Unclaimed Property Laws: Custodial Safekeeping or Disguised Tax?

September 20, 2016 | Author: Eileen Wilkins | Category: N/A
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1 Journal of Multistate Taxation and Incentives Volume 21, Number 9, January 2012 Department: PROCEDURE Unclaimed Proper...

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Journal of Multistate Taxation and Incentives Volume 21, Number 9, January 2012 Department: PROCEDURE

Unclaimed Property Laws: Custodial Safekeeping or Disguised Tax? The legal constraints and constitutional protections that normally apply to other forms of revenue generation might provide holders with valuable arguments in challenging unexpected and unpredictable unclaimed property audits and assessments. By: CHRIS HOPKINS AND MATTHEW HEDSTROM CHRIS HOPKINS, CPA, is a partner with the accounting firm of Crowe Horwath LLP, in the firm's New York City office. He has previously written for The Journal, and can be reached at (212) 5725592 or [email protected] MATTHEW HEDSTROM, J.D., LL.M., is an associate with the law firm of McDermott Will & Emery LLP, in the firm's New York City office. He can be reached at (212) 547-5781 or [email protected] This article appears in and is reproduced with the permission of the Journal of Multistate Taxation and Incentives, Vol. 21, No. 9, January 2012. Published by Warren, Gorham & Lamont, an imprint of Thomson Reuters. Copyright (c) 2011 Thomson Reuters/WG&L. All rights reserved.

It looks like a tax and acts like a tax, but—at least as originally envisioned—unclaimed property is not a tax. States continue to aggressively audit companies with regard to unclaimed property and issue huge assessments. The vast majority of the money collected through these assessments, however, is never returned to property owners. Indeed, in many cases, actual owners will never be located or identified because they do not exist. In this regard, often the unclaimed property lining the state coffers is arguably a "fiction"—one created by estimations made by auditors whose statistical modeling leads them to conclude that unclaimed property seemingly exists. 1 Aggressive enforcement, coupled with the typical basis for assessment—estimation 2—has become big business for states and, for a few, a major source of revenue. One of the troubling aspects of aggressive enforcement is that unclaimed property (and thus an assessment) is technically not a tax, and therefore is not—according to the states—subject to some of the constitutional constraints that apply to state taxation. Revenue-hungry states (and their contract auditors)

have exploited the lack of defined constitutional limitations and have put unclaimed property holders in the untenable position of defending against a liability asserted with little or no legal authority. 3 While several recent court cases have the tested states' current enforcement practices, these cases provide little in the way of hard authority on which holders can rely. In view of the sizable sums at stake and the high level of uncertainty that surrounds unclaimed property enforcement, one could argue that the time is right for a fundamental review of unclaimed property law in general and, in particular, the administrative procedures and practices states devise to assess liabilities and penalties, which can reach into the hundreds of millions of dollars. Although an unclaimed property assessment is technically not a tax, certain constitutional limitations that govern state taxation can provide a useful framework for reforming and stabilizing state unclaimed property laws to develop an equitable, reasonable, and predictable enforcement of the laws. The following discussion examines four significant areas of uncertainty: (1) There is no computational guidance provided by any state for determining an unclaimed property liability based on an estimate. (2) The use of third-party, contingent-fee auditors leads to larger assessments and continuing uncertainty. (3) What constitutes unclaimed property is uncertain and continues to evolve. (4) Other dynamic enforcement methods make voluntary compliance virtually impossible. To understand the context and significance of these issues, it is useful first to explore the background and foundation of the area of unclaimed property.

The Historical Foundation for Unclaimed Property Laws Unclaimed (or abandoned) property is property "held or owing" in the ordinary course of business that has not been claimed by the owner. Unclaimed property can include uncashed checks, unapplied accounts receivable credit balances, "lost" stock shares, and many other types of intangible property. After the expiration of a dormancy period, the holder of the unclaimed property must turn it over to the state. Unclaimed property (or escheat) laws are not—on their face—revenue generators but, rather, are a series of state succession laws related to property rights. The roots of this particular body of law go back to

