Alabama Federal District Court Declares Corporate Transparency Act Unconstitutional - Corporate Governance

Key Takeaways:

The U.S. Federal District Court for the District of Alabama declares the Corporate Transparency Act unconstitutional.
The relief granted is limited to the plaintiffs in the case, and therefore reporting companies not party to the action must still comply with all applicable filing deadlines pending further developments.

Overview

The U.S. Federal District Court for the District of Alabama (the "District Court") ruled on March 1, 2024, that the Corporate Transparency Act ("CTA") was unconstitutional. Presiding over the case was Judge Liles Burke, who granted the plaintiffs' motion for summary judgement and issued a permanent injunction after finding that the CTA "exceed[ed] the Constitution's limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress' policy goals."¹ The ruling, which comes only two months after the CTA went to effect on January 1, 2024, may have opened the door to similar attacks on the CTA and will certainly be appealed by the Biden administration.

The Corporate Transparency Act

Effective as of January 1, 2024, the CTA imposed new federal reporting obligations on many companies (both domestic and foreign entities registered to do business in the U.S.) including providing information on the beneficial owners of those companies to the U.S. Treasury Department's Financial Crimes Enforcement Network ("FinCEN"). Those who are unfamiliar with the CTA can find additional information at Foley Hoag's Corporate Transparency Act Resource Center, designed to provide essential information on exemptions, reporting obligations, and more under the CTA.

The Alabama Decision

The suit was filed in November 2022 by the National Small Business Association ("NSBA"), an Ohio nonprofit corporation, and Issac Winkles, an NSBA member, (together, the "Plaintiffs") against the U.S. Department of the Treasury, arguing that Congress did not have authority under the Constitution to enact the legislation. Conversely, the Government defended the CTA under its authority to regulate foreign affairs and taxing powers via the Constitution's Necessary and Proper Clause as well as the Commerce Clause.

As to the Commerce Clause, the Plaintiffs argued that the CTA neither regulates "the channels of interstate commerce" nor "person[s] or thing[s] in interstate commerce" and the activities that the CTA seeks to regulate are purely intrastate and do not "substantially affect interstate commerce." The basis of this argument rests on the Plaintiffs' characterization of the type of activity at issue – formation of entities under state law – which according to the Plaintiffs is neither an economic act nor necessarily motivated by a commercial purpose.

The Plaintiffs also drew an analogy between the CTA's reporting requirements and the provision of the Affordable Care Act that required individuals to buy health insurance, contending that "[n]ewly formed State entities, like individuals who refuse to buy health insurance, are 'doing nothing' at the moment of formation," and that Congress may not legislate based on anticipated activity.

The Plaintiffs also raised arguments based on First, Fourth, and Fifth Amendment grounds, although the District Court did not base its decision on these grounds.

In reaching its decision, the District Court first held that no authority exists for Congress under the Necessary and Proper Clause to carry out foreign affairs powers because those powers do not extend to "purely internal affairs" and that the act of incorporation is an arena traditionally reserved for state regulation. As to the Commerce Clause, the District Court found that the CTA does not regulate channels and instrumentalities of interstate commerce on its face, nor does it regulate commercial or economic activity. The mere act of incorporation, according to the District Court, is insufficient to permit regulation under the Commerce Clause.

Impact

The District Court's relief is narrow in scope, extending only to the Plaintiffs in the case. Additionally, in a press release dated March 4, 2024, FinCEN addressed the Court's judgement and indicated that it is complying with the order for as long as it remains in effect and "is not currently enforcing the Corporate Transparency Act against the plaintiffs in that action: Isaac Winkles, reporting companies for which Isaac Winkles is the beneficial owner or applicant, the National Small Business Association, and members of the National Small Business Association." Note that a similar lawsuit is currently pending in the U.S. District Court for the Northern District of Ohio: Robert J. Gargasz Co. v. Yellen.²

Next Steps

Non-plaintiff reporting companies must continue to comply with all applicable filing deadlines under the CTA pending further developments.

Footnotes

1. Opinion at *3, Nat'l Small Bus. United v. Yellen, No. 5:22-cv-01448-LCB (N.D. Ala. Mar. 1, 2024).

2. Robert J. Gargasz Co., LPA v. Yellen, No. 1:23-cv-02468 (N.D. Ohio Dec. 29, 2023).

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