On March 1, 2024, the federal district court in the Northern District of Alabama declared in the case of National Small Business United v. Yellen that the Corporate Transparency Act (“CTA”) exceeds the Constitution’s limits on Congress’s power. The court enjoined the Department of the Treasury and Financial Crimes Enforcement Network (“FinCEN”) – the agency responsible for implementing the CTA – from enforcing the CTA against the plaintiffs in this case. While the ruling enjoins enforcement only against the plaintiffs in the specific case, the rationale used by the court is a broad rejection of the constitutionality of the statute, rather than a more tailored “as applied” rationale. Following the ruling, FinCEN issued a statement clarifying it will only cease enforcement with respect to the specific plaintiffs in the case, rather than with respect to all reporting companies. Those plaintiffs include Isaac Winkles, reporting companies for which Isaac Winkles is the beneficial owner or applicant, the National Small Business Association (“NSBA”), and members of the NSBA as of March 1, 2024 (collectively, the “Plaintiffs”). As of now, the CTA and its beneficial ownership information (“BOI”) reporting requirements remain in effect for all other entities that are required to report BOI to FinCEN under the CTA.

Background

The BOI reporting requirements under the CTA, enacted as part of the Anti-Money Laundering Act of 2020 within the National Defense Authorization Act for Fiscal Year 2021, became effective on January 1, 2024, impacting millions of entities. See our previous client update, “Beneficial Ownership Reporting Requirements Under the Corporate Transparency Act Are Now in Effect.”

The lawsuit was initiated by the Plaintiffs in November 2022, shortly after FinCEN published its final rule for implementing the BOI reporting provisions of the CTA. The Plaintiffs alleged that the mandatory disclosure requirements of the CTA exceed Congress’s authority under Article I of the Constitution and violate the First, Fourth, Fifth, Ninth, and Tenth Amendments.

Alabama Court Holdings

In its 53-page memorandum opinion, the court asserted that the CTA surpassed constitutional limits, rejecting each of the government’s justifications for the constitutionality of the CTA – Congress’s foreign affairs and national security powers as well as the Commerce, Taxing, and Necessary and Proper Clauses. The court did not address the Plaintiffs’ other allegations regarding violations of the specific Amendments.

  • Foreign Affairs & National Security: The court found that Congress’s foreign affairs power does not justify the CTA’s regulation of corporate formation which traditionally falls within the jurisdiction of the states. The court reasoned that although the CTA does not establish general federal incorporation or force BOI reporting to be a requirement for incorporation, it imposes a federal reporting requirement on “entities that voluntarily incorporate” and still “involves a substantial extension of federal police resources.” The court also rejected the government’s effort to justify the CTA as “necessary and proper” to the exercise of Congress’s foreign affairs powers, such as bringing “the United States into compliance with international anti-money laundering and countering the financing of terrorism standards,” because it concluded that such a reading of the Necessary and Proper clause would give Congress “carte blanche to do as it pleases.”
  • Commerce Clause: The court further determined that the CTA falls outside Congress’s power to regulate non-commercial, intrastate activity. It found that the CTA cannot be justified as a valid regulation of the channels and instrumentalities of commerce because it does not regulate purely economic or commercial intrastate activity on its face, and the mere fact that some incorporated entities engage in interstate commerce is not sufficient for the Congress to regulate an entire class. The court also highlighted that the CTA lacks a jurisdictional hook to activities that are expressly connected to interstate commerce or have a substantial effect on interstate commerce.
  • Taxing Power: Finally, the court rejected the CTA’s constitutionality under Congress’s taxing power, stating that 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.”

Implications and Takeaways

The court’s decision has limited implications at this stage:

  • The court’s injunction does not extend beyond the Plaintiffs in this case and it does not affect state laws mirroring the federal CTA (for example, the New York State LLC Transparency Act).
  • The Department of the Treasury is likely to appeal the decision to the U.S. Court of Appeals for the Eleventh Circuit and may seek an interim stay of the ruling. Additionally, the decision is not binding in other courts.

Nonetheless, the ruling may influence similar, ongoing litigation and state corporate transparency legislation. The ruling is likely to encourage other challenges to the constitutionality of the CTA, and states presently contemplating their own corporate transparency laws may reconsider or temper their legislative efforts in light of the uncertain future of the CTA. Moreover, the DOJ has not made a public statement regarding its enforcement efforts under the criminal provisions of the CTA in light of the district court’s opinion. Various components of the Department of Justice testified in support of the CTA and related legislation, and the Department’s continued focus on AML and sanctions evasion prosecutions, in particular, reflect a continued law enforcement interest in scrutiny of companies that fall out of compliance with the CTA’s provisions. Given the district court and FinCEN’s limitation of the injunction to the plaintiffs at issue, companies should anticipate that DOJ will continue those investigative and prosecutorial efforts – at least as to parties other than the plaintiffs here – notwithstanding the sweep of the recent opinion, barring any contrary announcement by DOJ officials.

For most companies, except members of the NSBA as of March 1, 2024 and entities for which the named plaintiff in the Alabama case is a beneficial owner, the CTA will remain in effect. State corporate transparency laws are unaffected, even for the plaintiffs in this case. Ongoing vigilance is recommended as developments unfold, but for now, it is advisable for covered reporting companies to proceed under the assumption that the CTA and its accompanying regulations will remain in force.