Federal Court rules that the Corporate Transparency Act is Unconstitutional: What does it mean for Community Associations?

Federal Court rules that the Corporate Transparency Act is Unconstitutional: What does it mean for Community Associations?

On January 1, 2024, the Federal Crimes Enforcement Network (“FinCEN”) opened its online portal for corporate entities in the United States to begin compliance with the new reporting requirements under the Corporate Transparency Act (“CTA”). As discussed in our previous article, Navigating the CTA:  A Guide for Condos and HOAs to comply with the Corporate Transparency Act, the CTA would require those in control of various corporate entities, including most community associations, to disclose to the federal government certain personal information, such as names, date of birth, addresses, and an identifying number from a government identification document.  The failure to comply with the CTA could result in fines of up to $500 for each day a violation continues, capped at $10,000, imprisonment of up to 2 years, or other civil and criminal penalties. In National Small Business United, d/b/a the National Small Business Association, et al, v Janet Yellen, in her official capacity as Secy of the Treasury, et al, Case No. 5:22-CV-1448-LCB, 2024 WL 899372, at *1 (ND Ala, March 1, 2024), the National Small Business Association, and one of its members, Issac Winkles, filed a lawsuit against the federal government challenging the constitutionality of the Corporate Transparency Act.  On March 1, 2024, an Alabama federal court judge ruled that the CTA was unconstitutional, sending shockwaves throughout the country. While the Alabama court ruling is certainly a positive development, it muddies the waters for community associations that are attempting to navigate compliance with the new CTA requirements. As will be discussed below, we still recommend that community associations plan to comply with the CTA until FinCEN issues further guidance excusing compliance or until the appellate courts make final decisions on the constitutionality of the CTA given the risks associated with noncompliance.  However, board members may want to wait a few months to see how the impact of the Alabama federal court’s ruling plays out over the next few months before filing beneficial owner reports.

Impact on Condominium and Homeowners Associations

It is important to understand that the decision in National Small Business United, d/b/a the National Small Business Association, et al, v Janet Yellen, in her official capacity as Secy of the Treasury, et al, Case No. 5:22-CV-1448-LCB, 2024 WL 899372, at *1 (ND Ala, March 1, 2024) does not automatically exempt community associations from compliance with the Corporate Transparency Act.  Specifically, community associations should be aware of the following important points:

1. The Federal Government will likely file an appeal.

The federal government is likely to appeal the ruling and may request that the trial court stay enforcement of the ruling while it appeals.  Either the trial court or an appellate court may grant a stay until all appellate remedies are exhausted.  This is also the type of case that could be heard by the United States Supreme Court, which could add years to any potential resolution.

2. FinCen may issue additional guidance.

When implementing the Corporate Transparency Act, FinCEN created a FAQ page on its website that provides helpful tips on how to comply with the CTA.  We recommend monitoring the FinCEN website as we anticipate that FinCen will issue further guidance or add additional FAQ’s as to its expectations for CTA compliance in the coming weeks.

3. The decision has limited application.

The federal court’s ruling was limited to issuing an injunction that prohibited FinCEN from enforcing the CTA against the plaintiffs in that specific lawsuit.  The court did not prevent FinCEN from enforcing the CTA against community associations that are not parties to that lawsuit.  On March 4, 2024, FinCEN issued a statement demonstrating its belief that the ruling has limited application:

On March 1, 2024, in the case of National Small Business United v. Yellen, No. 5:22-cv-01448 (N.D. Ala.), a federal district court in the Northern District of Alabama, Northeastern Division, entered a final declaratory judgment, concluding that the Corporate Transparency Act exceeds the Constitution’s limits on Congress’s power and enjoining the Department of the Treasury and FinCEN from enforcing the Corporate Transparency Act against the plaintiffs. FinCEN will comply with the court’s order for as long as it remains in effect. As a result, the government is not currently enforcing the Corporate Transparency Act against the plaintiffs in that action: Isaac Winkles, reporting companies for which Isaac Winkles is the beneficial owner or applicant, the National Small Business Association, and members of the National Small Business Association (as of March 1, 2024). Those individuals and entities are not required to report beneficial ownership information to FinCEN at this time.

While the court’s decision is persuasive authority, it is not binding on courts in other jurisdictions, and it is possible that lawsuits in other jurisdictions will have different outcomes.

Why did the Court hold that the Corporate Transparency Act was Unconstitutional?

