United States: State + Local Tax Insights: Spring 2014

Edited by Nicole L. Johnson and Rebecca M. Ulich

WHERE'S WALDEN? FINDING PROTECTION UNDER THE DUE PROCESS CLAUSE

By R. Gregory Roberts and Rebecca M. Ulich

In the aftermath of Quill, and the seemingly low threshold to satisfy the Due Process Clause articulated by the U.S. Supreme Court, many practitioners and taxpayers essentially abandoned the Due Process Clause as a tool to challenge assertions of nexus, preferring instead to focus on the Commerce Clause. However, several recent Supreme Court decisions should cause practitioners and taxpayers to rethink that strategy.

The Court's decisions in Goodyear, J. McIntyre Machinery, Daimler and Walden not only show the Court's renewed emphasis on the Due Process Clause as a limitation on assertions of jurisdiction under state long-arm statutes, but also provide taxpayers with a framework to challenge the ever-increasing assertions of nexus for tax purposes by state legislatures and taxing authorities.¹

This article begins with an overview of the Due Process Clause, including a discussion of the distinction between "specific" and "general" jurisdiction that was central to the Court's recent due process decisions. This article then discusses the Court's due process analyses in Goodyear, J. McIntyre Machinery, Daimler and Walden and concludes with insights into the potential impact of these cases in the state tax arena.

The Due Process Clause: Specific and General Jurisdiction

The Due Process Clause sets the outer boundaries of a state's jurisdiction over an out-of-state entity.² In determining whether the exercise of jurisdiction is permissible under the Due Process Clause, the Supreme Court has explained that "[i]t is evident that the criteria by which we mark the boundary line between those activities which justify the subjection of a corporation to suit and those which do not cannot be simply mechanical or quantitative."³ The Court stated that "[t]he test is not merely, as has sometimes been suggested, whether the activity, which the corporation has seen fit to procure through its agents in another state, is a little more or a little less."⁴ Rather, the Court explained that "[w]hether due process is satisfied must depend . . . upon the quality and nature of the activity in relation to the fair and orderly administration of the laws which it was the purpose of the due process clause to insure."⁵ To satisfy due process, a state may only exercise jurisdiction over an out-of-state defendant that has certain "minimum contacts" with the state, such that the maintenance of the suit does not offend "traditional notions of fair play and substantial justice."⁶

The distinction between "specific" and "general" jurisdiction evolved from the Supreme Court's decision in International Shoe Co. v. Washington, in which the Court elaborated on the concept of "fair play and substantial justice" by recognizing that jurisdiction may be found over an out-of-state corporation where (i) the suit arises out of or relates to the corporation's contacts with the forum state ("specific" jurisdiction), or (ii) the corporation's continuous corporate operations within the forum state are so substantial and of such a nature as to justify suit against it on unrelated causes of action ("general" jurisdiction).⁷

After its decision in International Shoe in 1945, the Court's opinions focused primarily on circumstances involving specific jurisdiction. Prior to Goodyear and Daimler, the Court had issued only two decisions since International Shoe that considered whether an out-of-state corporate defendant's in-state contacts were sufficiently "continuous and systematic" to justify the exercise of general jurisdiction, which the Court has acknowledged requires a "higher threshold" showing than specific jurisdiction.⁸

The Court's recent decisions involving specific jurisdiction are particularly relevant in the state tax context, as indicated by the Court's decision in Quill, which followed a specific jurisdiction analysis.⁹

General Jurisdiction: Goodyear and Daimler

Goodyear involved a wrongful death suit filed in North Carolina state court by North Carolina residents whose sons had died in a bus accident in France, allegedly due to tires manufactured by the foreign subsidiaries of Goodyear.

