On June 1, 2007, in Taylor et al. v. Westly, the U.S. District Court for the Eastern District of California issued a preliminary injunction against the State of California ordering that the California Controller “shall not accept, take title to, or possession of any property, nor sell, convert to cash, or destroy any property, including, but not limited to, securities and the contents of safe deposit boxes, pursuant to the California Unclaimed Property Law (California Code of Civil Procedure §§ 1500 et seq.) until the Controller has first promulgated regulations providing for fair notice to the owner and public, satisfactory to and approved by this court”. The preliminary injunction is effective immediately and will remain in effect until otherwise ordered by the court.
The U.S. District Court’s order was based on the decision of the U.S. Court of Appeals for the Ninth Circuit granting a preliminary injunction in Taylor v. Westly. The case involved a lawsuit by two individuals claiming that California took their property (securities) and sold it in violation of the Due Process and Takings Clauses of the United States Constitution, federal securities laws and California’s Unclaimed Property Act. The plaintiffs requested a declaratory judgment, a “disgorgement and return of either their stock investment or the return of the reasonable value thereof,” money damages, an injunction ordering the Controller to return their stock and refrain from engaging in future similar seizures without proper notice, and other relief. The Ninth Circuit held that a preliminary injunction should be granted because (1) the plaintiffs demonstrated a high likelihood of success on the merit and (2) the plaintiffs demonstrated a possibility of irreparable harm in the absence of the requested injunction.
Likelihood of Success on the Merits
Regarding the likelihood of success on the merits, the Ninth Circuit stated that, before the government may disturb a person’s ownership of his property, “due process requires the government to provide ‘notice reasonably calculated, under all the circumstances, to apprise [the] interested part[y] of the pendency of the action and afford [him] an opportunity to present [his] objections.’” California’s notice practices consisted of the following:
(i) placing advertisements in the newspaper stating that people concerned about possible escheat may check a Web site to see if their names or property are listed;
(ii) mailing written notice to some, but not all, individuals whose property has been escheated; and
(iii) relying on corporations, banks and other holders of the property subject to escheat to provide notice to the individuals owning the property.
The Ninth Circuit stated that the first two methods of notice do not meet the requirement that notice be given prior to the state’s taking of such property. In addition, the Ninth Circuit pointed out that the U.S. Supreme Court has held that mere publication is “not constitutionally adequate” except in special circumstances because “[c]hance alone brings a person’s attention to ‘an advertisement in small type inserted in the back pages of a newspaper.’” As for California’s reliance on notice given by third parties, the Ninth Circuit noted that the Supreme Court has clearly held that the state must give notice.
Possibility of Irreparable Harm
Regarding the possibility of irreparable harm, the Ninth Circuit stated that, without a preliminary injunction, plaintiffs “run the risk that California will permanently deprive them of their property pursuant to its policy of immediately selling property upon escheat” and, once the property is sold, it may be impossible for plaintiffs to reacquire it. In reaching this conclusion, the Ninth Circuit rejected California’s argument that “the plaintiffs were unlikely to suffer irreparable harm because they were now aware of California’s policy and would henceforth be able to protect their property from escheat.”10 The Ninth Circuit stated that although such knowledge may decrease the likelihood of future harm, it does not eliminate it.
Scope of Preliminary Injunction
The Ninth Circuit did not discuss the specific scope of the preliminary injunction to be issued by the District Court, except to say that (1) federal courts lack jurisdiction to issue injunctions ordering compliance with state law and (2) since California has not yet taken any action to remedy the constitutional defect with its unclaimed property law, the District Court may wish to consider whether some sort of supervision, such as requiring court approval of new regulations, may be necessary.
The District Court justified issuing a broad preliminary injunction based on the Ninth Circuit’s statement that the injunction “should be granted based on the ‘combination of [plaintiffs’] probable success on the merits and the possibility of irreparable injury.’”11 The court stated that, under Ranchers Cattlemen Action Legal Fund v. U.S. Department of Agriculture,12 where the probability of success on the merits is high, a less showing of irreparable harm is needed for an injunction to issue. Thus, the court reasoned that, since there is a “very high probability” that plaintiffs will ultimately succeed on the merits, the preliminary injunction should be sufficiently broad to cover actions that result in even small degrees of irreparable harm. Accordingly, the court determined that the injunction should apply not only to California’s sale of unclaimed property (which creates a significant harm), but also to California’s custodial taking of unclaimed property in the first place.
Withdrawal/Modification of Preliminary Injunction
The District Court also ordered the California Controller to submit any new proposed regulations concerning the administration of California’s Unclaimed Property Act to the court for its review.
If the court determines that the regulations are sufficient to meet the requirements of due process, it will withdraw or modify the preliminary injunction. The plaintiffs conceded at oral argument that the pre
-1968 version of Section 1531 of the California Code of Civil Procedure (which is actually former Section 1511 of the California Code of Civil Procedure) would meet such requirements.
Less than three weeks after the U.S. District Court issued its preliminary injunction in Taylor v. Westly, a California Court of Appeal reached a decision in Porcile v. Connell.13 This case involved many of the same issues raised in Taylor v. Westly, including whether the state’s seizure and subsequent sale of “abandoned” stock violated the Due Process Clause of the U.S. Constitution.
The California Court of Appeal cited Harris v. Westly14 for the proposition that there is “no legal basis for a requirement of prior notice before conversion of stock to cash” and thus held that the sale of the plaintiff’s property by the state did not violate due process. The Harris court based this conclusion primarily on the fact that (a) the shareholders were entitled to the proceeds from the stock sale, and (b) there was no legal authority directly on point.
