Litigation Update: Arizona v. California

Listen & Download

The Supreme Court recently denied Arizona’s motion for leave in Arizona v. California, which sought to challenge California’s extraterritorial taxation and seizures of out-of-state funds as unconstitutional.  Specifically, California imposed a “doing business” tax on Arizona entities that conduct no actual business in California and have no connection to the state except for purely passive investments in California companies.  Justices Thomas and Alito dissented, and explained that the Court’s policy of treating its jurisdiction over suits between states as discretionary was “not only textually suspect, but also inequitable.”

The Court’s action raises important questions about the nature of the Supreme Court’s original jurisdiction and the Court’s failure to provide any detailed rationale of how its jurisdiction—which is “original and exclusive”—is also discretionary.  Listen to Arizona Attorney General Mark Brnovich talk about how this decision could impact future original actions, including pending actions by Montana and Wyoming against Washington and Texas against California.

Featuring: 

Hon. Mark Brnovich, Arizona Attorney General

 

 

Teleforum calls are open to all dues paying members of the Federalist Society. To become a member, sign up on our website. As a member, you should receive email announcements of upcoming Teleforum calls which contain the conference call phone number. If you are not receiving those email announcements, please contact us at 202-822-8138.

 

Event Transcript

Operator:  Welcome to The Federalist Society's Practice Group Podcast. The following podcast, hosted by The Federalist Society's Litigation Practice Group, was recorded on Friday, February 28, 2020, during a live teleforum conference call held exclusively for Federalist Society members.          

 

Micah Wallen:  Welcome to The Federalist Society's teleforum conference call. This afternoon’s topic is a Litigation Update on Arizona v. California. My name is Micah Wallen, and I'm the Assistant Director of Practice Groups at The Federalist Society.

 

      As always, please note that all expressions of opinion are those of the expert on today's call.  

 

Today we are fortunate to have with us the Honorable Mark Brnovich, who is the Attorney General of Arizona. After our speaker gives his opening remarks, we will then go to audience Q&A. Thank you for sharing with us today. The floor is yours.

 

Hon. Mark Brnovich:  Thank you very much, and thank you to everyone that may be listening on this call. It’s great to be here in sunny Arizona. Let me just start with an overview of the case.

 

      On February 25th, the U.S. Supreme Court denied Arizona’s -- our motion for leave to file an original action against California. There was a dissent that was filed by Justice Thomas and Justice Alito. Arizona’s complaint alleged that California has an imposition of a “doing business” tax and its efforts to collect these taxes in other states without warrants or any judicial process.

 

      Basically, what California was doing was imposed an $800 “doing business” tax on companies that were doing business in there. It assesses that tax so expansively, though, that it reaches out-of-state companies, including those in Arizona, that do not conduct any actual business in California and, I would argue, have no connection to the state except for purely passive investments in California companies.

 

      We have argued that the Due Process Clause restricts a state’s ability to tax out-of-state entities. And the Supreme Court has imposed a minimum contacts requirement that largely mirrors the minimum contacts standards for personal jurisdiction. Furthermore, the Supreme Court has squarely held that passive investments do not constitute sufficient minimum contacts to exercise personal jurisdiction; thus, California’s tax assessments violate the Due Process Clause.

 

      Additionally, the Commerce Clause imposes four independent requirements on an out-of-state taxation. A tax violates the Commerce Clause unless there is 1) applied to an activity with a substantial nexus with the taxed state; 2) is fairly apportioned; 3) is non-discriminatory – that is, it doesn’t discriminate against interstate commerce; and 4) is fairly related to the services provided by the state. Although failing any one of these requirements is constitutionally fatal, Arizona’s complaint alleges that California’s tax manages to violate all four of them. So the amount of taxes here is substantial. Arizona estimates that the assessment exceed $10 million a year just here in Arizona and likely more than $100 million nationally.

 

      So if a business doesn’t pay these taxes voluntarily to the State of California, the State of California frequently procures funds through extraterritorial seizures, which are both non-judicial and warrantless. Specifically, California will find money in out-of-state bank accounts with the tax companies and then send the relevant banks demand letters. Those letters instruct the banks to transfer the requested funds or else California will take the money from the banks instead.

 

      Those seizure demands are issued ex parte without any warrant, without any judicial involvement, and expressly preclude the banks from seeking judicial review. And in a remarkable bit of Orwellian logic, California’s brief defends the demand letters as “voluntary” compliance.