The North Carolina Court of Appeals held that it could exercise general jurisdiction over the foreign corporations because their products had reached the State through "the stream of commerce," despite the fact that they had no presence in North Carolina and did not take any affirmative action to cause their tires to be shipped to the State.¹⁰ In rejecting this "sprawling view of general jurisdiction," the Court found that "a connection so limited between the forum and the foreign corporation" was an "inadequate basis for the exercise of general jurisdiction" and would result in "any substantial manufacturer or seller of goods . . . be[ing] amenable to suit, on any claim for relief, wherever its products are distributed."¹¹ In reaching its decision, the Court concluded that "mere purchases made in the forum State, even if occurring at regular intervals, are not enough to warrant a State's assertion of general jurisdiction over a nonresident corporation in a cause of action not related to those purchase transactions."¹²

Elaborating on the distinction between specific and general jurisdiction, the Court in Daimler reversed the Ninth Circuit and held that California could not exercise general jurisdiction over a foreign corporation based solely on the presence in the State of a subsidiary.¹³ Daimler involved Argentinian residents who filed a complaint against DaimlerChrysler Aktiengesellschaft ("Daimler"), a German company, based on allegations that Daimler's Argentinian subsidiary, Mercedes-Benz Argentina ("MB Argentina") collaborated with state security forces to commit human rights violations.¹⁴ Jurisdiction for the suit was predicated on the California contacts of Mercedes-Benz USA, LLC ("MBUSA"), a U.S. subsidiary of Daimler that distributed Daimler-manufactured vehicles to independent dealerships throughout the United States, including California.¹⁵

The Ninth Circuit held that it could exercise general jurisdiction over Daimler based on an agency theory.¹⁶ The Court noted that the Ninth Circuit's finding of an agency relationship "rested primarily on its observation that MBUSA's services were 'important' to Daimler" and, therefore, that "[t]he Ninth Circuit's agency theory thus appears to subject foreign corporations to general jurisdiction whenever they have an in-state subsidiary or affiliate, an outcome that would sweep beyond even the 'sprawling view of general jurisdiction' we rejected in Goodyear."¹⁷

Specific Jurisdiction: McIntyre and Walden

The Court's plurality opinion in McIntyre was released on the same day as Goodyear, and held that the New Jersey courts could not exercise specific jurisdiction over a foreign manufacturer that "at no time had [] advertised in, sent goods to, or in any relevant sense targeted the State."¹⁸ In McIntyre, Robert Nicastro filed a products liability suit against J. McIntyre Machinery, Ltd. ("J. McIntyre") in New Jersey state court after injuring his hand while using a metal-shearing machine.¹⁹ The machine was manufactured by J. McIntyre in England, where the company was incorporated and operated.²⁰ The assertion of jurisdiction rested on three facts: (i) "[t]he distributor agreed to sell J. McIntyre's machines in the United States;" (ii) "J. McIntyre officials attended trade shows in several States but not in New Jersey;" and (iii) "up to four machines ended up in New Jersey."²¹ The New Jersey Supreme Court concluded that the exercise of "[j]urisdiction was proper . . . because the injury occurred in New Jersey," because J. McIntyre "knew or reasonably should have known that its products are distributed through a nationwide distribution system that might lead to those products being sold in any of the fifty states" and "failed to take some reasonable step to prevent the distribution of its products in th[e] State."²²

In reversing the New Jersey Supreme Court's decision and finding that the State could not exercise jurisdiction over J. McIntyre, the U.S. Supreme Court explained that "[a] person may submit to a State's authority in a number of ways:" (i) "explicit consent;" (ii) "general submission to a State's powers [(general jurisdiction)];" and (iii) "a more limited form of submission to a State's authority for disputes that arise out of or are connected with the activities within the state [(specific jurisdiction)]."²³ The Court further explained that:

The Court then clarified its jurisprudence regarding the relationship between jurisdiction and the "stream of commerce" by noting that, although "[t]his Court has stated that a defendant's placing goods into the stream of commerce with the expectation that they will be purchased by consumers within the forum State may indicate purposeful availment," this "does not amend the general rule of personal jurisdiction."²⁵ Rather, the Court's prior statement "merely observe[d] that a defendant may in an appropriate case be subject to jurisdiction without entering the forum."²⁶ The Court elaborated that the principal inquiry is whether the defendant's activities manifested an intention to submit to the power of a sovereign, "[i]n other words, the defendant must purposefully avail itself of the privilege of conducting activities within the forum State, thus invoking the benefits and protections of its laws."²⁷ The plurality acknowledged that "[s]ometimes a defendant does so by sending its goods rather than its agents" into the forum state, further noting that "[t]he defendant's transmission of goods permits the exercise of jurisdiction only where the defendant can be said to have targeted the forum; as a general rule, it is not enough that the defendant might have predicted that its goods will reach the forum State."²⁸