English common law—some say even further, to Roman law—which established the principle of bona vacantia (literally, "vacant goods"). Today, true escheat exists only for intestate property, but the term is widely used to refer to unclaimed property in general. In the U.S., modern custodial state statutes have been in existence since 1940. The concept was further advanced in 1951 in Standard Oil Co. v. New Jersey, 4 in which the U.S. Supreme Court solidified states' rights to take possession of unclaimed property. 5 In Standard Oil, the Supreme Court held that New Jersey's unclaimed property laws were constitutional as applied to stock and dividends that had been abandoned for 14 years. The Court echoed existing precedent and established a basic premise of modern unclaimed property law: that unclaimed property is better held by the states and used for the general good (that is, public benefit) than held by an individual or entity for a singular enrichment. Within a few years, the patchwork of unclaimed property laws in various states began to coalesce into a more predictable set of model statutes. In 1954, the National Conference of Commissioners on Uniform State Laws (NCCUSL) promulgated the Uniform Disposition of Unclaimed Property Act of 1954 to provide uniform national standards. This act was amended in 1966, and the NCCUSL subsequently adopted, in turn, the Uniform Unclaimed Property Act of 1981 and the Uniform Unclaimed Property Act of 1995 (the Uniform Acts). 6 Most states have adopted one of the Uniform Acts, but more than 15 years have passed since the last reform, and the Uniform Acts are out of sync with the current environment. Despite the emergence of new property types—from unused cell phone minutes 7 to expired procurement cards—there has been limited legislative development. Much of the current practice surrounding unclaimed property law administration is the result of innovative and informal interpretations. And much of the case law in this area is the result of businesses challenging assessments that were unexpected, unpredictable, and, they would argue, unreasonable based on these informal interpretations. One can form one's own opinion as to whether the states have adopted a balanced approach—an approach that recognizes the overwhelming obligations placed on property holders, while respecting the important policies underlying state unclaimed property laws. What seems clear, however, is that establishing welldefined limitations through ad hoc litigation seems insufficient.

What Is at Stake: For Businesses and States According to the National Association of Unclaimed Property Administrators (NAUPA), state treasurers and other agencies currently are safeguarding nearly $32.9 billion in unclaimed property. NAUPA's

website notes that almost $1.8 billion was returned to rightful owners in fiscal year 2006, the most recent year cited by the organization, leaving the majority of property in the custody of states. 8 Much of the emphasis on NAUPA's site is on the steps states take to locate owners of unclaimed property, and how owners can determine if they have a claim. Virtually no attention, however, is given to the question of what happens when owners cannot be found, or do not even exist. Unlike a forgotten stock certificate in an abandoned safe deposit box or an overlooked life insurance policy, which may at some point be claimed, most property will never be claimed, resulting in significant revenue windfalls for states. As a preferred state of incorporation, Delaware is particularly active in pursuing unclaimed property audits. Moreover, unlike some states, Delaware deposits all unclaimed property collections directly into the state's general fund. 9 According to the Delaware Fiscal Notebook, the state's unclaimed property collections rose from $106 million in 1998 to $493 million in 2010. In fact, unclaimed property assessments are the third largest source of revenue for the state, accounting for approximately 15% of total revenue—more than the state lottery, and more than corporate income taxes, cigarette taxes, alcoholic beverage taxes, and inheritance taxes combined. 10 The vast revenue generated not only demonstrates the size of the issue, but also calls into question whether unclaimed property enforcement practices have evolved far beyond their original stated purpose. In a 2010 working paper, the Washington Legal Foundation issued a warning to businesses incorporated in Delaware, stating: "[T]he Delaware Division of Revenue ... is a tough adversary and auditor of companies' unclaimed property liabilities, as evidenced by penalties and interest that often equal up to 75 percent of an unclaimed property assessment. The Division is also creative at identifying other items that it contends are unclaimed ‘property.’ Because Delaware provides no statute of limitations defense for a holder that has not filed Delaware unclaimed property reports, the Division's unclaimed property audits routinely cover all years back to 1981 (the year Delaware enacted its unclaimed property statute), or to the year the holder was incorporated or organized in Delaware if more recent." 11

