Zimmerman v. Cambridge Credit Counseling Corp. ( 2005 )


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  •           United States Court of Appeals
    For the First Circuit
    No. 04-2039
    ANDREW ZIMMERMAN, KELLY ZIMMERMAN
    On behalf of Themselves and All Others Similarly Situated,
    Plaintiffs, Appellants,
    v.
    CAMBRIDGE CREDIT COUNSELING CORP., CAMBRIDGE/BRIGHTON
    BUDGET PLANNING CORP., CAMBRIDGE CREDIT CORP., BRIGHTON
    CREDIT CORP., BRIGHTON CREDIT CORP. OF MASSACHUSETTS,
    JOHN PUCCIO, RICHARD PUCCIO,
    Defendants, Appellees.
    APPEAL FROM THE UNITED STATES DISTRICT COURT
    FOR THE DISTRICT OF MASSACHUSETTS
    [Hon. Michael A. Ponsor, U.S. District Judge]
    Before
    Howard, Circuit Judge,
    Cyr, and Stahl, Senior Circuit Judges.
    David J. Vendler, with whom Richard H. Nakamura, Maureen M.
    Home, Morris Polich & Purdy, LLP, Stephen G. Hennessy, Garrett M.
    Smith, Gary W. Kendall, Michie, Hamlett, Lowry, Rasmussen & Tweel,
    PC, and Gregory S. Duncan, were on brief, for appellants.
    Paul M. Kaplan, with whom Michael J. Tuteur, Lawrence M.
    Kraus, Stephen D. Riden and Epstein Becker & Green, P.C., were on
    brief for appellees.
    May 31, 2005
    HOWARD, Circuit Judge.     The Credit Repair Organizations
    Act (CROA or the Act) creates a cause of action for consumers
    harmed by the unscrupulous business and advertising practices on
    the part of credit repair organizations.          See 
    15 U.S.C. § 1679
     et
    seq.       But the Act does not permit lawsuits against "any nonprofit
    organization which is exempt from taxation under section 501(c)(3)"
    of the Internal Revenue Code.      See 15 U.S.C. § 1679a(3)(B)(i).   The
    question we face is whether an Internal Revenue Service (IRS)
    determination that an entity is tax-exempt under section 501(c)(3)
    is sufficient to bring the entity within the statutory exclusion
    set forth in § 1679(a)(3)(B)(i).
    I.
    Saddled with substantial debt, the plaintiffs, Andrew and
    Kelly Zimmerman, sought assistance from Cambridge Credit Counseling
    Corporation (Cambridge) near the end of 2001.1         The plaintiffs had
    seen advertising from Cambridge claiming that it could help debtors
    obtain lower interest rates, eliminate fees, re-age debt, and
    otherwise assist in debt management efforts.          The plaintiffs say
    that they were drawn to Cambridge because it identified itself as
    a nonprofit organization.       This led the plaintiffs to believe that
    Cambridge would charge low fees for its services.           Cambridge is
    1
    As this appeal arises from the grant of the defendants'
    motion to dismiss, we accept the well pleaded allegations in the
    complaint as true. See Viqueira v. First Bank, 
    140 F.3d 12
    , 15
    (1st Cir. 1998).
    -2-
    organized as a charitable organization under Massachusetts law, see
    Mass. Gen. Laws ch. 180, and has obtained an IRS determination that
    it is tax-exempt under section 501(c)(3) of the Internal Revenue
    Code,    see 
    26 U.S.C. § 501
    (c)(3).2
    In early 2002, the plaintiffs enrolled with Cambridge.
    For a fee of $948 per month, Cambridge developed a customized debt
    management program for them.     Several months later, the plaintiffs
    cancelled    their   contract   with    Cambridge   after   they   became
    dissatisfied with its services.        At the time of cancellation, the
    plaintiffs owed more money and had worse credit scores than before
    contracting with Cambridge. Believing that they had been swindled,
    the plaintiffs sued Cambridge, its owners John and Richard Puccio,
    and several related entities for violations of the CROA.3            They
    alleged that Cambridge was subject to suit under the Act because
    its claimed nonprofit status was a sham.
    2
    Section 501(c)(3) specifies that, inter alia, charitable and
    educational organizations, whose net earnings do not benefit
    shareholders or individuals, are exempt from federal taxation. See
    
    26 U.S.C. § 501
    (c)(3).
