1 2 3 4 5 6 7 UNITED STATES DISTRICT COURT 8 EASTERN DISTRICT OF CALIFORNIA 9 10 LARRY C. FLYNT; HAIG No. 2:16-cv-02831-JAM-EFB

KELEGIAN, SR.; HAIG T.

11 KELEGIAN, JR., 12 Plaintiffs, ORDER GRANTING IN PART AND

DENYING IN PART DEFENDANTS’

13 v. MOTION TO DISMISS 14 STEPHANIE K. SHIMAZU, in her official capacity as the 15 Director of the California Department of Justice, Bureau 16 of Gambling Control, et al., 17 Defendants. 18 19 Larry Flynt, Haig Kelegian, Sr., and Haig Kelegian Jr. own 20 card clubs in California. Flynt and the Kelegians want to 21 substantially invest in out-of-state casinos, but California law 22 prohibits them from owning more than a one-percent interest in 23 facilities that host casino-style gambling. In 2016, Plaintiffs 24 challenged the constitutionality of this prohibition, arguing it 25 violates the Due Process Clause and the dormant commerce 26 doctrine. Compl., ECF No. 1. Plaintiffs have since abandoned 27 their due process claim. See Flynt v. Shimazu, 940 F.3d 457, 460 28 n.2 (9th Cir. 2019) 1 This Court previously dismissed Plaintiffs’ suit with 2 prejudice, finding the two-year statute of limitations barred 3 their claims. Order Granting Defendants’ Motion to Dismiss with 4 Prejudice, ECF No. 40. The Ninth Circuit disagreed. See Flynt, 5 940 F.3d at 462-63. Adopting the Sixth and Seventh Circuit’s 6 approach to the continuing violations doctrine, the Ninth Circuit 7 found that “the continued enforcement of a statute inflicts a 8 continuing or repeated harm” such that plaintiffs suffer a new 9 injury each time they abstain from prohibited conduct. Id. 10 Applying this doctrine, the Ninth Circuit found Plaintiffs’ 11 claims fell within the applicable limitations period. See id. 12 462-63. 13 On remand, Defendants filed another motion to dismiss.1 14 Mot. to Dismiss (“Mot.”), ECF No. 50. Plaintiffs oppose the 15 motion. Opp’n, ECF No. 51; see also Defs.’ Reply, ECF No. 52. 16 For the reasons discussed below, the Court grants in part and 17 denies in part Defendants’ motion to dismiss. To the extent 18 that Plaintiffs’ dormant commerce doctrine claims rest upon the 19 theory that California Business and Professions Code Sections 20 19858 and 19858.5 directly regulate or discriminate against 21 interstate commerce, the Court dismisses them without prejudice. 22 Plaintiffs lack standing to allege Sections 19858 and 19858.5 23 improperly discriminate against out-of-state investors. 24 Moreover, their allegations that these provisions directly 25 regulate interstate commerce fail as a matter of law. Plaintiffs 26

27 1 This motion was determined to be suitable for decision without oral argument. E.D. Cal. L.R. 230(g). The hearing was 28 scheduled for May 5, 2020. 1 do, however, adequately allege that Sections 19858 and 19858.5 2 indirectly regulate interstate commerce. To the extent that 3 Plaintiffs’ dormant commerce claims rests upon this theory of 4 liability, the Court denies Defendants’ motion to dismiss. 5 I. BACKGROUND 6 Subject to some restrictions, California permits in-state 7 gambling. Specifically, it allows both residents and non- 8 residents to operate cardrooms. Prospective cardroom owners must 9 obtain a California gambling license, and renew it every two 10 years, to operate within the state. Cal. Bus. Prof. Code 11 § 19876(a). To avoid monetary and licensing penalties, 12 California cardroom licensees must comply with California 13 gambling laws. This case arises at the intersection of three of 14 these state laws. 15 First, California prohibits cardrooms from engaging in 16 casino-like activities (e.g., blackjack, roulette, and other 17 house-banked or percentage games). Cal. Penal Code § 330. 18 Second, California prohibits a person from “hold[ing] a state 19 gambling license to own a gambling establishment if,” among other 20 things, he “has any financial interest in any business or 21 organization that is engaged in any form of gambling prohibited 22 by Section 330 of the Penal Code.” Cal. Bus. & Prof. Code 23 § 19858(a). This restriction applies to business investments 24 “within [and] without [the] state.” Id. Finally, California 25 carves out a limited exception to § 19858’s prohibition. See 26 Cal. Bus. & Prof. Code § 19858.5. Section 19858.5 allows 27 California cardroom licensees to hold up to a 1% financial 28 interest in entities that host gambling prohibited by California 1 law, so long as the gambling is legal in the state where it 2 occurs. 