Opinion analysis: Tough day for the Fifth Circuit
The Fifth Circuit had a hard day at the Court on Tuesday – the Court’s second and third decisions of the Term were unanimous reversals of the Fifth Circuit. The first one was Atlantic Marine Construction Co. v. United States District Court, in which the Court reversed the Fifth Circuit’s refusal to enforce a forum-selection clause. The unanimous result in this case was no surprise. After the argument reversal seemed a foregone conclusion; the principal remaining question was what doctrinal route the Court would take, given the existence of strong precedent complicating either of the obvious routes to reversal.
The case involves a commonplace construction contract between a firm in Virginia and a firm in Texas, for work to be done in Texas. The contract included a clause selecting Virginia as the appropriate forum, but when the Texas firm filed suit in Texas, the Fifth Circuit concluded that the convenience of the parties justified keeping the case there notwithstanding the clause. Justice Alito’s sharply worded opinion (he now has two of the three majority opinions so far this Term) left no doubt about the Court’s rejection of the Fifth Circuit’s analysis. His train of analysis, though, reflected what most would regard as the more moderate “balancing” position offered by Atlantic Marine (the Virginia firm seeking to enforce the forum-selection clause).
Justice Alito started by rejecting Atlantic Marine’s argument that dismissal was mandated, because the clause made venue “wrong” under 28 U.S.C. § 1406 or “improper” under Federal Rule of Civil Procedure 12(b)(3). For the Court, proper “venue” is a matter of statute, and the private contract cannot change that. Most importantly to the Court, a holding that venue was improper when it contravened a forum-selection clause would have meant that there were some cases in which there was no proper venue –if the clause selected a state or foreign venue. This position was at least suggested by the Court’s opinion in Stewart Organization v. Ricoh Corp., and strongly articulated by Justice Kagan at argument, so it is no surprise seeing it in the opinion.
Once he made that decision, the problem Justice Alito faced was that once Section 1406 (and Rule 12(b)(3)) were put to the side, the only basis for dismissal (or transfer) is Section 1404, under which courts routinely base transfer decisions on a vague and multi-factored analysis suggested by the Court’s decision in Stewart. It was not obvious how the Court could produce crisp and reliable enforcement of forum-selection clauses under such an ungoverned mode of analysis.
Justice Alito solved that problem by explaining that all factors related to “the private interests of the parties” are irrelevant in a case with a forum-selection clause. Because the only apparent public-interest factors relate to judicial congestion and the like, the Court could emphasize that such cases would be “uncommon” and “most unusual.” To underscore the point, Justice Alito ridiculed the only public interest that J-Crew (the Texas firm challenging the clause) had presented – the difficulty of a Virginia court applying Texas law: “[F]ederal judges routinely apply the law of a State other than the State in which they sit. We are not aware of any exceptionally arcane features of Texas contract law that are likely to defy comprehension by a federal judge sitting in Virginia.”
The biggest doctrinal problem the Court faced in analyzing the case under Section 1404 (rather than Section 1406) was the (previously well-settled) rule that a case transferred under Section 1404 carries with it the choice-of-law rules of the jurisdiction in which it originally was filed. Thus, in this case, the Virginia court would have applied Texas choice-of-law rules, rather than the Virginia rules for which Atlantic Marine (arguably) bargained. The Justices solved that difficulty by articulating an exception for forum-selection clauses: transfers based on a forum-selection clause are to apply the forum-selection rules of the selected venue.
The most intriguing passage in the opinion is a prominent discussion of an amicus brief by Duke professor Steven Sachs. He argues that the simplest way to resolve these cases is with a motion to dismiss under Rule 12(b)(6). Because the forum-selection clause gives Atlantic Marine a complete defense to litigation in Texas, he argues that the court in Texas could simply dismiss the case on that basis. Although Justice Alito declined to address that argument because Atlantic Marine had not filed such a motion, he underscored and explicitly left open the possibility that it was correct.
The Fifth Circuit did no better in United States v. Woods, a unanimous opinion by Justice Scalia upholding the IRS’s application of a valuation “misstatement” penalty to a tax-shelter scam. The Court presumably granted review because the Fifth Circuit’s position was out of line with the rule in other circuits; when it granted review it asked for briefs also on the propriety of jurisdiction (a question not raised by the parties, but in the Court’s view the subject of a separate circuit conflict). Justice Scalia’s succinct opinion, for all practical purposes, tracked the argument presented by the Solicitor General.
