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WBK Industry News - Litigation Developments

9th Circuit Uses Dormant Commerce Clause to Strike Down California Licensing Statute which Required Companies to be Incorporated under California Law

The U.S. Court of Appeals for the Ninth Circuit recently struck down a California licensing statute which required companies engaged in debt prorating (receiving money from a debtor in order to distribute it among creditors) to be incorporated under California law.

Nationwide Biweekly Administration, Inc. v. Owen involved a Company which operated a “biweekly interest savings” mortgage payment program.  The company collected half of a mortgage borrower’s full monthly payment every two weeks (equal to a full monthly payment every four weeks) and remitted the money to the mortgage servicer.  Since calendar months are slightly longer than four weeks, the effect of the program was for borrowers to pay the equivalent of 13 monthly payments each year instead of the normal 12 payments.  The extra payment was used to pay down the principal and resulted in an earlier payoff of the loan balance, which reduced the overall amount of interest paid over the life of the loan.  The Company made money for its service by charging various fees to the borrower.

The Company qualified as a “prorater” under California law, which applies to any person who, for compensation, engages in the business of receiving money for the purpose of distributing the money among creditors in payment or partial payment of the obligations of a debtor.  Proraters must be licensed by the State, but the licenses are only available to companies which are incorporated in California and are specifically organized for the purpose of offering prorater services.  Since the Company was incorporated in Ohio, it was not eligible for the license.

After the State informed the Company that it was unlawfully operating in California without a license and that it could not obtain a license in its current form, the Company filed suit against the State in federal court asserting that the licensing statute violated the Dormant Commerce Clause of the U.S. Constitution because it made licenses available only to corporations incorporated under the laws of California.  The district court rejected the claim, but the Ninth Circuit reversed.

Except in very narrow circumstances, state laws violate the Dormant Commerce Clause if they mandate different treatment of in-state versus out-of-state economic interests in a way that benefits the former and burdens the latter.  Thus, states generally cannot require an out-of-state company to become a resident in order to compete on equal terms.  The Court held that California’s prorater licensing law discriminates on its face against out-of-state economic interests since licenses are only available to companies organized under California law.  If states were allowed to require local incorporation as a condition of engaging in interstate commerce, then national corporations could be required to incorporate in all 50 states in order to do business, such as by creating an individual subsidiary for each.  Requiring incorporation under the laws of each individual state in order to operate a national business would contribute toward the “economic Balkanization” that the Dormant Commerce Clause is meant to prevent.

The Court also rejected an accompanying First Amendment challenge to California regulations which required proraters to include various disclosures and disclaimers with their advertisements and solicitations.  The government may compel truthful disclosures in commercial speech as long as the compelled disclosure is reasonably related to a substantial governmental interest.  Here, the Court found that the disclosures were truthful and accurate statements, and that they prevented consumers from being misled or confused about the nature of the prorater services.

The opinion is available here.