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THOMAS v. NETWORK SOLUTIONS

April 3, 1998

WILLIAM THOMAS, et al., Plaintiffs,
v.
NETWORK SOLUTIONS, INC, and NATIONAL SCIENCE FOUNDATION, Defendants.



The opinion of the court was delivered by: HOGAN

MEMORANDUM OPINION

 Pending before the Court are three motions: plaintiffs' motion for summary judgment on Counts One and Three of the Amended Complaint, plaintiffs' motion for a preliminary injunction, and defendants' motion to dismiss the entire Amended Complaint. The Court held a hearing on these motions on March 17, 1998. After consideration of the parties' briefs and arguments at that hearing, the Court will grant plaintiffs' motion for summary judgment on Count One; at this time, however, the Court will grant judgment only on the issue of liability, and will reserve judgment on the issue of damages and other relief until it has ruled on plaintiffs' motion for class certification. The Court will deny plaintiffs' motion for judgment on Count Three, and will grant defendants' motion to dismiss as to all counts of the Amended Complaint, except Count One. The Court will deny plaintiffs' motion for a preliminary injunction, and will dismiss ail counts of the Amended Complaint, except Count One.

 I Background

 A. The Parties

 Defendant National Science Foundation ("NSF") is an independent agency of the United States government, organized pursuant to a federal statute. 42 U.S.C. § 1861. NSF's primary function is to support and strengthen scientific research, engineering, and educational activity. 42 U.S.C. § 1862(a)(1). With the passage of the Scientific and Advanced Technology Act in 1992, NSF received an expanded mandate to support development of the Internet and to facilitate its use. See 42 U.S.C. § 1862(g).

 Defendant Network Solutions, Inc. ("NSI") is a private company that has been engaged in the registration of domain names since 1991. In 1991, NSI won a subcontract to a procurement contract that Government Services, Inc. (GSI) had been awarded by the Defense Information Services Agency. NSI's duties under that subcontract were to perform domain name registrations and to assign Internet Protocol (IP) numbers. In 1992, NSI entered into a cooperative agreement with NSF to perform essentially the same functions. Under the terms of that agreement, which is scheduled to expire later this year, NSI manages and maintains the registry of domain names.

 There are nine plaintiffs-- three individuals and six corporations. Plaintiffs each allege that they have paid fees to NSI for the right to register domain names for use on the Internet.

 B. The Internet and Domain Name System

 The Internet is a complex network that links computers worldwide. It is the outgrowth of a system known as ARPANET, a network that the military created in 1969 to link its computers with those of defense contractors and universities. See generally, Reno v. ACLU, 138 L. Ed. 2d 874, 117 S. Ct. 2329, 2334 (1997). While that network no longer exists, it provided a model for a number of similar, civilian networks that eventually coalesced into the backbone of the modern Internet.

 Use of the Internet has grown exponentially over the past eighteen years. In 1981, an estimated 300 computers were linked via these networks; by 1996, the number had risen to an estimated 9.4 million computers, and some experts believe that 200 million persons will use the Internet by 1999. Nearly 60% of the computers currently linked to the Internet are located in the United States.

 In order to fully access the Internet, a user needs a unique address, called an "Internet Protocol," or "IP," address. It is from this address that a user may post information, access information at other addresses, or exchange information with another user. IP addresses are composed of a long string of numbers; because of this, however, they are themselves rarely memorable. In order to smooth the transfer of information, a user will often attach an alphanumeric "domain name" to his or her IP address.

 Domain names consist of a series of letters or numbers, followed by a period and a specific three letter designation. The series of letters and numbers to the left of the period is called the "second level domain name," and it is unique to the individual user. This name can be tailored to be easily remembered, and even to convey information about the user-- it is often descriptive, catchy, and occasionally clever. In the United States, the three letter designation to the right of the period is one of seven handles: "gov," "org," "com," "net," "edu," "mil," or "int." *fn1" These seven handles are called "top level domain names."

 It is clear that domain names make the Internet much more accessible. Instead of seeking information at a site designated only by a random number, the user can access a site by its descriptive name. If the name is properly registered and linked to an IP address, the user will be conveyed to the site he or she seeks.

 The key, of course, is that the name and the IP address must be linked together. In order to prevent confusion-- two users with the same name, for example-- users must register their second level names with one of the seven top level names. Although there has been discussion of competition in the registration of domain names, at this time a user may register in a top level domain name only through defendants. *fn2"

 B. Solicitation and Award of Cooperative Agreement to NSI

 Before 1992, NSF performed many administrative tasks in regard to the non-military aspect of the nascent Internet. Among these tasks was the registration of domain names and the maintenance of the registry of names. However, in March 1992, NSF issued Solicitation 92-24 for a Network Information Services Manager for the Internet. NSF considered proposals from three firms that wished to assume the task of providing registration services for the non-military component of the Internet.