3 Flynt and the Kelegians are California residents who possess 4 state-issued gambling licenses to operate card clubs in 5 California. First Amended Compl. (“FAC”) ¶¶ 8-10, ECF No. 32. 6 Plaintiffs stand “ready, willing, and able to compete for the 7 opportunity to invest in and/or operate out of-state-casinos,” 8 but Sections 19858 and 19858.5 limit their ability to do so. At 9 various points since 2014, Plaintiffs have declined otherwise 10 attractive business opportunities because the investments would 11 cost them their California gambling licenses. FAC ¶ 4. 12 II. OPINION 13 To state a section 1983 claim, “a plaintiff must allege the 14 violation of a right secured by the Constitution and laws of the 15 United States, and must show that the alleged deprivation was 16 committed by a person acting under color of state law.” West v. 17 Atkins, 487 U.S. 42, 48 (1988). Plaintiffs allege Defendants 18 violated their rights to be free from California’s regulation of, 19 and discrimination against, interstate commerce. FAC ¶ 5. 20 Defendants, however, maintain Plaintiffs failed to allege a 21 cognizable theory of liability under the dormant commerce 22 doctrine. Mot. at 5-10. Moreover, Defendants contend Kelegian, 23 Jr.’s failure to exhaust his state administrative remedies bars 24 his claim. Mot. at 14-15. 25 A. Exhaustion Requirement 26 California law provides that “[a]ny person aggrieved by a 27 final decision or order of the commission that limits, 28 conditions, suspends, or revokes any previously granted license” 1 may petition the Sacramento County Superior Court for review. 2 Cal. Bus. & Prof. § 19932(a). “Under California law, exhaustion 3 of administrative remedies is a jurisdictional requirement and 4 ‘absent a clear indication of legislative intent [a court] 5 should refrain from inferring a statutory exemption from [the 6 State's] settled rule requiring exhaustion of administrative 7 remedies.’” City of Oakland, Cal. v. Hotels.com LP, 572 F.3d 8 958, 961 (9th Cir. 2009). 9 In 2014, the California Bureau of Gambling Control found 10 that Kelegian, Jr. violated California’s 1% rule. FAC ¶¶ 69-70, 11 ECF No. 32. As a result, Kelegian, Jr. had to pay $210,000 in 12 fines and assessments. FAC ¶ 71. Moreover, the state bureau 13 required him to “refrain from any and all investment in out-of- 14 state casino-style gambling facilities.” FAC ¶ 71. Kelegian, 15 Jr. did not petition for review of this decision. 16 Defendants argue this failure to exhaust administrative 17 remedies precludes judicial review. Mot. at 14-15. Plaintiffs 18 disagree, arguing Defendants waived their exhaustion argument by 19 not raising it in their original motions to dismiss. Opp’n at 6 20 n.5. Neither argument controls. Rather, it is well-established 21 that plaintiffs need not exhaust state administrative remedies 22 before initiating a section 1983 suit in federal court. Knick 23 v. Township of Scott, Pennsylvania, 139 S. Ct. 2162, 2167-68 24 (2019) (citing Patsy v. Bd. of Regents of State of Fla., 457 25 U.S. 496, 501 (1982)). The Court therefore declines to dismiss 26 Kelegian, Jr.’s claims on this ground. 27 B. Dormant Commerce Doctrine 28 “The Commerce Clause of the United States Constitution 1 assigns to Congress the authority ‘[t]o regulate Commerce with 2 foreign Nations, and among the several States.’” Sam Francis 3 Foundation v. Christies, Inc., 784 F.3d 1320, 1323 (quoting U.S. 4 Const. art. I, § 8, cl. 3) (modifications in original). This 5 affirmative grant of authority to federal lawmakers contains an 6 implied restriction on states’ powers to regulate. Id. Courts 7 refer to this limitation as either the dormant Commerce Clause 8 or, more precisely, the dormant commerce doctrine. See id.; 9 United States v. Durham, 902 F.3d 1180, 1203 (10th Cir. 2018). 10 Imposing the dormant commerce doctrine’s limits on state 11 regulation is necessary to “ensure that state autonomy over 12 ‘local needs’ does not inhibit ‘the overriding requirement of 13 freedom for the national commerce.’” Id. (quoting Great Atl. & 14 Pac. Tea Co. v. Cottrell, 424 U.S. 366, 361 (1976)). 