The federal government relied on three sources of constitutional authority to justify the enactment and enforcement of the Corporate Transparency Act.  The Alabama federal court rejected the federal government’s arguments on the following grounds:

1. Foreign Affairs and National Security.

The federal government argued that the “Necessary and Proper” clause of the United States Constitution provided it with extensive powers over foreign affairs and national security.  Specifically, the government argued that collecting beneficial ownership information under the CTA was necessary for law enforcement to counter money laundering, financing terrorism, and other illegal activities.  The Court rejected this argument on the following grounds:

…the CTA is not authorized by Congress’ foreign affairs powers, because those powers do not extend to purely internal affairs, especially in an arena traditionally left to the States. Nor can Congress look to international standards or agreements to extend those powers, no matter how praiseworthy the policy goal, because “no agreement with a foreign nation,” formal or informal, “can confer power on the Congress, or on any other branch of Government, which is free from the restraints of the Constitution.” Reid v. Covert, 354 U.S. 1, 16 (1957). As a result, this Court must look somewhere other than Congress’ foreign policy powers to justify the CTA.

Id at *10.

2. The Commerce Clause.

The federal government argued that the CTA’s regulations were permitted under the Commerce Clause of the United States Constitution.  Specifically, the government argued that the Commer Clause permits it to regulate (1) the channels of interstate and foreign commerce, (2) the instrumentalities of, and things and persons in, interstate and foreign commerce, and (3) activities that have a substantial effect on interstate and foreign commerce.  The court rejected these arguments, and stated, “[b]ecause the CTA does not regulate commerce on its face, contain a jurisdictional hook, or serve as an essential part of a comprehensive regulatory scheme, it falls outside Congress’ power to regulate non-commercial, intrastate activity.” Id at *20.  While many complex arguments were presented as part of this lengthy analysis, the court stated that inartful drafting of the CTA, specifically failing to limit its regulation to a specific set of activities that had an explicit connection with commerce, was one of the main reasons it failed to pass constitutional muster.

3. Taxing Power.

The federal government also argued that the collection of beneficial ownership information is necessary to ensure that taxable income is properly reported for tax administration purposes.  The government indicated that the CTA’s regulations were constitutional because they were “incidental” to its taxing power.  The Court rejected this argument as well, and held as follows:

It would be a “substantial expansion of federal authority” to permit Congress to bring its taxing power to bear just by collecting “useful” data and allowing tax-enforcement officials access to that data. NFIB, 567 U.S. at 560. Read that way, the Necessary and Proper Clause would sanction any law that provided for the collection of information useful for tax administration and provided tax officials with access. All Congress would have to do to craft a constitutional law is simply impose a disclosure requirement and give tax officials access to the information.

Id. at *21.

Conclusion

While the ruling in National Small Business United, d/b/a the National Small Business Association, et al, v Janet Yellen, in her official capacity as Secy of the Treasury, et al, Case No. 5:22-CV-1448-LCB, 2024 WL 899372, at *1 (ND Ala, March 1, 2024) will most likely be appealed, it is a short-term victory from community associations. Given that legislation is pending that would extend the deadlines to comply with the CTA, and the Community Associations Institute (“CAI”) is lobbying to exempt community associations from CTA compliance, this ruling may help persuade Congress that community associations are not a hotbed for foreign money laundering and that imposing onerous requirements on volunteer board members will deter good candidates from attempting to run for the board of directors in a community association. Please follow our blog for additional updates on this evolving area of law, as we anticipate further guidance from the courts and FinCEN in the near future.  As of the publication of this article, we still recommend that community associations plan to comply with the CTA until FinCEN issues further guidance or until the appellate courts make final decisions on the constitutionality of the CTA.  Delaying compliance with the CTA for existing community associations, who are not required to file a beneficial owner report until the end of 2024 is certainly an option, as the filing may become unnecessary.  However, given the potential penalties associated with failing to comply with the CTA, the fact that the Alabama decision is subject to appeal, and the ruling is only applicable to the parties in that case, there is no harm in community associations continuing to file beneficial owner reports as these issues continue to be sorted out.  If you are unsure whether your community association is required to comply with the CTA considering this recent ruling, please contact us for further assistance.

Kevin Hirzel is the Managing Member of Hirzel Law, PLC and concentrates his practice on community association law, condominium law, Fair Housing Act compliance, homeowners association law and real estate law. Mr. Hirzel is a fellow in the College of Community Association Lawyers, a prestigious designation given to less than 175 attorneys in the country. Mr. Hirzel has been recognized as a Super Lawyer in Real Estate Law by Super Lawyers Magazine, a Leading Lawyer in Condominium & HOA law by Leading Lawyers Magazine, and as a Best Lawyer in Real Estate Law by U.S News and World Report’s Best Lawyers Publication. Hirzel Law, PLC represents community associations, condominium associations, cooperatives, and homeowners associations in Michigan and Illinois. He may be reached at (312) 552-7669 or kevin@hirzellaw.com.