    3
    The plaintiffs also sued under the Fair Debt Collection
    Practices Act, see 
    15 U.S.C. § 1692
    , and state law. The district
    court dismissed the Fair Debt Collection Practices Act claim on
    statute of limitations grounds and declined to exercise
    jurisdiction over the state law claims under 
    28 U.S.C. § 1367
    (b).
    See Zimmerman v. Cambridge Credit Counseling Corp., 
    322 F. Supp. 2d 95
    , 98 & 101 (D. Mass. 2004). The plaintiffs have not appealed
    these rulings.
    -3-
    The defendants moved to dismiss the complaint on the
    ground     that    Cambridge       was    a     section   501(c)(3)         tax-exempt
    organization and therefore within the exclusion specified in 15
    U.S.C. § 1679a(3)(B)(i).           The district court agreed and dismissed
    the CROA claim.         See Zimmerman,        
    322 F. Supp. 2d at 99-101
    .             The
    court found the CROA exclusion applicable because the IRS had
    determined that Cambridge qualified for section 501(c)(3) tax-
    exempt status.          See 
    id.
              The court based its interpretation
    principally on a policy rationale.                It concluded that permitting
    courts to "go behind the IRS's designation and proceed to make
    their own independent determinations, on a case-by-case basis, of
    an   entity's      substantive       classification       according        to    section
    501(c)(3)"    would       create     excessive    uncertainty        concerning      the
    validity     of    an     entity's    tax-exempt      status,        and    that    this
    uncertainty       could    destabilize     the    operation     of    the       nonprofit
    sector.    See 
    id. at 100
    .         The plaintiffs timely appealed.
    II.
    Our review of the district court's grant of the motion to
    dismiss is de novo.4         See Goldings v. Winn, 
    383 F.3d 17
    , 21 (1st
    Cir. 2004).       At issue is the reach of 15 U.S.C. § 1679a(3)(B)(i),
    4
    The parties dispute whether the defendants' motion should
    have been raised under Fed. R. Civ. P. 12(b)(1) or Fed. R. Civ. P.
    12(b)(6). This dispute is immaterial because the parties agree
    that either way we must accept the well pleaded allegations as true
    and consider the interpretive question de novo.
    -4-
    which provides that "a credit repair organization does not include
    any nonprofit organization which is exempt from taxation under
    section 501(c)(3)" of the Internal Revenue Code.        15 U.S.C. §
    1679a(3)(B)(i).   The plaintiffs argue that the exclusion requires
    (1) that the credit repair organization actually operates as a
    nonprofit entity and (2) that the credit repair organization meets
    the eligibility requirements in in section 501(c)(3) of the tax
    code. The defendants respond that the phrase "exempt from taxation
    under   section   501(c)(3)"   defines   "nonprofit   organization."
    Therefore, the defendants contend that a credit repair organization
    must only have received section 501(c)(3) from the IRS to qualify
    for the exclusion.
    "As in any case of statutory construction, our analysis
    begins with the language of the statute."    Hughes Aircraft Co. v.
    Jacobson, 
    525 U.S. 432
    , 438 (1999) (internal quotation marks and
    citation omitted). The Act qualifies a large group of entities for
    the exclusion -- all nonprofit organizations -- and then limits the
    excluded group to a smaller group of nonprofit organizations "which
    are tax-exempt under section 501(c)(3) . . . ."         15 U.S.C. §
    1679a(3)(B)(i).   The most natural reading of the text is that it
    establishes two requirements. The nonprofit language excludes some
    entities from eligibility (namely, profit making entities), and the
    "tax-exempt" language distills the excluded group to the kinds of
    organizations identified in section 501(c)(3) (e.g., charitable or
    -5-
    educational organizations) which are, in fact, tax-exempt. Read in
    this way, the Act does not define "nonprofit organization" as an
    entity with section 501(c)(3) status but rather establishes two
    independent       criteria     for   the   exclusion:         nonprofit      status   and
    section 501(c)(3) status.
    This plain reading of the exclusion is supported by the
    surrounding text.       See Massachusetts v. Morash, 
    490 U.S. 107
    , 115
    (1989).     In addition to excluding nonprofit organizations with
    section     501(c)(3)        status,   the       CROA       excludes   creditors      and
    depository       institutions.       But   as    to     these    latter      exclusions,
    Congress defined the excluded entities by reference to another
    section of the United States Code. See 15 U.S.C. § 1679a(3)(B)(ii)
    (excluding "any creditor (as defined in section 1062 of this
    title)"); 15 U.S.C. § 1679a(3)(B)(iii) (excluding "any depository
    institution (as that term is defined in section 1813 of Title
    12)"). Had the drafters of the CROA intended to define "nonprofit"
    simply by reference to section 501(c)(3) of the Internal Revenue
    Code,     they    had   at     their   disposal         a    method    for    doing    so
    unambiguously -- a method they employed for other exclusions under
    the CROA.        See King v. St. Vincent's Hosp., 
    502 U.S. 215
    , 220-21
    (1991).
