The Supreme Court of Louisiana’s recent decision in Rismiller v. Gemini Ins. Co., 2020-0313 (La. 12/11/20), will impact all stages of civil litigation. In Rismiller, the Court held that, like biological and adopted children, children who have been given in adoption fall within the enumerated class of beneficiaries who may bring a wrongful death and/or survival action arising from the death of their biological family members.

Rismiller was the result of a motor vehicle collision that caused the deaths of Richard Stewart and his two minor children, George and Vera Cheyanne Stewart. Wrongful death and survival actions were filed by Mr. Stewart’s wife, Lisa Watts Stewart (who was not the biological mother of George and Vera), and their two adult children, Daniel Goins and David Watts, both of whom had been given up for adoption as minors.

The insurer of the driver who allegedly caused the accident, Gemini Insurance Company, filed an exception of no right of action as to the claims of Mr. Goins and Mr. Watts for the deaths of their biological father and half-siblings. Gemini argued that because Mr. Goins and Mr. Watts had been given in adoption and filiated to another, they did not fall within the enumerated class of beneficiaries who may bring a wrongful death or survival action under La. Civ. Code arts. 2315.1 and 2315.2. The 7th Judicial District Court overruled the exception, and the question eventually worked its way to the Supreme Court.

Supreme Court Justice Boddie, presiding ad hoc, authored the majority opinion. Applying the “clear and unambiguous wording” of La. Civ. Code arts. 2315.1 and 2315.2, the Court held that biological children given in adoption were “children of the deceased” and “brothers of the deceased” who were permitted to bring wrongful death and survival actions arising from deaths of their biological father and half-siblings.

Based on this decision, children previously given up in adoption would retain the right to bring wrongful death and survival actions for both their biological parent and their adoptive parent. This will affect the questions asked in depositions, written discovery requests, fact investigations, and signatures sought and required in settlements. Practitioners will need to inquire as to any and all children of the decedent, both biological and adopted, and should consider filing an exception of failure to join a necessary or indispensable party if any of the decedent’s children are not named plaintiffs to the suit.

One question left unanswered by the Court, but which was raised in Justice Crichton’s dissenting opinion, is how damages would be apportioned in the event that both the biological and adoptive parents of a child given in adoption are killed by the fault of others. Justice Crichton opined that the majority’s holding would “double the rights of the child,” who would collect twice the amount of damages as a child not given in adoption. According to Justice Crichton, this “absurd” outcome is contrary to the intent of the law “which is to equalize children given in adoption unless otherwise provided.” As this question was not before the Court in Rismiller, Louisiana practitioners will be left to debate it amongst themselves until such time as the Court elects to untangle that Gordian Knot.

The U.S. Supreme Court offered some good news to secured lenders last week, tempered with words of caution.  In Chicago v. Fulton, the Court held that a secured creditor does not violate Section 362(a)(3) of the Bankruptcy Code by merely continuing to hold property of its debtor after that debtor files a bankruptcy petition.  The 8-0 opinion written by Justice Alito, and particularly the separate concurring opinion written by Justice Sotomayor, cautioned that a creditor holding a bankrupt debtor’s property could easily run afoul of Section 362(a)(4) or (6) (prohibiting acts to enforce liens and to collect a claim, respectively), or of Section 542(a)’s obligation to deliver property to the debtor or trustee.  But at least there is nationwide clarity on one issue: merely continuing to hold a debtor’s property that was lawfully seized prepetition is not a violation of 11 U.S.C. § 362(a)(3).

This decision arises from several Chapter 13 bankruptcy cases where individuals filed bankruptcy and then demanded that the City of Chicago release their vehicles, which had been impounded for past-due parking fines.  The City refused.  The Bankruptcy Court found that the City’s refusal violated the automatic stay created by 11 U.S.C. § 362(a).  The Seventh Circuit Court of Appeals agreed that by retaining the debtors’ cars, the City had acted “to exercise control over” their property, in violation of the automatic stay.  Decisions from the Second, Eighth, Ninth, and Eleventh Circuits also imposed an affirmative duty on creditors to return seized property once a bankruptcy petition is filed; failure to do so was a violation of the automatic stay in those Circuits.  The Third, Tenth, and District of Columbia Circuits held that merely retaining property was not a violation of the automatic stay.   The Supreme Court resolved the circuit split by holding that simply holding property lawfully seized prepetition (i.e., before the debtor filed its petition for relief in bankruptcy court) and maintaining the status quo is not a violation of the automatic stay.

One interesting effect of this decision is that lenders now have even more incentive to move quickly to seize their collateral.  In commercial cases, the fact that a debtor cannot get its property back by simply filing bankruptcy will affect negotiations between borrowers and lenders, both in and out of a bankruptcy courtroom.  Justice Sotomayor’s concurring opinion notes that where the debtor is an individual, he or she may not be able to get to work to earn money to pay any creditors if his or her car is impounded for parking fines the debtor cannot afford to pay . . . effectively undermining the debtor’s bankruptcy case before it gets underway.  Her opinion suggests some ways that Congress could improve the Bankruptcy Code to give working debtors a better chance at a successful outcome for their case and unsecured creditors a better chance of getting paid something on their claims.  Perhaps the incoming Congress will accept her invitation to make some changes to the Bankruptcy Code.

On January 12, 2021, the U.S. Court of Appeals for the Fifth Circuit vastly changed the landscape for collective action wage and hour claims under the federal Fair Labor Standards Act.

In Swales v. KLLM Transport Services, L.L.C., the Fifth Circuit rejected the lenient standard typically employed by federal district courts for “conditionally certifying” collective actions and ruled that courts must, instead, do the difficult work to rigorously scrutinize whether workers are similarly situated to the named plaintiff before sending notice to potential opt-in plaintiffs.  According to the Court, the importance of the collective action certification issue “cannot be overstated.”

Background: FLSA Collective Actions

The FLSA allows plaintiffs to proceed collectively in litigation, but only when the plaintiffs can show that they and the members of the proposed collective are “similarly situated.”

Group litigation under the FLSA is different from class actions under Federal Rule of Civil Procedure 23. Whereas Rule 23 provides an “opt out” mechanism for class action members to avoid being bound by any judgment, the FLSA requires that similarly situated individuals file written consents to “opt-in” to the collective action.  But, the FLSA does not define what it means to be “similarly situated.”

