On February 3, 2023, the Sixth Circuit for the U.S. Court of Appeals held that an Illinois coal producer was likely to succeed on the merits of its claim that a Kentucky law directing Kentucky utilities purchasing coal to evaluate the reasonableness of coal bid prices after subtracting severance taxes from the actual bid price, including Kentucky’s own severance tax, discriminated against interstate commerce in violation of the Commerce Clause of the U.S. Constitution. Foresight Coal Sales, LLC. V. Chandler, No. 21-6069 (6th Cir. 2023). The Court found that the law was discriminatory in practice, making coal from states with severance taxes, like Kentucky, cheaper for Kentucky utilities by the amount of the severance taxes and rejected Kentucky’s argument that the purpose of the law was to “level the playing field” for Kentucky coal producers disadvantaged by Kentucky’s own severance tax. The case is an important reminder that laws that discriminate against interstate commerce, including discriminatory tax laws, are “virtually per se invalid” and challengers of discriminatory laws should have the upper hand in litigation against states seeking to defend them.

The Facts: Some states impose severance taxes on the value of natural resources, such as coal, that are “severed” from the land within the state’s borders. Only the state from which a natural resource is extracted can impose a severance tax on the natural resource. Kentucky imposes on Kentucky coal producers a severance tax equal to 4.5 percent of the gross value of coal extracted in Kentucky. Utilities in Kentucky are regulated by the Kentucky Public Service Commission and are generally encouraged to purchase coal at the cheapest prices available, which puts Kentucky coal producers at a disadvantage against coal producers in states that do not impose severance taxes, such as Illinois, as coal producers not subject to severance taxes can afford to sell coal at lower prices.

In 2021, Kentucky passed a law requiring the Commission to “evaluate the reasonableness of fuel costs in contracts and competing bids based on the cost of the fuel less any coal severance tax imposed by any jurisdiction.” Ky. Rev. Stat. Ann. § 278.277(1). An Illinois coal producer, Foresight Coal Sales, LLC (“Foresight”), brought a lawsuit and sought a preliminary injunction to prevent the law from going into effect. The threshold question in determining whether to grant the injunction was whether Foresight had a strong likelihood of success on the merits of its claim that the Kentucky law unconstitutionally discriminated against interstate commerce. The district court held that Foresight did not have a strong likelihood of success on the merits of its discrimination claim and Foresight appealed to the Sixth Circuit.

The Decision: The Court held that, whether on its face or in effect, the Kentucky law discriminated against out-of-state coal businesses. Kentucky argued that its law could not be discriminatory because it was necessary to “level the playing field” for Kentucky coal producers competing against coal producers from other states that did not impose severance taxes. However, the court observed that “the ‘leveling’ effect may be precisely what is discriminatory.” While the Kentucky law permitted the Commission to consider other state severance taxes and coal producers from other states imposing severance taxes could also benefit from the law, the Court found that the law’s “discrimination isn’t alleviated either by the fact that some states already impose severance taxes (in varying amounts) and that others may choose to impose severance taxes of their own.” According to the Court, a state’s “policy is discriminatory if its claim to neutrality depends on another state enacting the same policy.”

Inasmuch as the Court concluded that Foresight was likely to succeed on the merits of its claim that the Kentucky law unconstitutionally discriminated against interstate commerce, the case was remanded to the district court for it to consider the remaining preliminary injunction factors.

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