A facial challenge to Delaware’s use of contingency-fee unclaimed property auditors has been given new life by a federal appellate court, which held that the arrangement is subject to due process review, reversing the lower court’s dismissal of the action.
On August 9, 2017, the United States Court of Appeals for the Third Circuit held in Plains All American Pipeline L.P. v. Cook, No. 16-3631, 2017 WL 3403129 (3d Cir. Aug. 9, 2017) that Delaware’s delegation of its audit authority to a contingency-fee auditor during an unclaimed property audit raised sufficient due process concerns that the case should be allowed to proceed.
Plains is one of a series of cases brought in recent years challenging the constitutionality of Delaware’s unclaimed property regime. In Temple-Inland v. Cook, No. 14-cv-654, 2016 WL 3536710 CV 14-654-GMS (D. Del. Jun. 28, 2016), the Delaware federal court held that Delaware had violated a holder’s constitutional due process rights by issuing an unclaimed property assessment based on an estimated liability back to 1986. Two other cases are currently on appeal involving Delaware’s attempt to audit unredeemed gift cards issued by non-Delaware holders.
In Plains, the district court dismissed a pre-assessment challenge to Delaware’s unclaimed property statute and audit procedures for lack of ripeness and for failure to state a claim upon which relief could be granted. The Third Circuit affirmed the district court’s dismissal in all respects, except that it held that the holder’s procedural due process claim was ripe.
In response to an audit notice from Delaware and document requests from its third-party auditor, the holder in Plains filed a request for declaratory and injunctive relief on the grounds that the proposed audit (and portions of the unclaimed property statute) violated its constitutional rights. The Third Circuit held that the majority of the holder’s claims were not ripe primarily because any possible harm to the holder was contingent on the auditor’s findings, the costs associated with an audit that had not yet begun were wholly speculative, and an audit confined to past conduct would not have a direct effect on the holder’s day-to-day business. The Third Circuit, however, came to a different conclusion regarding the holder’s due process challenge to Delaware’s use of a contingency-fee auditor to conduct the audit.
The holder alleged that the fee structure between Delaware and its contingency-fee auditor gave the auditor a direct financial stake in the outcome of the audit. The holder further alleged that its procedural due process rights had been violated because Delaware’s delegation of its audit authority was tantamount to allowing a non-neutral third party to act in a quasi-judicial capacity.
The Third Circuit declared that the harm element of ripeness had been met because “[t]o establish a due process violation, all [the holder] must show is that it was required to submit a dispute to a self-interested party.” The Third Circuit stated that the conclusiveness and utility elements of ripeness had been met because no further factual development was needed to address the merits of the claim, and Delaware’s widespread use of third-party auditors would make a ruling on the merits useful to others. This decision means that the case will be returned to the district court in Delaware for further litigation over Delaware’s contingency-fee auditor contracts.
Although the Third Circuit explicitly left the merits question open when it stated, “[p]erhaps this arrangement is constitutional,” its ripeness holding was based on a finding that the auditor was self-interested. Clearly, the role of a contingency-fee auditor in Plains caused the Third Circuit concern and therefore could raise similar concerns with other courts. Thus, holders confronted with contingency-fee audit arrangements should consider incorporating objections to these arrangements into their broader defense strategy.