GILLETTE COMPANY v. FRANCHISE TAX BOARDRespondent’s Reply Brief on the MeritsCal.September 20, 2013Jn the Supreme Court of the State of California The Gillette Company & Subsidiaries, Plaintiffs and Appellants, v. _ California Franchise Tax Board, an Agencyofthe State of California, Defendant-Respondent. SUPREME COURT Case No. $206587 SEP 2.0 2013 ire Clerk Frank A. McGu Deputy First Appellate District Division Four, Case No. A130803 San Francisco County Superior Court, Case No. CGC-10-495911 The Honorable Richard A. Kramer, Judge REPLY BRIEF ON THE MERITS KAMALA D. HARRIS Attorney General of California SUSAN DUNCAN LEE Acting Solicitor General KATHLEEN A. KENEALY Chief Assistant Attorney General PAUL D. GIFFORD Senior Assistant Attorney General W. DEAN FREEMAN Supervising Deputy Attorney General Lucy F. WANG Deputy Attorney General State Bar No. 199772 455 Golden Gate Avenue, Suite 11000 San Francisco, CA 94102-7004 Telephone: (415) 703-5202 Fax: (415) 703-5480 Email: Lucy.Wang@doj.ca.gov Attorneysfor Defendant and Respondent Franchise Tax Board TABLE OF CONTENTS Page INTRODUCTION.........cccccescesscceneseseessncecseeeeecsenesaceeseeceeeecneeseseeseeesenteeaeeats 1 ARGUMENT........cssccssseccsstecstscssecssccsaeessseceaesescessseesseseaceesueesceeesseaeesasesseetaeees 2 I, SECTION 25128 DOES NOT CONFLICT WITH THE MULTISTATE TAX COMPACT......c.cccssssssnsrsesssscssssecsssesssesseennees 3 A. Tarrant Supports The MemberStates’ Construction Of The Compact. .....ccsccesccscssseecesseeescececeessneeesceeeeeeeaaeensneesenseenes 3 1. Memberstates’ course of CONGUCL.........ececseccsteeeteeees 5 2. State SOVELCIQNLY ......ceeesscccsecesstecesreceesseneeteeseeeesaneseaees 5 3. Other COMPACTS 0...eee eee eesneeeeseeeeeeneeeeetseeeerseeeeeaeens 6 B. Each MemberState Retained The Authority Under The Compact To Enact Subsequent Legislation Mandating The Use OfA Different, Alternate Apportionment FOrmulla........ceecccsssccsseesseceeseeceacesensanensneessaceeseneeeeseeesesesaeessaeeeaas 6 1. The memberstates’ construction is consistent with the Compact...eeecoeseeaeneneaeaeneateneeneateneens 6 2. The Compactis silent, and thus ambiguous, on whether memberstates may enact subsequent Jegislation. .......a eeeeeseeesseeeseeeseeeeeeeeeesse eceeeteecsnaeeesteseses 8 3. The memberstates’ construction is consistent — with the purposes of the Compact. 0.00... seecsesereeeees 9 4. Evidence of the memberstates’ construction of the Compact andtheir course of conduct is indispensable. ......... eee eeseeeseeseceeseeeeeeeeeceeesreeseeeeeeens 10 5. The mostrelevant extrinsic evidenceis the memberstates’ construction of the Compact and their course Of CONGUCT. 0.0... oie ecceecessccceeeceseeeesseesees 10 6. The memberstates’ conductestablishes that a member mayenact a different, alternate mandatory apportionment formula. 0.0.00...eee 11 TABLE OF CONTENTS (continued) Page 7. The Multistate Tax Commission’s Florida Resolution supports the commonconstruction that memberstates may enact different mandatory formulas. ........ ccs eescccsesseeteceeeeesecsseseseees 12 8. Policy considerations support the members’ commonconstruction permitting different FOPMUIAS. «0... eeesceesesecssseccseneeesseeeeesreceneesstneseuseseseees 13 Il. SECTION 25128 DOES NOT VIOLATE THE CONTRACT CLAUSE, w.eseeccesseessenseeneceeressevesessseseecsascessecsessnsessoessseesesseeesnte 13 A. There Is No Substantial Impairment OfA Contractual Relationship. ..........cccsecscsceeeseeeseeetreeseees 15 B. Section 25128 Has a Significant and Legitimate Public Purpose...0......ccceeececscceesseceseeeeseeeseeeteeneesaeerees 17 C. Section 25128 Was Reasonable and Appropriate to the Public Purpose... eeeeeeeeees 18 Il. SECTION 25128 DOES NOT VIOLATE THE REENACTMENT RULE. ooo eeeesceeceesnesereeesaneseaecesesesevsereseseeesseusenssensesesssseeseeessesns 18 CONCLUSION...eeeeeeee rene seeeseeesessenessessseseesseessesdseesseusenssasssesseeseneegey 22 ii TABLE OF AUTHORITIES Page CASES Alabama vy. North Carolina (2010) 560 U.S. 330 [130 S.Ct. 2295, 176 L.Ed.2d 1070, 1091)....... 3,5, 11 American Lung v. Wilson . (1996) 51 CalApp.4th 743 oooceeesseeseesessteesecereeesenstseserseres 19, 20 Corwin v. Los Angeles Newspaper Service Bureau, Inc. (1978) 22 Cal.3d 302 o.occcccccscsessestencecesssetectseereceeecessesenseseserenenteenees 7 Crestview Cemetery Assn. v. Dieden (1960) 54 Cal.2d 744 ooceccseseceeeeeeeseeseneeeceneseeetenstensssnenssseeessssseaes 7,8 Doe v. Ward (W.D. Pa. 2000) 124 F.Supp.2d 900.0...ccc eeesseccteseeteeseeetseeneeneaees 14 Energy Reserves Group, Inc. v. Kansas Power & Light Co. (1983) 459 U.S. 400.eeceeeeeceseseseenecseseeseesscnesenseseevenenees 13, 15,17, 18 Fireman’s Fund Ins. Co. v. Maryland Casualty Co. (1994) 21 Cal.App.4th 1586cececseseseessessecsseveseneeneregs 15 General Expressways v. Iowa Reciprocity Board (1968) 163 N.W.2d 413 .ccccecccssesssessseesssenesseesessneeneesneeneessneeseteneeetenes 14 General Motors Corp. v. Romein (1992) 503 U.S. [8]cceccceecenescssseesesenseeeeesesenessenesensseaeeenessssseteens 14, 15 Green v. Biddle (1823) 21 U.S. L ccccccccecsesesescecesscssenseeseeseseneseescenesereneneneasneeseserenentesees 14 Hellman v. Shoulters : (1896) 114 Cal. 136 co. ccccecseecceecesssenesseeecseseesenesenecersneseeetsensnenteerenes 19 Inre C.B. (2010) 188 Cal.App.4th 1034 ooeseccnseesseneeeeeeeteseneeeeetersnsenents 10, 13 Kansas vy. Colorado (1995) 514 US. 673eeecece cerececessesessssessssssseseceeeesseesseeeeeereeney 10 ili Klasjic v. Castaic Lake Water Agency (2004) 121 Cal.App.4th 5 oo.ceesececsssceesecsessesecesssecseeeneesseseesetereaeees 20 Louisville Water Co. v. Clark (1892) 143 U.S. Lcececeeseeeeeseeeeeeeeeeteescoseeennesnseesaeesnecssseeteeesseesears LT McComb v. Wambaugh (3rd Cir. 1991) 934 F.2d 474occseteeetseecseceseseesseseteseeseaseneness 14, 16 New Jersey v. Delaware (2008) 552 U.S. 597. ecccsesseseseteeeseseseneneacsessseetsnesssessceseeseteseneneateees 11 Pacific Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co. (1968) 69 Cal.2d 33 ooeeseseretensesserenesssssssssssssnsenseecssetsnersneesseneenees 8 Pennsylvania v. Wheeling & Belmont Bridge Company (1952) 54 US. S18vcceeeeeccneeecnenesseseeeeeesensesteeseeesaeeesetsneesseseeeneneeee 14 Railroad Co. v. Peniston (1873) 85 U.S. 21 cccesccssseseseseeeteeeeseseseseseseeestenenstesetseeesseneseensacenenees 5 Scott Co. v. Workers’ Comp. Appeals Board (1983) 139 Cal.App.3d 