The Stated—and Unstated—Purpose of Unclaimed Property Laws As noted above, limited case law exists regarding the application of state unclaimed property laws, and thus enforcement should always be guided (although it is often not) by the fundamental purpose of

unclaimed property statutes and the derivative rights doctrine. 12 The primary purpose of unclaimed property laws in every state is to collect "deemed abandoned" property, hold the property on behalf of the owner until that owner is found, and ultimately return the property to the owner or the owner's heirs. A secondary purpose, which arises only if an owner cannot be found, is that a state may use the property to benefit the public at large rather than allowing the holder of such property to retain a windfall. In other words, unclaimed property law is concerned with preventing a windfall to private individuals and businesses and would prefer that the property benefit the public. No thought has been given, though, to situations that generate a financial bonanza, that is, a windfall, for the state. The seminal case in unclaimed property law that established the current jurisdictional rules was Texas v. New Jersey. 13 In that 1965 case, the U.S. Supreme Court, exercising its Article III jurisdiction over controversies between two or more states, established rules that specify the state to which a holder should report and pay unclaimed property. As established by Texas v. New Jersey, first-priority jurisdiction belongs to the state of the owner's (or apparent owner's) last known address, as shown on the holder's books and records. Second-priority jurisdiction belongs to the holder's state of legal domicile (incorporation). This second-priority jurisdictional rule typically applies when the holder lacks the owner's address on its books and records. In recent years, certain states have adopted an overly broad, and arguably specious, interpretation of the jurisdictional rules, by relying on auditors' estimates rather than actual disclosures to determine the amount of intangible assets that should escheat to the second-priority jurisdiction. Limited case law defining the rules of engagement (that is, the lack of constraint, constitutional or otherwise, on enforcement) has resulted in considerable uncertainty. Recent trends suggest that states have taken advantage of that uncertainty. Even where records are unavailable, and thus estimation might be appropriate, auditors' estimation methods are often overly aggressive. These aggressive estimation methods create a windfall for the states because there is no specific property generated that the states are required to pay to any owner. In addition to the inherent issues associated with estimates rather than actual disclosures to determine the amount of unclaimed property that should escheat to the states, states are identifying new unclaimed property types (that arguably have no actual owner because the apparent owner affirmatively makes no claim to the property or the apparent owner has no right to property at issue) and shortening dormancy

periods. These recent trends suggest a revenue-generating approach to the enforcement of states' unclaimed property laws. Using unclaimed property laws to generate state revenue was a key issue in a recent case, American Express Travel Related Services Company v. Hollenbach. 14 In this case, American Express initially was successful in challenging an amendment to Kentucky's unclaimed property law that shortened the dormancy period for uncashed travelers' checks. In its initial opinion, the federal district court concluded, in a well-reasoned opinion, that because the state's objective clearly was to raise revenue rather than to reunite citizens with their lost property, the statute violated the Due Process Clause of the U.S. Constitution. After the decision was issued, one had to wonder whether it would be the beginning of a trend of holder-favorable decisions. An even more interesting question was whether the decision would have broader ramifications; would a court be willing to read revenue-raising intent into a state's unclaimed property legislation where no intent was specifically noted and thus impose some constraints on unclaimed property administration generally? 15 Despite this initial success, the U.S. Court of Appeals for the Sixth Circuit overturned the district court's decision in American Express, concluding, in effect, that raising revenue is a legitimate state purpose, and shortening the dormancy periods was rationally related to that purpose. The case has been remanded to address the other challenges, namely that Kentucky's law violates the takings clause and contracts clause of the U.S. Constitution, and that its retroactive application to travelers' checks sold in the past violates the Due Process Clause. We suggest, however, that these additional constitutional issues are subordinate to the key due process issue already decided. With this decision in mind, one must question whether the states have been granted even greater freedom in using unclaimed property law to raise revenue—rather than simply imposing higher taxes. This is especially true considering the broad language in the Sixth Circuit's decision, which stated: "if a statute can be upheld under any plausible justification offered by the state, or even hypothesized by the court, it survives rational-basis scrutiny." Then again, this principle is hard to reconcile with the federal district court's decision in Taylor v. Chiang 16 in which the court stated that "[i]f the purpose of the law is ... to reunite owners with their lost or forgotten property, its ultimate goal should be to generate little or no revenue at all for the state."

Taking Custody of an Estimate—and Other Ambiguities

Despite the Sixth Circuit's decision in the case, American Express still is significant because it highlighted the novel application of unclaimed property laws that states have employed in recent years and the inherent uncertainties surrounding their administration and enforcement. 17 Following are four significant areas of uncertainty:

