policy of Virginia is to encourage manufacturing in the Commonwealth.’”[51]

Virginia, in essence, has endorsed a localized version of “supply side economics,” predicting that the lowering of taxes on the production of both goods (e.g., furniture, as in Woodmark I) and services (e.g., financing, as in FMCC)[52] will, in turn, spur economic growth in Virginia, particularly in the form of job creation. As a result, Virginia localities, faced with a subtle yet significant decrease in millions of dollars of property tax and BPOL tax revenue, may be compelled to shift this burden directly onto consumers, whom, incidentally, are less capable lobbyists than large corporations.[53] If the courts succeed in incentivizing large employers to make Virginia their home, it may come at the cost of overtaxing less lucky Virginians.

[1] Ford Motor Credit Company v. Chesterfield County, 2011 WL 744985 (Va. 2011).

[[2] David Shipley, The Limits of Fair Apportionment: How Fair is Fair Enough?, 93 St. & Loc. Tax Law 34, 34 (2007).

[3] Id.

[4] 430 U.S. 274 (1977).

[5] 463 U.S. 159, 169.

[6] Id.

[7] Shipley, at 34.

[8] Container,463 U.S. at 169 (emphasis added).

[9] Id.at 170.

[10]  488 U.S. 252, 262  (emphasis added).

[11] Ford Motor Credit Company, at *3.

[12] Id.

[13] Id.

[14] Id.

[15] Id.

[16] Id.

[17] Id. at *4.

[18] Id.

[19] Id.

[20] Id.

[21] Id.

[22] Id.

[23] Id.

[24] Id. at *5

[25] Id.

[26] Id. at *6

[27] Id. at *5 (emphasis added).

[28]  Id. at *6.

[29] Idat *7.

[30] Id.

[31] Id. The Court also ruled that a “tax assessment made by the proper authorities isprima facie correct and valid, and the burden is no the taxpayer to show that such assessment is erroneous.” Id.

[32] Id. (emphasis added).

[33] Id. at*8.

[34] Id.

[35] Id. at *9.

[36] Id (emphasis added).

[37] Id.

[38] Id. 

[39] Id.

[40] Id. (emphasis added).

[41] Id. at *10.

[42] Id. at *11.

[43] Id.

[44] Id. at *13.

[45]  American Woodmark Corp. v. City of Winchester, 464 S.E.2d 148 (Va. 1995).See generally, Stacey Wilson, Good Intentions, But Unintended Consequences: Expanding Virginia’s Manufacturing Tax Exemption Under City of Winchester v. American WoodmarkCorp, 41 WM & MARY L. REVIEW 67 (2000)

[46] Virginia Code § 58.1-1101(A)(2), cited in Wilson at 69.

[47] Wilsonat 73.

[48] Id.

[49] Id.

[50] Id.

[51] 34 Va. Cir. 421, 434 (1994) (citing County of Chesterfield v. BBC Brown Boveri, Inc., 380 S.E.2d 890, 893 (Va. 1989)), cited by Wilson at 84.

[52] Ford Motor Company, at *8. (“Neither party contests that FMCC was a service business for purposes of Code § 58.1–3703.1(A)(3)(a)(4).”)

[53] Wilson, at 73.

Adam Blander © Copyright 2011

Under The Radar–The Supreme Court, Commercial Speech and the First Amendment

Recently posted in the National Law Review an article by attorney  Charles M. English of Ober | Kaler regarding U.S. Supreme Court’s  view of the First Amendment as applied especially to political speech:

Ober

Over the past several years, a great deal has been written about the .  In both the 2010 and 2011 terms the Court in dramatic and well-publicized cases struck down federal (Citizens United) and state (Arizona Free Enterprise Club’s Freedom PAC) campaign finance restrictions as applied to corporate political donations and laws supporting public financing of candidates who forgo private donations.  These are of course significant, far-reaching decisions with major impacts on political discourse in the United States.  But even more may be going on in First Amendment jurisprudence when one looks beyond the headline-grabbing cases to less well publicized commercial speech cases.

More often than not the Court moves not dramatically, but in incremental steps as both the law and the Justices evolve and the Court personnel change.   Such an incremental step appears to have been taken by the Court this year with respect to commercial speech regulation – speech intended not for political discourse, but by commercial entities seeking to buy, sell, advertise, market or provide information to each other and consumers.

On June 23, 2011, the Court, in a 6-3 majority, issued Sorrell v. IMS Health, Inc.,No. 10-779, striking down on First Amendment grounds Vermont’s law that prohibited the sale and use of physician prescription data for commercial purposes especially by pharmaceutical companies wishing to use that data to advertise and otherwise reach out to physicians in order to market their drugs.  Having monitored the case closely and attended the Court’s oral argument, I don’t think that the result itself was much of a surprise.  The Court concluded that the regulated activity interfered with the exchange of ideas and was thus speech and then concluded that the protected speech could not be regulated by Vermont in the fashion proposed.