 NSF chose NSI, and on January 3, 1993, the two entered into Cooperative Agreement No. NCR-9218742. The contract specified that, after a three month "phase-in" period, NSI would provide registration services for five years, with a six month "flexibility period" at the end. Therefore, the cooperative agreement that became effective on January 1, 1993, was due to expire on March 31, 1998, and has a flexibility period that will expire on September 30, 1998.

 The original contract called for NSI to operate on a "cost-plus-fee" basis, meaning that NSI received reimbursement for its costs, plus a fixed fee that ensured the company's profit. Under this original contract, the costs and fees were paid by NSF out of its operating budget; users did not have to pay fees to register or to maintain domain names. The contract estimated that, over the five year life of the agreement, NSI would receive $ 4,854,061 in cost reimbursement and $ 365,278 in fixed fee profit. See Cooperative Agreement at Art. 8, PA.

 C. Amendment of Cooperative Agreement

 The original agreement provided that changes may eventually be made; among these contemplated changes was "the imposition of a user based fee structure." Id. at Art. 3, PG. The contract provided that the fee structure could be re-assessed through peer review at any time before December 31, 1994. Id. at Art. 5, PB. An independent panel (allegedly with no representatives of NSI or NSF) began its review in late 1994; in March 1995, NSI proposed to charge prospective users for registration.

 On September 13, 1995, NSF and NSI entered into Amendment 4 of the Cooperative Agreement. This amendment eliminated the "cost-plus-fee" method of compensation. In its place, it permitted NSI to charge fees for the registration and maintenance of domain names, which meant that, for the first time, users had to pay to register and maintain their domain names. The amendment set the fees at $ 100 to register and at $ 50 to renew annually. *fn3" Since 1995, NSI has been solely responsible for collecting these fees.

 The amendment does not permit NSI to keep the entire fee as reimbursement for costs and profit. Instead, NSI keeps 70% of each fee for itself and places the remaining 30% *fn4" into the Intellectual Infrastructure Fund. The 30% contribution is commonly known as the "Preservation Assessment." NSI is responsible for maintaining the Fund, but the government directs the expenditure of monies from the Fund.

 D. NSI's Experience Under the Cooperative Agreement

 The Internet landscape is substantially different in 1998 than it was in 1993, when NSI and NSF entered into their cooperative agreement. In 1992, NSF and NSI estimated that the latter would perform about 229 new registrations per month. That estimate quickly became outdated. In March of 1994, NSI was performing 1,376 new registrations per month. In December 1994, it performed 3,164, and in April 1995, the number was 9,774. NSI estimates that, by late 1997, it was handling 120,000 new registrations per month, and it had registered a total of 2,269,751 domain names, including 1,957,239 in the ".com" top level domain.

 Given the fee structure in place after September 1995, NSI clearly had substantial receipts for its efforts. The parties disagree to some extent about the exact amount of receipts, and the parties disagree as to NSI's profit margins. Plaintiffs allege that NSF gave NSI all its hardware and software free of charge. Plaintiffs further allege that NSI's per registration cost is approximately $ 10, and that it does not exceed $ 20 in any case. *fn5" Therefore, argue plaintiffs, NSI has amassed $ 89.7 million in above cost profit in just under five years. *fn6"

 Defendants dispute plaintiffs' characterizations. They argue that plaintiffs' economic models intentionally overestimate profits and underestimate costs. NSI asserts that it has incurred, and continues to incur, substantial costs. It argues that it has purchased most of its own equipment and software, and that its registration activities require substantial, expensive human involvement. NSI asserts that it performs both the relatively inexpensive "back-end registry" function that its would-be competitors might also perform, and the more expensive, "customer-facing registrar" function, which requires more man hours. Therefore, NSI argues, its fees are more closely aligned to its costs. NSI does not actually reveal those costs, but it does state that its total profits under the Cooperative Agreement are approximately $ 7.1 million, not the $ 89.7 million estimated by plaintiffs.

 E. Intellectual Infrastructure Fund

 According to Amendment 4, 30% of all registration fees *fn7" are considered part of the "Preservation Assessment," and are placed in the Intellectual Infrastructure Fund. As of September 30, 1997, the Fund contained at least $ 37 million. Plaintiffs claim that, at the current rate of domain name registration, the Fund will exceed $ 120 million by December 1998. According to NSI's own statements, it deposits these funds and maintains the account, but it does so only as a proxy for NSF; NSI admits-- and, indeed, insists-- that the Intellectual Infrastructure Fund is the government's money, and that the government alone can choose how and when to spend it. NSI makes no claim at all for ownership of these funds.