Lusardi Two-Step Process

There has been much confusion and a lack of uniformity among district courts over how collective actions should proceed.  District courts are required to ensure that notice of the litigation is sent to those who are similarly situated to the named plaintiff, but they must do so in a way that scrupulously avoids endorsing the merits of the case.  Most district courts within the Fifth Circuit applied a “two-step” process to determine (1) who should receive notice of the potential collective action, and then (2) who should be allowed to proceed to trial as a collective.  This method comes from a New Jersey district court case, Lusardi v. Xerox Corp.  Under Lusardi, district courts utilize the two-step process to determine whether other employees or former employees of the defendant are “similarly situated” to the named plaintiff.

In the first step of Lusardi, the district court determines whether the proposed members are similar enough to the named plaintiff to receive notice of the lawsuit. This step is referred to as “conditional certification” of the putative class.  Typically, it is a lenient standard and a relatively low hurdle for the plaintiff to satisfy.

The second step occurs at the end of discovery.  At that time, the district court makes a second and final determination (utilizing a stricter standard) of whether the named plaintiff and opt-in plaintiffs are “similarly situated,” such that they may proceed to trial collectively.  If the court determines that the opt-ins are not sufficiently similar to the named plaintiff, then the opt-ins are dismissed from the lawsuit, and the named plaintiff proceeds to trial.  This step is referred to as “decertification.”

The Swales Court Rejected Lusardi; New Standard Announced

Last week, in Swales, the Fifth Circuit expressly rejected Lusardi. The Court found that the FLSA does not support Lusardi’s lenient conditional certification of a collective. Instead, the Court instructed district courts to “rigorously scrutinize” whether workers are similarly situated at the outset of the case.

Specifically, the district courts are to identify, before sending notice to any potential opt-ins, what facts and legal considerations will be material to determining whether a group of employees is similarly situated.  Then, the district court should authorize preliminary discovery specifically tailored to those facts and legal considerations.  The Fifth Circuit recognized that the amount of discovery necessary to make the determination will vary case-by-case; but the Court made clear that the determination “must be made, and as early as possible.”  As a result, notices of the lawsuit will only be sent to the individuals who actually are similarly situated to the named plaintiff.

Impact on Employers

Swales is a positive development for employers who face the potentially grueling and costly collective action process. Under Swales, threshold and potentially dispositive issues must be addressed early in the case. While the Swales framework may require more discovery at the beginning of the case, it also limits the scope of potential opt-in plaintiffs and number of individuals receiving notice to only those who truly have an interest in the outcome of the case.  The Fifth Circuit’s new standard also provides litigants with more certainty regarding the issues and parties in the case.

Buried in the 5,500-page Consolidated Appropriations Act for 2021 among various COVID-19 relief was the Trademark Modernization Act of 2020 (“TMA”). The TMA, which will become effective on December 27, 2021, makes several important amendments to federal trademark law (the Lanham Act) intended to modernize trademark application examinations and clean house of trademark registrations for marks not used in commerce. For litigants, the TMA also adds important clarity to the Lanham Act’s standard for obtaining injunctive relief by restoring the rebuttable presumption of irreparable harm called into question by the Supreme Court’s decision in eBay v. MercExchange, LLC, 547 U.S. 388 (2006). A summary of these key changes for trademark registrations and trademark litigation follows.

Ex Parte Challenges to Current Trademark Registrations

A significant impetus for the TMA was comments during a 2019 hearing before the House Subcommittee on Courts, Intellectual Property, and the Internet concerning “clutter” and “deadwood” on the United States Patent and Trademark Office (“USPTO”) trademark registers. As of July 18, 2019, the USPTO trademark register comprised approximately 2.4 million registrations.[1]  As testified by Commissioner for Trademarks Mary Boney Denison, the USPTO had seen an increase in trademark applications or registration maintenance filings that contained false or misleading claims and information, particularly with regard to specimens of use.[2] Trademark applicants are required to submit evidence with their applications that the applied-for trademark is actually being used in commerce in the class of goods or services listed on their respective application. Trademark owners are required to regularly submit similar evidence to maintain their registrations. Commissioner Denison testified that the USPTO has increasingly received fake or digitally altered specimens that do not actually show use of the mark in commerce as required by the Lanham Act.[3] These false submissions, as well as excessive registrations for marks no longer in use, limit the usefulness of Trademark Register and significantly increase trademark clearance costs.

The TMA seeks to address these issues through two new ex parte proceedings. The first mechanism, an ex parte reexamination, permits third parties to challenge use-based registrations where the trademark owner swore that the marks were used in commerce, either in the application itself or in a statement of use. This mechanism allows the USPTO to reexamine the accuracy of the applicant’s claim of use at the time the averment was made. The second mechanism primarily targets foreign applications that claim use under Lanham Act section 44(e) or 66(a)—which allows foreign applicants to bypass submitting a statement of use in lieu of providing evidence of trademark registration in another country—and allows challenges to marks that have never been used in commerce. These proceedings can each be initiated by submitting testimony or evidence establishing a prima facie case of non-use, or the Director of the USPTO may determine on his or her own initiative that a prima facie case of nonuse exists. The registrant will then have the opportunity to respond to the alleged prima facie case. The registration will then either be cancelled, subject to the registrant’s right of appeal to the Trademark Trial and Appeal Board, or confirmed valid. A validity decision will preclude all further ex parte challenges to the registration.

These ex parte mechanisms add renewed focus to the Lanham Act’s requirement of “use” for trademark rights. The Lanham Act requires “bona fide use of a trademark in the ordinary course of trade.” For goods, that can include consistently placing the trademark on the product or its packaging, labels, or tags or, if it is impractical to use on the product itself, invoices and documents associated with the sale of the goods. For services, use can include advertising in connection with actual offers for the services.[4] Given these new mechanisms and an increase in fraudulent applications, USPTO trademark examiners may more strictly scrutinize specimens of use for compliance with trademark use requirements. To avoid unnecessary delays in trademark applications, applicants should take care to ensure specimens meet the requirements of the Trademark Manual of Examining Procedure (“TMEP”) and that their use actually qualifies as trademark use. Experience intellectual property counsel can help clients navigate the TMEP and trademark application procedures.