1. There is no computational guidance provided by any state for determining an unclaimed property liability based on an estimate. One of the most contentious issues related to unclaimed property enforcement is using sampling and estimates to determine the extent of a holder's unclaimed property liability. Some states use estimation techniques during unclaimed property audits to determine the amount of unclaimed property that the holder supposedly retained during periods for which the holder no longer has books and records. And because there are obviously no owner names and addresses associated with a liability based on an estimate, the holder's state of incorporation typically will claim the entire amount. The use of estimation is specifically permitted in limited circumstances by the 1981 and 1995 Uniform Acts. 18 Many states, however, have employed aggressive estimation techniques that lead to assessments significantly larger than what was likely anticipated by the drafters of the Uniform Acts. Typically, an auditor selects a base period covering several years for which records are available, and develops an "escheat percentage" (often referred to as an "error rate") based on all items that the audit uncovers that might be considered abandoned property. Obviously, the sampling methods, the chosen base periods, and the bases against which the unclaimed property is measured (e.g., revenues, sales, or expenses) are all critical metrics that, if chosen and sampled aggressively, can lead to huge estimated liabilities. The auditor then applies this escheat percentage retroactively to all the years for which records are not available. In the case of Delaware, this extrapolation can go as far back as 1981. This extended, 30-year look-back period is another one of the many ambiguities with which companies must contend, since there generally is no statute of limitations. Moreover, there is no requirement that the look-back period bear any relation to the record-retention rules related to business taxes or any other common business practices. 19

The authors are aware of only one court decision in which a holder challenged a state's ability to estimate a putative unclaimed property liability. In State of New Jersey v. Chubb, 20 the New Jersey Superior Court held that statistical sampling and estimation techniques could be used to determine an unclaimed property liability when records are not available. Ironically, in Chubb the court held also that the jurisdictional rule that allows a holder's state of incorporation to claim "no address" property did not apply. 21

Recent challenges have raised the issue of sampling and estimates as a legitimate tool for determining

unclaimed property liability but, thus far, no other court has ruled on what estimation methodologies are reasonable or if estimates are even permissible. 22 Delaware, through recent legislation, has tried to temper the use of estimation by providing a reasonableness standard, but the meaning of "reasonable" is not defined by that statute (or by regulation) and has not been defined by the courts in a similar context. 23 Indeed, an inquiry into what is reasonable often is highly dependent on the facts and leads to ad hoc applications of law. The lack of judicial guidance addressing the use of sampling and estimates to determine the extent of a holder's unclaimed property liability raises an interesting question: If the unclaimed property cannot be shown to exist, but its existence is inferred only by estimating, how could the state possibly turn over the asset to the rightful owner? If the asset cannot be identified, the rightful owner obviously cannot be identified either. In other words, when using estimation to determine an unclaimed property liability, how can the state possibly contend it is engaged in a custodial taking if there is no custody, and no custodian? At best, it is a theoretical custodial taking and at worst it is purely a revenue-generating taking. If states administer (or amend) their unclaimed property laws with the purpose of generating revenue or generating revenue faster, the reason for the law's existence, that is, its fundamental purpose, is nullified.

2. The use of third-party, contingent-fee auditors leads to larger assessments and continuing uncertainty. A separate but related concern in unclaimed property law is the use of third-party auditors who are paid on a contingentfee basis. Not all states employ third-party auditors—Texas and New York are notable exceptions. Delaware, however, generally considered the leading state in unclaimed property enforcement, uses them extensively. These audits are almost invariably extremely broad in scope, growing and expanding over an extended period of time. In fact, a typical contract audit takes three to six years to complete. 24 In a recent whitepaper on unclaimed property laws, the Council on State Taxation (COST) 25 criticizes this practice. In the paper, COST cites the use of contingent-fee auditors as one of six critical factors it uses to

rank various states' unclaimed property laws for clarity and fairness—or lack thereof. COST's report sums up the issue succinctly: "Contingent-fee arrangements encourage auditors to be overly aggressive, to interpret State laws to their own advantage rather than in society's best interest, to ‘cherry pick’ audit targets, and to ignore holder errors that would result in lower assessments. The risk of abuse creates a perception of unfairness that colors holders' relationships with administrators and creates an atmosphere of mistrust that hinders compliance. Equally important, excessive payments to contingent fee auditors significantly reduce funds that would otherwise be available for the owners of the property or for the general revenue of the state." 26