 Congress also seems to treat the Intellectual Infrastructure Fund as government money. In October of 1997, Congress passed the Department of Veterans Affairs and Housing and Urban Development and Independent Agencies Appropriations Act, Pub. L. No. 105-65, 111 Stat. 1344 (1997), which authorized an expenditure of $ 23 million on the "Next Generation Internet" program. The Next Generation program is aimed primarily at upgrading the Internet infrastructure, improving the speed and accuracy of information delivery, and increasing access for schools. Although the statute does not mention the Intellectual Infrastructure Fund by name, there is little dispute that Congress intended it as the source of funding for the Next Generation project.

 There are indications that the Preservation Assessment is designed to raise funds for government use. For example NSF's Inspector General commented that "a portion of the fees obtained to register Internet addresses [should] be allocated to support further Internet development." Inspector General's Report, February 7, 1997, at 1. In order to implement this proposal, the I.G. suggested that "federal oversight of Internet addresses should generate income for the government." Id. at 9. The Report then presents the Preservation Assessment scheme as the means to generate that income for use on broader Internet projects.

 II Plaintiffs' Summary Judgment Motion

 Plaintiffs have moved for summary judgment on Counts One and Three of their Amended Complaint. In these counts, plaintiffs argue that the Preservation Assessment is an illegal tax and, therefore, that the collection of this fee must cease and that the funds must be returned. On February 2, 1998, the Court granted plaintiffs' motion for a preliminary injunction based on the allegations in these counts, and the Court enjoined defendants from spending, or otherwise using or dissipating, the money in the Intellectual Infrastructure Fund.

 Summary judgment is appropriate only if there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56; Celotex Corp. v. Catrett, 477 U.S. 317, 322, 91 L. Ed. 2d 265, 106 S. Ct. 2548 (1986). In considering a motion for summary judgment, the "evidence of the non-movant is to be believed, and all justifiable inferences are to be drawn in his favor." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1986). There is a genuine issue of fact only if there is such evidence that a reasonable jury could return a verdict for the non-moving party; a fact is material only if it might affect the outcome of the suit under applicable law. Id. at 248.

 Plaintiffs argue that the Preservation Assessment is an illegal tax because it was not authorized by Congress. It is clear that only Congress has the power to levy taxes. U.S. Const., Art. I, Sec. 8; National Cable Television Ass'n, Inc. v. United States, 415 U.S. 336, 340, 39 L. Ed. 2d 370, 94 S. Ct. 1146 (1974); Bell Atlantic Telephone Cos. v. Federal Communications Commission, 306 U.S. App. D.C. 333, 24 F.3d 1441, 1445 (D.C. Cir. 1994). It is undisputed that Congress did not itself impose the Preservation Assessment-- NSF and NSI devised it in Amendment 4 to the Cooperative Agreement. Therefore, as the Court indicated in its February 2, 1998, Memorandum Opinion, plaintiffs will prevail on their claim if they show both (1) that the assessment is a tax, and (2) that Congress has not ratified the tax.

 A. Character of the Assessment

 Plaintiffs argue that the Preservation Assessment is a tax; defendants argue that it is a fee, which may be collected without Congressional action, or that it is "program income," which is a category of revenue that is special to grants and cooperative agreements.

 1. Tax or Fee

 Defendants first argue that the Preservation Assessment is not a tax, but a regulatory fee. There is no single test to evaluate the assessment's character, but several cases present criteria that are useful for the Court's consideration. The Supreme Court distinguishes a tax as a payment which is arbitrarily imposed for some public purpose. In contrast, a fee is payment for a voluntary act, such as obtaining a permit, that goes to defray the expenses of regulating that act. National Cable, 415 U.S. at 340; Williams v. Motley, 925 F.2d 741, 743 (4th Cir. 1991); United States v. Maryland, 471 F. Supp. 1030, 1036 (D. Md. 1979); In Re Farmers Frozen Food Co., 221 F. Supp. 385 (N.D. Cal. 1963).

 Other courts focus more specifically on the benefits conferred by an assessment. These courts hold that a payment is a tax when it confers no special benefit on the payee, or when the assessment is intended to raise general revenue; in contrast, a fee gives the payee value for payment, in the form of defraying the regulatory expenses necessary to keep certain services active. See Cumberland Farms, Inc. v. State of Maine, 116 F.3d 943, 946-47 (1st Cir. 1997); United ...


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