98.0... csccsceseecetstseerseeeessesesereeeteessnensntseseey 21 Sofias v. Bank ofAmerica (1985) 172 Cal.App.3d 583 oo. eeccceesesecesececessetcesttsessetsestecseeeasaeatenees 15, 16 Sullivan v. Dept. ofTransp. (1998) 708 A.2d 481oececcsssseersesenssceeseseeeseesssasseaeaetesscasesneesndecnens 10 Tarrant Regional Water District v. Herrmann (2013) 560 U.S. 330 [133 S.Ct. 2120, 186 L.Ed.2d 153] 0... passim Texas v. New Mexico (1983) 462 U.S. S54.eeeeesceeteseeseneeeseesessacasaesneeseneeeesseaeeeteneeenenseesey 10 U.S. Steel Corp. v. Multistate Tax Commission . (1978) 434 US. 452.eeeteseeeeseneneceeseaeseseseneseneneevesaeaeesescesseneneneneneaes 9 Universal Sales Corp. v. California Press Mfg. Co. (1942) 20 Cal.2d 751 oeeccsessccsescsesescsesenescesseerseceescneseneeeeeeseseeneasaneenens 8 White v. State ofCalifornia (2001) 88 CalApp.4th 298 ooo. csesneseeeeereseseessneeeseseesenseesees 18, 19 iv STATUTES Civil Code § 1559... euaceecscececeesssceesaecessauceceeaccescecesecessacecssceeecesatesessusessestusessntegeass 15 Education Code § 12510, art. VIII (D) oo. eee eeccssseesseceseeeeseecssessseeeeesaaessseesesesessenesees 6 Family Code § 7907 ..ecesccsscscessscssscesscessecsenecesuecsssessnsesesensesesesssessaseseaeesnsessssesstecaeenaes 6 Penal Code § 11180, art. XTV, §8A, Buicceeesseeseesseecsecesesenecscseseseseseesseseseneaees 6 Revenue & Taxation Code § 25128cc cccsssesetseeeeceseceseeeeseeecsenseseseucnsesescseseaeneaeeesseeacaeceesvetaesenees passim § 3012 oeccccssesssesesecsescseesesecesscseeeseevstsssessesesesesesaeeeeseseesessaeseeseesseeens 19 § 38006 vceccccsscecsccsssssssscsesssssvssssssssecsssssssesssssssssuveceesssssunvecsssnssecsss 2, 19, 20, 21 Vehicle Code § 15023 (C) .ccccesscsssesssecesscesteccssssecsnecesececcsacesseesseceesesesneseseseseeseeseneeeaes 6 Welfare & Institution Code § L400, art. XK (D) cccccesscsssceseseseseseeeseeseseesseeesesesneasseseeseeeseneseseeeeeeeeseneaes 6 CONSTITUTIONAL PROVISIONS California Constitution art. TV, § 9 ccccccccsssscsssssssesssssssssssssvevessssssessvvecsevsesecseseeseeseceeceneesssesesseeeeeesensi 18 art. XIIL, § 31 cccccsscsssssccsssssssssssssscvssssssssevsesssvssivecceseesvesceseescessseseessseeeeeseesees 17 OTHER AUTHORITIES California Opinion of the Attorney General No. 96-806 (80 Ops. Cal. Atty. Gen. 213, August 5, 1997)....cceeesessseeteesseeseees 17 Black’s Law Dictionary (8th ed. 2004) p. 81, COL. 2 ooeeeseesceeeecreeseeeeeseeeesseeaeteeetaeenneaes 20 Merriam-Webster’s Collegiate Dictionary (1999) p. 29, COL. 2 oe eeseneseseesesesesessecesseseaeecsensnsseeseneeeseestsasasesserereeas 20 INTRODUCTION Gillette urges the Court to adopt an interpretation of the Multistate Tax Compactcontrary to that held by its members. Though the Compact contains a provision allowing taxpayers to elect a specific tax formula, the memberstates reasonably construe the Compactto allow them to mandate the use of other, different formulas. In 1971, the memberstates unanimously approved a member’srepeal of the election provision, and 14 of the 20 memberstates have since enacted other mandatory formulas. In Gillette’s view, the memberstates’ construction and course of conduct are irrelevant and may not be considered because(it argues) the Compact’s election provision is unambiguous. Gillette errs, however, focusing solely on the election provision. The key question is whether the Compact bars memberstates from subsequently imposing other mandatory formulas, which requires consideration of the Compactin its entirety. Because the Compactis silent on this question, the memberstates’ course of conductis indispensable to resolving the question. The recent compact case from the Supreme Court of the United States, Tarrant Regional Water District v. Herrmann (2013) 560 U.S. 330 [133 S.Ct. 2120, 186 L.Ed.2d 153], is instructive. It dealt with a similar ambiguity, and looked to three factors that are also present here in construing the compact before it: the memberstates’ course of conduct; the likelihood (or unlikelihood) that states would surrender a vital sovereign interest without unmistakably stating so; and similar treatment of the subject matter in other compacts. Gillette’s interpretation is also bad public policy. It disregards the states’ vital interest in having a flexible Compact that both addresses the commonconcerns of the memberstates, and yet allows each state to protect its own sovereignty to enact tax laws as neededto protect its unique concerns. Moreover, Gillette’s interpretation would imposea rule that threatens the existence of the Compact, by barring memberstates from changing apportionment formulas withoutcompletely withdrawing from the Compact. ARGUMENT In 1974, California joined the Multistate Tax Compact, the text of which provides taxpayers with an election to apportion their income using either the state’s defined formula, or an equally weighted three-factor formula as provided for in Article IV of the Compact.The Compact was set out in former Revenue and Taxation Code section 38006. At that time, California used the same three-factor formula, which wasset out in section 25128.' In 1993, California amendedsection 25128 to require that most taxpayers use a different formula.” Section 25128, subdivision (a), provided that, “[nJotwithstanding Section 38006,” multistate taxpayers were required to apportion their business income by exclusively using a double-weighted sales factor formula. The Court ofAppeal held that section 25128 was invalid and unconstitutional for three reasons: “First, under established compact law, the Compact superseded subsequent conflicting state law. Second, the federal and state Constitutions prohibit states from passing laws that impair the obligations of contracts. Andfinally, the [Board’s] construction of the effect of the amended section 25128 runs afoul of the reenactment clause of the California Constitution.” (Slip opn.at p. 16.) The Board established in its openingbrief on the merits that section 25128 did not conflict with the Compact because (1) the Compact reasonably permitted a memberstate to subsequently enact a law ! Unless otherwise indicated, all statutory references are to the Revenue and Taxation Code. * Subsequent references to section 25128 refer to the amended ‘version unless otherwisestated. establishing an alternate mandatory apportionment formula, and (2) states retain the authority to changetheir tax laws, unless that right has been surrendered