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Fighting Unclaimed Property Audits

Delaware's Legislative Hall viewed through a gap in a reproduction of the Liberty Bell
Legislative Hall, Dover, Del. Photo by Flickr user Jeffrey.

It was not exactly a surprise when a federal judge declared earlier this summer that Delaware’s aggressive approach toward seizing so-called unclaimed property held by businesses “shocks the conscience.” It shocked my conscience years ago.

But businesses, as well as other states, are fighting back, and they are getting significant traction in the courts. A few months ago, I wrote about the 21 jurisdictions that asked the Supreme Court to hear complaints about Delaware’s Pac-Man position on MoneyGram’s “official checks.” While those cases remain in the pipeline, two federal rulings suggest Delaware has good reason to worry about their potential outcome in the meantime.

First, a federal court in Delaware threw out a significant part of Delaware’s audit approach in a dispute with forest products company Temple-Inland, Inc. Then, in a case brought by Plains All American Pipeline, another federal court declared that companies are under no obligation to even discuss unclaimed property with Delaware’s contingency fee auditors until and unless the state issues a subpoena for records, the scope and nature of which can be challenged in court.

The state is now on the defensive. After appealing its loss in the Temple-Inland case to the 3rd U.S. Circuit Court of Appeals, the state settled with the company. The terms were not officially disclosed, but the industry newsletter “Inside SALT” (State and Local Taxes, in industry-speak) reported that the state surrendered its entire claim against the company and also agreed to pay the company’s legal fees. That tells us all we need to know about how eager the state was to avoid submitting its practices to the federal appeals court’s scrutiny.

By dropping its audit and litigation with Temple-Inland, Delaware avoided – for now – the necessity of determining exactly how it would scale back its aggressive claims against companies legally organized in the state but operating primarily, or sometimes entirely, elsewhere. As I have written previously, Delaware’s popularity as a place to organize a business has led it to lean more and more heavily on unclaimed property to fund its state budget.

This has resulted in all sorts of questionable behavior on the state’s part. Delaware asserted it could audit a business as many years in the past as it chose (a period that was limited to 22 years last summer). Delaware also regularly alleged a business’ liability using estimates based on extrapolation, rather than identifying particular assets left unclaimed. Or, rather, the state’s bounty hunters performed such extrapolation, since the state gave them every incentive to do so by paying them with contingent fees rather than a set fee. Such extrapolation could generate huge claims without the inconvenience of identifying actual property that could be reunited with its actual owners – the ostensible purpose of unclaimed property law.

In Temple-Inland’s case, the third-party auditor Kelmar used such estimation techniques, since the company had no records to offer earlier than 2003. While the federal court ruling did not determine whether the estimation formula was, itself, reasonable, the judge did note that Kelmar’s use of “calendar sales” was questionable since it suggested a link between the state of the economy and abandoned property that even Delaware conceded does not exist. While the decision did not specify how Delaware needs to amend its estimation process, it made clear that some changes will be necessary if the state wishes to avoid more litigation from the subjects of its audits.

Plains All American Pipeline objected because Delaware’s bounty-hunter auditors (also from Kelmar) issued a sweeping demand for documents and sought to make claims not just on Delaware’s behalf, but – under color of the state’s authority – on behalf of other states as well. Although a federal judge denied the company’s request to block the audit, the denial was simply based on the fact that the company was under no legal obligation even to talk to the auditors until the state issued a subpoena or other enforcement action – which will now be subject to the adverse precedent set by the Temple-Inland case. As a commentary from law firm Reed Smith observed, “Plains’ loss resulted only because the claim was brought too early – not because the state was right as to its authority.”

In the face of the courts’ stances in these two cases, Delaware, which has relied on unclaimed property for up to 15 percent of its total state budget in recent years, is being forced to backpedal. State officials have promised to take a good look at their entire escheat program to make it more reasonable and business friendly. Of course, they have little choice, especially while more than 20 other states have joined private companies in fighting Delaware in the courts.

In the meantime, however, we can safely assume that the bounty hunters remain hard at work, probably targeting smaller firms. Those firms either may not know of Delaware’s recent setbacks or may lack the financial resources to fight back as hard or to risk the massive penalties that the state has threatened to impose for companies that don’t roll over under auditors’ scrutiny. Delaware no doubt hopes to squeeze out the revenue it can before the courts turn the unclaimed property spigot down to a trickle.

The internet is a great leveler, however. Decisions like those pertaining to Temple-Inland and Plains All American Pipeline, along with commentary by law firms that closely follow this issue and by other observers (including yours truly), should put nearly every enterprise on notice that when Delaware’s soldiers of fortune come calling, there are options besides merely inviting them inside.

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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