Changes to Trademark Registration Examination Procedures

The Lanham Act currently requires trademark applicants to respond to office actions issued during the examination within 6 months. The TMA now allows the USPTO increased flexibility to set shorter response deadlines. Specifically, the USPTO can, through regulations, set shorter response periods between 60 days to 6 months, provided applicants can receive extensions of time to respond up to the standard 6 months. Much like extensions of time granted by the USPTO for patent applications, any such extension requests will incur additional fees.

Formalization of the Informal Protest Procedure

Though not a formal process, the USPTO has long allowed third parties to submit evidence regarding registrability of a mark during examination of a trademark application. Section 3 of the TMA now formalizes that process by: (1) expressly allowing third party evidence submissions; (2) setting requirements that the submission include identification of the grounds for refusal to which the submission relates; and (3) authorizing the USPTO to charge a fee for the submission. The USPTO is required to act on that submission within two months of its filing. The decision on the submission is final, but the applicant may raise any issue regarding the grounds for refusal in the application or any other proceeding.

Presumption of Irreparable Harm for Trademark Infringement Plaintiffs

The primary goal of most trademark infringement litigation is to stop the infringing behavior, typically through injunctions. Section 6 of the TMA provides that a “plaintiff seeking an injunction shall be entitled to a rebuttable presumption of irreparable harm.” This language codifies a standard that most courts had applied to establish harm before the U.S. Supreme Court’s 2006 decision in eBay v. MercExchange, LLC.[5] In eBay, the Supreme Court held that patent owners were no different than any other litigant seeking equitable relief, so those owners must demonstrate irreparable harm to be entitled to a permanent injunction. Several courts then applied eBay’s holding by extension to trademark owners, finding they also must demonstrate irreparable harm for an injunction to be warranted.[6] Some courts, like the Fifth Circuit, have struggled in their application of eBay to trademark infringement disputes, leading to confusion and disagreement among lower district courts.[7] The eBay decision thus ultimately led to a circuit split on whether the rule presuming irreparable harm remained valid in Lanham Act cases.[8]

The TMA makes clear that trademark infringement plaintiffs are entitled to the presumption that they will be irreparably harmed if the infringer is allowed to continue use of the infringing trademark. Section 6(b) further confirms the retroactivity of this presumption, stating that Section 6’s amendment “shall not be construed to mean that a plaintiff seeking an injunction was not entitled to a presumption of irreparable harm before the date of enactment of this Act.” This change increases the likelihood that trademark infringement plaintiffs will be awarded preliminary and permanent injunctive relief, decreasing overall litigation costs and evidentiary burdens on plaintiffs.

The Trademark Modernization Act of 2020 addresses a grab-bag of challenging trademark issues that together provide additional protections for trademark owners and, ultimately, consumers. Trademark owners seeking to register their marks will soon have expedited procedures to tackle fraudulent or “deadwood” registrations that block their trademark applications. The Act further resolves a circuit split for awarding an injunction, easing the burden on trademark owners to show harm. While the ultimate effect of the TMA remains to be seen, these changes should empower trademark holders with additional tools to combat problematic registrations and ease litigation burdens.

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[1] Statement of the Commissioner for Trademarks Mary Boney Denison before the United States House Subcommittee on Courts, Intellectual Property, and the Internet Committee on the Judiciary, Jul. 18, 2019 (available at https://www.uspto.gov/about-us/news-updates/statement-commissioner-trademarks-mary-boney-denison-united-states-house_).

[2] Id.

[3] Id.

[4] Services must actually be offered in connection with the advertisement to qualify as “use.” Couture v. Playdom, Inc., 778 F.3d 1379 (Fed. Cir. 2015).

[5] 547 U.S. 388 (2006).

[6] See Peter J. Karol, Trademark’s eBay Problem, 26 Fordham Intell. Prop. Media & Ent. L.J. 625, 636–653 (2016) (available at https://ir.lawnet.fordham.edu/cgi/viewcontent.cgi?article=1623&context=iplj); Mark A. Lemley, Did eBay Irreparably Injury Trademark Law?, 92 Notre Dame L. Rev. 1795 (2017) . See also Gene Quinn, “Why eBay v. MercExchange Should, But Won’t, Be Overruled”, IPWatchdog.com (Feb. 16, 2020) (https://www.ipwatchdog.com/2020/02/16/ebay-v-mercexchange-wont-overruled/id=118929/).

[7] See Karol, supra n. 5 at 646–47.

[8] Testimony of Douglas A. Rettew, “Fraudulent Trademarks: How They Undermine the Trademark System and Harm American Consumers and Businesses” at p. 13, Hearing Before the Senate Committee on the Judiciary, Subcommittee on Intellectual Property (Dec. 3, 2019) (available at https://www.judiciary.senate.gov/imo/media/doc/Rettew%20Testimony.pdf).

The Louisiana First Circuit Court of Appeal once again recognized the primacy of legislation as a source of law in the state and that the power to tax is reserved to the Legislature alone, not the Louisiana Department of Revenue (the “Department”). In Davis-Lynch Holding Co., Inc. v. Robinson, 2019-1574 (La. App. 1 Cir. 12/30/20), ___ So.3d ___, the court invalidated a regulation that had the effect of increasing the corporate taxpayer’s Louisiana apportionment percentage and, therefore, its corporate tax liability. The Davis-Lynch court held that the Department’s regulation (LAC 61:I.1134(D), the “Regulation”)  improperly excluded sales not made in the regular course of a corporation’s business from the sales factor used to determine its Louisiana apportionment percentage and was, therefore, invalid, because it exceeded the scope of the underlying statute and intruded on the Legislature’s sole authority to tax.

La. R.S. 47:287.95(F) (the “Apportionment Statute”) provides the three ratios used to determine the taxpayer-corporation’s Louisiana apportionment percentage. The only ratio at issue – the sales ratio – includes “net sales made in the regular course of business and other gross apportionable attributable to [Louisiana]” in the numerator and includes “total net sales made in the regular course of business and other gross apportionable income of the taxpayer” in the denominator. The Apportionment Statute does not exclude income from sales that were not made in the regular course of a taxpayer’s business. In contrast, the Department’s Regulation excludes sales not made in the regular course of business from the numerator and the denominator, which inflates an affected corporation’s Louisiana apportionment percentages. After reviewing the rules of statutory construction and the Apportionment Statute’s legislative history, the Davis-Lynch court concluded that the Legislature did not intend to exclude sales not made in the regular course of business from the sales factor. Therefore, the court held that the Regulation impermissibly exceeded the scope of the Apportionment Statute and as a result, was invalid.