3. What constitutes unclaimed property is uncertain and continues to evolve. New definitions of unclaimed property can develop over the course of an audit, giving businesses little chance to comply with requirements that have yet to be defined. In District of Columbia v. AT&T Corp., 27 the issue was whether unused balances on prepaid calling cards were unclaimed property. AT&T (and, in a separate action, Verizon) disputed the District's contention that calling card balances were covered by the District's Unclaimed Property Act. The cases were subsequently settled when the two companies each agreed to donate 2,500 free calling cards worth 250,000 minutes, to be made available to District government agencies that provide assistance to people in need. 28 There are other instances where unclaimed property has been defined during the course of an audit. For example, in McKesson Corp. v. Cook, 29 the issue was the retroactive creation of a new type of unclaimed property. The case raised several statutory and constitutional issues. The dispute began in 2009 when McKesson (a distributor of pharmaceutical drugs and medical devices) challenged a $4.6 million assessment from Delaware that resulted from a contingent-fee audit. The property in question was inventory mismatches and unbilled payables (also known as "goods received—invoice received" or GR/IR); these variances result from shortages or overages in the purchase of inventory, or when goods are received with no subsequent receipt of a vendor invoice (e.g., complimentary or sample products). McKesson contended the property was neither unclaimed nor abandoned. Rather, McKesson argued, the assessed property comprised free goods—excess pharmaceuticals furnished by its suppliers. McKesson noted that, prior to 2003, Delaware did not audit businesses for unclaimed property liability related to inventory and did not require companies to escheat inventory in connection with any audits. 30

With Delaware's passage of legislation eliminating inventory mismatches and unbilled payables from the definition of unclaimed property, 31 the issues associated generally with the evolution of new unclaimed property types remain unanswered. Certainly, however, similar issues will arise. States and third-party contract auditors are eager to uncover new property types despite all of the arguments as to why these new property types are not, or should not be, subject to escheat.

4. Other dynamic enforcement methods make voluntary compliance virtually impossible. The dynamic nature of unclaimed property enforcement and administration makes it difficult for businesses to anticipate their compliance obligations. In this regard, state unclaimed property laws have become somewhat of a moving target. In contrast to the state tax context where voluntary disclosure agreements (VDAs) typically do not result in a subsequent audit of the disclosed liability, Delaware routinely audits holders if it seems possible that the disclosed liability is (in the state's view) inaccurate, resulting in a full audit as if the voluntary disclosure never happened. Historically, such audits often have occurred years after the VDA had been submitted, and most often involved estimation. 32 Of note is that the Delaware voluntary disclosure rules do not require the use of estimation in making a submission. 33

Jurisdictional Limitations on State Taxation Putting aside the Sixth Circuit's holding in American Express, if the assessment of liability is not a custodial taking (that is, if the primary purpose is not to reunite property with its owner), but instead is done only for the purpose of generating revenue for the state's general fund, should the normal constraints and limitations that apply to all other revenue generating activities—that is, state taxation—be applied? Even if we assume that a revenue-generating purpose satisfies due process (which we are not conceding), should other Due Process or even Commerce Clause limitations on state taxation be used as a framework in considering what constitutes the equitable administration of state unclaimed property laws? As argued earlier in this discussion, certain unclaimed property law enforcement practices undermine the pretense of a custodial safekeeping and, instead, reveal themselves to be straightforward revenue generators—fundamentally a means of taxation. In other words, if there is no actual owner of the property at issue, or the owner has no rights under the derivative rights doctrine, and estimation is used to determine liability, then escheatment of an estimated liability would not satisfy the primary purpose of

state unclaimed property laws because there is no owner to reunite with the property. Similarly, the secondary purpose is not satisfied because the state cannot be sure it is escheating property that is unclaimed, and indeed may never be required to be returned to an owner. If neither of the stated purposes is satisfied because there is no owner to protect and there is no windfall to avoid, then unclaimed property law starts looking very much like a tax. If this is so, it could be argued that many of today's most disputed unclaimed property assessments are unconstitutional under a number of principles. 34

In contrast to the state tax context, where the U.S. Supreme Court, in Complete Auto Transit, Inc. v. Brady, 35 elucidated a four-part test to assess the constitutionality of a state tax imposition under the Commerce Clause, 36 no similar test exists in the unclaimed property context. Numerous subsequent Supreme Court decisions further define the four-part test. For example, cases address the question of fair apportionment, 37 what constitutes substantial nexus, 38 and discrimination. 39 Again, holders have no defined test when considering the validity of an estimated unclaimed property assessment and are left without clear rules of engagement. While all four parts of Complete Auto are not readily applicable to the constitutional issues associated with estimated unclaimed property assessments or other issues facing holders, more general constitutional principles may be. For example, one has to wonder whether an estimated assessment would satisfy due process under Wisconsin v. J.C. Penney Co., 40 in which the U.S. Supreme Court noted that "[t]he simple but controlling question is whether the state has given anything for which it can ask return," or whether an estimated assessment is "out of all appropriate proportion." 41