Justice Breyer and Justice Alito's concurrence similarly rejected the New Jersey Supreme Court's analysis because adopting the State court's view would "abandon the heretofore accepted inquiry of whether, focusing upon the relationship between the defendant, the forum, and the litigation, it is fair, in light of the defendant's contacts with that forum, to subject the defendant to suit there."²⁹ Instead, the Justices stated that they would rest jurisdiction "upon no more than the occurrence of a product-based accident in the forum State," but that "this Court has rejected the notion that a defendant's amenability to suit travels with the chattel."³⁰

In Walden v. Fiore, the Supreme Court again engaged in an analysis involving specific jurisdiction and reversed the Ninth Circuit after finding that a Georgia police officer who was sued in Nevada by Nevada residents for an allegedly improper search and seizure in a Georgia airport lacked the "minimal contacts" necessary to be subject to specific jurisdiction in Nevada.³¹

Anthony Walden was a police officer working at an airport in Atlanta, Georgia as part of a Drug Enforcement Agency task force. Mr. Walden seized cash from Gina Fiore and Keith Gipson while they were attempting to board a connecting flight to Nevada.³² Ultimately, no forfeiture complaint was filed against Ms. Fiore and Mr. Gipson and the funds were returned.³³ However, at some point after Mr. Walden seized the cash, he helped draft an affidavit to show probable cause for the forfeiture of the funds and forwarded that affidavit to a U.S. Attorney's Office in Georgia.³⁴ Ms. Fiore and Mr. Gipson alleged that the affidavit was false and misleading and filed suit against Mr. Walden in the federal district court for Nevada, claiming that their Fourth Amendment rights against unreasonable searches and seizures had been violated.³⁵

The district court granted Mr. Walden's motion to dismiss for lack of personal jurisdiction because it found that the search and seizure in Georgia were not sufficient to establish jurisdiction in Nevada and further, that even if Mr. Walden caused Ms. Fiore and Mr. Gipson harm while knowing that they lived in Nevada, that fact alone did not confer jurisdiction to Nevada.³⁶

On appeal to the Ninth Circuit, a divided panel reversed the district court's decision.³⁷ Although the Ninth Circuit assumed that the search and seizure in Georgia could not support an exercise of personal jurisdiction in Nevada, the court held that jurisdiction could be exercised based on Mr. Walden's affidavit.³⁸ The court found that, because Mr. Walden knew that the affidavit would affect persons with a "significant connection" to Nevada, Mr. Walden's submission of the affidavit was "expressly aimed" at Nevada.³⁹ Further, the court found that personal jurisdiction was proper because the delay in returning the funds caused "foreseeable harm" in Nevada and the exercise of personal jurisdiction was otherwise reasonable.⁴⁰

The Supreme Court reversed. In reaching its decision, the Court explained that "[t]he inquiry whether a forum State may assert specific jurisdiction over a nonresident defendant focuses on the relationship among the defendant, the forum, and the litigation."⁴¹ The Court also stated that, "[f]or a State to exercise jurisdiction consistent with due process, the defendant's suit-related conduct must create a substantial connection with the forum State."⁴²

The Court emphasized that for specific jurisdiction, the necessary relationship with the state "must arise out of contacts that the defendant himself creates with the forum State" and noted that the Court has "consistently rejected attempts to satisfy the defendant-focused 'minimum contacts' inquiry by demonstrating contacts between the plaintiff (or third parties) and the forum State."⁴³ Thus, the "'minimum contacts' analysis looks to the defendant's contacts with the forum State itself, not [to] the defendant's contacts with persons who reside there." Although the Court acknowledged that "a defendant's contacts with the forum State may be intertwined with his transactions or interactions with the plaintiff or other parties," the Court reiterated that "a defendant's relationship with a plaintiff or third party, standing alone, is an insufficient basis for jurisdiction."⁴⁴