Background

Davis-Lynch Holding Co., Inc. (“Davis-Lynch”) is a Texas Corporation that, during the relevant tax period, did not do business in the state of Louisiana. Its only business activity consisted of holding its interest in Davis-Lynch, LLC (“D-L LLC”), a Texas single-member limited liability company authorized to do business in Louisiana and that was disregarded for federal and state income tax purposes. D-L LLC manufactured float and cementing equipment and sold its products to, among others, customers drilling oil wells in Louisiana and the Gulf of Mexico. Davis-Lynch maintained a warehouse in Louisiana. In 2011, Davis-Lynch sold its interest in D-L LLC and realized a gain on the sale of its investment.

During the tax year at issue, 2011, Davis-Lynch derived Louisiana net apportionable income from: (i) D-L LLC’s manufacturing activities; and (ii) the gain realized from the sale of its interest in D-L LLC (the “Gain”). Davis-Lynch used the three-factor apportionment formula, described in the Apportionment Statute and consisting of sales; property; and payroll factors, to determine its 2011 Louisiana apportionment percentage. For the sales factor, Davis-Lynch included the Gain in its tax base and in the ratio’s denominator.

On audit, the Department removed the Gain from the sales factor ratio completely, relying on LAC 61:I.1134(D) (the “Regulation”), which provides that “[s]ales not made in the regular course of business are not included in the formula provided by R.S. 47:287.95(F).” Removing the Gain from the ratio resulted in a higher Louisiana apportionment percentage and, as a result, a corporation income tax deficiency. The Department assessed Davis-Lynch for the alleged deficiency and the taxpayer appealed to the Louisiana Board of Tax Appeals (the “BTA”) for redetermination of the assessment.

Applicable Louisiana Law

Under Louisiana’s corporate income tax laws, every item of corporate income falls into one of two categories:  allocable or apportionable. “Allocable” income consists of the exclusive, enumerated list of income provided in La. R.S. 47:287.92(B). “Apportionable” income is a residual class, which includes all income that is not defined as allocable, by default. See, La. R.S. 47:287.92(C). A corporation’s allocable income is taxable only by the state in which it was earned. A corporation’s apportionable income is taxable in proportion to its activities in a given state. The Gain was not a type of income enumerated in 2011 as “allocable” income. It was, therefore, apportionable, by default.

Before 2006, the Gain would have been classified as allocable income, because “profits…from the sale or exchange of property…not made in the regular course of business” was among the enumerated items of allocable income. See, La. R.S. 47:287.92(B)(2) (West 2005). But, in 2005, the Legislature amended the categories of allocable income for tax years beginning January 1, 2006 and removed profits from the sale or exchange of property as an enumerated category. See, La. Acts 2005, No. 401 (Reg. Sess.). As a result, after 2005, the profits from the sale of property not made in the regular course of business were included in the residual class – apportionable income.

To determine what proportion of Davis-Lynch’s apportionable income Louisiana may tax (i.e., its Louisiana apportionment percentage), the starting point is La. R.S. 47:287.95(F)(1). The sales factor ratio during the Taxable Period was as follows:

The ratio of net sales made in the regular course of business and other gross apportionable income attributable to this state to the total net sales made in the regular course of business and other gross apportionable income of the taxpayer.

La. R.S. 47:287.95(F)(1)(c). Davis-Lynch included the Gain in the denominator as “other gross apportionable income of the taxpayer.” On audit, the Department removed the Gain from the sales factor pursuant to the Regulation, which provides that “[s]ales not made in the regular course of business are not included in the formula provided by [the Apportionment Statute].”

The Board of Tax Appeals Decision

After receiving the assessment from the Department, Davis-Lynch filed a Petition for Redetermination with the BTA. At issue in the case was: (i) whether the Regulation exceeded the scope of the underlying statute; and (ii) whether Davis-Lynch properly included the Gain in the denominator of the sales factor ratio under the Apportionment Statute. The BTA ruled, after a trial, that the Apportionment Statute required inclusion of the Gain in the sales factor ratio’s denominator but not its numerator. The BTA determined that the Regulation exceeded the scope of the underlying statute. In so holding, the BTA reasoned that “the clear meaning of [the Apportionment Statute] requires that the ‘other gross apportionable income’ be included in the ratio” and that the Department’s  attempt to “exclude entirely the income recognized by Davis-Lynch on the sale of the LLC from the three factor ratio”  was “a result clearly not contemplated by the statute.”  The BTA found that the Department’s interpretation would “render the phrase ‘other gross apportionable income’ meaningless.” Thus, the Board found the Gain was properly included in the denominator of the sales factor ratio.

The First Circuit Court of Appeal’s Decision

The Department appealed the BTA’s judgment to the Louisiana First Circuit Court of Appeal. On appeal, the Department argued that the Regulation is applicable, operates with the full force and effect of law, and mandates that sales not made in the regular course of business, such as the sale of D-L LLC, be excluded from the sales factor.  In response, Davis-Lynch asserted that the Apportionment Statute required the Gain be included in the denominator of the sales factor as “other gross apportionable income of the taxpayer” and that the Regulation exceeded the scope of the statute and was invalid.

On review, the First Circuit recognized the well-established principle that, even though the Department “has the authority to prescribe rules and regulations to carry out the purposes of Louisiana’s tax statutes, and such rules and regulations will have the full force and effect of law,” the Department’s regulations cannot “extend the taxing jurisdiction of the statute, as taxes are imposed by the legislature, not the Department.” In addition, the court noted, the Department’s “construction of its own regulation cannot be given effect where it is contrary to or inconsistent with the legislative intent of the applicable statute.” Thus, it was necessary to determine whether the Regulation was a reasonable interpretation of the Apportionment Statute or “a prohibited expansion of the scope of the statute.”

