October 26, 2020

Volume X, Number 300


October 26, 2020

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Litigation Alert | Third Circuit Reaffirms Scope of Federal Priority Rules

On December 4, 2017, the US Court of Appeals for the Third Circuit issued its much-anticipated precedential opinion in Marathon Petroleum Corp. et al., v. Secretary of Finance et al., No. 16-4011. The opinion affirms the Third Circuit’s existing view (described in its 2012 New Jersey Retailers Association decision) that US Supreme Court precedent permits a private cause of action to enforce the federal priority rules, overruling the federal district court’s conclusion (in this case and Temple-Inland) that the priority rules only apply to disputes between states.

The plaintiffs in this case ultimately lost (i.e., Delaware’s motion to dismiss was upheld) on ripeness grounds because the state had not yet taken formal steps to compel cooperation with the third-party auditor’s document request (i.e., Delaware had not yet issued a subpoena, but had only threatened it). The Third Circuit also rejected to the plaintiff’s argument that Delaware is barred from auditing the out-of-state gift card entities altogether—noting that Delaware plainly has the ability to audit both the plaintiffs and subsidiary gift card companies to determine who is the true holder and whether the formalities of corporate separateness have been observed. For these reasons, the Third Circuit vacated and remanded the case back to the federal district court to clarify that the plaintiffs preemption claim is dismissed withoutprejudice—i.e., the plaintiffs can still challenging the state’s audit authority under the federal priority rules if action is taken to enforce the disputed gift card related document request.

Practice Note

Looking beyond the plaintiffs’ procedural loss, this precedential opinion represents a substantial victory for the broader holder community and should provide much-needed certainty to companies with gift card entities that any positions taken on audit by Delaware (or other states within the Third Circuit, including New Jersey and Pennsylvania) that are inconsistent with the federal priority rules can be challenged in state or federal court. This is significant, given that Delaware is currently litigating a qui tam lawsuit against a number of retailers, their subsidiary gift card entities and Vacation Properties (f/k/a CardFact, Ltd.). See State ex rel. French v. Card Compliant LLC et al., No. N13C-06-289 PRW [CCLD]. Auditors for Delaware are now routinely issuing document requests to gift card issuers formed in other states. Many of the questions in the requests are unrelated to the issues of fraud and corporate separateness. Audit targets should consider whether to provide the information or withhold it and challenge any subsequent subpoena from the state based on the Marathon Petroleum decision.

Retailers with gift card entity structures in place are encouraged to contact the authors to discuss the potential impact of this opinion and the pending Delaware qui tam lawsuit in more detail in light of their unique facts.

© 2020 McDermott Will & EmeryNational Law Review, Volume VII, Number 341



About this Author

Stephen P. Kranz Lawyer McDermott Will

Stephen P. Kranz is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  He engages in all forms of taxpayer advocacy, including audit defense and litigation, legislative monitoring, and the formation and leadership of taxpayer coalitions.  Steve is at the forefront of state and local tax issues, including developments arising in the world of cloud computing and digital goods and services.  He assists clients in understanding planning opportunities and compliance obligations for all states and all tax types. ...


Diann Smith is counsel in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office.  Diann focuses her practice on state and local taxation with an emphasis on tax challenges relating to compliance, controversy, planning and legislative activity.   

Eric Carstens Tax Attorney McDermott Will Emery

Eric D. Carstens is an associate in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Washington, D.C., office. He focuses his practice on state and local tax matters.

Eric assists clients with state tax controversy, compliance and multistate planning across all states for a variety of tax types and unclaimed property. He engages in all forms of taxpayer advocacy, including litigation, legislative monitoring and audit defense. He works closely with several of the Firm’s taxpayer coalitions focused on specific state tax...

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