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Small Favors From A Small State

Welcome to Delaware interstate sign against forested background
photo by Ken Lund

A little bit of bad publicity doesn’t get you very far in Delaware.

Then again, Delaware is a small place. Getting very far in Delaware means getting out of Delaware - which is exactly what I have been doing with clients interested in organizing a business, given Delaware’s we-want-something-for-nothing administrative scheme.

A couple of years ago, I wrote in this space about state unclaimed property laws that prioritized revenue over reuniting owners with their lost financial accounts, with Delaware as an especially egregious offender. The system in Delaware pits the state against business owners who allegedly hold ownerless property, assessing the business for property that cannot be returned to nonexistent owners.

In the short term, the state has done quite well with this aggressive program. In the most recent fiscal year, unclaimed property audits represented the state’s third-largest source of income and almost 14 percent of its total revenue; as of March, the state expected to generate $554 million from the program in 2016.

But for Delaware, a state that has long cultivated a reputation as a hospitable place to organize a company, the overreach led to significant pushback. Those looking to organize new businesses have looked to other states, such as Nevada, for a friendlier climate. Complaints on social media platforms and in the media have remained steady. And existing companies have taken to the courts.

This summer, Delaware’s legislators listened. Sort of. Delaware’s Senate Bill 141, which the governor signed on July 22, is the third set of revisions to the unclaimed property statute in just over a year. The new rules provide an appearance of responsiveness, but without actually responding to the big problems. The state can still send commission-based bounty hunters to comb through a company’s business records, looking for anything that may look like it owes someone something - even if what the auditors find is a mere accounting entry that, for example, fails to reflect a discount the company took for paying an invoice early. None of that has changed.

Now, though, the accounting entry can’t be more than 22 years old. As long as the business owner can produce that 22-year-old invoice showing the business paid the entire amount due, everything should be fine.

Thanks, Delaware!

(For the record, actual highway robbery in Delaware presumably falls under the state’s statute of limitations for felonies: five years, or 10 years if there is DNA evidence. Make of that what you will.)

The new rules also give business owners the opportunity to self-audit before the bounty hunters move in. Business that self-report “only” have to go back 19 years, rather than 22, as long as the business completes its review within two years of filing an application to self-report. Companies must opt in to this program, and the business has 60 days to do so after being notified that the state is interested in an examination. In theory, it is less burdensome to self-audit, and unlike third-party auditors, businesses won’t have an incentive to go hunting for bookkeeping errors and other undotted i’s and uncrossed t’s.

But the state can still audit a business even after voluntary disclosure. The form for such disclosure indicates that the state will “take the Holder’s actions into consideration in any decision whether to audit the Holder’s books and records.” So if a business owner finds that the business doesn’t owe anything, or doesn’t owe as much as the state hopes to get, the bounty hunters can - and probably will - move in anyway.

These audits are particularly burdensome for smaller companies that do not have extensive accounting staffs or infrastructure to handle unclaimed property - and which, in many cases, have good reasons to doubt they hold any assets that rightfully should be turned over to the state. Quite a few of those companies have no contact with Delaware at all, except for the fact that they are organized there and file annual business tax forms with the state. But that does not protect them from the bounty hunters.

Larger companies expect to deal with this issue in Delaware, as well as in other states where they do business. Abandoned property is not high on their list of concerns. But the big kids have their own complaints with Delaware. The Wall Street Journal reported yesterday that Dole Food Co. and other large enterprises are becoming disenchanted with Delaware’s treatment of them too, largely because they feel the state is undermining their defenses against unwarranted shareholder lawsuits. Other states, like Nevada, Michigan and Oklahoma, see an opening to capitalize on this crack in Delaware’s “franchise,” much as Delaware captured incorporation business from New York and New Jersey a century ago by offering a more hospitable legal climate.

Delaware’s changes to its unclaimed property law are a response to adverse publicity and legal challenges, but that response is best described as pitiful. Or maybe embarrassing. Or maybe shameless. It seems that Delaware may not have gotten the message that there are 49 other states out there, and a lot of them want your business. And some of them don’t feel any need or entitlement to get something out of you for nothing.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us,” and Chapter 4, “The Family Business.” Larry was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

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One Response to "Small Favors From A Small State"

  • Anne K. Scully
    August 6, 2015 - 4:12 pm

    Your article is spot on. Perhaps the State is beginning to feel the potential consequences from the recent March 2015, federal court decision regarding Temple-Inland. Specifically, the Court refused to dismiss Temple-Inland’s lawsuit which claims that Delaware’s practice of estimating a corporation’s unclaimed property liability violated Temple-Inland’s constitutional due process rights by subjecting the company to arbitrary actions, retroactively changing established rules and then levying fines based on the new definitions, as well as taking property without properly compensating the company.

    We are already seeing the fallout from the lawsuit. With the case still pending, other companies facing their own Delaware unclaimed property audits/claims have become less willing to settle with–and pay off–the State. This should raise a red flag regarding the State’s 2016 budget projections, in which it estimates $554MM in unclaimed property revenues to be generated in 2016. Somebody needs to give the budgeteers a reality check or take the fairy dust away from them.

    If Delaware prevails over Temple-Inland, you will see more companies depart for better corporate climes. And Delaware will have no one to blame but itself for its greedy attitude. As the southern expression goes, “pigs get fat and hogs get slaughtered.” Delaware is too late to save its bacon.