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 Kentucky v. Davis: A Question of Tax Parity in a Flat World

By Caryl Stephens Johnson

 Caryl Stephens Johnson is an associate in the Norfolk office of Kaufman & Canoles and a member of the Public Finance Committee. Kenneth W. Bond, chair of the Public Finance Committee, provided editorial assistance.

Before this article is published, the U.S. Supreme Court (the “Court”) should have determined whether to hear Kentucky v. Davis,¹ on a petition by writ of certiorari by the Commonwealth of Kentucky (the “Commonwealth” or “ Kentucky”). This case is of significance to the states and their political subdivisions engaged in borrowing funds through the authorization and issuance of tax-exempt municipal securities² because, if affirmed by the Court, it will nationalize the market for municipal bonds of any state. Further, this case is important to the municipal securities industry where underwriting tax-exempt bond mutual funds is currently limited to state-specific offerings. It is hoped that the Court will hear this case and provide bright line guideposts in the nascent concept of tax parity of municipal securities to assist municipal securities practitioners.

Kentucky v. Davis arose from an appeal by taxpayers to a grant by the trial court of summary judgment in favor of the Department of Revenue of the Finance and Administration Cabinet for the Commonwealth of Kentucky over the issue of Kentucky’s state policy of taxing the interest on tax-exempt municipal bonds issued by “sister states.” The central issue in the case is the constitutionality under the dormant Commerce Clause of the U.S. Constitution³ of a state exempting from taxation the interest on bonds issued by the state or its political subdivisions while taxing the income on out-of-state bonds, which are tax-exempt under the Internal Revenue Code and under the tax laws of such “sister” state. The Kentucky Court of Appeals⁴ ruled in favor of the taxpayers to the effect that taxing out-of-state bonds while exempting in-state bonds from taxation was found to be discriminatory in violation of the Commerce Clause without the benefit of any judicially recognized exception. The Kentucky Supreme Court refused to hear the case on further appeal, and the Commonwealth sought certiorari on the ground of unconstitutionality and a contrary holding on similar facts in an Ohio decision, Shaper v. Tracy,⁵ causing a split among state courts.⁶

In the Shaper case, an Ohio appeals court found that under identical facts, Ohio taxpayers were not entitled to relief from paying tax on out-of-state tax-exempt bonds they owned on the theory that Ohio’s tax regime violates the Commerce Clause. The court in Shaperapplied recognized exceptions to finding unconstitutionality under the dormant Commerce Clause (discussed supra) and upheld the state tax prohibiting the exemption from taxation of interest on non-Ohio municipal securities.

The dormant Commerce Clause forbids states from interfering with interstate commerce by protecting in-state economic interests at the expense of out-of-state economic interests. In analyzing the constitutionality of a statute under the Commerce Clause, one that is found to be per se discriminatory will be upheld under a strict scrutiny standard if there exists a reason unrelated to economic protectionism to justify the discriminatory action.⁷ Alternatively, if a court finds that the statute is not facially invalid, but its impact is discriminatory, a court may apply a balancing test to determine if there is any legitimate reason for the discriminatory action.⁸

This analysis has led the Court to create several exceptions to the application of the dormant Commerce Clause, namely, the “market participant” exception, the “sovereign entity” exception, and the “subsidy” exception. The “market participant” exception sanctions a state’s discriminatory actions when the state is a market participant, for example, when the state is a buyer or a seller (say, as an issuer of municipal securities).⁹ In Kentucky v. Davis, the Commonwealth argued the “market participant” exception, not as a business enterprise, but as a sovereign acting on behalf of itself, in a manner to favor itself over other sovereign states.¹⁰ Further, the Commonwealth argued that the Court has not found a constitutional basis that would prohibit a state from favoring its own citizens over out-of-state citizens,¹¹ and that the in-state tax exemption is an inducement to Commonwealth residents to purchase the Commonwealth’s bonds instead of corporate securities or bonds of other states.¹² The Commonwealth pointed out to the Court that the issuance and sale of tax-exempt bonds by any state that exempts from taxation the income earned by its citizens from its bonds while taxing the income earned by its citizens on “sister state” tax-exempt obligations is a question that needs to be formally addressed by the Court to prevent further division.¹³

