Indiana cities seeking to tax Netflix and Hulu video streams won a significant victory when a federal judge ordered the case back to state court, citing the “doctrine of comity” under which federal courts are supposed to avoid wading into disputes over state taxes.
The decision, combined with a similar victory by municipal plaintiffs in Missouri last year, could encourage more cities to sue to assess franchise fees traditionally paid by cable television operators against companies that stream video content over the Internet.
Private lawyers, some of them also involved in multibillion-dollar opioid lawsuits, have recruited cities around the country to press franchise-fee cases as a method for recovering tax revenue that has dwindled as more consumers “cut the cord” from traditional cable TV. The suits, if successful, would mean consumers pay a new 5% tax on streaming video content – with some of the money going to the private lawyers working under contingency-fee contracts.
Netflix and Hulu argued the Indiana cases belonged in federal court, partly because they hinge upon questions of federal law including the Internet Tax Freedom Act, which prohibits state and local taxes on Internet access.
Those arguments hit a brick wall with U.S. District Judge Jane Magnus-Stinson. In a Nov. 18 decision, she cited a 2010 decision by the U.S. Supreme Court to rule that Netflix and Hulu must seek relief in Indiana state court. In Levin v. Commerce Energy, a unanimous court ruled that gas companies challenging a tax that gave preferential treatment to local distributors had to sue in state court first. The decision strengthened the doctrine of comity, under which federal judges are supposed to respect the power of state and local legislators to craft tax policy and allow state judges to decide how to enforce those laws.
The Indiana cities, like municipalities elsewhere in the country, claim Netflix, Hulu and other video providers must obtain franchise certificates from the state and pay taxes in order to stream their content to customers. They are seeking class action status on behalf of some 600 municipalities.
Netflix and Hulu removed the case to federal court, citing the Class Action Fairness Act, which allows defendants to shift class actions to federal court if they involve amounts more than $75,000. The cities didn’t argue they were seeking less than $75,000, but cited comity as a reason for the cases to be remanded, as a Missouri court did last year in a similar lawsuit against satellite streaming services.
The streaming companies argued CAFA overrode any concerns over comity, citing a 2017 decision out of Oregon rejecting remand.
“This matter is a dispute over commercial regulation and does not involve a party's fundamental rights or a suspect classification requiring heightened judicial scrutiny,” Judge Stinson ruled, however.
The case requires a court to interpret Indiana state law on questions that haven’t been decided before, she wrote, so even if a federal court agreed to hear it, that court would probably have to ask the Indiana Supreme Court for its opinion on key legal issues.