Terrence Schumacher is a Colorado resident who owns Nebraska farmland in five counties. Neither he nor his relatives live, work on, or manage the farmland. Mr. Schumacher wanted to transfer his farmland to a limited liability entity for estate planning purposes and to reduce his exposure to a potential lawsuit.
Shad Dahlgren is a paraplegic Nebraska resident who wanted to purchase a row-crop farm with other investors and hold the farm in a corporation to limit his liability. Because of his disability, Mr. Dahlgren cannot perform the day-to-day labor and management needed to operate the farm, and his needed medical care prevented him from living on the farm.
Both Mr. Schumacher and Mr. Dahlgren were prevented from owning farm property in a limited liability entity by Initiative 300. Initiative 300, adopted by a vote of Nebraska voters in 1982, added a provision to the Nebraska constitution which stated that “no corporation or syndicate shall acquire, or otherwise obtain an interest… in any title to real estate used for farming or ranching in this state, or engage in farming or ranching.” The restrictions of Initiative 300 did not apply to family farm or ranch corporations, if one member of the family either resided on the farm or ranch or was actively engaged in the day to day labor or management of the farm or ranch.
The Eighth Circuit’s Decision Striking Down Initiative 300
In Jones v. Gale, the Eighth Circuit Court of Appeals affirmed the ruling of the U.S. District Court that Initiative 300 was unconstitutional because it violated the “dormant Commerce Clause” of the U.S. Constitution.
To understand the Eighth Circuit’s decision, it is first necessary to understand what the “dormant Commerce Clause” is. The U.S. Constitution grants Congress the power “to regulate commerce with foreign nations, and among the several states…” This clause is commonly known as the “Commerce Clause.” The dormant Commerce Clause is the negative implication of the Commerce Clause: states may not enact laws that discriminate against or unfairly burden interstate commerce. As stated by the U.S. Supreme Court: “This principle that our economic unit is the Nation, which alone has the gamut of powers necessary to control the economy … has as its corollary that the states are not separable economic units.” Therefore, the “dormant Commerce Clause” has long been seen as a limitation on state regulatory powers.
When determining whether a state law violates the “dormant Commerce Clause,” a court will first determine whether the state law discriminates against interstate commerce. A law will discriminate against interstate commerce if it treats in-state and out-of-state economic interests differently, to benefit in-state interests while burdening out-of-state interests. A state law will also violate the “dormant Commerce Clause” if it was passed with the intent to discriminate against out-of-state economic interests.
The Eighth Circuit ruled that Initiative 300 was discriminatory for two reasons. First, the Eighth Circuit found that Initiative 300 favored Nebraska residents and those people who lived so close to Nebraska that they could commute to a Nebraska farm or ranch to work. Initiative 300 did not apply to family farm or ranch corporations if one member of the family lived on or worked at the farm or ranch. Those people were not burdened by Initiative 300 as out-of-state residents were. Second, the Eighth Circuit found that Initiative 300 was intended to discriminate against out-of-state residents, based on the statements of the law’s drafters and even the television advertisements run by the law’s supporters.
Under the “dormant Commerce Clause,” an otherwise discriminatory law will be upheld if a state can prove that the law advances “a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.” However, courts will closely scrutinize a state’s claim that there are no reasonable alternatives to a discriminatory law. The Eighth Circuit examined Nebraska’s justifications for Initiative 300, but ruled that no justifications met the strict test.
U.S. Supreme Court Declines To Hear The State’s Appeal
On January 23, Nebraska Attorney General Jon Bruning appealed the Eighth Circuit’s decision to the U.S. Supreme Court. On April 2, the U.S. Supreme Court declined to hear the State’s appeal. That decision permanently removed Initiative 300 from the Nebraska Constitution.
State Reactions to Jones v. Gale
In response to Jones v. Gale, the Legislature’s Agriculture Committee proposed LB 516, which would create a Corporate Farming Policy Advisory Council. The Council would investigate how the state may still fulfill the Legislature’s goals of preserving dispersed ownership of farming and ranching operations in family farmers and promoting responsible stewardship of natural resources. The Council would be charged with developing a formal Corporate Farming Policy Plan to be given to the Legislature. As of April 3, LB 516 was being held by the Agriculture Committee, which was considering having its staff do an interim study instead.
PRACTICE POINTERS AFTER JONES V. GALE
The elimination of Initiative 300 allows Nebraska farmers and ranchers the opportunity to organize their business as they see fit. Advisors may consider how these opportunities could impact their clients:
Larger Scale Operations. The elimination of Initiative 300 will allow farmers and ranchers to consolidate and pool their resources to deal with the increasing market pressures on smaller operations. Farmers can also take advantage of additional sources of capital, such as investment by outside investors, that can be facilitated using a corporate structure.
Asset Protection. Farmers and ranchers that currently operate under a partnership to comply with Initiative 300 should consider converting to a limited liability entity for asset protection purposes.
Valuation Discount Planning. Farmers and ranchers can now do valuation discount planning, by placing their assets into limited liability entities and gifting minority interests in those entities. Farmers and ranchers may be able to value the shares they will give by utilizing a valuation discount. This will facilitate lifetime gifting by farmers and ranchers and allow farmers and ranchers to reduce their potential exposure to gift and estate taxes.