in terms that are unmistakably clear. Moreover, the Board established that section 25128 did not violate the contract clauses of the federal and state constitutions, or the reenactmentrule. L SECTION 25128 DOES NOT CONFLICT WITH THE MULTISTATE TAX COMPACT. According to Gillette, the amended apportionment formula in section 25128 conflicts with the Compact because the election provisionis expressly stated, supports the purposes of the Compact, andis unambiguous. Therefore, Gillette maintains, the memberstates’ intent and actions are irrelevant, as are the policy reasons behind the Compact. | But while the election provision may be express, the Compactas a wholeis utterly silent, and thus ambiguous, on the question of whether there is any limitation on a memberstate’s authority to enact subsequent legislation mandating the use of a different apportionment formula. When faced with a similar ambiguity, the Supreme Court recently explained in Tarrant Regional Water District v. Herrmann, supra, 133 S.Ct. 2120, that it was necessary to look “to other interpretive tools [.]” (Ud. at p. 2132.) The Court’s primary task here is to determine the memberstates’ intent in forming the Compact. (See Alabama v. North Carolina (2010) 560 U.S. 330 [130 S.Ct. 2295, 176 L.Ed.2d 1070, 1091] [conc. opn. of Kennedy, J.].) Thus, the policy reasons behind the Compact, and the memberstates’ actions in carrying it out, are not only relevant but indispensable to construing the Compact. (Zarrant Regional Water District v. Herrmann, supra, 133 S.Ct. at p. 2132.) A. Tarrant Supports the Member States’ Construction of the Compact. In Tarrant, the Red River Compact provided that the memberstates | “shall have equal rights to the use of [relevant] runoff... and undesignated water[.]” (Zarrant Regional Water District v. Herrmann, supra, 133 S.Ct. at p. 2127.) Attempting to enforce its “equal rights” under the compact, a Texas state agency providing water to north Texas applied to Oklahomafor permits to divert compact water from Oklahomainto Texas. After joining the compact, Oklahomahad enacted statutes that effectively barred the cross-border diversion of compact water. Like Gillette, Texas claimed that Oklahoma’s subsequentlegislation conflicted with the compact, and therefore was preempted. Oklahoma,like the Board, pointed out that the compactwassilent on the key issue as to whether subsequently enacted legislation would be permitted to alter certain particulars of a state’s performance under the compact. In Zarrant, the Supreme Court of the United States recognized that the pertinent question is not whether a compact promiseof “equalrights”is express and unambiguous, but whether the memberstates’ right to impose limitations on the “equal rights” is ambiguous. (Zarrant Regional Water District v. Herrmann, supra, 133 S.Ct. at p. 2132 [“§5.05(b)(1)’s silence is ambiguousregarding cross-border rights under the Compact”].) That distinction is important here. Had the Supreme Courtdecided Tarrant on the basis of the argument Gillette has made, it would have determined that the Red River Compact’s provision on “equal rights” to water was express, and therefore that there was no need to look deeper. Instead, the Court determined that the memberstates’ right to enact subsequentlegislation was ambiguous, and therefore that the Court must “turn to other interpretive tools to shed light on the intent of the Compact’s drafters.” (bid.) | The Supreme Court lookedat three factorsin aid ofits interpretation—each of which is also present in this case, and each of which supports the Board’s construction: the memberstates’ course of conduct; principles of state sovereignty; and language in other compacts. 1. Memberstates’ course of conduct The Tarrant Court explained that a memberstate’s “‘course of performance under the Compactis highly significant evidence ofits understanding of the compact’s terms.” (Tarrant Regional Water District v. Herrmann, supra, 133 S.Ct. at p. 2135, quoting Alabama v. North Carolina, supra, 130 S.Ct. at p. 2295.) The Court noted that “[s]ince the Compact was approved by Congress in 1980, no signatory State had pressed for a cross-border diversion under the Compact until Tarrantfiled suit in 2007.” ([bid.) The memberstates’ course of conductin the present case is even more telling. Rather than an absence of action by the memberstates, in the present case, fourteen (14) member states—including California—have affirmatively enacted different mandatory apportionment formulas. And not one memberstate has claimed those changesviolated the Compact. 2. State sovereignty The Tarrant Court acknowledgedthat a state’s authority over water within its own borderis “an essential attribute of sovereignty.” (Tarrant Regional Water District v. Herrmann, supra, 133 S.Ct. at p. 2132.) Contrary to the assertion that silence meant the memberstates had surrendered their sovereignty in this respect, the Court explained that “[s]tates rarely relinquish their sovereign powers, so when they do we would expect a clear indication of such devolution, not inscrutable silence.” (id. at pp. 2132-33.) This applies fully to the present case, because taxation is also an essential attribute of state sovereignty. (Railroad Co. v. Peniston (1873) 85 U.S. 21, 29.) Giving up the right to mandate the use of an apportionment formula (without having to withdraw from the Compact) would be a limitation on state sovereignty; states would not be expected to relinquish an aspect of sovereignty in this manner withoutstating so | explicitly. 3. Other compacts The Tarrant Court also noted that in other compacts, states giving up a sovereign right did so explicitly. (Tarrant Regional Water Districtv. Herrmann, supra, 133 S.Ct. at pp. 2133-34.) While not an exhaustive survey,it is worth noting that, unlike the Multistate Tax Compact, the text of almost every compact cited by Gillette explicitly provides that the compactat issue is binding, supersedes state law, or must be given full force andeffect.? (See AnswerBrief at p. 26.) As in Tarrant, the fact that states have explicitly given up their sovereign rights in the compacts cited by Gillette supports the Compact memberstates’ construction that they would not have given up their sovereignty here without saying so explicitly. B. Each MemberState Retained the Authority Under the Compact to Enact Subsequent Legislation Mandating the Use of a Different, Alternate Apportionment Formula. 