The California Court of Appeal held in a published decision Sept. 2 that Reed Smith secured a significant benefit for the public by bringing a case that resulted in the Court striking down portions of an unconstitutional and discriminatory tax incentive in Cutler v. Franchise Tax Board.1 The Court of Appeal’s published decision in the underlying case—that California’s Qualified Small Business Stock incentives were unlawfully restricted to investments in California companies—paved the way for the decision ordering the FTB to pay Cutler’s law firm, Reed Smith, its attorney fees for representing Cutler in the action.2 The basis for the fee award was California’s Private Attorney General statute (Code of Civil Procedure section 1021.5), which requires the other side to pay attorney fees when the moving party secures a significant benefit to the public through litigation that is not cost-effective without the award of fees. In other words, Cutler had an insufficient amount at stake to justify litigation that resulted in the enforcement of an important right—in this case, enforcing the non-discrimination provisions of the Commerce Clause of the U.S. Constitution. Cutler’s lead counsel in both the action for attorney fees and the underlying case was Reed Smith partner Marty Dakessian.
Cutler and Reed Smith moved for an award of just less than $700,000 in attorney fees under 1021.5 at the trial court level because they enforced a constitutional right that benefited a broad class of taxpayers, and their litigation costs well exceeded the $440,000 in controversy. The FTB argued that despite securing a published appellate opinion leveling the playing field between in-state and out-of-state businesses, Cutler and Reed Smith conferred no benefit on the public and that, regardless, because Cutler was “wealthy,” by definition, this was not the type of public interest case that 1021.5 was meant to address. The FTB argued that the amount at issue was more than the $440,000 of tax Cutler paid for 1998, because there were other years at the administrative level involving similar issues. The trial court agreed with the FTB and denied the fee award. Cutler and Reed Smith appealed.
The Court of Appeal said the trial court was “clearly wrong” and found that, as a matter of the law, Reed Smith had created a significant public benefit because a large number of taxpayers would be eligible for refunds by virtue of the published appellate opinion, and also because leveling the playing field and enforcing an important constitutional right under the Commerce Clause was a non-pecuniary benefit in and of itself. The court also said that it didn’t matter whether the plaintiff was wealthy, and that the trial court improperly considered this as a factor not permitted by the guiding precedent in the California Supreme Court decision of In re Conservatorship of Whitley.3 The court said that a person’s financial status is irrelevant to an analysis under 1021.5, and that what controlled was whether a person’s litigation costs—regardless of financial status—exceeded the risk-weighted value of the case. This, the court said, was the appropriate test under Whitley. Finally, the Court of Appeal held that the litigation costs well exceeded the risk-weighted amount in controversy, and that the trial court erred in finding otherwise.
The Court of Appeal published its opinion so it serves as precedent for other taxpayers.
In sum, Reed Smith and its client have conferred at least three significant benefits as a result of its litigation: (1) a pecuniary benefit on a large class of taxpayers who were entitled to refunds as a result of its litigation; (2) a non-pecuniary benefit by enforcing an important constitutional right, by eliminating discriminatory taxation; and (3) by obtaining a published appellate opinion, Reed Smith has helped improve access to the court system for other taxpayers, regardless of financial status.
The Court of Appeal noted that in response to the Cutler decision, the Franchise Tax Board attempted to remedy the discrimination by issuing retroactive assessments back to 2008 against other taxpayers who benefitted from the discriminatory incentive—which was pre-empted by legislative action blocking the attempted retroactive taxes and allowing the benefit through 2013 to all taxpayers who met the criteria—regardless of the location of the companies they invested in.
Reed Smith then formed a coalition of affected taxpayers and, along with other taxpayer groups, helped to overturn the FTB’s administrative policy via legislation (AB 1412), arguing that the FTB action was unconstitutional (violated the Due Process Clause’s limitation on retroactive assessments) and bad tax policy.
About Reed Smith State Tax Reed Smith’s state and local tax practice is comprised of more than 30 lawyers across seven offices nationwide. The practice focuses on state and local audit defense and refund appeals (from the administrative level through the appellate courts), as well as planning and transactional matters involving income, franchise, unclaimed property, sales and use, and property tax issues. Click here to view our State Tax team. For more information on Reed Smith’s California tax practice, visit www.reedsmith.com/catax.
Client Alert 2014-229