The jurisdictional problem involves the tax code’s treatment of partnerships. Generally speaking, partnerships do not pay taxes, but rather pass through to their partners the tax effects of their various activities. Still, the partnerships file tax returns, which of course can violate applicable law just as readily as individual returns. The case before the Court is a “partnership-level” proceeding in which the IRS is trying to determine the appropriate response to the flagrant improprieties of the tax-shelter partnerships out of which the case arose. The IRS wants to apply the penalties at the partnership level (where it can bind all partners at once); the taxpayer wants the determination made separately for each partner in later proceedings for the individual partners.
The statute permits the court in this case to determine “the applicability of any penalty . . . which relates to an adjustment to a partnership item.” Because the penalty is based on the misstatement at the partner level (the partner’s statement of his basis in the partnership) rather than any error at the partnership level, the penalty relates to the partnership adjustment only indirectly.
The Court concluded, however, that it makes more sense to read the statute as permitting the partnership-level proceeding to determine the applicability of the penalty. He acknowledges that “relates to” is “essentially indeterminate,” but resolves the problem by reference to the general structure of the statute. The statute plainly contemplates that determinations related to some penalties will be made at the partnership level (or it would not include the language quoted above). But all penalties are imposed at the partner level (because partnerships never pay taxes). But all penalties will depend on some events at the partner level. (For example, did the partner copy the partnership’s error? Did the partner have enough income for the penalty to be appropriate?) Thus, a narrow reading of “relates to” would mean that no penalties would be determined at the partnership level. Accordingly, the Court holds, the broad meaning of “relate to” makes more sense, and partnership-level determinations are appropriate here.
The Court’s analysis on the merits was similarly brisk. When the opinion starts by explaining that the IRS’s position is “straightforward,” you can have no doubt where it is going. To his mind, it is almost self-evident that an underpayment of tax is “attributable” to a misstatement of “adjusted basis” when the claimed basis rested solely on sham transactions. The Court did not directly address Woods’s central argument – that the statute was directed to misstatements about the value of particular assets rather than misstatements about the tax consequences of transactions – but rather rejected in sequence most of the points Woods offered to support that argument.
So, for example, the Court rejected the idea that “value” refers to factual rather than legal issues, citing earlier tax cases in which value was treated as a question of law. It also rejected the idea that Congress’s recent adoption of a penalty specifically directed at tax shelters suggested the absence of a penalty at the time of this case (before that statute); the opinion explained that the new statute covered different transactions than the one at issue here, so neither was superfluous.
Not surprisingly, the Court was most interested in Woods’s purely textual argument. Because the relevant phrase – “the value of any property (or the adjusted basis of any property)” – puts adjusted basis inside a parenthetical, Woods argues that the kinds of adjusted basis that are relevant must be a subset of property valuations, not some entirely separate category of basis errors (like the ones at issue here). The Court’s response emphasizes the common use of “or” as “disjunctive,” implying that the second category should be distinct, rather than included. It concludes that “[t]he parentheses thus do not justify robbing the term adjusted basis of its independent and ordinary significance” (internal brackets and quotation marks omitted).
One final note – the discussion above does not mention what probably will be the most commonly cited passage in the opinion. At the opinion’s end, the Court responds to the argument that the analysis of the penalty in the “Blue Book” so important to tax scholars – a regularized piece of post-enactment legislative history in the tax field – should influence the Court’s decision. It would surprise nobody that Justice Scalia would reject that idea. But the Court previously had relied on such materials, and so it is surprising that he could get a unanimous Court, without even a concurrence, to sign on to his view that “our more recent precedents disapprove of that practice.”
ATLANTIC MARINE PLAIN-LANGUAGE SUMMARY: If a contract states that the parties agree to file suit in a particular court, a federal court should not accept a case filed in a different court. This is true even if the court in which the case is filed is more convenient to the parties.
UNITED STATES V. WOODS PLAIN-LANGUAGE SUMMARY: The Internal Revenue Code has a “misstatement” penalty that applies to tax returns that seriously misstate the value of assets. This case involves a tax shelter in which the entire investment was a sham, as opposed to the more typical case in which a taxpayer misstates the value of a particular asset (a painting or piece of land, for example). The Court holds that the penalty applies even in the tax-shelter case.