15 The dormant commerce doctrine prohibits two types of state 16 lawmaking: (1) direct regulation of interstate commerce and 17 (2) discrimination against interstate commerce. Daniels 18 Sharpsmart, Inc. v. Smith (“Daniels”), 889 F.3d 608, 614 (9th 19 Cir. 2018). “If a state statute ‘directly regulates or 20 discriminates against interstate commerce, or . . . its effect 21 is to favor in-state economic interests over out-of-state 22 interests,’ it is ‘struck down . . . without further inquiry.’” 23 Chinatown Neighborhood Ass’n v. Harris, 794 F.3d 1136, 1145 (9th 24 Cir. 2015) (quoting Brown-Forman Distillers Corp. v. N.Y. State 25 Liquor Auth., 476 U.S. 573, 579 (1986)). 26 If, however, a state statute “regulates evenhandedly” and 27 “has only indirect effects on interstate commerce,” courts 28 proceed to ask whether those indirect effects “impose[] a 1 ‘significant burden on interstate commerce.’” Id. at 1146. If 2 not, Ninth Circuit precedent “preclude[s] any judicial 3 ‘assessment of the benefits of [a state] law[] and the . . . 4 wisdom in adopting’ it.” Id. (quoting Nat’l Ass’n of 5 Optometrists & Opticians v. Harris, 682 F.3d 1144, 1156 (9th 6 Cir. 2012)) (modifications in original). But if the statue 7 imposes a “significant burden” on interstate commerce, courts 8 must weigh that burden against the law’s intrastate benefits. 9 See Pike v. Bruce Church, Inc., 397 U.S. 137, 142 (1970). 10 Chinatown Neighborhood Ass’n, 794 F.3d at 1145-46. A state law 11 will survive “Pike balancing” so long as the burden it imposes 12 on interstate commerce is not “clearly excessive in relation to 13 the putative local businesses.” Pike, 397 U.S. at 142. 14 1. Discrimination Against Interstate Commerce 15 Within the context of the dormant commerce doctrine, 16 “discrimination simply means differential treatment of in-state 17 and out-of-state economic interests that benefits the former and 18 burdens the latter.” United Haulers Assoc., Inc. v. Oneida- 19 Herkimer Solid Waste Mgt. Auth., 550 U.S. 330, 338 (2007) 20 (internal quotations omitted). A statutory scheme can 21 discriminate against out-of-state interests in three ways: 22 facially, purposefully, or in effect. Nat’l Ass’n of 23 Optometrists & Opticians LensCrafters, Inc. v. Brown, 567 F.3d 24 521, 525 (9th Cir. 2009). Although Plaintiffs contend an 25 earlier iteration of Section 19858 was discriminatory on its 26 face, they do not allege that the law in its current form is 27 facially discriminatory. Correctly so. California law 28 prohibits both residents and non-residents with California 1 cardroom licenses from owning more than a 1% interest in casino- 2 style gambling entities. Cal. Penal Code § 330; Cal. Bus & 3 Prof. Code §§ 19858, 19858.5 The text of these provisions does 4 not discriminate. 5 Plaintiffs do, however, argue that the purpose and effect 6 of these laws are discriminatory. See Opp’n at 9-11; FAC ¶¶ 3, 7 5.a, 6, 26, 29, 41, 44-45. The complaint alleges that state 8 officials, including former-Governor Gray Davis have said that 9 Section 19858 was “primarily [] intended to prohibit out-of- 10 state gambling interests from owning cardrooms in California.” 11 FAC ¶ 45. Plaintiffs argue discovery will show that “the only 12 businesses that would be interested in obtaining [California] 13 cardroom licenses are indeed casinos.” Opp’n at 11. If true, 14 the laws serve as a barrier to all out-of-state competition with 15 in-state cardrooms. Id. But this injury does not align with 16 the injury Plaintiffs claim. 17 The standing doctrine’s “‘injury in fact’ test requires 18 more than an injury to a cognizable interest. It requires that 19 the party seeking review be himself among the injured.’” Lujan 20 v. Defenders of Wildlife, 504 U.S. 555, 563 (1992) (quoting 21 Sierra Club v. Morton, 405 U.S. 727, 734-735 (1972)). 22 Plaintiffs are California residents with California gambling 23 licenses. Their alleged injury is that California law prevents 24 them from substantially investing in out-of-state casinos while 25 retaining their licenses. See FAC ¶¶ 72, 75. Plaintiffs are 26 not out-of-state casinos barred from procuring a California 27 gambling license and competing with local cardrooms. They 28 therefore lack standing to allege discrimination on an out-of- 1 state investor’s behalf. See Lujan, 504 U.S. at 563; see also 2 RK Ventures, Inc. v. City, 307 F.3d 1045, 1056 (9th Cir. 2002) 3 (addressing the issue of standing sua sponte). To the extent 4 that Plaintiffs’ dormant-commerce claim rests on this theory of 5 liability, the Court grants Defendants’ motion to dismiss. 