On May 13, 2019, the U.S. Supreme Court decided Franchise Tax Board of California v. Hyatt
, ruling that an individual taxpayer was not permitted to bring a private lawsuit against the California Franchise Tax Board (FTB) in a Nevada state court under sovereign immunity principles implicit in the U.S. Constitution.1
In a split 5-4 decision, the Court overturned its 1979 decision in Nevada v. Hall
, which held that the U.S. Constitution does not bar suits brought by an individual against a state in the courts of another state.2
The decision marks the latest in a string of state victories in tax cases coming before the Court, potentially limiting future state tax appeal options available to nonresident taxpayers.
Jamie C. Yesnowitz
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The origins of the Hyatt
decision date back to 1993, the year in which the FTB began an expansive residency audit of Gilbert P. Hyatt, an inventor and long-time California resident who moved to Nevada in 1991 and claimed that state as his primary place of residence. Not only did Hyatt protest the audit, but he also claimed that the FTB’s methods were so intrusive that he sued in Nevada state court for torts he alleged that the agency committed during the audit. Roughly two decades of litigation followed, with three separate issues appealed to and reaching the U.S. Supreme Court.
The central issue before the Court in the first two appeals was how much immunity the FTB should receive from the Nevada state court system. In the first appeal, the Nevada Supreme Court rejected the FTB’s argument that the Full Faith and Credit Clause of the U.S. Constitution3
required Nevada courts to apply California law to immunize the state agency from liability. The Nevada Supreme Court instead held that general principles of comity entitled the FTB only to the same immunity that Nevada law afforded Nevada agencies. The Court affirmed, holding that the Full Faith and Credit Clause did not prohibit Nevada from applying its own immunity law.4
On remand, the Nevada jury returned a verdict for Hyatt that exceeded $490 million with prejudgment interest and costs.
On the second appeal, the Nevada Supreme Court rejected most of the damages awarded by the lower court, upholding a $1 million judgment on one of Hyatt’s claims and remanding for a new damages trial on the other. The court also declined to apply Nevada’s $50,000 statutory cap on tort liability applicable to Nevada state agencies. The U.S. Supreme Court reversed the second appeal, holding that the Full Faith and Credit Clause required Nevada courts to grant the FTB the same immunity that Nevada agencies enjoy.5
On remand, the Nevada Supreme Court instructed the trial court to enter damages in accordance with the statutory cap for Nevada agencies. On appeal to the U.S. Supreme Court for a third time, the sole question before the Court was whether the Court’s 1979 decision in Hall
should be overruled.6
Court finds state sovereign immunity extends to private suits
In an opinion authored by Justice Clarence Thomas, the Court held that states retain their sovereign immunity from private suits brought in the courts of other states.7
In doing so, the Court overruled Hall
, finding the case “contrary to our constitutional design and the understanding of sovereign immunity shared by the States that ratified the Constitution.” In reviewing its prior decision in Hall
, the Court determined that the majority rested its decision on the Founders’ assumption that “prevailing notions of comity would provide adequate protection against the unlikely prospect of an attempt by the courts of one State to assert jurisdiction over another.” The Court concluded that the Hall
decision in fact misapprehended the constitutional design created by the Founders, noting that the Constitution implicitly limits states’ ability to decline to recognize each other’s immunity in their own courts.
In reviewing the issue of state sovereignty, the Court explained that states were immune from suit both under the common law and under the law of nations. The majority proceeded to enumerate the constitutional provisions and amendments abrogating certain aspects of the states’ traditional immunity. Article III, for example, provides a neutral federal forum in which the states agreed to be sued by other states. The states also surrendered a portion of their immunity in ratifying the Constitution, whereby they consented to suits brought against them by the United States in federal courts. That being the case, the ratification of the Eleventh Amendment established that private U.S. or foreign citizens could not bring suit against the states in federal court.8
The majority inferred the adoption of the Eleventh Amendment’s adoption to mean that “the Constitution was understood . . . to preserve the States’ traditional immunity from private suits.”
Agreeing with the FTB that state sovereign immunity in another state’s courts is integral to the structure of the U.S. Constitution, the majority noted that the Constitution altered the relationships between the states so that they no longer related to each other as true foreign sovereigns. Further, the Constitution confirmed that states were no longer fully independent nations free to disregard each other’s sovereignty.9
Rejecting Hyatt’s argument as “ahistorical literalism,” the majority compared this form of sovereign immunity with other constitutional doctrines not explicitly spelled out in the Constitution but established via case law, including judicial review, intergovernmental tax immunity, executive privilege, executive immunity, and the President’s removal power. Similar to these doctrines, the Court found the states’ sovereign immunity to be a “historically rooted principle embedded in the text and structure of the Constitution.”
Recognizing that overruling Hall
would depart from the Court’s adherence to stare decisis
, the majority looked to four factors in determining whether to overturn the case: (i) the quality of the decision’s reasoning; (ii) its consistency with related decisions; (iii) legal developments since the decision; and (iv) reliance on the decision.10
The majority easily concluded that the first three factors supported its decision to overrule Hall
. As to the fourth factor, the majority found that Hyatt’s case-specific costs were insufficient to persuade the Court to follow what it characterized as “an incorrect resolution of an important constitutional question.” Finding Hall
“irreconcilable with our constitutional structure,” the Court reversed the most recent judgment of the Nevada Supreme Court and remanded the case for further proceedings.