In the appeal to the Court, the respondent-taxpayers, the Davises, argued that Kentucky’s tax statute is facially invalid and violates the dormant Commerce Clause per se,and that the court of appeals decision (finding the statute unconstitutional) is consistent with the Court’s jurisprudence in this area.¹⁴ The respondents argued that reduced borrowing costs for the Commonwealth’s tax-exempt bonds is a form of economic protectionism and, therefore, not constitutionally permissible.¹⁵

Some commentators have equated the concept of the tax exemption on in-state municipal securities to that of a subsidy, which the Court has found to be permissible¹⁶ (i.e., when an increase in yield on a municipal security inures to the benefit of in-state bondholders). This argument most recently was advanced in West Lynn Creamery v. Healy.¹⁷ The Court, in West Lynn Creamery, determined that, when a pure subsidy is funded out of the general revenue and paid for by all taxpayers, there is no burden on interstate commerce.¹⁸ Applying this analysis to Kentucky v. Davis, all taxpayers pay for a state tax exemption equally from the general fund of the state, therefore, providing the exemption does not burden interstate commerce. However, the court of appeals did not adopt this view.

Because of the novelty and importance of Kentucky v. Davis to the municipal securities industry, some observers believe the Court will hear the case. An affirming decision from the Court may provide definitive rules by which to apply dormant Commerce Clause analysis. Indeed the dissents in Camps Newfound/Owatanna v. Town of Harrison, Maine evidence pause for concern among the Justices that the Court’s jurisprudence in the area of the dormant Commerce Clause may have gone astray. Interestingly in Justice Thomas’s dissent, he finds another basis a taxpayer could use to challenge state taxation of municipal securities: the Import-Export Clause.¹⁹ Justice Thomas’s dissent includes a discussion of the historical significance and meaning of the Import-Export Clause and its application to the imposition of taxes on written property that crosses state borders.²⁰ It is Justice Thomas’s contention that the Import-Export Clause prohibits not only taxation of foreign imports, but also the taxation of commerce between the states.²¹

Should the Court hear the case, there are at least two important outcomes. First, the Court could decide to uphold the Kentucky Court of Appeals decision and clarify the dormant Commerce Clause in that context. States would have to decide whether to tax all municipal securities or exempt all municipal securities from state taxation. State concern as to how much revenue would be gained or lost from taxation would take center stage. Further, state concern would focus on potentially significant borrowing rate increases, if all state and local government bonds are taxed at the state level. With affirmation by the Court, there may suffer the demise of single-state mutual funds.²² Some estimate that the interest rate on single-state mutual funds may be between 10 to 25 basis points lower than the mutual funds of those states that do not provide the state tax exemption. Those states that do not offer tax exemptions may realize reduced borrowing costs because they would no longer have to offer taxable high-yield bonds to attract investment dollars.²³

What are the implications for states like Louisiana that have seen their credit ratings slide in the wake of natural disasters? A thought worth considering is whether a national or multi-state bond fund would be considered less risky than a state-specific fund because the investment pool would be more diverse. The fund theoretically would be more sensitive to national economic cycles and less sensitive to geographic economic cycles—and tax-exempt or not at the state level depending on the Court’s decision in Kentucky v. Davis.

Second, the Court could overturn the court of appeals and adopt an exception to the dormant Commerce Clause doctrine for municipal securities while ignoring Justice Thomas’s argument that the Import-Export Clause should apply to domestic commerce. In that case, the ruling of Kentucky v. Davis will extend no further than Kentucky, and as to state taxation of municipal securities, it will not be a flat world²⁴ after all.

Certainly, creating a national or multi-state market for municipal bonds would seem to be the direction Congress and the U.S. Securities and Exchange Commission would like the Court to move. Likewise, market makers in municipal securities could greatly expand their product mix and investment offerings in a national market, replete with all the trappings of full disclosure and transparency that accompany flat world thinking. With regulators and the regulated community both cheering on the Court to accept certiorari and affirm, the outcome of this case will not go unnoticed.