6 2. Direct Regulation of Interstate Commerce 7 “Direct regulation [of interstate commerce] occurs when 8 state law directly affects transactions that take place across 9 state lines or entirely outside of the state’s borders.” 10 Daniels, 889 F.3d at 614. States cannot enact laws that 11 “directly control[]” commerce occurring “wholly outside” the 12 state’s boundaries. Id. (quoting Healy v. Beer Inst., 491 U.S. 13 324, 336 (1989)). State laws that regulate extraterritorially 14 are per se invalid under the dormant commerce doctrine, 15 “regardless of whether the statute’s extraterritorial reach was 16 intended by the legislature.” Id. 17 In determining whether a state statute directly regulates 18 out-of-state business, “[t]he critical inquiry is whether the 19 practical effect of the regulation is to control conduct beyond 20 the boundaries of the state.” Healy, 491 U.S. at 336. 21 Plaintiffs contend their extraterritorial-regulation argument 22 directly mirrors the one recognized in Daniels, 889 F.3d at 615- 23 616. Daniels addressed a medical waste handler’s dormant 24 commerce challenge to the California Medical Waste Management 25 Act (MWMA). Id. at 612. Plaintiff sought and obtained a 26 preliminary injunction against the Department’s MWMA 27 enforcement. Id. at 613. The Ninth Circuit upheld the 28 injunction. In doing so, it found Plaintiff was likely to 1 succeed on his claim that the Department’s extraterritorial 2 application of the MWMA violated the dormant commerce doctrine. 3 Id. at 615-616. 4 But Daniels is not a perfect match for this case. In 5 Daniels, the Ninth Circuit found itself “faced with an attempt 6 to reach beyond the borders of California and control 7 transactions that occur wholly outside of the state after the 8 material in question . . . ha[d] been removed from the state.” 9 Id. at 615. Put simply: the state was regulating activity it 10 had no business regulating. Sections 19858 and 19858.5 do not, 11 however, regulate conduct that is wholly unrelated to, or occurs 12 wholly outside of, the state. These provisions regulate the 13 ownership of cardrooms within California’s borders and prevent 14 illegal gambling interests from becoming too intertwined with 15 legal gambling operations. These provisions have 16 extraterritorial effects, such as requiring Plaintiffs to 17 restructure out-of-state business deals or forego them entirely. 18 See FAC ¶¶ 49-77. But extraterritorial effects do not render a 19 law per se invalid if those effects “result from a regulation of 20 in-state conduct.” Chinatown Neighborhood Ass’n, 794 F.3d at 21 1145-46 (collecting cases). Sections 19858 and 19858.5’s out- 22 of-state consequences flow from California’s valid regulation of 23 its in-state cardrooms. 24 Plaintiffs argue this case differs from cases like 25 Chinatown Neighborhood Ass’n and Nat’l Ass’n of Optometrists & 26 Opticians LensCrafters, Inc. v. Brown where the Ninth Circuit 27 upheld state statutes with extraterritorial effects. Opp’n at 28 8-9. Specifically, they argue the laws upheld in those cases 1 did not bar California residents from going to another state and 2 engaging in business that was lawful outside California. This 3 argument misgauges the scope of Sections 19858 and 19858.5. 4 Plaintiffs do not allege these provisions restrict all 5 California residents from investing in out-of-state casinos. 6 Nor do Plaintiffs allege these laws prevent all California 7 residents from owning casinos in states where casino-style 8 gambling is lawful. California law only restricts these business 9 practices when they intersect with the ownership or operation of 10 a card club located in California. 11 Finally, Plaintiffs argue Sections 19858 and 19858.5 12 impermissibly regulate wholly out-of-state conduct because “the 13 Statutes’ effect is not only on the cardroom licensees, but 14 instead, applies to all of the licensee’s partners, officers, 15 directors, and shareholders, regardless of their location.” 16 Opp’n at 8 (citing FAC ¶¶ 26, 57-63) (emphasis in original). 