The First Circuit began its analysis by considering prior legislative actions related to the classification and treatment of the Gain. In La. Acts 1993, No. 690 (“Act 690”), the Legislature first attempted to reclassify “profits or losses from the sales or exchanges of property…not made in the regular course of business” from allocable to apportionable income. Act 690 would have, further, amended the statute providing specific apportionment formulas (i.e., La. R.S. 47:287.95) to expressly provide that “gross apportionable income…shall not include sales not made in the regular course of business…” See, La. Acts 1993, No. 690 (emphasis supplied). However, Act 690 was later declared unconstitutional. In 2005, the Legislature again attempted to reclassify “profits or losses from the sales or exchanges of property…not made in the regular course of business” as apportionable income, but it declined to exclude sales not made in the regular course of business from “gross apportionable income” as it had in Act 690. See, La. Acts 2005, No. 401 (“Act 401”). Nevertheless, in 2006, the Department adopted the Regulation, which provided, simply, that sales not made in the regular course of business are not included from the sales factor ratio.

The First Circuit found significant and determinative that the Legislature’s previous expression in Act 690, that sales not made in the regular course of business were not included as “gross apportionable income,” was not contained in the 2005 legislation (Act 401). The court, recognizing the primacy of law in the state, stated:

Legislation is the superior source of law in Louisiana. Where the Legislature expressly repealed the provisions of La. R.S. 47:287.95 stating “gross apportionable income shall not include…income not made in the regular course of business” and the language was not reintroduced in subsequent amendments, we find the Legislature’s intent was not to include this language in La. R.S. 47:287.95.

As a result, the court concluded that the Department’s exclusion of sales not made in the regular course of business from the sales factor was “contrary to the clear wording of the [Apportionment Statute] as well as the legislative history excluding similar language from the [Apportionment Statute].” Thus, the court held that the Gain should be included in the denominator as “other gross apportionable income” (but not the numerator) and that the Regulation impermissibly expanded the scope of [the Apportionment Statute].

Implications

The Davis-Lynch decision directly impacts any business whose Louisiana apportionment percentage is determined using the ratio provided in the Apportionment Statute. This includes pipeline transportation companies; businesses whose net apportionable income is derived primarily from the manufacture, production, or sale of tangible personal property; and any business whose net apportionable income is not derived primarily from (i) transportation by aircraft; (ii) transportation by means other than by aircraft or pipeline; (iii) services; or (iv) the exploration, production, refining or marketing of oil and gas. See, La. R.S. 47:287.95(F)(b)(i)-(ii). If the decision becomes final or is otherwise affirmed by the Louisiana Supreme Court on review, all gross apportionable income, from whatever source, must be included in the sales factor ratio’s denominator.

In Davis-Lynch’s case, the Gain was a significant amount from a sale not made in the regular course of its business and including the Gain in the ratio’s denominator had the effect of reducing the taxpayer’s Louisiana apportionment percentage. For other taxpayers, including such sales may not have a similarly beneficial effect on its sales factor. Louisiana taxpayers who determined their Louisiana apportionment percentage and corporate income tax liability using the Regulation – that is, excluding sales not made in the regular course of business – should consider reviewing their returns for whether refund opportunities exist.

The decision is also important because it is yet another example of a Louisiana court recognizing the primacy of legislation as a source of law and denying the Department’s ability to make law through regulation when that regulation exceeds the scope of the statute it purports to interpret. The First Circuit’s decision in UTELCOM, Inc., et al. v. Bridges, 2010-0654 (La. App. 1 Cir. 9/12/2011), 77 So.3d 39 is the most prominent example of this in recent years. The courts’ fidelity to this well-established principle of law is an important check on the Department’s expansive view of its rule-making authority.

As of the date of publication, it is unclear whether the Department will move the First Circuit Court of Appeal for a rehearing or seek a writ of certiorari from the Louisiana Supreme Court.

Other Considerations

The decision makes note of a second assessment the Department issued Davis-Lynch for the 2011 tax period. After the audit, and more than a year into the litigation, the Department determined that Davis-Lynch should have used single-factor versus three-factor apportionment, because it earned income from D-L LLC and D-L LLC derived its income primarily from the manufacturing, production, or sale of tangible personal property. The Department relied on La. R.S. 47:287.95(F)(2)(b)(i), which provides: “For taxable periods beginning on or after January 1, 2006, and for the purpose of this Subsection, the Louisiana apportionment percent of any taxpayer whose net apportionable income is derived primarily from the business of manufacturing or merchandising shall be computed by means of a single ratio consisting of the ratio provided for in Subparagraph (1)(c) of this Subsection.” – i.e., the sales factor ratio.

The Department reversed the three-factor apportionment formula Davis-Lynch used and recomputed its Louisiana apportionment percentage using a single sales factor ratio (excluding the Gain). The reversal had the effect of further increasing the Davis-Lynch’s alleged deficiency for the 2011 year. Davis-Lynch appealed the second assessment to the BTA arguing that, because the Gain far exceeded the income it earned from D-L LLC, its net apportionable income for 2011 was not derived “primarily from the business of manufacturing or merchandising,” but from the sale of D-L LLC. The Department conceded the matter and withdrew the assessment in open hearing before the BTA. Davis-Lynch, thereafter, formally dismissed its appeal.

It is important to note the second assessment in order to make clear that the appropriate apportionment formula is determined by a taxpayer’s net apportionable income for the year in question, not necessarily its primary business.

Conclusion

In summary, the Davis-Lynch court determined that, because the Legislature had included language in its previous attempt in 1993 (Act 690) to remove “profits…from the sales or exchanges of property…not made in the regular course of business” as allocable income, rendering it apportionable, and expressly provided that “gross apportionable income shall not include income…not made in the regular course of business,” its decision declining to include similar language in its subsequent attempt in 2005 (Act 401) showed that the Legislature did not intend to exclude sales not made in the regular course of business from the sales factor. Thus, the Department improperly decided on its own to make such a change through regulation. While state regulations are generally given a large amount of deference by state courts, it is important to remember, as this case demonstrates, that a regulation may not constrain or expand the scope of a taxing statute in any way. Taxpayers should not hesitate to test the validity of any regulation that exceeds the underlying taxing statute.

If you are interested in discussing the Davis-Lynch decision and whether or how it impacts the determination of your business’s Louisiana apportionment percentages for current or past periods, please contact: Jason R. Brown at (504) 293-5769, Willie J. Kolarik II at (225) 382-3441, or Michael W. McLoughlin at (504) 620-3351.

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Jason R. Brown and Willie J. Kolarik II of Kean Miller LLP represented Davis-Lynch Holding Co., Inc. in this litigation.