Endnotes

1. Kentucky v. Davis, No. 2004-CA-001940-MR, 2006 Ky. Ct. App. (6th Cir. Jan. 6, 2006) (to be published).

2. I.R.C. §§ 103(a) et seq. & 144 et seq. (1986).

3. U.S. Const., art. I, § 8, cl. 3.

4. Kentucky v. Davis, No. 2004-CA-001940-MR, 2006 Ky. Ct. App. (6th Cir. Jan. 6, 2006), petition for cert.filed (No. 06–666).

5. Shaper v. Tracy, 647 N.E.2d 550 (Ohio Ct. App. 1994)

6. Kentucky v. Davis, No. 2004-CA-001940-MR, 2006 Ky. Ct. App. (6th Cir. Jan. 6, 2006), petition for cert.filed (No. 06–666).

7. New Energy Co. of Ind. v. Limbach, 486 U.S. 269, 278 (1988).

8. Camps Newfound/Owatanna, Inc. v. Town of Harrison, Maine, 520 U.S. 564, 598 (1997) (quoting Piker v. Bruce Church, Inc., 397 U.S. 137, 142 (1970)).

9. Shaper, 647 N.E.2d at 763.

10. Kentucky v. Davis, No. 2004-CA-001940-MR, 2006 Ky. Ct. App. (6th Cir. Jan. 6, 2006), petition for cert.filed (No. 06–666), at 14.

11. Id. at 15.

12. Id. at 16 (citing Hughes v. Alexandria Scrap Corp., 426 U.S. 794, 810 (1976)).

13. Kentucky v. Davis, No. 2004-CA-001940-MR, 2006 Ky. Ct. App. (6th Cir. Jan. 6, 2006), petition for cert.filed (No. 06–666), at 13.

14. Brief for Respondent at 4, Kentuckyv. Davis, No. 2004-CA-001940-MR, 2006 Ky. Ct. App. (6th Cir. Jan. 6, 2006) (No. 06–666).

15. Id. at 7.

16. Dan T. Coenen, Untangling the Market-Participant Exemption to the Dormant Commerce Clause, 88 Mich. L. Rev. 395, 474 (1989).

17. 512 U.S. 186 (1994).

18. Camps Newfound/Owatanna, Inc., 520 U.S. at 564.

19. ‑No state shall, without the consent of the Congress, lay any imposts or duties on imports produce of all duties and imposts, laid by any state on imports or exports, shall be for the use of the treasury of the United States; and all such laws shall be subject to the revision and control of the Congress.

U.S. Const ., art. I, § 10 cl. 2.

20. Camps Newfound/Owatanna, Inc., 520 U.S. at 621.

21. Id.

22. At current estimates, there are over 1300 single-state mutual funds.

23. John Birger, A Bomb in the Muni Market?, Fortune, Feb. 5, 2007, at 112, available at http://money.cnn.com/magazines/fortune/fortune_archive/2007/ 02/05/8399181/index.htm.

24. Thomas L. Friedman , The World Is Flat: A Brief History of the Twenty-First Century (Farrar, Straus & Giroux 2005).

Regulating Cemeteries: Understanding and Sensitivity Can Go a Long Way

By Ronald D. Richards, Jr.

 Ronald D. Richards, Jr., is an associate in the Lansing, Michigan, office of Foster, Swift, Collins & Smith, P.C.

 From a distance, cemeteries appear as a sanctuary of peace and quiet where one can pay respect to loved ones. In the best of cases, cemeteries are just that for everyone. Yet many municipalities that own and operate a cemetery can face great challenges. For example, they must navigate the several evolving and perhaps lesser known cemetery laws in place and recognize potential premises liability issues.

Equally important, municipalities with local cemetery ordinances face the daunting task of enforcing cemetery regulations without attracting negative publicity that can so easily arise in these contexts. This is no easy task, particularly given the heavy emotions and unique dynamics cemetery issues can invoke. Consider the following hypothetical:

Wanting to pay respects to her deceased husband of 50-plus years, Mrs. Smith places 5 flower pots, 2 family markers, a 4 foot tall cement angel statute, and a cement bench next to her deceased husband’s burial plot in a township-owned cemetery. She also has dirt brought in to create a raised landscape bed. The township discovers this, and realizes its cemetery ordinance bars all items except 2 pots and 1 marker. The township wants to enforce its ordinance, but is worried about looking like an 800 pound gorilla being insensitive to an elderly lady’s devotion to her husband and attracting negative publicity. What can the Township do?

