Northwest Energetic Serv. V. Franchise Tax

• Decision Date: 31 January 2008
• Docket Number: No. A114805.,No. A115950.,No. A115841.,A114805.,A115841.,A115950.
• Court: California Court of Appeals Court of Appeals
• Parties: NORTHWEST ENERGETIC SERVICES, LLC, Plaintiff and Respondent, v. CALIFORNIA FRANCHISE TAX BOARD, Defendant and Appellant.

71 Cal.Rptr.3d 642

159 Cal.App.4th 841

NORTHWEST ENERGETIC SERVICES, LLC, Plaintiff and Respondent, v. CALIFORNIA FRANCHISE TAX BOARD, Defendant and Appellant.

No. A114805.

No. A115841.

No. A115950.

Court of Appeal, First District, Division 5.

January 31, 2008.

As Modified on Denial of Rehearing March 3, 2008.

Edmund G. Brown, Jr., Attorney General, Randall P. Borcherding, Supervising Deputy Attorney General, Jeffrey Rich, Deputy Attorney General, Marguerite C. Stricklin, Deputy Attorney General, for Defendant and Appellant.

Silverstein & Pomerantz, Amy L. Silverstein, Edwin P. Antolin, San Francisco, for Plaintiff and Respondent.

NEEDHAM, J.

In these consolidated appeals, the California Franchise Tax Board (FTB) challenges a judgment awarding respondent Northwest Energetic Services, LLC (Northwest) a refund of amounts paid under Revenue and Taxation Code section 17942¹ and an order awarding attorney fees. In awarding the refund, the trial court concluded that former section 17942—a levy on limited liability companies registered to do business in California—is unconstitutional because the levy is measured by the limited liability company's total income, regardless of whether the income derived from or is attributable to business within the state. FTB contends this ruling was erroneous. As to the award of attorney fees, FTB urges that section 19717 is the exclusive means of obtaining attorney fees in a tax refund action, Northwest failed to establish entitlement to a recovery of attorney fees under Code of Civil Procedure section 1021.5 and the common fund doctrine, and the court erred in awarding fees in an amount several times greater than the lodestar.

We hold that former section 17942, as applied to Northwest in the years in question, violated the Commerce Clause of the United States (Commerce Clause), and that Northwest is entitled to a refund. We further hold, however, that the trial court's order does not support an award of attorney fees greater than the lodestar. We therefore reverse the attorney fees order and remand for further consideration of the attorney fees award consistent with this opinion.

I. FACTS AND PROCEDURAL HISTORY

At all times relevant to this appeal, Northwest was a limited liability company (LLC) organized under the laws of the State of Washington, with business locations in Washington and Oregon. It engaged in the business of distributing explosives and explosives-related services to customers in Washington, Montana, Oregon, and Idaho. Northwest had no operations, property, inventory, employees, agents, independent contractors or place of business in California. Nor did it solicit customers in California or make any deliveries to customers in California.

Northwest nonetheless registered as a limited liability company (LLC) with the California Secretary of State pursuant to Corporations Code section 17451 in June 1997. In years following, it filed tax returns with the FTB and untimely paid an $800 minimum tax imposed under section 17941. It did not, however, pay an amount imposed under former section 17942, based on an LLC's "total income from all sources reportable to this state for the taxable year." (Former § 17942, subd. (a).) The parties agree that this amount (the Levy) is imposed on the LLC's statutorily-defined "total income," wherever earned, without apportionment according to the percentage of business or income attributable to activities in California.

FTB subsequently notified Northwest that it owed $27,458.13 for amounts due under the Levy, along with late payment penalties and interest, for tax years 1997, 1999, 2000, and 2001 (Years in Issue). Northwest paid the $27,458.13 and cancelled its registration with the Secretary of State effective June 13, 2002.

Northwest filed a claim for refund, which FTB denied. Northwest thereafter exhausted its administrative remedies, including appealing the FTB's decision to the State Board of Equalization, without success.

Northwest filed this lawsuit in January 2005, seeking a refund of the amounts it paid for the Levy, penalties, and interest. Among other things, Northwest alleged that the Levy was unconstitutional on its face and as applied, because former section 17942 contains no method for apportioning the Levy to the proportionate amount of income earned in California and, therefore, discriminates against interstate commerce and violates due process and equal protection rights.