 

On December 27th, the President signed into law a second pandemic relief package as part of a larger government funding bill passed by Congress entitled The Consolidated Appropriations Act, 2021 (“CAA”). In March of this year, President Trump signed the first pandemic-related stimulus bill: H.R. 748, the Coronavirus Aid, Relief and Economic Security Act (Public Law No: 116-136, the “CARES Act”). The tax provisions in the CAA, are numerous, but for the most part, extend certain tax relief provided in the CARES Act and resolve the controversy regarding Congress’ intent related to certain CARES Act relief provisions.  The CAA also contains several important federal income tax changes, as set out below.

Tax Treatment of PPP Loans

The CAA clarifies that otherwise-deductible expenses funded by loans received under the Paycheck Protection Program (PPP), which was created by the CARES Act, will be deductible under Internal Revenue Code (“IRC”) Section 163. While Congress made clear in the CARES Act that the loans made under PPP were not taxable, it was not clear whether expenses funded by PPP loans would be deductible.  Confusion arose regarding deductibility of the expenses when the Internal Revenue Service (the “IRS”) issued guidance that expenses funded by PPP loans would not be deductible.  However, the new legislation clarifies that it was Congress’ intent that such expenses be fully deductible.

Retention Credit Expanded

One of the major business policies behind the CARES Act was to encourage businesses to retain their employees during the economic turmoil caused by the lockdowns. To that end, the CARES Act provided an employee retention credit to employers, based on wages (and a proportionate amount of qualified health plan expenses) paid to employees.  The CAA  increases the credit percentage to 70 percent of qualified wages and expands the wage base to $10,000 per employee per quarter (as opposed to per year in the CARES Act). The CAA  also reduces the amount of losses that a business must incur to be eligible for the credit.  In addition, the CAA revises the credit to allow a business that received a PPP loan to claim the credit to cover payroll expenses not covered by PPP. The credit expires four quarters after June 30, 2021.

Business Meals Deduction

In an effort to help restaurants that have suffered substantial economic losses during the pandemic, the CAA  increases the deduction for business related meals to 100 percent through December 31, 2022.  Under current federal income tax law, a business may only deduct 50 percent of the cost of business-related meals.

Again, these are just a few of the many tax provisions proposed in the CAA.  Businesses and individuals will be analyzing the impacts of the new law for quite some time.

For additional information, please contact: Jaye Calhoun at (504) 293-5936, Willie Kolarik at (225) 382-3441, or Michael McLoughlin at (504) 620-3351.

On December 21, 2020 Congress passed the lengthiest piece of legislation in its history—nearly 5600 pages. While most Americans are focused on the provisions of the “Consolidated Appropriations Act, 2021” related to coronavirus response and recovery, it also included provisions that will directly impact pipeline operators.

The “Protecting Our Infrastructure of Pipelines and Enhancing Safety Act of 2020” appears at page 2634. The Act contains two provisions which will expand federal regulation of the natural gas pipeline industry.

First, the Act requires PHMSA to, “Not later than 90 days after date of enactment of this Act… issue a final rule with respect to the proposed rule issued on April 8, 2016 …that relates to consideration of gathering pipelines.” The proposed rule published in 2016 changed the existing definition of gathering lines to remove the reference to the API RP 80 definition of gathering lines and replace it with a definition drafted by PHMSA. It also expanded regulation of rural gathering to all lines  more than 8.625 inches in outside diameter. Although recent information from PHMSA shows that it may reconsider some of the provisions of the proposed rule before adoption, industry representatives should pay attention to this issue.

Second, the Act requires PHMSA to adopt, within the next year, regulations that require operators of certain regulated gathering lines to conduct leak detection and repair programs. Once again, industry representatives will want to follow PHMSA’s efforts on this topic.

On Monday, December 21, 2020, Congress passed another stimulus package to provide certain coronavirus relief for individuals and businesses, among other things. One looming question was whether Congress would extend the emergency paid sick leave (EPSL) and emergency paid family leave (EFMLA) provisions of the Families First Coronavirus Response Act (FFCRA) into next year?

The answer is – no. The FFCRA paid leave laws have not been extended, and thus the paid leave law mandates for employers who have fewer than 500 employees expire at 11:59pm on December 31, 2020.

However, Congress’s latest package does allow qualifying employers to voluntarily extend those benefits to employees during the period January 1, 2021 through March 31, 2021 if the employer so chooses, and the employer can continue to receive a credit against payroll taxes as before, with one caveat. In order to claim the payroll tax credits, the employer must comply with the requirements of the EPSL and/or EFMLA as if they were so extended through March 31, 2021.

Importantly, employers cannot claim payroll tax credits for any such paid leave in the first quarter of 2021 if the employee already used up his/her allotment of FFCRA emergency paid sick or family leave in 2020. There may be an exception to this for those employers who use the calendar year for determining the FMLA 12-month period, and hopefully the DOL or the IRS will provide some clarity through regulation, answers to FAQs, or other agency guidance. The new package also does not appear to prohibit an employer from choosing to continue the EPSL through March 31, 2020 but not the EFMLA, or vice versa. The best advice is to talk with your counsel if you have questions or if you are weighing whether to extend such paid leave benefits into the new year.

In the recent 2-1 decision of Knight v. Kirby Offshore Marine Pac., L.L.C, No. 19-30756, 2020 WL 7393534, at *1 (5th Cir. Dec. 17, 2020), the Fifth Circuit held that a Jones Act Seaman was contributorily negligent for his injuries when following the general orders of his superior.  The Court analyzed the differences between general and specific orders for purposes of a seaman’s contributory negligence in emphasizing that a seaman must act with ordinary prudence when carrying out those orders, though the dissent disagreed with the majority. This is a case to watch.

Plaintiff was a seaman aboard a tugboat owned by Defendant. The tugboat housed a stern line to secure barges when entering and exiting ports. At one point, the line chafed, and the captain ordered Plaintiff and another crewmember to replace it. When the order was given, the weather conditions were adverse consisting of four-foot seas and winds of at least twenty miles per hour. After Plaintiff and the other crewmember removed the chafed line, they place it on the deck next to them. As they were installing the new one, Plaintiff stepped on the chafed line and injured his ankle.

Following a bench trial, the district court concluded that Defendant was negligent because the captain ordered the change of line during bad weather. However, the district court also concluded that Plaintiff himself was contributorily negligent as he failed to watch his footing while replacing the chafed line and failed to move the chafed line to a location where he would not have stepped on it. As a result, the district court assigned equal percentages of fault to each party.

