Federal District Court Rules Corporate Transparency Act Unconstitutional

On March 1, 2024, the U.S. District Court for the Northern District of Alabama (the “Court”) issued an opinion declaring the Corporate Transparency Act (“CTA”) unconstitutional.  On the same date, the Court issued a Final Judgment enjoining the U.S. Department of the Treasury (“Treasury”) from enforcing the CTA as to the named plaintiffs.  On March 11, Treasury filed a notice of appeal of the Court’s ruling.  According to Treasury’s Financial Crimes Enforcement Network (“FinCEN”), the only immediate impact of the Court’s injunction is to the named plaintiffs and the members of the National Small Business Foundation, effective March 1, 2024. 

CTA Background

Congress enacted the CTA as part of the Anti-Money Laundering Act of 2020 (“AMLA”), which was part of the National Defense Authorization Act for Fiscal Year 2021.  Aiming to provide the U.S. government with more information about the natural persons that own U.S. corporate entities, and to discourage the use of shell companies by money launderers and other illicit actors, the CTA requires certain corporations, limited liability companies and other similar entities, that register or are registered to conduct business in the United States (known as “Reporting Companies”), to report personal identifying information about their owners or control persons.  Specifically, the CTA requires Reporting Companies to report beneficial ownership information, (“BOI”) about their ultimate owners or individuals who ultimately own or control such entities to FinCEN, unless exempt from reporting.  FinCEN subsequently issued implementing regulations under the CTA, which took effect on January 1, 2024. 

As relevant to the Court’s decision, failure to provide requisite BOI to FinCEN or providing false BOI to FinCEN may result in civil or criminal penalties against individuals or entities.  Under the CTA and regulations issued by FinCEN, FinCEN maintains the BOI it collects in a database, with disclosure of such BOI limited to certain qualified persons, including law enforcement and financial institutions using BOI to comply with those institutions’ BSA obligations, such as the Customer Due Diligence Rule (the “CDD Rule”)

Plaintiffs’ Challenge to the CTA

On November 15, 2022, National Small Business United, d/b/a/ the National Small Business Association (“NSBA”), and Isaac Winkles, a major shareholder of an NSBA member (together, the “Plaintiffs”) filed a lawsuit against Treasury, seeking declaratory judgment that the CTA is unconstitutional, and exceeding Congress’ authority under Article I of the Constitution and violating the First, Fourth, Fifth, Ninth, and Tenth Amendments.  Plaintiffs also sought an injunction preventing the U.S. Government from enforcing the CTA against the Plaintiffs.  On March 1, 2024, the Court granted Plaintiffs’ motion for summary judgment. 

The Court’s Decision

The Court took an expansive view of states’ rights and a more limited view of Congress’ ability to regulate certain activity out of concern for U.S. national security, and rejected the government’s arguments that the CTA was constitutional under Congress’ abilities to regulate Commerce, regulate foreign affairs, and to impose taxes.  In its ruling, the Court concluded that the “CTA exceeds the Constitution’s limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’ policy goals.”

In reaching its decision, the Court found that corporations are established by state law, and that the Congressional findings in the CTA expressing concerns over foreign money laundering and necessity of collection of BOI for U.S. national security interests were not sufficient to justify regulation of the domestic activity of incorporation under Congress’ foreign affairs powers. 

In addressing Congress’ authority under the Commerce Clause, the Court acknowledged that Congress could issue legislation regulating commercial intermediaries, such as banks, and cited to Supreme Court precedent upholding aspects of the BSA.  However, the Court found that the CTA was unlike the BSA’s regulation of financial institutions as those institutions move funds in foreign and interstate commerce.  The Court rejected the government’s argument that state-registered entities would almost certainly engage in interstate commerce, finding that the act of incorporation of an entity under state law, without more, was insufficient to implicate the Commerce Clause.  In so ruling, the Court expressed a narrow view of the question presented: “‘Does Congress have authority under the Commerce Clause to regulate non-commercial, intrastate activity when ‘certain entities, which have availed themselves of States’ incorporation laws, use the channels of commerce, and their anonymous operations substantially affect interstate and foreign commerce?’”  The Court concluded Congress does not. 

The Court also rejected the government’s argument that Congress could enact the CTA under the Constitution’s Necessary and Proper Clause.  The Court pointed to the CDD Rule, which applies to financial institutions and requires them to collect nearly identical BOI as the CTA, except the Court found the CDD does so in a constitutionally permissible manner because it regulates intermediaries in commerce.

The Court went on to reject the Government’s argument that Congress could enact the CTA under Congress’ constitutional taxing authorities.  The Court found that the penalties for CTA violations are not “taxes,” as they are not paid into the Treasury, are not connected to income thresholds, are not enforced by the IRS, and are not found in the Internal Revenue Code.  The Court further found that the creation of a database containing BOI for tax administration purposes was not sufficient to be constitutional under Congress’ Necessary and Proper Clause.

The Court did not address the remainder of Plaintiffs’ challenges under other Constitutional amendments, including freedom of speech (First Amendment), unreasonable search and seizure (Fourth Amendment), and the privilege against self-incrimination (Fifth Amendment).  Notably, the Court provided specific views on how Congress could conceivably amend the CTA to pass constitutional muster, including, for example, requiring collection of BOI from entities as soon as those entities engage in interstate commerce.

Implications

As of now, the Court’s decision is limited, in that it applies only to the named plaintiffs and members of the NSBA (which claims it has as many as 65,000 members).  As a result, and based on FinCEN’s acknowledgement of the ruling, the overwhelming majority of entities in the United States are unlikely to be impacted by this specific ruling, and therefore, should continue to consider their CTA obligations and associated reporting deadlines. 

Further, as this was a challenge only to Congress’ ability to enact the CTA, it does not impact state laws similar to the CTA, such as New York State’s analogous law.

In addition to the government’s appeal of the decision, we expect that the government will seek a stay of the Court’s ruling pending appeal.  If such a stay is granted, the CTA will remain in effect, without limitation.  However, given the Court’s ruling, future challenges to the CTA by other plaintiffs raising similar arguments could lead to other courts enjoining enforcement of the CTA, which would create even more confusion over the applicability of the statute.