Onerous unclaimed property audits and vexing compliance issues will continue to challenge companies in a wide range of industries in 2018. Even with the robust economy, new federal tax provisions will push states to view escheat as an important source of revenue and contingent fee auditors will do their part to broaden the scope of escheat laws. Legislation enacted in 2017 has rewritten some states’ rules in this already uncertain area, and 2018 promises to be another year of rapidly evolving standards and ongoing disputes. Companies under audit confront difficult choices while those companies not (yet) under audit face an uncertain risk and compliance landscape.
Here are five key developments to watch in 2018.
1. Rapidly Evolving State Unclaimed Property Laws. State legislatures were extremely active on unclaimed property issues in 2017 and more legislative changes are expected in 2018. Following the promulgation of a new uniform act for unclaimed property in 2016, four states (Delaware, Illinois, Tennessee, and Utah) enacted wholesale replacements to their statutes in 2017 based in part on the new model. Already for 2018, Nebraska, Washington, Minnesota, and the District of Columbia are considering enacting the new uniform act, and proposed unclaimed property legislation is under discussion in Maine and Maryland. Other states are considering proposed legislation and/or regulations focused on particular issues, including Ohio (proposed legislation on stored value cards), New Jersey (proposed regulations on stored value cards), Wisconsin (proposed legislation on contingency fee auditors and life insurance), and Indiana (proposed legislation on time deposits).
Holders should be prepared for continued uncertainty and rapid changes in the laws in this area.
2. Delaware Again on the Move. After a period of relative calm for Delaware audits in 2017—during which Delaware overhauled its unclaimed property statute and adopted new audit regulations—Delaware is again pushing ahead with active unclaimed property enforcement. In late 2017, the Delaware Secretary of State began sending several rounds of notices to non-compliant holders threatening them with an audit if they do not enroll in the state’s voluntary disclosure agreement (VDA) program. Because Delaware law no longer permits the state to initiate audits without first giving a company the opportunity to enter into the VDA program,1 the notices from the Secretary of State are the first step for Delaware to start new rounds of audits. The short deadline to respond to the VDA notice (60 days from mailing) gives companies limited time to consider their options upon receipt of a notice. (In contrast, other states that send similar VDA notices typically give companies more time to elect to enter into a VDA.) Companies that receive a VDA notice but do not enroll in the Delaware VDA program should expect an audit, and any new Delaware audits will be conducted by third-party auditors. The first set of VDA notices were sent in October 2017, but Delaware has indicated that the notice process will be an ongoing initiative.
3. The Present and Future of Estimation. The use of estimation in audits continues to be a hotly disputed issue. Because the lookback period for an audit often exceeds typical record retention periods, auditors will use estimation techniques to estimate a liability for periods where records are not available. These methods are highly controversial, because they can sometimes result in a disproportionate assessment for historic liabilities. In 2016, a federal court struck down an estimated assessment and held that Delaware violated a holder’s constitutional due process rights by issuing an unclaimed property assessment based on an estimated liability back to 1986. See Temple-Inland v. Cook, 192 F. Supp. 3d 527 (D. Del. 2016). The court held that the specific audit estimation method employed by the state’s third-party auditor, Kelmar Associates, was a “gotcha” that “shocks the conscience.” Specifically, the court in Temple-Inland identified six “troubling” aspects of the assessment and held that Delaware violated the holder’s constitutional due process rights by: (1) waiting 22 years to audit Temple-Inland and then issuing an audit assessment for a 17-year period back to 1986; (2) avoiding the six-year statute of limitations by “exploit[ing] loopholes” under dubious circumstances; (3) giving holders no notice that they needed to retain unclaimed property records for periods beyond standard retention periods to defend against “unmeritorious audits” using estimation; (4) failing to articulate a reason other than raising revenue for retroactively applying a 2010 statute that authorized the use of “reasonable estimates”; (5) calculating an estimate on a 50-state basis and claiming the full amount for Delaware; and (6) subjecting Temple-Inland to potential “multiple liability” on the same property from various states.
In the wake of that court decision, Delaware overhauled its unclaimed property statute and promulgated new regulations governing audits. Although Delaware shortened the state’s lookback period to 10 reporting years plus dormancy (i.e., 15 years total for most property types), the new regulations mostly reaffirm Delaware’s commitment to continue using the same disputed audit methods. Most significantly, for companies incorporated in Delaware, the state continues to take the controversial position that it has the power to review all of the company’s data, regardless of jurisdiction, and to issue an estimated assessment for a 50-state liability on behalf of only Delaware for the periods where complete records are no longer available.2 Some other states also continue to take this position, even though this method appears to be in direct conflict with the Temple-Inland decision. Any estimation method that awards all estimated property to the state of incorporation will continue to expose holders to a risk of double jeopardy if another state asserts the right to take custody of the same unclaimed property during the estimated years.
4. Ongoing Disputes Over Gift Cards and State Priority Rules. States and holders continue to dispute the application of the priority rules (i.e., the rules that determine which state has the right to take custody of unclaimed property), particularly in the context of gift cards, where some states offer broad exemptions from escheat. Holders won a significant victory on gift card priority rules in late 2017 in the Third Circuit Court of Appeals, in Marathon Petroleum v. Delaware, 876 F.3d 481 (3d Cir. 2017). The case arose when Delaware sought to audit gift cards issued by an Ohio subsidiary of the Delaware parent company. The holder pushed back against broad audit requests, and then filed a case in federal court arguing that the priority rules prevented Delaware from conducting a comprehensive audit of an Ohio company. In its decision, the Third Circuit confirmed that a holder can assert the priority rules as a defense against a state audit, and also articulated limitations on the scope of Delaware’s rights to audit non-Delaware gift card issuers.
Looking ahead in 2018, litigation continues in another significant case involving gift cards, French ex rel. Delaware v. Card Compliant, in which Delaware is challenging a structure where more than a dozen retailers used a non-Delaware third party to issue gift cards. Delaware contends that the arrangement was a fraudulent attempt to avoid the Delaware escheat law. Although some retailers have been dismissed from the case, approximately a dozen retailers continue to litigate, and a decision on motions for summary judgment is expected in early 2018.
Another case to watch in 2018 is the pending U.S. Supreme Court case involving uncashed official checks issued by MoneyGram and later remitted to Delaware as unclaimed property. More than 20 states have sued Delaware to claim the funds, arguing that the place of purchase has priority over the state of incorporation under the Abandoned Money Orders and Traveler’s Checks Act, 12 U.S.C. §§ 2501-2503, which modifies the normal priority rules for money orders, traveler’s checks, and similar written instruments. The case has been referred to a special master and the litigation is ongoing.
5. Proliferation of Audits and Auditors. States and third-party auditors are initiating unclaimed property audits at a record pace, and 2018 is expected to see a continued wave of new activity. Several trends from 2016 and 2017 are expected to continue in 2018, namely, the increasing activity of new(er) auditing firms, and more audit activity by states that have not historically been as active as states such as Delaware, New York, and California. Another troublesome trend has been for states to begin asserting claims for late interest and/or penalties on audit findings, rather than waiving interest and penalties for cooperative holders.
We expect many more developments in 2018 on these and other issues, with rapid developments in legislation, regulation, litigation, and audits, all of which will present a range of challenges for holders this year and beyond.