1. The memberstates’ construction is consistent with the Compact. . According to Gillette, this Court may consider only the Compact’s text to determine its meaning. (AnswerBrief at p. 22.) But there is no hard and fast rule to that effect, and the cases Gillette relies on do not support 3 Veh. Code, § 15023, subd. (c) [Driver License Compact requires party states’ laws“shall contain such provisions as may be necessaryto ensure that full force and effect is given to this section”]; Welf. & Inst. Code, § 1400, art. X, subd. (b) [nterstate Compact on Juveniles “shall becomeeffective and binding uponlegislative enactment” of required numberofstates]; Pen. Code, § 11180, art. XIV, §§ A, B L/nterstate Compactfor Adult Offender Supervision provides “laws conflicting with this Compact are supersededto the extent of the conflict”]; Ed. Code, § 12510, art. VIII, subd. (b) [Compactfor Education “shall become binding” whenproperly adopted]; Fam. Code, § 7907 [Interstate Compact on the Placement ofChildren states that “[n]o provision oflaw restricting out-of- state placementof children for adoption shall apply to placements made pursuantto the Interstate Compact on the Placement of Children”]. this claim. The sameauthority states have to enter into compactsin thefirst instance must also allow states to enter into compacts that permit subsequentlegislative exercises of state sovereignty, whether the operative provisions are expressly stated or not. The Zarrant Court certainly recognized this when it upheld Oklahoma’s subsequentlegislation, which effectively barred Texas from obtaining “equal rights” to Red River Compact water in Oklahoma. (Zarrant Regional Water Districtv. Herrmann,supra, 133 S.Ct. at p. 2133.) Nor does Alabama v. North Carolina (2010) 560 U.S. 330 [130 S.Ct. 2295, 2313] hold otherwise. Ina dispute between memberstates, the Supreme Court held that a compact imposed no expresslimitations on a state’s right to withdraw, and wasnot subject to an implied duty of good faith. (/d. at p. 2313.) That is not the samething as refusing to recognize the memberstates’ non-disputed, extra-textual common understanding that they had the right under the Compact to enact subsequentlegislation mandating a different apportionment formula. Gillette also erroneously claimsthat its text-only rule comes from contract law. In Corwin v. Los Angeles Newspaper Service Bureau, Inc. (1978) 22 Cal.3d 302, this Court held otherwise. “[E]ven if... the words [of the contract] standing alone might mean one thing to the members of this court, where the parties have demonstrated by their actions . . . that to them the contract [means] something quite different, the meaning and intent of the parties should be enforced.” (/d. at p. 314; internal quotation marks and citations omitted.) . . Corwin followed Crestview Cemetery Assn. v. Dieden (1960) 54 Cal.2d 744, in which this Court discussed the rule of “practical construction,” and explained that “the parties by their actions have created the ‘ambiguity’ required to bring the rule into operation. If this were not the rule the courts would be enforcing one contract when [the] parties have demonstrated that they meant and intended the contract to be quite different.” (/d. at p. 755.) Similarly, in Pacific Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co. (1968) 69 Cal.2d 33, this Court explainedthat, “The exclusion of parol evidence . . . merely because the words do not appear ambiguous to the reader can easily lead to the attribution to a written instrumentof a meaning that was neverintended.” (/d. at p. 39; Universal Sales Corp. v. California Press Mfg. Co. (1942) 20 Cal.2d 751, 762-763.) Gillette’s exclusive reliance upon express languageis contrary to both compact cases and contract cases, and should be rejected. 2. The Compactis silent, and thus ambiguous, on whether memberstates may enact subsequent legislation. The Compact is ambiguous. Gillette argues that because the Compact expressly allows variations from someofits terms, its silence on changesin the election provision showsthat the provision is mandatory. (AnswerBrief at p. 25.) However, Gillette’s examples offer it no support. The audit provision in Article VIII is an opt-in requirementthat affects the Multistate Tax Commission’s operations, and the withdrawal provision is a commonaffirmative right that, when exercised, affects member dues. A state’s changein its apportionment formula has no similar impact. Gillette also claims that the memberstates’ construction jeopardizes many compacts “with similar withdrawal provisions which . . . could now be modified at will by party states.” (AnswerBrief at p. 26.) But, again, the express text of each of the compacts Gillette specifically mentions explicitly provides that that compactis binding, supersedesstate law, or mustbe given full force and effect. That is not the case here. 3. The memberstates’ construction is consistent with the purposes of the Compact. Gillette argues that its construction of the Compact advancesthe Compact’s express purposes (AnswerBrief at p. 28), while the member states’ construction “result[s] in less uniformity[.]” (Answer Briefat p. 29). Gillette confuses “to promote uniformity,” an express purpose of the Compact, with “to secure uniformity,” whichis not. Promote means:“to help or encourageto exist or flourish[.]” (Random House Webster’s Unabridged Dict. (1997) p. 1548.) Secure, on the other hand, means:“to effect; make certain of; ensure[.]” (Random House Webster’s Unabridged Dict. (1997) p. 1731).) The Compact’s own language showsits purpose wasto encourage uniformity, not to mandate or require it. Gillette also confuses which formula best serves uniformity. More states, both members and non-members, now employa hyper-weighted sales factor formula than the Compact’s original formula.’ Thereality is that the mere existence of the Compact “promotes” uniformity because it provides a forum for memberstates to address commonproblemsand encourage uniform solutions. Gillette stubbornly clings to the notion that the memberstates were so concerned about possible federal action that they gave upall rights to vary from the Compact’s three-factor formula unless, and until, they completely withdrew. But by the time the Compact becameeffective in California in 1974, six different attempts to deal with the subject of state taxation had died in Congress. (U.S. Steel Corp. v. Multistate Tax Commission (1978) 434 U.S. 452, 456.) In fact, to this day, Congress has * According to a Multistate Tax Commission analysis, of the 47 states and the District of Columbia that levy corporate incometaxes, only 13 states use the equally weighted three-factor apportionment formula. (Board’s Appendix in Support of Respondent’s Brief, Exh. 1.) not yet acted in this area. The course of history strongly suggests that Gillette’s concern about potential congressional interference is unduly magnified. 