Plaintiff appealed the district court’s decision contending that, as a matter of law, a Jones Act seaman may not be held contributorily negligent when carrying out an order. Plaintiff based his argument on the decision Williams v. Brasea, Inc., 497 F.2d 67 (5th Cir. 1974) in which the Fifth Circuit previously stated that “a seaman may not be contributorily negligent for carrying out orders that result in his own injury.”

Although that language appears clear, the majority determined that it was dicta, which does not have binding authority. Further, the majority surveyed the case law and made a distinction between specific and general orders for purposes of the contributory negligence of the seaman. A specific order is one that must be accomplished using a specific manner and method, leaving the seaman with no reasonable alternative to complete the assigned task. The Fifth Circuit applied a narrow interpretation of the dicta in Williams when stating that a “seaman may not be found contributorily negligent for carrying out a specific order from his superior.” In this case, the captain’s order to change the chafed line was one of a general nature. Thus, as a matter of law, the district court was not precluded from reducing Plaintiff’s award by his proportion of fault.

However, the dissent applied a broader interpretation in concluding that the district court ignored binding and longstanding precedent in Williams that seamen who are injured while following orders cannot be held contributorily negligent.

The narrower interpretation of the majority opinion appears to emphasize the duty of a seaman to act with ordinary prudence when carrying out his orders, particularly when receiving orders of general nature. This is a case to continue watching.

One of the most confounding situations faced by corporate taxpayers engaged in a Louisiana income tax audit is the receipt of preliminary workpapers that disallow interest expense deductions with no opportunity to prove that the interest expense is properly deductible because it is directly attributable to the production of apportionable income. The Louisiana Department of Revenue (the “Department”) takes the position, based on what appears to be an incorrect interpretation of the applicable law, that it is not possible for a company to ever directly trace expenses to apportionable income because money is fungible. Therefore, interest expenses must always be indirectly traced to all classes of Louisiana income, i.e., apportionable, allocable and non-taxable, and taxpayers will be required to add back legitimate deductions that nonetheless, clearly relate to apportionable income.

This narrow reading of the state’s expense allocation provisions, and the federal tax laws on which they are based, often produces incongruous results and assessments which, even auditors may agree, are not logical and don’t make good business sense.  That being said, the Department’s regulations provide formulas (discussed below) which auditors feel bound to follow even when the result is problematic and likely wrong, for example, where a corporate taxpayer is deemed to have incurred a very large amount of interest expense over a number of years in order to generate a very small amount of allocable income.  Such a result ignores the realities of how businesses operate under the premise of defeating “tax arbitrage,” even where no such attempt has been made.

Applicable Louisiana Law

The Louisiana corporation income tax is based on a corporation’s “Louisiana taxable income”[1], which is defined as “Louisiana net income, after adjustments, less the federal income tax deduction allowed by R.S. 47:287.85.”[2]  The “net income” of a corporation is defined as “ the taxable income of the corporation computed in accordance with federal law for the same accounting period and under the same method of accounting, including statutorily required accounting adjustments, subject to the modifications specified” in Louisiana law.[3]  A taxpayer is allowed the same deductions allowed under Internal Revenue Code (the “Code”) Section 163 unless a specific statutory modification exist under Louisiana law.

A multistate business operating in Louisiana is taxed on the combination of its Louisiana net apportionable income and its Louisiana net allocable income.  In addition, Louisiana specifically exempts interest and dividend income from tax.[4]

Louisiana net apportionable income is calculated by subtracting the following amounts from the taxpayer’s gross apportionable income:

  • Expenses, losses and other allowable deductions which are directly attributable to gross apportionable income; and
  • A ratable portion of allowable deductions which are not directly attributable to any item or class of gross income.[5]

Louisiana’s interest expense attribution provisions are intended to prevent taxpayers from receiving a double tax benefit through engaging in a type of “tax arbitrage,” e.g., using borrowed capital to fund activities that produce non-taxable income while using equity capital to fund taxable operations.  Thus, the taxpayer would receive a deduction in determining state taxable income for interest expense incurred to generate income that is not subject to tax in the state.  If the expenses related to generating tax-exempt income are deductible, the taxpayer may be able to generate a tax loss even when there has been an economic gain in the state.  While the policy of requiring an addback of expenses related to income not taxable in the state makes sense, and is adopted by many states, the Department has taken such a narrow view of the statutory provisions addressing interest expense allocation, both in its regulations and on audit, that the end result is that taxpayers are paying tax on income that is simply not taxable under Louisiana law.

Interest Expense Attribution

The Department determines  the “ratable portion” of allowable deductions not directly attributable to any item or class of gross income under La. R.S. 47:287.93(B)(2), based on its regulation, La. Admin. Code 61.I.1130(B) (“the Allocation Regulation”), which provides a formula for allocating interest expense within and without Louisiana.  The Allocation Regulation is based on the theory, taken from federal income tax law, that money is fungible and the debt of a multi-state business will always be used, to some extent, to generate both allocable and apportionable income.  Even though the Allocation Regulation is specifically limited by its title[6] to the computation of allocable income, the regulation states that the same formula for allocating interest expense also applies to deductions disallowed under La. Rev. Stat. § 47:287.81 as being related to non-taxable income.[7]

Under the asset-based formula for indirectly attributing expenses, interest expense is allocated through a ratio “the numerator of which is the average value of assets that produce or that are held for the production of Louisiana allocable income and the denominator of which is the average value of assets that produce or that are held for the production of allocable income within and without Louisiana.”[8]

The Louisiana expense attribution provisions outlined above are based on federal tax  provisions aimed at preventing United States taxpayers from claiming deductions for amounts incurred to generate income not included in federal taxable income by the United States.[9]  There are two Internal Revenue Code  (“Code”) provisions on which the Louisiana law is based: Section 265, which addresses the treatment of interest expense incurred to generate income that is not taxed by the U.S., e.g., government bond income, as well as Code Section 861, which addresses interest expenses related to income that would be taxable in the U.S. but is allocated outside of the U.S. based on the source of the income.

