Not So Sweet Home Alabama – Corporate and Company Law

In a recent opinion out of the U.S. District Court for the
Northern District of Alabama, the newly-effective Corporate
Transparency Act¹ (“CTA”) has been found
unconstitutional. In National Small Business United v. Janet
Yellen,² Plaintiffs Isaac Winkles and the National
Small Business Association challenged Congress’ authority to
compel the disclosure of beneficial ownership information from
entities incorporated at the state level. Judge Liles C. Burke
agreed with the plaintiffs, finding that the CTA exceeds
congressional authority under the Constitution because it lacks a
sufficient nexus to Congress’ enumerated powers.

The CTA was passed as part of the 2021 National Defense
Authorization Act, and pursuant to a final rule issued by FinCEN in
2022, the CTA took effect on January 1, 2024. The CTA is designed
to elicit certain identifying information from state-registered
entities for the purpose of combating illicit activities such as
money laundering and tax evasion. Specifically, the CTA requires
“reporting companies” to disclose the identity and
address of their beneficial owners to FinCEN. Remedies for the
failure to disclose include civil penalties and criminal
liability.

The plaintiffs challenged the CTA on a number of grounds,
arguing that Congress lacked the authority to mandate such
disclosures under its enumerated powers, and contending that said
disclosure requirements violate the plaintiffs First, Fourth, and
Fifth Amendment rights. The government offered four sources for
congressional authority to implement the CTA, and Judge Burke
addressed each in turn.

First, the government argued that the CTA was a valid exercise
of Congress’ foreign affairs powers and the Necessary and
Proper Clause, because the collection of beneficial ownership
information is necessary to protect national security interests and
bring the United States into compliance with international
financial standards. While acknowledging Congress’ extensive
foreign affairs powers and the deference typically given to
Congress on policy matters, the court rejected the government’s
arguments because it found state-level incorporation to be an
internal affair, not one of foreign affairs, because incorporation
is a creature of state law and has historically remained within the
purview of the states. Consequently, the CTA cannot be justified as
an extension of Congress’ foreign affairs powers, and instead
must be justified under Congress’ enumerated powers.

Second, the government argued that the CTA is a valid exercise
of the Commerce Clause and Necessary and Proper Clause, because
many CTA reporting companies are frequent users of the channels and
instrumentalities of interstate and foreign commerce. The court,
however, found no constitutional justification for regulation of
the entire class of state-incorporated entities just because some
members of that class may utilize the channels and
instrumentalities of commerce at some point after formation. Judge
Burke even remarked that the CTA could have been validly written to
regulate the channels and instrumentalities of commerce, had it
prohibited their use “for harmful purposes, even if the
targeted harm itself occurs outside the flow of
commerce.”³ Because the CTA imposes disclosure
obligations upon state registration, and not when the entities
actually engage in commerce, it cannot be sustained as a regulation
of those channels and instrumentalities of commerce.

Third, the government argued that the CTA was justified under
the Commerce Clause in that reporting companies have a substantial
effect on commerce in the aggregate when they collectively withhold
their beneficial ownership information from regulatory bodies.
Judge Burke found the government’s purported connection between
entity formation and the illicit activity the CTA seeks to combat
as far too attenuated to permit Congress to exercise its Commerce
Clause authority. Likewise, Judge Burke rejected the
government’s argument that the CTA was a necessary and proper
means of exercising Congress’ power to curb illicit commercial
activity, because the recipient of the disclosed ownership
information, FinCEN, already receives such information under its
Customer Due Diligence rules.

Lastly, the government argued that CTA’s collection of
beneficial ownership information can be justified as a necessary
and proper method of effectuating efficient tax administration,
thereby validating the CTA under Congress’ taxing powers.
Again, the court rejected this argument for its attenuation,
finding that the mere provision of access to a new database of
information for tax administration does not establish a close
enough relationship between CTA’s disclosure provisions and
Congress’ taxing power, so as to justify it under that taxing
power. To find differently, opined Judge Burke, would constitute a
“substantial expansion of federal
authority.”⁴

Given the court’s determination that the CTA is
unconstitutional for its lack of justification under Congress’
enumerated powers, the court did not need to address whether it
violated Plaintiffs’ First, Fourth, or Fifth Amendment rights.
While this decision raises questions about the viability of the
CTA, it must be noted that the decision only applies to the
plaintiffs in this case. The CTA remains fully enforceable against
all other reporting companies, and it does not affect similar
state-level legislation such as the New York LLC Corporate
Transparency Act. As expected, this decision has been appealed and
we will monitor and report on any future developments.

Footnotes

1. 31 U.S.C. § 5336

2. No. 5:22-cv-01448-LCB, 2024 WL 899372 (N.D. Ala. Mar.
1, 2024).

3. Memorandum Opinion, Nat’l Small Bus. United v.
Yellen, No. 5:22-cv-01448-LCB, at 32.

4. Id. at 52.

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