A lawsuit challenging the unclaimed property estimation methodology used by the State of Delaware and its auditor Kelmar Associates will proceed, according to a ruling issued by a Delaware federal district court on March 11. In Temple Inland v. Cook, the plaintiff brought federal preemption and constitutional claims challenging the use of statistical models to establish a purported liability in an unclaimed property audit and to issue an unclaimed property assessment. The court granted in part and denied in part Delaware’s motion to dismiss and denied the company’s motion for partial summary judgment. The end result is that the company’s challenge to the assessment will go forward.

The lawsuit arose after Delaware issued a $2 million unclaimed property assessment to the company following an unclaimed property audit conducted by Kelmar. For the years in which the company had maintained records, the auditor identified only $147.30 in unclaimed monies that had not been escheated to the state. Because the company was unable to produce records before 2003, however, the auditor used an estimation method to extrapolate to an alleged underpayment of approximately $2 million going back to 1981. The assessment was reduced to $1.4 million following an administrative appeal. The company filed a lawsuit in federal court against the Delaware State Escheator and Secretary of Finance challenging the assessment. The Delaware defendants filed a motion to dismiss, and the company sought partial summary judgment.

The court’s key rulings were as follows:

The court dismissed the company’s claim that the use of estimation techniques should be found to be preempted by federal common law. The company had argued that Texas v. New Jersey and Delaware v. New York require that there be a specifically identifiable debtor-creditor relationship before a state can require escheatment, and the use of estimation techniques was inconsistent with these principles:

The court finds that, consistent with the stated purpose of the priority scheme in Delaware to “resolve disputes among States,” the Texas Cases apply to disputes among States, not to disputes between private parties and States.  . . .   As the court discerns no preemptive federal law, it need not reach the question of whether Delaware bars the use of estimates to fix a holder’s escheat liability.

The court denied, however, Delaware’s motion to dismiss the company’s substantive due process claim:

[P]laintiff alleges a deprivation of property in the form of the money claimed by the State under authority of the Escheat Act, arguing that the use of estimates to calculate the debt results in two or more States claiming the same property as expressly prohibited by the Texas Cases. Although, as an estimate, the disputed debt itself cannot be attributed to a particular owner, the unclaimed money on which the estimate is based may be traced to identifiable creditors. Plaintiff alleges that defendants’ estimate is based on, inter alia: (1) uncashed checks escheated to other states under the primary rule . . .; (2) checks that were voided, reissued and cashed by the payees . . .; and (3) checks payable to payees with addresses in other States, some of which expressly exempt the property from escheat . . . . If the allegations as claimed are true, the disputed money may indeed violate the Supreme Court’s prohibition against “more than one State . . . escheating a given item of property.” Texas, 379 U.S. at 676.

The court denied Delaware’s motion to dismiss the company’s ex post facto claim, which was based on the argument that the current estimation provision was enacted in 2010, that it constitutes a penalty, and that it was being applied retroactively. The court left this issue for another day, and denied the company’s motion for summary judgment on this claim for the same reason:

The drafters of the UUPA anticipated a potential conflict with the TexasCases for dual-liability by authorizing the use of estimates, and they forestalled any such conflict by explaining that § 20 was to be viewed as a penalty. See Uniform Unclaimed Property Act § 20(f) cmt. The Delaware General Assembly, on the other hand, eliminated the document retention requirement and avoided characterizing § 1155 as a penalty. In so doing, the General Assembly set the stage for a violation of substantive due process. In other words, defendants are faced with a dilemma: If § 1155 is not a penalty provision, it likely violates plaintiff’s rights to substantive due process. If, on the other hand, § 1155 is a penalty provision, its retroactive application likely violates the Ex Post Facto Clause. The court is unprepared, at this juncture, to determine which scenario is most likely.

The court also denied Delaware’s motion to dismiss the Takings Clause claim:

The parties focus their dispute on whether plaintiff has a legitimate property interest in the assets, with defendants arguing that plaintiff is merely holding the property for the legitimate owner and plaintiff arguing that defendants have failed to identify any property legitimately subject to escheat. As previously explained, the court finds that plaintiff has pled sufficient facts to support the position that it has a legitimate property interest in the estimated debt given that the estimate may not be traceable to bona fide creditors. It follows that, if Delaware does not have the authority to escheat the property in question, then the seizure of such property without just compensation would be a violation of the Takings Clause.

Finally, the court denied the motion to dismiss the Commerce Clause and Full Faith and Credit Clause claims, deferring those issues for another day:

Given the brevity of the parties’ briefing, the court is unprepared, at this stage, to determine whether the Supreme Court intended secondary priority to attach if the laws of the creditor’s State are silent on the question of escheat or if, as defendants allege, secondary priority attaches if the laws of the creditor’s State actively exempt certain property from escheat. Whether or not it is appropriate for the State where the debtor is incorporated to base estimates on property that was exempted by the creditor’s State, plaintiff also alleges that estimates were based on cashed checks as well as property actually escheated to other States. These latter examples, if true, are in tension with the Supreme Court’s prohibition against double escheat as a violation of the Full Faith and Credit Clause…. As pled, the Full Faith and Credit Clause violation is inexorably intertwined with the alleged violation of the Commerce Clause. The court is unwilling to dispense with a potentially meritorious Commerce Clause claim at this stage of the litigation, as a more complete factual record would aid the court in making a determination. 

The court’s ruling allows the majority of the company’s claims to survive Delaware’s motion to dismiss, and this case will continue to be closely watched by companies facing unclaimed property audits.