The Court of Appeal also concluded that there was no due process violation in connection with the state’s initial seizure of the stock. The court emphasized that California was only taking custody of the property, and thus a lesser standard of notice was required than if the state were seeking title to the property. The court relied on a U.S. Supreme Court case, Texaco, Inc. v. Short,15 in support of this proposition. Texaco involved an Indiana statute that provided that unused mineral interests would lapse and revert to the surface owner after 20 years unless the owner of such interests filed a statement of claim with the local county recorder’s office. The Supreme Court held that the owners had no constitutional right to be advised that the 20-year period of nonuse was about to expire.
The Court distinguished between a final adjudication regarding a plaintiff’s right to property and a law providing for the abandonment of property, and held that the latter is analogous to a statute of limitations. The Court then went on to state that “[t]he Due Process Clause does not require a defendant to notify a potential plaintiff that a statute of limitations is about to run, although it certainly would preclude him from obtaining a declaratory judgment that his adversary’s claim is barred without giving notice of that proceeding.”16
The California Court of Appeal also relied on Fong v. Westly,17 which held that “due process did not require the Controller to give notice to plaintiffs . . . beyond what plaintiffs had already received constructively” by publication of the unclaimed property law. Fong thus concluded, based on its reading of Texaco, that the mere enactment and publication of an unclaimed property law provides sufficient notice to property owners to satisfy due process. In addition, the court in Fong also pointed out that the property owners had also presumably received notices from another state regarding the abandonment of their property.
The reasoning of the California Courts of Appeal in Porcile, Harris and Fong is suspect. Most importantly, the courts in Porcile and Harris failed to recognize that the sale of stock for cash constitutes a permanent deprivation of the owner’s property and, as illustrated by the facts of Taylor v. Westly, such a deprivation can be exceedingly costly to the owner (California sold the stock of one of the plaintiffs in Taylor for $200,000, whereas if the stock had not been sold, it would have been worth almost $4 million).
The courts thus failed to undertake the requisite analysis of whether California’s notice procedures were adequate for purposes of due process. The courts’ reliance on Texaco to support their conclusion that the mere enactment and publication of a custodial unclaimed property law provides sufficient notice to satisfy Due Process is also misplaced. The goals of the Indiana lapse statute at issue in Texaco were to encourage owners of mineral interests to develop such interests and to aid the state in the collection of property taxes.
In addition, the Supreme Court believed it was reasonable to impose on the mineral interest owner the burden of keeping informed of the use or nonuse of his own property based on the tangible nature of the property at issue, the minimal extent of the actions necessary to avoid a lapse by the owner and the generous (20-year) period given to the owner to take such actions.
Porcile, Harris and Fong involved entirely different circumstances from those in Texaco. The primary purpose of California’s unclaimed property act is to return abandoned property to its owner – not to encourage any use of property by its owner, assist in tax collection, or any similar goal. Thus, there is no policy rationale supporting a lapse in the owner’s rights in his property; to the contrary, the act’s very purpose demands that such rights be preserved – and proper notice would seem to be the first step in doing so. Furthermore, the property at issue in Porcile, Harris and Fong (stock) is intangible in nature, and thus has no clear “situs” in any particular state. Nor is it a natural resource that is intended to be eventually used or developed by its owner. Rather, the purpose of owning such property is to hold it, perhaps exercise certain rights with respect to it (e.g., voting right), and eventually sell it, and the timing of the sale by the owner is often a key factor in determining the property’s ultimate value.
Even if the state does not sell the property it seizes, the state’s seizure itself deprives the owner of his rights during the time the property is seized. Finally, the California unclaimed property act generally provides that intangible property becomes “presumed abandoned” and is required to be reported and remitted to the state after only three years of nonuse. It is far from clear that the U.S. Supreme Court would have reached the same result in Texaco if the Indiana statute at issue had provided that a lapse in the rights of the property owner occurred after such a short period of time.
Effects and Implications of the Taylor v. Westly Decision
We anticipate that the Taylor v. Westly decision will have a number of significant effects, both in California and nationwide. Of course, the primary effect, at least in the near future, is that California will (most likely) be required to enact new legislation (or promulgate new regulations) with more stringent notice requirements to owners of unclaimed property. Indeed, on June 19, 2007, the California budget committee approved an $8 million plan in response to the U.S. District Court’s injunction. The new plan would require the state to send a notice to the last known address of the owner before property is seized. The state would also be prohibited from selling stock for at least 12 months (and certain safe deposit box items for at least 18 months) after it has been seized. However, it is unlikely that such a plan will satisfy the requirements of Due Process. After all, even if California had taken such actions in Taylor v. Westly, it is not clear that it would have prevented the harm suffered by the plaintiffs in that case.
Many (if not most) other states likewise engage in the general practice of immediately liquidating any non-cash unclaimed property (such as securities) remitted to the state. Most states also have notice requirements (and practices) that are similar to those in California. Thus, we believe that similar challenges will eventually be made in other states, and courts in those states will likely follow the Ninth Circuit’s lead on this issue – at least with respect to property that is immediately sold after receipt.
Finally, it is worth noting that Taylor v. Westly has resulted in a significant inquiry into California’s relationship with Affiliated Computer Services (ACS), which is a firm that audits holders of unclaimed property on behalf of the state and earns a commission based on the amount of unclaimed property turned over to the state. ACS has similar contracts with more than 40 states and also provides extensive record-keeping services for states with respect to unclaimed property. Although it is too soon to know where this inquiry may lead, it has long been observed that third-party contingent fee audits may well violate both public policy and constitutional due process, particularly where such audits are carried out (as they often are) on behalf of multiple states simultaneously.18