17 The Court declines to address the merits of this argument. To 18 sufficiently allege a facial challenge, a plaintiff “must 19 establish that no set of circumstances exist under which the Act 20 would be valid.” United States v. Salerno, 481 U.S. 739, 745 21 (1987). Plaintiffs therefore had to allege Sections 19858 and 22 19858.5 directly regulated interstate commerce with respect to 23 licensees and non-licensees. As previously discussed, 24 Plaintiffs fail to allege Sections 19858 and 19858.5 directly 25 regulate interstate commerce with respect to California cardroom 26 licensees. The laws’ application to non-licensees cannot, in 27 itself, revive Plaintiffs’ facial challenge. Nor can it serve 28 as the basis for an as-applied challenge. Plaintiffs, as 1 licensees, lack standing to challenge Sections 19858 and 19858.5 2 on non-licensees’ behalf. Lujan, 504 U.S. at 563. 3 The Court finds Plaintiffs lack a cognizable legal theory 4 for their claim that Sections 19858 and 19858.5 directly 5 regulate interstate commerce. To the extent that Plaintiffs’ 6 dormant commerce claims rest upon a direct-regulation theory, 7 the Court grants Defendants’ motion to dismiss. 8 3. Indirect Regulation of Interstate Commerce 9 A state’s evenhanded regulation of intrastate activity will 10 nonetheless violate the dormant commerce doctrine if its indirect 11 effects on interstate commerce impose a “significant burden” that 12 is “clearly excessive in relation to the putative local 13 benefits.” Pike, 397 U.S. at 142; Nat’l Ass’n of Optometrists & 14 Opticians v. Harris, 682 F.3d at 1156-57. 15 Plaintiffs allege Sections 19858 and 19858.5 impose a 16 significant burden on interstate commerce in two respects. 17 First, the State’s 1% rule not only prevents Plaintiffs from 18 substantially investing in casino-style gambling; it also 19 prevents Plaintiffs from doing business with anyone who has 20 substantial investments in casino-style gambling. FAC ¶ 83. As 21 enforced, this restriction all but completely bars California 22 cardroom licensees from investing in out-of-state gambling 23 ventures. Opp’n at 12-13. Second, the laws restrict Plaintiffs’ 24 ability to invest in businesses unrelated to gambling. Flynt, 25 for example, owns an out-of-state “exotic dance establishment.” 26 FAC ¶ 83. If Flynt’s business partner independently invests in a 27 Nevada casino, Flynt will have to divest his interest in the 28 dance club—even though the dance club itself does not host 1 gambling that is illegal under California law. Id. Plaintiffs 2 argue Sections 19858 and 19858.5’s ability to regulate industries 3 unrelated to gambling adds to the significance of their burden on 4 interstate commerce. Opp’n at 3. 5 Plaintiffs contend these burdens are “clearly excessive” in 6 relation to California’s claimed interest in crime prevention— 7 namely because this interest no longer exists. FAC ¶ 85. They 8 allege state officials on both sides of the political spectrum 9 have repudiated the notion that Sections 19858 and 19858.5 are 10 still necessary to prevent crime. FAC ¶¶ 39, 44-46. That the 11 State has exempted various cardrooms from complying with the 1% 12 rule only further undermines this putative benefit. See FAC 13 ¶¶ 28, 36, 40-41. Defendants fail to illustrate how these 14 allegations are insufficient as a matter of law. To the extent 15 that Plaintiffs’ dormant commerce doctrine claims rest upon an 16 indirect-regulation theory of liability, the Court denies 17 Defendants’ motion to dismiss. 18 III. ORDER 19 For the reasons set forth above, the Court GRANTS IN PART 20 and DENIES IN PART Defendants’ motion to dismiss. To the extent 21 that Plaintiffs’ dormant commerce doctrine claims rest upon the 22 theory that Sections 19858 and 19858.5 directly regulate or 23 discriminate against interstate commerce, the Court DISMISSES 24 them WITHOUT PREJUDICE. Plaintiffs lack standing to allege 25 Sections 19858 and 19858.5 improperly discriminate against out- 26 of-state investors. Moreover, their allegations that these 27 provisions directly regulate interstate commerce fail as a matter 28 of law. Plaintiffs do, however, adequately allege that Sections WwAOe 2.4 VV VEOULUVYAAIVIT RE RYVEUPTIOTE or FIR Ue PAY OT OT

1 19858 and 19858.5 indirectly regulate interstate commerce. To 2 the extent that Plaintiffs’ dormant commerce claims rests upon 3 this theory of liability, the Court DENIES Defendants’ motion to 4 dismiss. 5 If Plaintiffs amend their complaint, they shall file an 6 | Amended Complaint within twenty (20) days of this Order. 7 Defendants' responsive pleading is due twenty days thereafter. 8 IT IS SO ORDERED. 9 Dated: June 12, 2020 10 he Me Geren aaa pebrsacr 00k 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 14