This article addresses an area that in the best of times goes unnoticed, but which, when issues arise, can present very challenging issues for a municipality. The article first reviews some of the many cemetery laws in place, including one enacted in January 2007, and then summarizes a recent court decision addressing premises liability issues in the municipal-owned cemetery context. The article then notes how municipalities may meet statutory or other legal duties through cemetery ordinances, and concludes with suggestions on addressing cemetery issues in an efficient, cost-effective way while limiting the dreaded public relations headache.

I. Summary of Cemetery Laws

The State of Michigan has a long-adopted policy of promoting the establishment of cemeteries, as well as their preservation, care, and maintenance.¹ Indeed, the legislature has been enacting laws relating to cemeteries since at least 1855² through the present.³ Cemetery laws cover a wide range of topics: from requiring some operators to register with the state to setting rules regarding caring for, transferring, and vacating cemeteries, and how cemetery care funds may be used. Some laws are very new. Some are quite old. All must be heeded.⁴ Although the limited scope of this article could not summarize all laws, many are highlighted below.

A. 2006 Public Act 627: Free Flag Holders and Flags for Veterans

Act 627, the legislature’s most recent cemetery law, changes the rules regarding providing flag holders and U.S. flags for veterans:

• A municipality (except a county) no longer has the choice, upon a proper petition, to buy a flag holder and U.S flag for a veteran buried in a cemetery in its boundaries, but not owned by it. Now, a municipality (except a county) must buy a holder and flag for a veteran buried within a public or private cemetery.

• The petition asking a municipality to buy a holder and flag may now come from either five eligible voters or a recognized veterans’ organization.

• A county now has the choice whether to buy at its expense a suitable flag and flag holder for a veteran buried in a public or private cemetery.

B. Cemetery Regulation Act⁵: Registration, Audits, and Ordinances

This Act creates a “cemetery commissioner” as the director of the Department of Labor and Economic Growth or the director’s designee and requires those seeking to establish a cemetery to secure a valid permit or registration from the commissioner. It allows audits of cemetery trust funds required under law. It further lets municipalities pass cemetery ordinances and exempts a cemetery owned and operated by a municipality, church, or religious institution from the Act.

C. Cemetery or Burial Grounds Act⁶: Perpetual Care

This Act authorizes a municipality owning or controlling a cemetery to, by ordinance, provide for the perpetual care and maintenance of a cemetery upon payment by the lot owner of an agreed sum. It also allows multiple municipalities to form a nonprofit corporation to acquire, own, operate, maintain, and sell property used for a cemetery or burial ground.

D. Care of Cemeteries Act⁷: Duty to Care for Cemeteries

This Act imposes on townships the duty to ensure all cemeteries in its boundaries are properly taken care of. A person interested in the maintenance of a lot in any cemetery may deposit up to $500 in trust with the treasurer, with the interest or principal used to maintain the lot as designated in the letter of deposit or by agreement with the township. The township supervisor supervises all expenditures. To help townships meet their required duty to care for cemeteries, this Act even creates a “Cemetery Day”—the third Wednesday in August of each year—on which township residents may spend time to improve local cemeteries.

E. Trust Fund for Care of Cemeteries Act⁸: Cemetery Care Trust Funds

Townships may hold property granted it in trust to care for lots or a cemetery. Likewise, townships may receive monies for cemetery purposes; these monies are under the township board’s control and unless otherwise expressed by the grantor, must be invested in safe interest bearing securities with the interest used as designated in the trust. The principal or income derived from trust funds may not be transferred to the general cemetery or other fund, used for general cemetery purposes, or diverted contrary to the trust’s provisions. The township clerk is the custodian of these funds.