As Mr. Walden's activities related to the search and seizure, including the drafting and submission of the affidavit, occurred in Georgia, and as Mr. Walden had no connections with Nevada, the Court found that Mr. Walden had "formed no jurisdictionally relevant contacts with Nevada."⁴⁵

In reaching its decision, the Court noted that the Ninth Circuit's opinion had erroneously "shift[ed] the analytical focus from [Mr. Walden's] contacts with the forum to his contacts with [Ms. Fiore and Mr. Gipson]."⁴⁶ The Court explained that the Ninth Circuit's reasoning "improperly attributes a plaintiff's forum connections to the defendant and makes those connections 'decisive' in the jurisdictional analysis" and "also obscures the reality that none of petitioner's challenged conduct had anything to do with Nevada itself."⁴⁷ Further, the Court noted that, even if the deprivation of access to their funds constituted a distinct injury to Ms. Fiore and Mr. Gipson, such an injury "is not the sort of effect that is tethered to Nevada in any meaningful way" because they "would have experienced this same lack of access in California, Mississippi, or wherever else they might have traveled and found themselves wanting more money than they had."⁴⁸ Thus, the Court found that the effects of Mr. Walden's conduct on Ms. Fiore and Mr. Gipson were not connected to Nevada "in a way that makes those effects a proper basis for jurisdiction."⁴⁹ Similarly, the Court found that contact by Ms. Fiore and Mr. Gipson's attorney was "precisely the sort of 'unilateral activity' of a third party that cannot satisfy the requirement of contact with the forum State" and the fact that some of the seized cash originated in Nevada was also an "attenuated connection [that] was not created by petitioner."⁵⁰

Insights

The Supreme Court's recent attention to the Due Process Clause, as well as recent state supreme court decisions in Scioto and ConAgra, have injected new life into the previously moribund Due Process Clause as a mechanism to challenge the ever-increasing assertions of nexus by states.⁵¹ The Court's decisions in Goodyear, McIntyre, Daimler and Walden provide important insight into the types of connections with the forum state that are necessary to establish jurisdiction under the Due Process Clause. In particular, the plurality's emphasis on "purposeful availment" in McIntyre, together with the Court's emphasis on the defendant's contact with the forum state in Walden, provide a useful framework for challenging assertions of nexus in the state tax arena.

At a minimum, the Court's analyses call into question state assertions of nexus based solely on the activities of in-state subsidiaries or affiliates, as well as bright-line nexus provisions that impute nexus on entities based solely on the amount of sales into the state. These types of provisions also seemingly contravene the Court's warning against "simply mechanical or quantitative" tests to determine whether the exercise of jurisdiction is proper under the Due Process Clause.⁵²

Further, in light of the Court's statement in Walden that an out-of-state entity's activities must be "tethered" to the state in a "meaningful way," together with its "purposeful availment" analysis in McIntyre, it is at least questionable whether the Court would view merely selling items over the Internet or through an online intermediary, for example, without any additional contact with the forum state, to be sufficient to establish nexus under the Due Process Clause.⁵³

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Footnotes

1 Goodyear Dunlop Tires Operations, S.A. v. Brown, 131 S. Ct. 2846 (2011); J. McIntyre Mach., Ltd. v. Nicastro, 131 S. Ct. 2780 (2011); Daimler AG v. Bauman, 134 S. Ct. 746 (2014); Walden v. Fiore, No. 12-574 (Feb. 25, 2014). 2 Goodyear, 131 S. Ct. at 2853; World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286, 291 (1980).

3 International Shoe Co. v. Washington, 326 U.S. 310, 319 (1945).

4 Id.

5 Id.

6 Goodyear, 131 S. Ct. at 2853 (quoting and citing International Shoe) (internal quotations omitted).

7 326 U.S. 310 (1945); see also Daimler, 134 S. Ct. at 754 (discussing the development of specific and general jurisdiction); Goodyear, 131 S. Ct. at 2853-54 (same).

8 Goodyear, 131 S. Ct. at 2854 (citing to Perkins v. Benguet Consol. Mining Co., 342 U.S. 437 (1952) and Helicopteros Nacionales de Colombia, S.A. v. Hall, 466 U.S. 408 (1984) as the two post-International Shoe cases involving an analysis of general jurisdiction).