4. Evidence of the memberstates’ construction of the Compactand their course of conductis indispensable. Gillette’s claim that courts may not consider memberstates’ course of conduct is unsupported. (AnswerBrief at p. 31.) Three of the cases Gillette cites—Texas v. New Mexico (1983) 462 U.S. 554, Alabama v. North Carolina, supra, 560 U.S. 330, and Kansas v. Colorado (1995) 514 U.S. 673—involved disputes between compact members where the Supreme Court was reasonably concerned about imposing a burden upon a compact memberstate to which the state had not expressly agreed. In contrast, California’s actions in amending section 25128 have imposed no burden on other states, or even on the Multistate Tax Commission itself. Gillette’s interpretation would impose a burden on all Compact memberstates by removinga right that they commonly believe they have, and could invalidate actions many took pursuantto that right. The other two cases Gillette cites—Sullivanv. Dept. ofTransp. (1998) 708 A.2d 481, and In re C.B. (2010) 188 Cal.App.4th 1034, 1036— refer to compacts, as discussed above, which expressly provide that the compacts themselves or specific provisions in them are binding. 5. The most relevant extrinsic evidence is the member states’ construction of the Compact andtheir course of conduct. Gillette argues that the most probative evidenceis “evidence of the drafting and negotiation as well as the express purposes of the Compact, not evidence of subsequent conductofparty states.” (AnswerBriefat p. 32.) Yet none ofthe cases Gillette relies upon involve facts demonstrating a course of subsequent actions by the memberstates, let alone a 40-year 10 course of conduct. As demonstrated in Jarrant, course of conduct by memberstates subsequent to the compactis especially important. (Zarrant Regional Water District v. Herrmann, supra, 133 8.Ct. at p. 2135.) In addition, in New Jersey v. Delaware (2008) 552 U.S. 597, the Supreme Court followed the lead of a Special Master in placing “considerable 2 66weight” on the memberstates’ “prior course of conduct”in construing an interstate compact. (/d. at pp. 618-619.) 6. The memberstates’ conduct establishes that a member mayenact a different, alternate mandatory apportionment formula. Gillette claims that “no court has used ‘course ofperformance’ evidence to override the express termsof an interstate compact.” (Answer Briefat p. 34.) However, Zarrant recently did that very thing. (Jarrant Regional Water District v. Herrmann, supra, 133 S.Ct. at p. 2135.) Even before that, the Court in Alabama v. North Carolina explained that“the parties’ course of performance under the Compactis highly significant”in determining whether North Carolina took appropriate steps under the terms of a compact to obtain a license to operate a regional waste facility. (Alabamav. North Carolina, supra, 130 S.Ct. at p. 2309.) Gillette also argues that subsequentlegislation “cannot be used to establish the intent of the earlier legislature[.]” (Answer Brief at p. 35.) But, section 25128 was based on the memberstates’ common understanding of the Compact. It did - not substitute a new intent for earlier intent, but took an action based upon an understanding of that earlier intent. California could have chosen to | withdraw from the Compactinstead, butit clearly believed it was not necessary to do so. California, and the other states that made similar changesin their laws, understandably relied on their interpretation of the Compact that such changes wereallowed. 11 Finally, the suggestion that the 40-year history “is not a reliable indicator . . . because party states do not perform or deliver obligations to one another and have no incentive to enforce the Compact” (AnswerBrief at p. 35), underscores why the memberstates’ construction is correct. The lack of reciprocal obligations is not a disincentive to enforcing the Compact, but rather goes hand-in-hand with the memberstates’ construction and the inherent flexibility molded into the Compact. The Compact reasonably omitted obligations between memberstates as part of an overall package intended to maximizethe states’ flexibility to exercise their own sovereign authority to address their unique concerns. This construction is consistent with the memberstates’ commonunderstanding that the Compact allowed a memberstate to enact subsequentlegislation mandating the use of a different, alternate apportionment formula. 7. The Multistate Tax Commission’s Florida Resolution supports the common construction that member states may enact different mandatory formulas. Gillette claims that the Multistate Tax Commission’s Florida Resolution “does not suggest, as [the Board] contends, that party states understood they were free to completely eliminate the Compactelection.” (AnswerBrief at p. 37.) But eliminating the Compactelection is precisely whatFlorida did, and the other memberstates may, as well. Gillette also argues that Florida actually “maintained the three- factor, equal-weighted Compact formula,” therefore party states knew they could not eliminate the election provision. (AnswerBriefat p. 37.) Gillette’s representation, however, is wrong. While Florida did maintain a “three factor formula,” it did not maintain the equal-weighted formula, but rather used a double-weighted sales factor formula, just as California did in section 25128. (Supplemental Request for Judicial Notice, Ex. E, pp. 14- 15.) 