The words “unclaimed property” can be a source of headache for many companies, especially those incorporated in Delaware. Onerous reporting requirements across states often require that companies dedicate significant personnel time to the task. Penalties for noncompliance can also be steep, and states can audit companies and find noncompliance. Recent procedural developments in an ongoing lawsuit challenging the constitutionality of Delaware’s unclaimed property auditing practices are worth noting, as the case may have legal implications for the many companies with ties to Delaware. They also underscore that companies should ensure that they are compliant with state unclaimed property laws.
Background on Abandoned Property Law
US unclaimed property law traces its origins to the feudal English common law concept of “escheat” through which land occupied by someone other than the owner would be returned to the feudal lord after the death of an heirless tenant. The goal was to ensure that the land remained productive and was not usurped by “squatters” without an inheritance right to the land who might seek a claim to it by physical occupation. The law continued to evolve in England and eventually found its way to the United States in connection with the new country’s emphasis on property rights.1
Under modern US unclaimed property law, anyone owing property to an individual or business, referred to as a “holder,” is required to deliver – or “escheat” – that property to a state if the owner does not claim it after a statutory period of time, most often one to five years, depending on the property type. Companies are common holders. Among the broad scope of potentially escheatable property types are wages, unexchanged stock certificates, uncashed checks, unredeemed gift cards, and unclaimed credit balances and refunds.
Where the property escheats depends on the priority rules established in Texas v. New Jersey, 379 U.S. 674 (1965). Under the First Priority Rule, unclaimed property escheats to “the State of last known address of the owner, as shown by the holder’s books and records.” If the last address is unknown, under the Second Priority Rule the holder’s states of corporate domicile has the right to the unclaimed property.
Enter Delaware. Because many companies are formed there, they often have at least some escheatable property owed the state. For Delaware and many other states, the funds escheated from the broad range of property types covered have become a major revenue source. A recent Washington Post article noted an oft-cited reality: Unclaimed property is now “the third largest source of funds for [Delaware] state government, regularly exceeding half a billion dollars annually.”2 Industry consensus also has been that the state has become more even aggressive in seeking access to property that companies under its jurisdiction may owe.
Among the ways that Delaware has been able to aggressively seek unclaimed property funds is through audits. Delaware’s law gives the state the authority to examine holders, especially those incorporated in Delaware, for compliance with Delaware Escheat Law. Univar, Inc. is just one of the latest companies challenging the scope of the state’s audit powers.
In December 2018 Univar filed a lawsuit against the Delaware Department of Finance in the United States District Court for the District of Delaware questioning the constitutionality of the state’s auditing practices, including claims that the state was retroactively applying its February 2017 unclaimed property law amendments in attempt to force Univar to produce records in an audit that the state had initiated against the company in 2015.3 The 2017 law revisions added a provision giving the state the power to compel production of records in an examination by administrative subpoena.4 In October 2018 the state issued an administrative subpoena against Univar requesting a broad range of documents from the Company, such as balance statements, tax returns, and corporate structure details. Univar filed its lawsuit in response.
Among other constitutional claims that Univar filed against the state were that its estimation practices through which it determined holder liability for unavailable property records violated its due process rights under the Fourteenth Amendment for vagueness5, and that the state’s audit/estimation procedures and inspection/examination of documents violated its Fourth Amendment right to be free from unreasonable search and seizure. 6 Univar sought declaratory relief on the constitutional claims and enjoinment of the state from conducting its audit and threatening to impose penalties.7
The State of Delaware subsequently filed a separate lawsuit in the Delaware Court of Chancery seeking to compel Univar’s compliance with its administrative subpoena. Univar later filed a motion to dismiss the petition, or, alternatively, stay the Court of Chancery proceedings until the District Court of Delaware could rule on the constitutional claims.
Since these filings, Delaware Courts have made a few rulings in Univar’s favor. First, on April 8, 2019 the Delaware Court of Chancery granted Univar’s motion to stay the state’s complaint to enforce an administrative subpoena against Univar, allowing the declaratory judgment complaint to continue in federal court.8 This subsequently prompted the state to seek an interlocutory appeal of the ruling, which was also denied on May 6, 2019.9
In denying Delaware’s interlocutory appeal request, which the Chancery Court noted was only to be granted in “exceptional” circumstances, the court ruled that it was “satisfied” that the appeal should not be granted, as “the interests of justice would not be served by interlocutory review because the Court [had not yet] address[ed] the claims raised by the parties on the merits…With no substantial issue decided and no interest of justice implicated, [it could not be said] that the remote benefits of an interlocutory appeal outweigh certain costs.”10 In explaining the conclusion the court noted the fact that, despite Delaware having initiated an audit against Univar in 2015, it had not issued a subpoena seeking to compel records from Univar until October 30, 2018, while Univar “did not wait” to seek court relief after the October 2018 subpoena, having filed its lawsuit on December 3, 2018 – and only then did the state “rush” to Court to file an action against Univar.11
Moreover, the Chancery Court noted the state’s “poor track record of defending its escheat practices in federal courts,” footnoting several supporting cases from the last several years, among them the Third Circuit ruling that Delaware’s initiation of an escheat audit does not bar private citizens from bringing a lawsuit challenging the state’s audit practices under certain egregious circumstances,12 as well as another where the Delaware District Court noted that aspects of the state’s enforcement of unclaimed property law were “‘troubling’ and shock[ed] the conscience,’” in violation of substantive due process. 13
Finally, on June 18, 2019, the Delaware Supreme Court also rejected the state’s subsequent appeal of the May 2019 denial for interlocutory review, agreeing with the Chancery Court that it was not warranted.14
While the merits of the Univar case have not yet been litigated, the developments do indicate that Delaware may have to make more changes to its auditing practices. Previous litigation led the legislature in 2017 to limit the lookback period in an audit to 10 reporting years, or 15 actual years ( rather than 20+ years) and now before initiating an audit a state may give a company 60 days to enter a Voluntary Disclosure Agreement instead to remit past-due property.15 However, as shown through the ongoing Univar case, the state is still finding ways to aggressively pursue review of holder records in audits. Companies formed in Delaware or with significant unclaimed property liability there are especially encouraged to continue tracking this case. Also, to the extent that a company may be delinquent in reporting and remitting abandoned property, a VDA program through the Delaware Secretary of State is an important option to avoid audit. Companies can also initiate participation in a VDA completely voluntarily, without the state’s prompting.