9 Quill Corp. v. North Dakota, 504 U.S. 298, 308 (1992) (concluding that "there is no question that Quill has purposefully directed its activities at North Dakota residents, that the magnitude of those contacts are more than sufficient for due process purposes, and that the use tax is related to the benefits Quill receives from access to the State").

10 Goodyear, 131 S. Ct. at 2846.

11 Id. at 2851, 2856.

12 Id. at 2856 (quoting and citing Helicopteros, 466 U.S. at 418) (internal quotations omitted).

13 Daimler, 134 S. Ct. at 746.

14 Id.

15 Id.

16 Id.

17 Id. at 759-60. The Court noted that it "need not pass judgment on invocation of an agency theory in the context of general jurisdiction, for in no event can the appeals court's analysis be sustained." Id. at 759. Therefore, the question of whether an agency relationship is sufficient to establish general jurisdiction remains open. The Court, however, recognized that "[a]gency relationships . . . may be relevant to the existence of specific jurisdiction" but that "[i]t does not inevitably follow . . . that similar reasoning applies to general jurisdiction. Id. at n.13 (emphasis in original).

18 J. McIntyre Mach., 131 S. Ct. at 2780.

19 Id.

20 Id.

21 Id. at 2790.

22 Id. at 2786.

23 Id. at 2787.

24 Id. at 2787-88.

25 Id. at 2788 (quoting and citing World-Wide Volkswagen, 444 U.S. at 298) (internal quotations omitted).

26 Id. at 2788.

27 Id.

28 Id.

29 Id. at 2793 (quoting and citing Shaffer v. Heitner, 433 U.S. 186, 204 (1977)) (internal quotations omitted) (emphasis in original).

30 Id. at 2793 (quoting and citing World-Wide Volkswagen, 444 U.S. at 296) (internal quotations omitted). In questioning the Court's seemingly strict interpretation of "purposeful availment," however, the concurrence asked:

J. McIntyre Mach., 131 S. Ct. at 2793 (Breyer, J., concurring).

31 No. 12-574 (Feb. 25, 2014).

32 Id.

33 Id.

34 Id.

35 See Bivens v. Six Unknown Fed. Narcotics Agents, 403 U.S. 388 (1971) (finding an implied cause of action for individuals whose Fourth Amendment rights have been violated).

36 Walden, No. 12-574.

37 Id.

38 Id.

39 Id.

40 Id.

41 Id. (quoting and citing Keeton v. Hustler Magazine, Inc., 465 U.S. 770, 775 (1984) (quoting Shaffer, 433 U.S. at 204)) (internal quotations omitted).

42 Id.

43 Id. (citing Helicopteros, 466 U.S. at 417 and discussing Hanson v. Denckla, 357 U.S. 235, 253-54 (1958), World-Wide Volkswagen, 444 U.S. at 298 and Rush v. Savchuk, 444 U.S. 320, 332 (1980)).

44 Id.

45 Id.

46 Id.

47 Id.

48 Id.

49 Id.

50 Id.

51 Scioto Ins. Co. v. Okla. Tax Comm'n, 279 P.3d 782, 784 (Okla. 2012) (finding that "[d]ue process is offended by Oklahoma's attempt to tax an out of state corporation that has no contact with Oklahoma other than receiving payments from an Oklahoma taxpayer . . . under a contract not made in Oklahoma"); Griffith v. ConAgra Brands, Inc., 728 S.E.2d 74, 84 (W. Va. 2012) (holding that "royalties earned from the nation-wide licensing of food industry trademarks and trade names [did not] satisfy . . . 'purposeful direction' under the Due Process Clause").

52 International Shoe, 326 U.S. at 310.

53 In light of efforts to pass federal legislation, it should be noted that, "while Congress has plenary power to regulate commerce among the States and thus may authorize state actions that burden interstate commerce, it does not similarly have the power to authorize violations of the Due Process Clause." Quill, 504 U.S. at 305 (finding that due process was satisfied where the out-of-state company sold its products into the State and "solicit[ed] business through catalogs and flyers, advertisements in national periodicals, and telephone calls").

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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