12 8. Policy considerations support the members’ common construction permitting different formulas. Gillette claims that the Board is asking the Court “torewrite the Compact”for policy reasons. (AnswerBrief at p. 38.) To the contrary, the Board is asking the Court to enforce the memberstates’ common understanding of the Compact. Gillette cites In re C.B., supra, 188 Cal.App.4th 1024 for the proposition that “while compact association’s interpretation may be goodpolicy, [the] court was not authorized to alter compact terms agreedto by sovereign states[.]” (AnswerBriefat p. 38-39.) The Board, however, is not asking the Court to alter the Compact terms, but to enforce the member states’ common understanding of what those terms were andare. Il. SECTION 25128 DOES NOT VIOLATE THE CONTRACT CLAUSE. Gillette erroneously contends that section 25128 automatically violated the contract clause because, by eliminating the election provision, it “eviscerat[ed] a core provision of an interstate compact[.]” (Answer Brief at p. 39.) A state law that violates a compact or contract does not automatically run afoul of the contract clause. Modern contract clause analysis uses a three-prongedtest to determine whetherthere is an unconstitutional impairmentof contract rights. (Energy Reserves Group, Inc. v. Kansas Power & Light Co. (1983) 459 U.S. 400.) First, does the state law “operate[] as a substantial impairmentof a contractual relationship[?]” (/d. at p. 411.) Second, does the state law have a significant and legitimate public purpose? (/d. at p. 412.) Third, doesa . reasonable and appropriate public purpose justify the state law? (bid, 13 citing United States Trust Co. ofNew York v. New Jersey (1977) 431 U.S. 1, 22.)° Noneof Gillette’s cited cases support its argument that section 25128 automatically violated the contract clause by eliminating the election provision. Green v. Biddle (1823) 21 U.S. 1, 92-93 and Pennsylvania v. Wheeling & Belmont Bridge Company (1952) 54 U.S. 518 failed to discuss the factors that inform the Court’s modern contract clause analysis. General Expressways v. Iowa Reciprocity Board (1968) 163 N.W.2d 413, ‘merely construed state statute so that its terms did not conflict with a previously adopted interstate compact(id. at p. 421), and in Doe v. Ward (W.D.Pa. 2000) 124 F.Supp.2d 900, no contract clause issue wasraised, and the court did not engage in a contract clause analysis (id. at p. 911). Gillette argues that the Board’s reliance on modern contract clause analysis is misplaced. Gillette claims that “when the nature of [an] impaired obligation is a core provision of an interstate compact, .. . weighing is unnecessary. . . . In the context of a compact, the kind of exacting scrutiny sought by [the Board] is unwarranted.” (AnswerBriefat p. 42.) But this “exacting scrutiny” is whatis required by modern contract clause jurisprudence. Noneofthe cases cited by Gillette recognize this modern analysis, or even discuss it, and Gillette’s implication that interstate compacts are treated differently than other contracts is unsupported by the law. Even McComb v. Wambaugh (3rd Cir. 1991) 934 F.2d 474, 479, > Because Gillette’s argumentis based solely on the assumptionthat section 25128 violated the Compact, the Board will not repeat its argument in the openingbrief that 7/the Compact allows memberstates to enact subsequent legislation mandating the use of a different apportionment formula, then section 25128 does not violate the contract clauses of the state or federal constitutions becauseit does not “impair[] [the] contractual relationship[.]” (General Motors Corp. v. Romein (1992) 503 USS. 181, 186.) 14 which Gillette cited (AnswerBrief at pp. 19, 27), recognizes that compacts are construed as contracts. Despite this, Gillette fails to explain why a compact should betreated differently depending on whether the Court is conducting an interpretive analysis of the compact, or analyzing it under the contract clause. A. Thereis No Substantial Impairmentof a Contractual Relationship. Thefirst inquiry under modern contract clause analysis is “whether the state law has,in fact, operated as a substantial impairmentof a contractual relationship.” (Energy Reserves Group, Inc. v. Kansas Power — and Light, supra, 459 U.S. at p. 411; General Motors v. Romein (1992) 503 U.S. 181, 186.) Here, the answeris No. Gillette argues that no contractual relationship is necessary because this is a tax refundaction, “not a breach of contract case.” (AnswerBrief at pp. 44-45, fn. 15.) But Gillette cites no authority for the proposition that one ofthe prongsofthe multi-part analysis under the contract clause can be bypassed simply because the nature of Gillette’s action is a tax refund. Gillette cannot escape the fact thatit is not a signatory party to the Compact. | . | Alternatively, Gillette claims, it is an intended third-party beneficiary of the Compact. (AnswerBriefat pp. 44-45, fn. 15.) Confronted with the requirement that a contract must be expressly made to benefit a third person forit to be a third party beneficiary (Civ. Code,§ 1559; Fireman’s Fund Ins. Co. v. Maryland Casualty Co. (1994) 21 Cal.App.4th 1586, 1600), Gillette argues that “[t]he Compact was expressly intended to benefit taxpayers” (AnswerBriefat pp. 44-45, fn. 15). Purportedly, Sofias v. Bank ofAmerica (1985) 172 Cal.App.3d 583 supports this claim. 1) Gillette’s reliance on Sofias is misplaced. There, the court explained that ““expressly’ means ‘in an express manner; in direct or unmistakable 999terms; explicitly; definitely; directly.’” (Sofias v. Bank ofAmerica, supra, 172 Cal.App. 3d at p. 583.) But Gillette fails to identify any unmistakable terms showing that the Compact was entered into expressly for the benefit of taxpayers. Despite the absence of a contractual relationship between Gillette and the memberstates, Gillette claims taxpayers relied on the Compact’s election provision. (AnswerBrief, pp. 43-44.) However, since member states may withdraw from the Compactat anytime, there could be no reasonable reliance on the election provision and thus no substantial impairment of the Compact. Noris the election provision a vested right for any prospective tax year. Gillette argues that the substantial impairment requirement does not apply because “taxpayers are justified in having heightened expectations about states’ adherence to [the] terms [of a compact].” (AnswerBriefat p. 44.) This unsupported argument is unpersuasive. On what basis would a taxpayer bejustified in having heightened expectations about the member states’ adherence to the Compact? | There are compacts approved by Congress which express federal law, and which “are construed as contracts underthe principles of contract law.” (Tarrant Regional Water District v. Herrmann, supra, 133 S.Ct. at p. 2131.) And there are non-congressionally approved compacts that are