F. Public Cemeteries Act⁹: Terminating an Owner’s Rights to a Burial Site

This Act creates a process to terminate an owner’s right to a burial site in a public cemetery if the owner fails for seven years to maintain the space in accordance with cemetery care laws and regulations. The process starts with a cemetery board resolution finding the failure and then serving the owner with it. If the owner does not cure the failure within thirty days, the board may petition the circuit court for a termination order.

G. The Transfer of Rights to Municipal Corporations Act¹⁰: Transfer to Municipalities

A cemetery corporation may sell, assign, transfer, or convey to any municipality in which the cemetery is located (or to any municipality within ten miles of the municipality where that cemetery is located) all or part of its assets, rights, and liabilities. The transfer process requires the cemetery corporation to hold a special meeting and adopt an appropriate resolution, among other steps.

H. Vacating Cemetery in Township Act¹¹: Vacating a Cemetery

A township may take actions to vacate a private cemetery within its boundaries. The process starts with a complaint by ten or more residents alleging that the private cemetery has become neglected, abandoned, or a public nuisance, impedes the growth of a city or village in the township, or endangers the health of the people living in the immediate vicinity. Upon receiving the complaint, the township board must start proceedings to vacate the cemetery. If the township board refuses, a township resident may file the petition and proceed with the matter. If the court orders the cemetery vacated, all bodies and remains must be reinterred in a township cemetery or a suitable nearby cemetery.¹²

I. The Enlargement of Township Burial Ground Act¹³: Enlarging Cemeteries

Townships may acquire or buy new burying grounds or enlarge an existing burial ground. If the township and landowner cannot agree on the amount of compensation, the township may apply to the circuit court to resolve the issue. A jury determines the just compensation to be paid.

II. Caring for Cemeteries and Premises Liability

Regulating cemeteries does not merely entail complying with cemetery statutes. Rather, a municipality that owns and operates a cemetery must also recognize potential premises liability concerns, particularly given the many visitors cemeteries see every day.

Recently, the court of appeals addressed whether a person visiting a municipally owned cemetery is a licensee or invitee for purposes of premises liability duties.¹⁴ In Hiar v. Strong, a cemetery visitor fell into a 6-foot deep trench at a cemetery owned by the defendant township. The trench was dug by the cemetery sexton at the township’s direction to move a burial vault from one location to another. The court of appeals held that the visitor was a licensee because her visit had no commercial purpose. The court summarized the duty municipalities owning cemeteries owe licensees visiting cemeteries:

• warn of any hidden dangers known (or having reason to have known) if the licensee does not know or have reason to know the dangers involved,

• no duty to inspect or affirmatively make the premises safe, and

• no duty to safeguard licensees from open and obvious conditions.

Thus, at least when governmental immunity does not shield the municipality from liability, recognizing these premises liabilities is imperative.¹⁵

III. Common Ordinance Terms

Bearing in mind their duty to care for and maintain cemeteries and given their authority to enact cemetery ordinances,¹⁶ many municipalities adopt such ordinances. This is wise as ordinances can be a very effective regulation tool if comprehensive and clear. Although each municipality may have individualized concerns requiring additional terms, the following is a summary of terms that should be addressed in such ordinances:

• Sale or Transfer of Burial Lots: Address who a municipality may sell a cemetery lot to and at what price, and whether lots may be transferred and on what terms.

• Markers, Memorials, and Monuments: In addition to defining those terms,¹⁷ specify the number of monuments, markers, or memorials allowed per cemetery lot, and the type permitted (e.g., size, composition, footing).

• Interment Regulations: Specify those that may be buried in a burial lot (persons, pets), and the number per lot.

• Ground Maintenance: Address whether the following are allowed (and if so, the terms): tree planting, items (e.g., emblems, displays, pots, flowers, urns) that may interfere with the use of lawn mowers and lawn maintenance equipment, and dirt fill.

• Forfeiture of Vacant Cemetery Lots or Burial Spaces: Identify when, if at all, a burial lot that is vacant for a period of years may revert to the municipality.

• Hours of Operation: Address when the cemetery is open to the general public.