    This drafting choice cannot be considered accidental
    because the United States Code is replete with statues which
    clearly define a "nonprofit organization" as an entity that is tax-
    -6-
    exempt under the Internal Revenue Code.     Indeed, several statutes
    expressly define a nonprofit organization to mean an organization
    described under section 501(c) of the Internal Revenue Code.    See,
    e.g., 
    5 U.S.C. § 3102
    (a)(3) (stating that "'nonprofit organization'
    means an organization determined by the Secretary of the Treasury
    to be an organization described in section 501(c) of the Internal
    Revenue Code of 1986"); 16 U.S.C. § 1447a(5) (similar); 
    29 U.S.C. § 2703
    (4) (similar); 
    42 U.S.C. § 1485
    (w)(1)(B) (similar); 
    42 U.S.C. § 1760
    (d)(5) (similar); 
    42 U.S.C. § 5603
    (23) (similar).5       This
    construction links the definitional term "nonprofit" directly to
    the organization's federal tax-exempt status.    We may assume that,
    when drafting the CROA, Congress was aware of this archetypal
    language for equating nonprofit status with federal tax-exempt
    status.     See S. Dakota v. Yankton Sioux Tribe, 
    522 U.S. 329
    , 351
    (1998).     Yet Congress chose a different formulation for the CROA.
    This is strong evidence that Congress did not intend to conflate
    nonprofit status with section 501(c)(3)tax-exempt status.6
    The plaintiffs' interpretation of the exclusion also
    honors the principle "that '[a]ll words and provisions of statutes
    5
    These statutes predate the enactment of the CROA.
    6
    The legislative history is inconclusive. The only mention of
    the exclusion appears in the House of Representatives Ways and
    Means Committee report from the Congress preceding the one that
    enacted the CROA. H.R. Rep. No. 103-486 (1994), 
    1994 WL 164513
    .
    This report states that the definition of a credit repair
    organization "does not include a nonprofit organization." 
    Id.
    -7-
    are intended to have meaning and are to be given effect, and no
    construction should be adopted which would render statutory words
    or phrases meaningless, redundant, or superfluous.'" United States
    v. Ven-Fuel, Inc., 
    758 F.2d 741
    , 751-52 (1st Cir. 1985)).               The
    defendants read the exclusion as if it said only that the CROA
    excludes    any   organization   "which   is   tax-exempt   under   section
    501(c)(3). . . "     They have ascribed no independent meaning to the
    term "nonprofit."
    Additionally, the plaintiffs' reading is consonant with
    the rule favoring the narrow construction of exclusions in remedial
    statutes.    See Hogar Agua Y Vida En El Desierto, Inc. v. Suarez-
    Medina, 
    36 F.3d 177
    , 182 (1st Cir. 1994).          Congress enacted the
    CROA to remedy abuses in the credit repair industry.                The Act
    includes a finding by Congress that "[c]ertain advertising and
    business practices of some companies engaged in the business of
    credit repair services have worked a financial hardship upon
    consumers, particularly those of limited economic means and who are
    inexperienced in credit matters."         
    15 U.S.C. § 1679
    (a)(2).       The
    CROA's expressed purpose is to "to protect the public from unfair
    or deceptive advertising and business practices by credit repair
    organizations." 
    15 U.S.C. § 1679
    (b)(2). Its remedial goal is thus
    unmistakable.     See Fed. Trade Comm'n v. Gill, 
    265 F.3d 944
    , 949-50
    (9th Cir. 2001).
    -8-
    If a credit repair organization only needed to obtain a
    section 501(c)(3) designation to qualify for the exception, the
    exception might well eviscerate the liability-creating provisions.