 

      Our complaint alleged that these extraterritorial seizures violated the Due Process Clause since California has neither in personam0 jurisdiction over the out-of-state companies nor in rem jurisdiction over the out-of-state funds. We further argued that the seizures violate the Fourth Amendment since the seizures are warrantless, non-judicial and not supported by probable cause, and are unreasonable.

     

      So we know that in the dissent that was written by Justice Thomas and joined by Justice Alito, they dissent from the [inaudible 4:15] motion to leave and they specifically said—and I'm quoting from this from their dissent—that “The Constitution establishes our original jurisdiction in mandatory terms. Article III states that, “[i]n all Cases . . . in which a State shall be [a] Party, the supreme Court shall have original Jurisdiction.” §2, cl. 2. In this circumstance, “[w]e have no more right to decline the exercise of jurisdiction which is given, than to usurp that which is not given.” Furthermore, 28 U.S.C. §1251(a) confers “original and exclusive jurisdiction of all controversies between two or more States.”

 

      Nothing in this text limits the jurisdiction in any way intended to be discretionary. And the exclusive nature of it, we would argue, strongly suggests otherwise. Nonetheless, the Supreme Court began interpreting its jurisdiction to be discretionary in the 1970s. In the Court’s view, its original jurisdiction is so delicate and grave a character that it was not contemplated that it would be exercised, save when necessarily absolute.

 

      So in deciding whether to accept jurisdiction, the Court considers “the seriousness and dignity of the claim and the availability of another forum. So we, as I said, were denied, but I think one of the other relevant things that everyone on this call should know is that the Court did call for the views of the U.S. Solicitor General on June 24, 2019. On December 9, 2019, the United States Solicitor General’s Office recommended the Court deny Arizona’s motion for leave to challenge California’s unconstitutional taxes. I would tell you the SG's brief was a little strange. It contended that this issue needs to be “fleshed out,” whether California actually opposes extraterritorial assessments based purely on passive investments.

 

      But the irony is California has repeatedly admitted that it does just that, even in its official legal rulings. And the SG has also pointed out similar seizures by the IRS; although, we agree that the IRS --  the United States, excuse me, obviously share a sovereignty in the territory in the state of Arizona, but the state of California does not.

 

      So that lead us to the February 24, 2020 denial of our case. The Supreme Court followed the SG's advice and denied our motion for leave. That denial was not reasoned, but as I mentioned Justices Thomas and Alito filed the dissent. The dissenting justices explained that the Court likely does not have discretion to review cases, which are original jurisdiction arises between two or more states. And we noted and we argued, we believe that this is a case the Court, not only had to take, but should’ve taken because there are impacts in other jurisdictions.

 

      There are currently two other pending motions for leave to file original action for suits between states. Montana and Wyoming are currently seeking to challenge Washington’s denial of access to its ports for coal exports. Texas is also seeking to challenge California’s travel ban against Texas for state fund to travel due to Texas’ religious liberties law.

 

      So the decision on February 20th may have very important implications for those suits. The denial again signals that the Supreme Court not only reads jurisdiction to be discretionary but that it can impose a very high bar for accepting jurisdiction. Notably, neither California nor the United States has offered anything more than a token defense of the constitutionality of California’s actions. But the mere possibility that California courts might reach these other issues, even though they have failed to do so for more than a decade, was apparently enough to prevent the Court from taking jurisdiction.

     

      Montana, Wyoming, Texas are all likely to face substantial hurdles in convincing the Court to accept their cases. And this is particularly true if both suits seek, like Arizona’s, to assert Commerce Clause claims against sister states.

 

      In finality, I would just point to the brief of the National Taxpayer’s Union that pointed out that at the end of the day if the Supreme Court allows these types of taxes or passive taxes to remain in effect and that a state can’t challenge them, it opens up a can of worms. And as the National Taxpayer’s Union said, quoting from their brief, “the California’s cross-border seizure of funds from bank accounts of Arizona residents amounts to casus belli in the classic sense of requiring collective self-defense. But unlike conventional cross-border raids that rely on physical mobilization, technological advances allow California to reach into Arizona bank accounts without physically traveling outside its [own] borders. This precedent, if allowed to stand, would allow any state with revenue aspirations to reach passive investors in every other state by using multistate bank [accounts] as conduits for backdoor extractions.”

 

      So in summary, what we would argue is that not only would we say that what California is doing is unconstitutional, the Court made an error in not hearing our case. The Solicitor General’s Office of the United States compounded that error by not wanting the Court to hear -- by viewing this as a case the Court shouldn’t hear. And further, there are serious policy implications for not only Arizona but for other states when it comes to taxation. So thank you very much, and that’s the update on what happened.