A court trial was conducted based upon the parties' joint stipulation of facts and their stipulation regarding documents that could be admitted into evidence without objection. After the parties submitted trial briefs and the court held oral argument, the court issued a proposed statement of decision. FTB filed objections, to which Northwest replied. In the statement of decision, filed April 13, 2006, the court found that the Levy violated both the Commerce Clause and Due Process Clause of the United States Constitution. Accordingly, the Levy could not be applied to Northwest and Northwest was entitled to a refund of all amounts paid. In May 2006, the court entered judgment ordering a refund of $27,458.13 to Northwest, plus interest and costs to be determined.

FTB filed a notice of appeal from the judgment in July 2006. (Appeal No. Al 14805.)

Northwest thereafter filed a motion for attorney fees and costs, seeking $5 million in attorney fees. As explained further post, Northwest contended that it was entitled to attorney fees under the private attorney general doctrine codified in Code of Civil Procedure section 1021.5 and the common fund doctrine, that its reasonable attorney fees amounted to $214,287.50, and that this lodestar amount should be adjusted upward due to numerous factors as well as the significance of the benefit counsel obtained for LLC's. After briefing and oral argument, in August 2006 the court awarded Northwest $3.5 million in attorney fees under Code of Civil Procedure section 1021.5 and the common fund doctrine.

FTB filed notices of appeal from the attorney fees order in October 2006 (appeal Nos. A115841 & A115950).

On December 13, 2006, we granted FTB's motion to consolidate appeal numbers Al 14805, Al 15841, and Al 15950, pursuant to the parties' stipulation.²

II. DISCUSSION

The parties raise the following issues: (1) whether the Levy set forth in section 17942 is a tax or a fee; (2) whether the Levy violates the Due Process or Commerce Clauses of the United States Constitution; and (3) whether the trial court erred in its award of attorney fees to Northwest.

A. IS THE SECTION 17942 LEVY A TAX OR A FEE?

At the outset, the parties strenuously debate whether the Levy constitutes a tax or a fee. We first address the context of the Levy and then, based on its legislative history, conclude that it more closely resembles a tax.³

1. LLC's, Former Section 17942, and the Statutory Scheme

The Levy was enacted in 1994 as part of the Beverly-Killea Limited Liability Company Act (LLC Act). Codified as new Title 2.5 to the Corporations Code (Corp. Code, § 17000 et seq.) with conforming amendments to other codes such as the Revenue and Taxation Code, the LLC Act authorized for the first time the formation, operation, and regulation of LLC's within California. Before the enactment, a business entity could form in California only as a corporation, partnership, or sole proprietorship.

An LLC is a hybrid entity that offers certain advantages over corporations and partnerships, by combining aspects of each. Like a corporation, an LLC is a distinct legal entity and its members (owners) have limited liability for the entity's debts and obligations; LLC's thereby provide an advantage over certain partnerships and sole proprietorships. (Corp. Code, §§ 17001, subds. (t), (x), (z), 17101.) Like a partnership, a LLC's members may participate actively in the management of the organization, thus offering an advantage over certain corporations. (See Corp. Code, § 17150; see 9 Witkin, Summary of Cal. Law (2001 supp.) Corporations, § 43A, p. 346 (Witkin).) Moreover, unless it elects otherwise, an LLC is a passthrough entity for tax purposes, akin to a partnership or S-corporation (but without certain other limits placed on S-corporations). Profits are not taxed at the entity level but are instead passed through to members and taxed on an individual basis, thus avoiding the double-taxation aspect of a C-corporation.

In light of the growing popularity of LLC's, the California Legislature enacted the LLC Act with the aim of expanding California's competitive business environment. (9 Witkin, supra, at p. 346.) A Senate Rules Committee report for Senate Bill 469, the bill from which the LLC Act derived, stated in part: "The bill is intended to conform with the trend in other states to provide a new organizational vehicle for small and medium sized businesses, which would grant their owners limited liability, but at the same time allow them to be treated as partnerships for federal purposes (at considerable tax savings) and to receive preferential tax treatment by the state in comparison with corporate tax treatment. Sponsors argue that the availability of LLC status will improve California's business climate by facilitating formation of new businesses in California. Sponsors are further concerned that for lack of LLC legislation, the status of activities conducted by foreign LLC's will not be clear, which may reduce their enthusiasm for doing business in California." (Sen. Rules Com., Off. of Sen. Floor Analyses, 3d reading analysis of Sen. Bill No. 469 (1993-1994 Reg. Sess.) as amended Jan. 26,1994, p. 3.)

The LLC Act, among other things, sets forth: requirements for the formation of LLC's; regulations concerning the allocation of profits and losses, distributions of money and property, withdrawal of membership, assignment of interests, and dissolution of LLC's; requirements for the registration of foreign LLC's with the Secretary of...