    See generally Marta Lugones Moakley, Credit Repair Organizations
    After Regulation, 77-AUG Fla. B.J. 28, 33 (2003) (describing the
    increase in credit repair organizations seeking section 501(c)(3)
    status after the passage of the CROA).             After all, the IRS usually
    grants section 501(c)(3) status based solely on representations
    made by the applying entity.       See IRS Form 1023.          In fact, the IRS'
    subsequent notification that an entity has qualified for tax-exempt
    status contains a disclaimer stating that the IRS has made its
    determination based solely on representations provided to it by the
    party seeking the status. See Letter from IRS District Director to
    Cambridge Credit Counseling Corp. of 2/12/98 at 1 (stating that
    section   501    (c)(3)   status     is    granted    "based    on    information
    supplied, and assuming [that] operations will be as stated in your
    application      for   recognition    of     the     exemption").         And   the
    determination is not binding in subsequent litigation challenging
    the   applying    entity's   tax-exempt       status.      See       
    26 U.S.C. § 6110
    (k)(3) (stating that "a written determination [from the IRS]
    may not be cited as precedent").            Congress cannot have intended
    unscrupulous credit repair organizations to have such easy access
    to CROA immunity.      Cf. Edsen v. Bank of Boston, 
    229 F.3d 154
    , 177
    (2d Cir. 2000) ("An erroneous ruling by an IRS key district
    -9-
    director, especially when procured by submission of limited or
    confusing information, cannot defeat the express statutory rights
    of [consumers].           The adjudication of those rights is for the
    federal courts, not the field offices of the IRS.").
    The      district           court      rejected       the      plaintiffs'
    interpretation of the exclusion out of understandable concern that
    permitting     a    court       to    decide     whether   an   entity     is    actually
    operating      as     a       nonprofit     organization        will      substantially
    destabilize the nonprofit sector.                  See Zimmerman, 
    322 F. Supp. 2d at 99-100
    .     The concern is two-fold.                First, it will unsettle the
    expectations of the tax-exempt organization and those interacting
    with it if section 501(c)(3) status can be lost in non-tax related
    litigation.          Second,         subjecting    a   nonprofit     organization      to
    litigation over its status will significantly raise its cost of
    doing business.               Two responses to these concerns immediately
    suggest themselves.
    First,       a    determination       that    an   organization      is   not
    operating as a nonprofit for purposes of the CROA will not directly
    impact   the        organization's         tax-exempt       status       under    section
    501(c)(3).     Whether an entity is entitled to federal tax-exempt
    status is a determination that is committed, in the first instance,
    to the IRS.        See Bob Jones Univ. v. United States, 
    461 U.S. 574
    ,
    596-97 (1982).        True, a determination under the CROA that a credit
    repair organization is not operating as a nonprofit will likely
    -10-
    catch the attention of the IRS.            But there are already processes
    for alerting the IRS to improvident grants of tax-exempt status.
    There is a procedure for the IRS to field complaints about an
    entity's      abuse     of        its     tax-exempt       status.          See
    www.irs.gov/compliance/enforcement (last visited May 5, 2005).
    Moreover,    Congress   itself     occasionally    holds    hearings   on   the
    matter.7    Thus, a finding that a credit repair organization is not
    operating as a nonprofit for purposes of the CROA will be just
    another source of information from which the IRS can decide to
    target a particular credit repair organization for review.                  But
    such a finding will not mean that a credit repair organization
    loses its tax-exempt status without further action by the IRS.8
    Second,     it   is     already     common     for   courts     and
    administrative agencies to examine whether an entity actually
    7
    Indeed, Congress has held hearings on the abuse of tax-exempt
    status by credit counseling and repair organizations. See Section
    501(c)(3) Credit Counseling Organizations:      Hearing Before the
    House of Representatives Ways and Means Subcommittee on Oversight,
    108th Cong. (2003); Profiteering in a Non-Profit Industry: Abusive
    Practices in Credit Counseling: Hearing Before the Senate
    Governmental Affairs Subcommittee on Investigations, 108th Cong.
    (2004). The IRS has responded with an initiative to review the
    granting of tax-exempt status in this industry. See IRS Fact Sheet
    2003-17, IRS Takes Steps to Ensure Credit Counseling Organizations
    Comply with Requirements for Tax-Exempt Status (Oct. 2003).
    8
    In any event, even if a determination under the CROA could
    directly impact an organization's tax-exempt status, it would not
    typically affect the interests of those doing business with it.
    See Letter from IRS District Director to Cambridge of 2/12/98, at
    1 (stating that "contributors may rely on determination [of tax-
    exempt status] unless the Internal Revenue Service publishes notice
    to the contrary").
    -11-
    operates as a nonprofit, irrespective of its tax-exempt status.