IV. Enforcing Cemetery Regulations Without
Negative Publicity

Even with an understanding of cemetery laws and a comprehensive ordinance, a municipality’s regulation of cemeteries can still be a challenging endeavor given the unique dynamics at play and their propensity to create potential public relations headaches. For example, returning to the hypothetical at the beginning of this article, the municipality has a policy decision whether to pursue enforcement. If it seeks to do so, the municipality would do well to consider the following in trying to solve the conflict and gain compliance with its ordinance:

• Appreciate the sensitive feelings involved. The alleged offender’s actions may be inspired only by a desire to pay tribute to a loved one. Appreciating this “motive” will go a long way toward resolving the matter.

• Consider using a different strategy for cemetery ordinance violations. While a one-time violation notice threatening litigation absent immediate compliance may be effective and appropriate as to other ordinance violations, it is a questionable approach in the cemetery ordinance context given the dynamics. It may also only offend the alleged violator and lead to negative publicity or costly ordinance enforcement litigation.

• Consider scheduling a personal meeting with the alleged offender. This allows the offender to explain his or her actions, and the municipality to explain its goals underlying the ordinance (efficient maintenance, orderly grounds, etc.) and how the offender’s actions are inconsistent with those goals. By educating the offender, this approach may very well resolve the situation with limited cost and on amicable terms. Even if it does not and the municipality pursues enforcement in court, at least the municipality will be able to show it attempted to resolve the matter appreciative of the sensitive nature of the situation.

• Consider whether the situation at hand arose due to an ambiguity in the local ordinance. When that may be the case, consider rewriting ambiguous language to eliminate ambiguity and help avoid similar situations in the future.

Although conflicts in cemeteries are perhaps inevitable, the approach suggested above should help gain compliance outside of court action—i.e., efficiently and cost-effectively—and avoid aggravating a sensitive system to the point of attracting potentially negative newspaper involvement.

V. Conclusion

Cemeteries present unique dynamics that make their regulation challenging. Yet understanding the many cemetery laws on the books, having a clear local cemetery ordinance, and showing sensitivity when conflicts arise, a municipality should be on its way to regulating cemeteries in peace.

Endnotes

1. Avery v. Forest Lawn Cemetery Co. 86 N.W. 538 ( Mich. 1901).

2. 1855 Mich. Pub. Acts 87, as amended (now Mich. Comp. Laws § 456.1 et seq.).

3. 2006 Mich. Pub. Acts 627.

4. For example, the attorney general has recently begun cracking down on cemetery trust fund law violators. Derek Wallbank, State Seizes Cemeteries, Says Funds Mishandled, L ansing S t. J ., Dec. 20, 2006 (on file with author); Midday Update, State Freezes Attorney’s Assets in Cemetery Investigation, L ansing S t. J ., Jan. 26, 2007 (on file with author).

5. Mich. Comp. Laws § 456.521 et seq.

6. Mich. Comp. Laws § 128.1 et seq.

7. Mich. Comp. Laws 128.61 et seq.

8. See Mich. Comp. Laws § 128.71 et seq.

9. Mich. Comp. Laws § 128.11 et seq.

10. Mich. Comp. Laws § 456.181 et seq.

11. Mich. Comp. Laws § 128.31 et seq.

12. A separate statute, the Vacating Cemetery in City or Village Act, Mich. Comp. Laws § 128.51 et seq., addresses cities’ vacating cemeteries.

13. Mich. Comp. Laws § 128.151 et seq.

14. Hiar v. Strong, No. 257918, 2006 WL 664242 ( Mich. Ct. App. Mar. 16, 2006) (per curiam).

15. In Hiar, the Court noted that although not addressed below, the township’s alternative basis for affirming summary disposition—governmental immunity—supported affirmance. See id. at n.2.

16. Wetherby v. City of Jackson, 249 N.W. 484 ( Mich. 1933); see also Mich. Comp. Laws § 456.530.

17. Ordinances commonly define terms used therein, including these: burial space (a space within a cemetery lot appropriate for burial), cemetery lot (a burial space sufficient to accommodate one burial), marker (a stone or plaque, either flush or above the ground, indicating the given or family name of the deceased), monument (a stone extending above the ground inscribed with the family name only), and memorial (any other structure defined to pay tribute to one buried in a cemetery lot).