Application of Code Section 265

While the Louisiana law and regulations only specifically incorporate Code Section 861 by reference, it is clear that Code Section 265 is the basis for attributing interest expense to non-taxable interest and dividend income in Louisiana.  While the application of Code Section 265 has not been addressed by the Louisiana courts, the application of Code Section 265 to a very similar California interest expense attribution provision was addressed in Ampacet Corporation vs. Cynthia Bridges, Secretary, Department of Revenue and Taxation.[10]  In Zenith the California State Board of Equalization held that the fact that “section 265(a)(2) and its supporting regulatory scheme concern the allocation of interest expense between taxable and nontaxable activities” indicates that it applies to California’s expense attribution provisions even though Section 265 “by its terms, applies to tax exempt obligations and does not necessarily apply to [tax exempt income].”  On the other hand, Code Section 861 cannot be the basis for Louisiana’s attribution of expenses to exempt dividend and interest income because it does not apply to tax exempt income. Therefore, it makes sense that the federal basis of Louisiana’s attribution of interest expense to non-taxable income must be Code Section 265. Because the its Louisiana statutory counterpart appears to be based on this federal provision, the principles developed under Code Section 265 can be very helpful in interpreting the Louisiana statute so as to accomplish its objectives without taxing income that is simply not taxable by the state.

In fact, in applying Code Section 265 principles to California’s comparable statute attributing expenses to non-taxable income, in Zenith, the Board of Equalization stated that it is necessary to “determine whether the totality of the facts and circumstances establish a sufficiently direct relationship between the borrowing and the investment to allow for a direct allocation between those two items.”  Further, it was only required that the taxpayer establish that the “dominant purpose” for the borrowing was to generate taxable income in order to overcome the California Franchise Tax Board’s assertion that the use of an indirect allocation method was required to attribute the expense to taxable and non-taxable income.  There is no reason that the principles espoused in the well-reasoned Zenith decision should not be helpful to a Louisiana court interpreting the almost identical expense attribution provisions in Louisiana. But fundamentally, Louisiana can only tax income that has a connection with the state and, in fairness, a taxpayer must be given the opportunity on audit to demonstrate that the dominant purpose of a particular borrowing was to produce apportionable income.  The Department’s goal is to get it right under the law and, accordingly, the Department serves taxpayers and the system best by never refusing to acknowledge the reality of any particular situation in which there is no tax avoidance motive and in which imposition of tax ignores both the letter and spirit of the federal law on which Louisiana law is based.

Application of Code Section 861

With respect to the attribution of interest expense to allocable income, the federal predicate for the Louisiana provisions,  Code Section 861(b) addresses whether the expenses of a U.S. company with international operations are related to the production of  U.S. income or foreign source income, i.e., it prevents a U.S. taxpayer from receiving a deduction for expenses paid that are related to non-U.S. activities that are not subject to U.S. income tax.  Code Section 861 provides that, from items of gross income specified as income from sources within the United States, there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expenses, losses or other deductions which cannot definitely be allocated to some item or class of gross income.  The Service’s regulations enumerate specific classes of gross income, e.g., rents, royalties, interest, compensation for services, to which a company’s deductions must be allocated.    The deductions can be directly allocated to a specific class of gross income or, in the alternative, the related federal regulations provide a mechanism for the allocation and apportionment of expenses among classes of income.

The Department has narrowly interpreted Code Section 861 to require that indirect attribution always be used in regard to interest expense deductions based on the concept that money is fungible and a particular expense can never be attributed to a specific item of income.  But this overly broad application of fungibility was struck down by the Board of Tax Appeals (“Board”) in Ampacet Corporation vs. Cynthia Bridges, Secretary, Department of Revenue and Taxation.   In Ampacet, the taxpayer borrowed the funds at issue to purchase Industrial Revenue Bonds (“IRBs”) that were used to build a manufacturing facility in Deridder, Louisiana and deducted the related interest expense in computing its net apportionable income in Louisiana.  On audit, the Department required the taxpayer to instead indirectly allocate the expense to all classes of income using the asset method set out in the regulations.

The Board, however, found that an indirect attribution of the interest expense was not applicable to the IRBs at issue because the taxpayer successfully demonstrated that the money was borrowed for a specific purpose and there were rules requiring that the money to be used for that purpose. The Board stated that if the taxpayer can demonstrate that the “specified purpose” for the borrowing was to generate a particular class of income, the expense can be directly traced to that income.  While the Department has since interpreted the Ampacet decision to apply only to expenses related to IRBs, there is no justification for the Department’s narrow view. Such an interpretation is not supported by state law and directly conflicts the federal application of Code Section 861, which requires that a taxpayer be provided the opportunity to show that the “specified purpose” of the borrowing was to produce apportionable income. Only if the taxpayer cannot meet its burden of proof can the Department require the use of an indirect attribution method.

Conclusion

While determining what amount of a company’s interest expenses were incurred to produce a particular class of income may be complicated, the Department needs to make every effort to get to the right result.  It cannot fall back on administrative convenience and apply a one size fits all approach if this approach truly does not fit all. Based on state and federal precedent, a taxpayer must be given the opportunity to prove that its interest expense can be directly traced to a particular class of income.  The premise that money is fungible cannot support an assessment in which the result is an attempt to tax income that is not taxable by the state under applicable law.

For additional information, please contact: Jaye Calhoun at (504) 293-5936, Willie Kolarik at (225) 382-3441 or Michael McLoughlin at (504) 620-3351.

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[1] La. R.S. 47:287.11(A).

[2] La. R.S. 47:287.69.

[3] La. R.S., 47:287.65.

[4] La. R.S. 47:287.93(A)(2) and La. R.S. 47:287.738(F). For the period July 1, 2015, through June 30, 2018, Louisiana only allowed a deduction for dividends equal to the amount of 72% of those dividends.

[5] La. R.S. 47:287.94(A) (emphasis added).

[6] LAC 61:I.1130 is titled” Computation of Net Allocable Income from Louisiana Sources.”

[7] LAC 61.I.1130(B)(1(d)(iv).

[8] LAC 61:I.1130(B).

[9] See Code Section 861 and the regulations thereunder.

[10]  Appeal of Zenith National Insurance Corp., 98-SBE-001, 1998 WL 15204 (Cal. St. Bd. Of Equalization 1998).  See also Apple, Inc. v. Franchise Tax Bd. 199 Cal.App.4th 1 (Cal. Ct. of App., First District 2011); Appeal of B.B.C.A.F. Inc., OTA Case No. 18011333, 2019 WL 5902553 (Cal.Off.Tax App. 2019).