    For example, the Federal Trade Commission, which does not have
    jurisdiction over nonprofit organizations,         see 
    15 U.S.C. §§ 44
     &
    45(a), determines, without reference to a target organization's
    tax-exempt status, whether the organization in fact operates as a
    nonprofit and is therefore beyond its jurisdiction. See In re Ohio
    Christian Coll., 
    80 F.T.C. 815
    , 848-49 (1972).             Similarly, state
    courts frequently inquire into whether an entity actually operates
    as a nonprofit to determine whether the entity is entitled to tax-
    exemptions reserved for nonprofits.        See, e.g., W. Mass. Lifecare
    Corp. v. Bd. of Assessors, 
    747 N.E.2d 97
    , 103 (Mass. 2001) ("The
    mere fact that the organization . . . has been organized as a
    charitable corporation does not automatically mean that it is
    entitled   to   an   exemption   for     its   property.      Rather,   the
    organization must prove that it is in fact so conducted that in
    actual operation it is a public charity.") (internal quotation
    marks and citations omitted).9
    9
    In addition to relying on the district court's policy
    rationale, the defendants contend that their interpretation of the
    exclusion is superior because of the rule of construction providing
    that a specific term in a statute (viz. "exempt from taxation under
    section 501(c)(3)") governs over a more general term (viz.
    "nonprofit organization"). See Morales v. Trans World Airlines,
    Inc., 
    504 U.S. 374
    , 384 (1992). But this rule of interpretation
    applies only "where there is inescapable conflict between" the
    statute's terms. 2A Norman J. Singer, Sutherland on Statutes and
    Statutory Construction § 46.05, at 177 (2000).         Because the
    interpretation we adopt gives different meanings to "nonprofit" and
    "exempt from taxation under section 501(c)(3)," this rule of
    -12-
    In sum, to be excluded from the CROA under 15 U.S.C. §
    1679a(3)(B)(i), a credit repair organization must actually operate
    as a nonprofit organization and be exempt from taxation under
    section    501(c)(3).   Having   reached   this   conclusion,   we   must
    identify the standard to be applied in deciding whether an entity
    satisfies the "nonprofit" component of the exclusion.
    Where Congress left "nonprofit" undefined in an exclusion
    from another statutory scheme, we concluded that "nonprofit" status
    depended primarily on proof that the entity did "not distribute
    profits to stockholders or others."        See Town of Brookline v.
    Gorsuch,    
    667 F.2d 215
    , 221 (1st Cir. 1981).      This is consistent
    with the standard definition of the term:     a nonprofit corporation
    is "a corporation organized for some purpose other than making a
    profit."    Black's Law Dictionary at 367 (8th ed. 1999); see also
    Bruce Hopkins, The Law of Tax-Exempt Organizations 5 (8th ed. 2003)
    (A "nonprofit organization . . . is not permitted to distribute its
    profits . . . to those who control it . . . .").        Here, we apply
    the standard defintion.
    For motion to dismiss purposes, the plaintiffs' complaint
    sufficiently alleges that Cambridge was not, in fact, operating as
    construction does not apply.
    -13-
    a nonprofit organization.10      The complaint states that, while
    Cambridge claimed that its purpose was "to provide direct aid to
    financially distressed debtors," in reality "Cambridge's primary
    purpose was to make money for its owners and operators, John and
    Richard Puccio."    The complaint further claims that the Puccios
    never intended to operate Cambridge as a nonprofit, but rather
    intended to use it "to enrich themselves and their key executives
    by permitting them to siphon off corporate assets of their business
    through   huge   compensation   packages."   In   support   of   this
    allegation, the complaint alleges that the Puccios and their key
    executives have received exorbitant salaries from Cambridge. These
    allegations, if true, could support a finding that Cambridge was
    not actually operating as a nonprofit organization and is therefore
    subject to the CROA.
    III.
    For the reasons stated, we vacate the judgment and remand
    for proceedings consistent with this opinion.
    So ordered.
    10
    The parties have not briefed which side has the burden of
    proof on this issue. The majority view is that the burden rests
    with Cambridge. See United States v. Columbus Country Club, 
    915 F.2d 877
    , 881-82 (3d Cir. 1990); United States v. Lansdowne Swim
    Club, 
    894 F.2d 83
    , 85 (3d Cir. 1990); Quijano v. Univ. Fed. Credit
    Union, 
    617 F.2d 129
    , 132 (5th Cir. 1980); Nesmith v. YMCA, 
    397 F.2d 96
    , 101 (4th Cir. 1968). But there is contrary authority. See
    EEOC v. Chicago Club, 
    86 F.3d 1423
    , 1429 (7th Cir. 1996). We do
    not take a position on this question because, even if the
    plaintiffs shoulder the burden of proof, their complaint is
    adequate for motion to dismiss purposes.
    -14-