What to many observers was less predictable was the breadth of the decision and the language employed in the majority opinion written by Justice Anthony Kennedy and joined both by the four justices normally considered “conservative”, but also joined by Justice Sonia Sotomayor.  The majority appears to have applied a stricter standard to the “content and speaker-based” commercial speech restrictions than it has applied in the past.  So the question arises: Is the Court moving, however incrementally, towards a change in how it treats commercial speech under the First Amendment – one that would increase the level of scrutiny applied to restraints on such speech?

While Sorrell received far less coverage than many of other cases decided by the Court in the 2011 Term, commercial speech proponents have been quick to embrace the decision and to assert broader commercial speech rights.  After the Food and Drug Administration adopted new cigarette warning label requirements in the summer of 2011, R.J. Reynolds, together with other tobacco companies and supported by national advertising organizations, were quick to seek court intervention against the new warning label requirements. They relied in no small part on the expansive language found in Sorrell.  That suit, filed in mid-August, is set for a decision on motions for a preliminary injunction and summary judgment after a hearing before Judge Richard Leon in the U.S. District Court for the District of Columbia on September 21, 2011.

To understand where the Court may be heading, it is important first to know where we have been.  While the First Amendment, which is also applicable to the States, might appear to the casual reader to be absolute  – “Congress shall make no law . . . abridging the freedom of speech. . .”, it in fact has not been so regarded historically by the Court.  In 1942, the Court declared that commercial speech was not protected by the First Amendment at all.  The Court reversed course in 1976, declaring that some form of intermediate protection did exist for commercial speech, and established in 1980 a multi-part test (Central Hudson) for evaluating the constitutionality of commercial speech restrictions:  In order to regulated non-misleading commercial speech regarding otherwise legal activity, the government must establish that there is a substantial state interest, that the regulation directly advances that state interest, and that the regulation is narrowly tailored to advance that substantial interest.

It doesn’t take a lawyer to conclude that this test is confusing, and not surprisingly, most observers from a wide array of the political spectrum have concluded that the results of the cases decided under Central Hudson are unpredictable and that the test is simply unworkable.  Importantly, Justice Clarence Thomas has repeatedly criticized the Court’s commercial speech jurisprudence directly, with some indirect support from others from the Court’s so-called conservative wing.

The majority in Sorrell certainly did not overrule (at least not expressly or entirely)Central Hudson.  However, the majority opinion , however subtly, appears to provide a measurable shift in the First Amendment analysis by the Court by carving out in commercial speech cases types of restrictions to which the majority appears to provide some form of scrutiny greater than the protections found in theCentral Hudson test.   Indeed and perhaps most tellingly the minority opinion written by Justice Stephen Breyer accuses the majority of having created a new test, stricter than Central Hudson, for content-based or speaker-based speech that undermines the differentiation of commercial speech from what is often called core First Amendment speech.  If so, the court may have indirectly moved towards Justice Thomas’ assertion that commercial speech should not be treated differently from core speech.

In the short run, we should expect the decision in Sorrell to actually add to the confusion that surrounds Central Hudson.  Will lower courts such as the one now presented with the cigarette warning dispute conclude that there is a new, higher standard?  If so, in which cases will this new standard apply, and how will those cases be decided?  This is not an academic or legalistic point.  Both business and government thrive on certainty in results, and legal uncertainty is simply very expensive for everyone:  When states lose these First Amendment cases, they normally must pay the attorneys’ fees to the prevailing party; meanwhile, businesses subject to regulation of uncertain legality incur costs in complying and challenging such regulation.  Nobody benefits from this kind of uncertainty – well, except for the lawyers of course.

Of course, we may not have long to wait after all.  The case of the FDA regulation of cigarette packaging,  or possible other cases involving other governmental regulation of health-care claims or of health insurance, or new food safety regulation – any one of these could give rise to litigation that provides new guidance, clarity or even another incremental step.  However, when one goes back to the text of the First Amendment and its absolute prohibition on abridging the freedom of speech, examines the Court’s recent dramatic political speech cases in the past two terms, considers the muscular conservative majority, and carefully reads between the lines of Sorrell (decided with six votes in the majority), one must conclude that we are in for interesting times, and that advocates of commercial speech restrictions, including anti-smoking advocates, may now face a greater uphill battle in defending and maintaining what have come to be accepted restrictions in marketing and advertising in the United States.

© 2011 Ober | Kaler