 

Micah Wallen:  We’ll move on to that first caller.

 

Dave Hickman:  This is Dave Hickman in Washington State. What kind of tax is California asserting? Is this like an income tax? How are they calculating the tax?

 

Hon. Mark Brnovich:  It’s basically a franchise tax on companies, a “doing business” tax. And basically, it assess the tax on passive investments. So you could have somebody that has no physical contact, that’s not actually doing business in California, but because of their investment portfolio, they literally are getting taxed on that.

 

 Dave Hickman:  So it’s just a flat tax? Like a certain amount of money they have to pay for doing business in California.

 

Hon. Mark Brnovich:  It’s a flat fee, and it’s $800. So basically, it’s the whole notion of you assess this assessment on enough businesses, it starts turning into real money.

 

Micah Wallen:  Another question just popped in, so we’ll move to that next caller.

 

Caller 2:  I have a quick question regarding a case last year from Nevada on personal income taxes. Is there any relation to that with this case?

 

Hon. Mark Brnovich:  Not really. That case was really focused on sovereign immunity. So it’s a little bit different of a case. And part of our argument here was the notion that states like Arizona, we have to have a forum in order to challenge this taxing scheme in California because the reality is is that California courts have really done nothing. I mean, our brief pointed out that there’s actually a tax in California that a court there declared unconstitutional in 2008. But the class was certified 10 years later in 2018 and refunds have still not been paid, 10 or 12 years after the fact. So it just shows you that there’s really not a lot of forum if you're a taxpayer and you're trying to push back against the government.

 

Micah Wallen:  We have one question in the queue right now so we’ll go ahead and move to that caller.

 

Steve Herb (sp):  Hi, this is Steve Herb here in snowy Columbus, Ohio. I hope you're enjoying your Arizona sunshine. Since other states have now lost any defense against this in courts, perhaps one means to deal with this would be a quote/unquote “class action” of all other states against California but not in the legal sense. I’m inferring or replying or suggesting that perhaps all other states start doing exactly the same thing to the companies that are in California and basically see how California likes it.

 

Hon. Mark Brnovich:  A couple things. One is please say hello to my friend and colleague, Dave Yost, there. And I guess I would add that they're freezing up in Dayton, stuck in their cars, and I’m lying here underneath the sun and the stars. It is a gorgeous 70+ degrees here, so anyone listing to this call in freezing weather should feel free to come out here and enjoy some spring training games.

     

      To answer your question in all seriousness, part of the problem, part of our argument was the Supreme Court should hear our case for the very reason that we don’t want an arms race. We don’t want states to get into this arms race where there’re retaliatory taxes or these back-and-forth taxes where you have this extraterritorial jurisdiction where states receiving people’s banks accounts and putting banks in awkward positions without due process.

     

      And so we’re worried that that might actually happen. That you're going to start seeing more and more states do this. One thing that I’ve learned in my life, I’m fairly new to politics but I know a lot about government. And if there’s a way for a politician or a bureaucrat to tax something where they don’t have to be accountable to the voters, they're going to do it. And that’s the thing. So the concern is actually that more states will be doing this, and we don’t want to see that retaliatory nature.

 

      But as far as class action lawsuits, that’s actually one of the remedies of what really might happen here, is that you're going to have to have something happen in federal district court in California with taxpayers. They file something, and at that point, would we need to make a determination -- our office need to make a determination whether we would join as amici or how we would maybe support those efforts.

 

Micah Wallen:  All right. Mr. Brnovich, is there anything else you wanted to cover today?

 

Hon. Mark Brnovich:  I appreciate everyone’s time, and I know that this is one of those issues that maybe isn’t as sexy as some other issues out here. But this is an important issue, and I think the fact that Justices Thomas and Alito took that further step in writing that dissent is a signal that at least there’s some people on the Court that are really willing to look at these as mandatory jurisdiction versus discretionary jurisdiction for the Court.

 

Micah Wallen:  All right. And on behalf of The Federalist Society, I’ll go ahead and wrap us up today. I want to thank our expert for the benefit of his very valuable time and expertise today. We welcome listener feedback by email at info@fedsoc.org. Thank you all for joining us. We are adjourned.

 

Operator:  Thank you for listening. We hope you enjoyed this practice group podcast. For materials related to this podcast and other Federalist Society multimedia, please visit The Federalist Society's website at fedsoc.org/multimedia.