You've Been Served: Defending Against a State Tax Class Action; Are you prepared for this rising threat to your business?

• Author: Dorner, Dave

An email comes from the general counsel: your company has been sued by a customer who alleges that the company systematically overcharges sales tax. (1) The complaint--the legal document that starts the lawsuit--contains multiple counts for various violations of state statutes and common law doctrines and demands damages, attorney's fees, and costs and, maybe worst of all, requests class certification. The general counsel wants to meet in a few hours to discuss the allegations and next steps.

This article is a primer on what to do when you are served with a consumer class action complaint alleging the collection of excessive state taxes. The article focuses on the nuts and bolts of what a company must consider and act upon over the next few hours, days, and months. Although unique facts and circumstances drive each case, this article provides the foundation for defending against a state tax consumer class action.

State tax class actions are a rising threat to businesses. In 2021 alone, plaintiffs filed more than two dozen new state tax class actions. To date, these class action cases largely involve retail, lodging, telecommunications, and software transactions and generally claim that the defendant incorrectly classified transactions as taxable or applied an incorrect tax rate. However, any business that collects sales or excise taxes from consumers is vulnerable to a state tax consumer class action.

Class action lawyers are known to be aggressive, and they see state tax as a new opportunity to score paydays by targeting large vendors. Additionally, a business has no guarantee it will not wind up receiving a consumer class action complaint just because it taxes every transaction consistently with published guidance, because consumers can challenge the government's interpretation of tax law. (2) Consequently, tax executives should know how to react if their company is served with a state tax consumer class action complaint.

A state tax class action is a lawsuit by a consumer against a retailer in which the consumer alleges that the retailer overcharged state tax to the consumer, and to other similarly situated consumers, in violation of state law. Although state tax class actions can include common law claims (such as unjust enrichment, fraud, or negligence), consumers generally plead a violation of a state's consumer protection statutes. These statutes often provide for remedies not allowed for under common law actions, such as punitive damages, statutory damages, and attorney's fees.

What Is a Class Action?

A class action allows one or more persons to bring a lawsuit on a representative basis on behalf of a group of similarly situated people. Although class actions can be complex and costly to defend, they do provide a major benefit to defendants: once a class action is resolved, the outcome binds the entire class, and no member of the class can bring a similar claim against the defendant. Due to the binding effect of a class action, the proposed class must receive approval from a court in a process known as "class certification." Class certification ensures the adequate protection of the interests of the entire class. Until a court certifies a class, the case is referred to as a "putative class action."

For the court to certify a class, a plaintiff must establish four characteristics: numerosity (that "the class is so numerous that joinder of all members is impracticable"); commonality (that "there are questions of law or fact common to the class"); typicality (that "the claims or defenses of the representative parties are typical of the claims or defenses of the class"); and adequacy (that "the representative parties will fairly and adequately protect the interests of the class"). (3) If a plaintiff cannot prove any one of these four elements, then a court likely cannot certify a class. Defeating class certification can be a major win for the defendant, because plaintiffs' lawyers may not want to proceed on a nonclass basis. Accordingly, an important initial...