Dissent cautions against overturning court precedent
In a dissent joined by three other justices, Justice Stephen Breyer strongly disagreed with the Court’s decision to overrule Hall
, finding “no good reason” to overturn 40 years of what he considered to be settled law in the area of state sovereign immunity.11
Reviewing the historic principles of sovereign immunity, the dissent maintained that the Constitution does not provide an absolute grant of immunity to the states in each other’s courts. Rather, the dissent agreed with the Hall
court that the Constitution permits
states to grant or deny immunity to other states predicated on principles of comity and consent. The dissent found no express provision of the Constitution giving states absolute immunity in each other’s courts. Moreover, the dissent disagreed with the majority’s view that the Constitution implicitly guarantees immunity in each other’s courts, noting that concepts such as the “constitutional design” and the “plan of the Convention” are difficult to apply in practice.
From a stare decisis
perspective, the dissent took issue with the fact that the Court swiftly overruled the Court’s 40-year old holding in Hall
just because the majority disagreed with its reasoning and believed it was wrongly decided. Arguing that Hall
was a well-reasoned decision that has caused “no serious practical problems” in the four decades since it was decided, the dissent cautioned that overruling Hall would encourage litigants to pursue overruling other cases, lawyers to challenge settled law, and provide uncertainty as to the stability of the Court’s decisions. In closing, the dissent warned that “[t]oday’s decision can only cause one to wonder which cases the Court will overrule next.”
Although the Hyatt
decision may have broad implications with respect to the role of stare decisis
and other constitutional precedents in areas of the law outside state and local tax, the Court’s holding is certainly relevant for state and local tax practitioners on several levels. First, the decision represents another victory for the states with respect to tax cases that have come before the Court over the past year. In May 2018, the Court decided Murphy v. NCAA
, striking down a federal prohibition on states’ legalizing sports betting, finding that law encroached into the state sovereign legislative sphere.12
One month later, the Court issued a landmark decision in South Dakota v. Wayfair
, Inc., overturning long-standing stare decisis
and ruling that physical presence is no longer required in order for a state to impose a sales tax filing and collection obligation.13 Hyatt
continues the Court’s trend not only to overturn longstanding precedent in state tax cases, but also to favor state power to tax without federal statutory or judicial encroachments.
In the near term, the Hyatt
decision presents significant obstacles for taxpayers looking to sue a state outside of the state’s own court system, especially as a result of the Wayfair
decision. As a concrete example, Virginia law provides in-state taxpayers a legal avenue for challenging the constitutionality of nexus determinations asserted by out-of-state tax agencies.14
In a case predating the Wayfair
decision, Virginia-based Crutchfield Corporation sued the Massachusetts Department of Revenue in Virginia state court under the Virginia law, contending that Massachusetts’ sales tax nexus regulation violates the dormant Commerce Clause of the U.S. Constitution.15
In light of the Hyatt
decision, however, the Virginia cause of action may now be unconstitutional and there is a significant possibility that the Virginia court ultimately may not be able to render a substantive decision on the Crutchfield
ruling creates further complications for states that do not impose a sales and use tax and that are attempting to prevent sales tax collection on in-state businesses. Most recently in response to the Wayfair
decision, the New Hampshire legislature is considering a bill that would compel out-of-state taxing entities to waive sovereign immunity and file all related lawsuits in New Hampshire courts if they end up taxing in-state businesses.16
The Court’s holding in Hyatt
would appear to prevent such a waiver from being valid, likely jeopardizing the bill’s chances of enactment into law. Under Hyatt
, states need not answer suits brought against them in the courts of other states, leaving New Hampshire taxpayers no option but to bring suit in that state’s court system. Such a result may be particularly burdensome for small businesses attempting to comply with new sales tax collection obligations under Wayfair
not only in New Hampshire, but across the entire country.
One area where taxpayers may be particularly disadvantaged as a result of Hyatt
is in the area of state residency audit appeals, where taxpayers who have moved from one (typically high-tax) state to another (often, low- or no-tax) state do not want to litigate in their former home state. Hyatt himself did this over 20 years ago. Hyatt
now forces taxpayers to bring suit in the court that is home to the out-of-state taxing agency, which in many cases could be more sympathetic to the agency’s position. In the longer term, taxpayers may be more inclined to attempt to bring lawsuits in federal court instead of state court, where taxpayers may be more likely to receive a favorable result. However, comity principles and the federal Tax Injunction Act17
create procedural hurdles for taxpayers seeking to bring suit in the federal courts, making for an often long and costly litigation process.
With taxpayer appeal options further limited after Hyatt
, state and local taxing jurisdictions may be more inclined to enact laws and regulations applying to nonresident taxpayers to the greatest extent possible, knowing that they will no longer be required to answer to taxpayer lawsuits in nonresident courts. At the same time, Hyatt
tries to keep order between the states and prevents forum shopping among taxpayers that may have been previously inclined to choose a particular state forum to challenge unfavorable state tax laws. While not as groundbreaking a case as Wayfair
from a state tax perspective, Hyatt
nonetheless has the potential to change the state tax litigation landscape for years to come.
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