interpreted as both contracts and statutes pursuantto state law. (McComb Vv. Wambaugh, supra, 934 F.2d 474, 479.) Gillette seems to be claiming that the Compact belongs in a category other than these two,butthere is no 16 authority for that claim. Moreover, a taxpayer cannot have heightened expectations in the election provision whenit cannot reasonably rely on the fact that the state will not withdraw from it. B. Section 25128 Has a Significant and Legitimate Public Purpose. Evenif a state law constitutes a substantial impairment,therestill is no bar underthe contract clause if there is “a significant and legitimate public purpose behind the [law].” (Energy Reserves Group, Inc. v. Kansas Power and Light, supra, 459 U.S. at pp. 411-412,citing United States Trust Co. ofNew York v. New Jersey, supra, 431 U.S. at p. 22.) Gillette mistakenly contends that section 25128 lacks a proper public purpose unless it was based on the existence of some emergency,such as the Great Depression. (AnswerBrief atp. 45.) However, “public purpose need not be addressed to an emergency or temporary situation.” (Energy Reserves, supra, 459 U.S.atp. 412.) California has a significant and legitimate interest generally in matters of state taxation because taxation is a core exercise of its sovereign power. (See Louisville Water Co. v. Clark (1892) 143 U.S.1, 13; Cal. Const., art. XIII, § 31 [California’s “power to tax may not be surrendered or suspended by grant or contract’”’}.) The significant, legitimate purpose of section 25128 was to encourage and support the growth ofin-state ® Gillette cites the California Opinion of the Attorney General No. 96-806 (80 Ops. Cal. Atty. Gen. 213, August 5, 1997) for the proposition that the Compactis “a contract among the memberstates” which must be complied with until repealed. (Answer Brief at p. 21.) However, the Opinion is not relevant because it dealt with the effect of uncodified budget control language in the 1996-1997 Budget Act involving California’s membership in, and obligation to pay duesto, the Multistate Tax Commission. Nowhere is the Compact even directly referenced. 17 businesses by reducing the tax burden on California-based businesses without incurring a large loss of tax revenues. C. Section 25128 Was Reasonable and Appropriate to the Public Purpose. Whenthere is a significant and legitimate public purpose, the next inquiry is whether the state law is based on reasonable conditions andis of appropriate character. (Energy Reserves Group, Inc. v. Kansas Power and Light, supra, 459 U.S, at p. 412,citing United States Trust Co. ofNew York v. New Jersey, supra, 431 U.S.at p. 22.) Gillette claims that section 25128 was not reasonable or appropriate because its purpose was merely to “ increas[e] California’s tax revenues.” (AnswerBrief at p. 46.) However, the legislative history contradicts that claim. Indeed,it explains that section 25128 would result in both “winners and losers.” (See RJN-COA,Ex. 2.) Ill. SECTION 25128 DOES NOT VIOLATE THE REENACTMENT RULE. The reenactmentclause of the California Constitution, article IV, section 9, provides “{a] section of a statute may not be amendedunless the section is re-enacted as amended.” Gillette argues that “[w]ithout reenactmentof [s]ection 38006. in its amended form to show . . [the elimination of the election provision], neither taxpayers nor legislators couldtell that [s]ection 38006’s election had been eviscerated by [section 25128].” (AnswerBrief at p. 47.) This argument lacks merit. The “constitutional reenactmentrule does not apply to the addition ofnew code sections or the enactment of entirely independentacts that impliedly affect other sections.” (White v. State ofCalifornia (2001) 88 Cal.App.4th 298, 314, quoting American Lung v. Wilson (1996) 51 Cal.App.4th 743, 749.) The Legislature’s amendmentof section 25128 in 1993 does not offend the reenactmentrule because it replaced the previous formula with 18 an entirely new formula, and becauseit is a separate statute from the Compact, whichis set forth in section 38006. (White v. State ofCalifornia, supra, 88 Cal.App.4th at p. 314.) Similarly, Hellman v. Shoulters (1896) 114 Cal. 136, held a subsequentstatute did not violate the reenactmentrule whereit added a new section which by implication affected the operation of a previous act. As in Hellman,the Legislature amended section 25128 in its entirety by substituting a new apportionment formula, and adding two new subsections. While the addition of amended 25128 impliedly affects section 38006,this action “is not within the evils aimed at by [the reenactmentrule].” (Ud. at p. 152.) American Lung Association v. Wilson, supra, 51 Cal.App.4th at p. 749, identifies a distinguishable exception to the general rule that reenactment is unnecessary when the Legislature enacts a separate statute. It held that an uncodified appropriationsbill violated the reenactmentrule becauseit failed to provide notice that it was changing the statutory percentages of money going to different funds under the Tobacco Tax and Health Protection Act of 1988 (Rev. & Tax. Code, § 30121 et seq.). American Lung explainedthat “the key to the reenactment rule’s applicability . . . [is] whether legislators and the public have been | reasonably notified of direct changesin the law.” (American Lung Association v. Wilson, supra, 51 Cal.App.4th at p. 749, quoting Hellman v. Shoulters (1896) 114 Cal. 136, 152; italics added.) Becausethe bill challenged in American Lung did notreferto either of the statutory provisions it changed, the confusion it created was clear. There should not be any similar confusion in this case because amended section 25128 explicitly refers to section 38006, which is the Compact. Gillette claims that American Lung applies here because section 25128 failed to give adequate notice. (AnswerBriefat p. 48.) Gillette reasonsthat since “[s]ection 38006 was not amended,the notice is not 19 adequate[.]” (American Lung Association v. Wilson, supra, 51 Cal.App.4th - at p. 749.) However, section 38006 did not need to be amendedto provide legislators and the public sufficient notice because-section 25128 referred to it directly. Section 25128 states: (a) Notwithstanding section 38006,all business incomeshall be apportionedto this state by multiplying the business incomebya fraction, the numerator of whichis the property factor plus the payroll factor plus twice the sales factor, and the denominator of whichis four, except as provided in subdivision (b) or(c). (Rev. & Tax. Code, § 25128, as amended.) This plain languagestates that there will be only one apportionment formula, and it necessarily eliminates the election provision.’ This construction is confirmed by (1) the explicit reference to “[n]otwithstanding section 38006,” (2) the Legislature’s use of the word “all” before business income, and (3) the use of the word “shall” before setting forth the double- weighted sales apportionment formula. “All” means “collectively and individually” (Black’s Law Dict. (8th ed. 2004 p. 81, col. 2) or “the whole of” (Merriam-Webster’s Collegiate Dict. (1999) p. 29, col. 2.) “Shall,” on the other hand is defined “[h]as a duty to; more broadly, is required to.” (Black’s Law Dict. (8th ed. 2004 p. 1407, col. 2).) Section 25128 provides sufficient notice that taxpayers were required to use the newformula 7 Gillette’s argument that section 25128 can be read to avoid conflict with section 38006 is puzzling (AnswerBrief at p. 50) because the Court of Appeal acknowledgedthe “clear import” of section 25128 was to impose the mandatory use of the double-weighted sales factor formula. (Slip opn. at p. 15.) Gillette’s reliance upon Klasjic v. Castaic Lake Water Agency, (2004) 121 Cal.App.4th 5, 13, is also misplaced as Klasjic notes that the statutory phrase “notwithstanding any other law”has been called a “term of art” that “declares the legislative intent to override all contrary law (citations omitted).””» As amended bythe Legislature, section 25128 cannot be reconciled with the election provision. 20 regardless of what section 38006 says. Nor, for these same reasons, does section 25128 fail to provide a guide to either legislators or taxpayers as to whatportion of section 38006 is at issue. (AnswerBrief at pp. 48-49.) Gillette also asserts that the legislative history does not support the elimination of the election provision. (Answerbrief at p. 48.) But whether or notthe legislative history mentions the Compactby name, amended section 25128 is so clear that explicit reference in the history is not needed. Regardless, our legislature is presumed “aware of existing related laws and [to have] intended to maintain a consistent body of rules” when passing a statute. (Scott Co. v. Workers’ Comp. Appeals Board (1983) 139 Cal.App.3d 98, 103.) The Board explained in its opening brief that adoption of Gillette’s argument would call into question many other California statutes that use the word “notwithstanding.” Gillette counters that the Board misconstrues notwithstanding “as a repealer,” whereas it is more generally used to carve out an exception. (AnswerBrief at pp. 49-50.) That, however,is a distinction without a difference. Section 25128 both carves out an ‘exception to section 38008 that effectively repealsit, and directs that it no longer applies. 21 CONCLUSION For the foregoing reasons, the Court should reverse the decision of the Court of Appeal below. Dated: September 20, 2013 SF2010900595 Respectfully submitted, KAMALAD. HARRIS Attorney General of California SUSAN DUNCANLEE Acting Solicitor General KATHLEEN A. KENEALY Chief Assistant Attorney General PAUL D. GIFFORD Senior Assistant Attorney General W. DEAN FREEMAN Supervising Deputy Attorney General Lucy F. WANG Deputy Attorney General W fibw W. DEAN FREEMAN Supervising Deputy Attorney General Attorneysfor Defendant and Respondent Franchise Tax Board “22 CERTIFICATE OF COMPLIANCE I certify that the attached REPLY BRIEF ON THE MERITSuses a 13 point Times New Romanfont and contains 5,700 words. Dated: September 20, 2013 -KAMALA D. HARRIS Attorney General of California SUSAN DUNCAN LEE Acting Solicitor General KATHLEEN A. KENEALY Chief Assistant Attorney General PAUL D. GIFFORD Senior Assistant Attorney General W. DEAN FREEMAN Supervising Deputy Attorney General Lucy F. WANG Deputy Attorney General Ul Q--inr— W. DEAN FREEMAN Supervising Deputy Attorney General Attorneysfor Defendant and Respondent Franchise Tax Board DECLARATION OF SERVICE BY U.S. MAIL Case Name: The Gillette Company & Subsidiaries v California Franchise Tax Board Supreme Court Case No. 8206587 Court of Appeal Case No. A130803 San Francisco Superior Court Case No. CGC10495911 I declare: I am employedin the Office of the Attorney General, whichis the office of a memberofthe California State Bar, at which member's direction this service is made. I am 18 years of age or older and not a party to this matter. I am familiar with the business practice at the Office of the Attorney General for collection and processing of correspondence for mailing with the United States Postal Service. In accordance with that practice, correspondenceplaced in the internal mail collection system at the Office of the Attorney General is deposited with the United States Postal Service with postage thereon fully prepaid that same day in the ordinary course of business. On September 20, 2013, I served the attached REPLY BRIEF ON THE MERITSby placing true copy thereof enclosed in a sealed envelope in the internal mail collection system at the Office of the Attorney General at 455 Golden Gate Avenue, Suite 11000, San Francisco, CA . 94102-7004, addressed as follows: AmyL.Silverstein, Esq. Edwin P. Antolin, Esq. Silverstein & Pomerantz LLP 55 Hawthorne Street, Suite 440 San Francisco CA 94105. Clerk of the Court Court of Appeal First Appellate District 350 McAllister Street San Francisco CA 94102 Clerk of the Court San Francisco Superior Court 400 McAllister Street San Francisco CA 94102 Ellen F. Rosenblum Attorney General, State of Oregon Departmentof Justice Justice Building 1162 Court Street NE Salem OR 97301-4096 Jeffrey B. Litwak 1608 NE Knott Street Portland OR 97212 ’ Cory Fong, Tax Commissioner Office of State Tax Commissioner State of North Dakota 600 E. Boulevard Avenue, Department 127 Bismarck ND 58505-0599 Lawrence G. Wasden Attorney General, State of Idaho State of Idaho Office of the Attorney: General P.O, Box 83720 -Boise ID 83720-0010 R. Bruce Johnson Commission Chair Utah State Tax Commission 210 North 1950 West Salt Lake City UT 84134 I declare under penalty of perjury underthe laws of the State of California the foregoing is true and correct and that this declaration was executed on September , at SamnFrancisco, California. Jacinto P. Fernandez ? Declarant . oe . ignature (> SF2010900595 40772030.doc _ — _ — f ,