Estimated Assessments Should Be Constrained Like a Tax It would be difficult to argue that, in estimating a retroactive liability, a state is giving "anything for which it can ask return." If one assumes that the law and the estimation techniques are being used to generate revenue, such a law or administrative practice could be open to constitutional challenge on numerous grounds—equal protection, Commerce Clause, Takings Clause, and other constitutional limitations. It is hard to imagine a tax practitioner who would not be incensed by a revenue-generating measure with the following features:



No promulgated rules for calculating a taxpayer's liability.



No clear statutory definition of what is and is not taxable.



No consistent, stated method of allocation and apportionment of the tax among various taxing jurisdictions. Assessment of liability based entirely on form, with no consideration given to actual business



activity. Limited statutes of limitations, with indefinite look-back periods that are unrelated to any statutory



record-keeping requirements. •

Enforcement conducted largely by contingent-fee auditors.



No administrative appeals process, so that taxpayers who disagree with an estimate or assessment must take their case to civil court where they, as plaintiffs, bear the evidentiary burden. 42

Outrageous as these features would be in the tax context, they are commonplace in the unclaimed property world. While some states have taken steps toward more equitable and predictable practices, the unclaimed property practices of certain other states remain highly unpredictable. For years, organizations such as COST have argued for reform. In 2008, COST's board of directors approved an official policy position that called for states to develop unclaimed property programs that would:



Provide clear, reasonable, and consistent definitions of items included in and excluded from the definition of abandoned or unclaimed property.



Exclude from the definition of abandoned or unclaimed property unidentified remittances, credit balances arising from business-to-business transactions, merchandise due bills, gift cards, and gift certificates.



Refrain from deeming as "abandoned" or "unclaimed" items that are accounting or bookkeeping discrepancies, fraudulent transactions, or that do not have a rightful owner other than the holder.



Provide a reasonable statute of limitations for holders.



Ensure that administration of state unclaimed property statutes is conducted in a fair, evenhanded, and predictable manner by banning contingent-fee arrangements to compensate outside auditors and by providing holders meaningful access to an independent tribunal to appeal the findings or assessment resulting from an unclaimed property audit. 43

Conclusion Enacting legislation that meets these COST criteria (perhaps with an additional directive to adhere to the derivative rights doctrine) would greatly enhance the clarity, fairness, and predictability of unclaimed property administration. Until such statutes are in place, however, pending court challenges provide the only immediate hope for greater equity in the process. Ideally, even though estimated unclaimed property assessments might not technically be taxes, the legal constraints and constitutional protections that normally apply to other forms of revenue generation might provide holders with valuable arguments in challenging unexpected and unpredictable unclaimed property audits and assessments. ■

Sidebar Practice Note: Delaware's Unclaimed Property Administrative Appeals Process With the enactment of S.B. 272, 7/23/10 (Laws 2010, ch. 417), §1, adding new 12 Del. Code Ann. §§1156(b) through (j), Delaware adopted an unclaimed property administrative appeals process. Section 1156 (Internal Review Procedure; Court of Chancery—Jurisdiction) is reproduced below in its entirety. (a) If, after examining any report required by this chapter and filed by or on behalf of a holder (as defined in Section 1198 of this Title) or after the conclusion of an examination of a holder, the Abandoned Property Audit Manager (hereinafter the "Audit Manager") determines that a holder has underreported abandoned or unclaimed property due and owing under this chapter, the Audit Manager shall mail a Statement of Findings and Request for Payment to the holder that filed, or on whose behalf the report was filed, or that was the subject of an examination. Sixty days after the date on which the Audit Manager mails a Statement of Findings and Request for Payment, it shall constitute the Audit Manager's final determination of the amount of the holder's liability, including interest and penalties, if any, for the abandoned or unclaimed property specified in the Statement of Findings and Request for Payment, excepting only the property types and amounts included in the Statement of Findings and Request for Payment as to which the holder files a timely protest with the Audit Manager pursuant to subsection (b). The State Escheator may thereafter enforce any final determination in accordance with subsection (k). (b) Within sixty days after the date of the mailing of a Statement of Findings and Request for Payment under subsection (a) the holder may file with the Audit Manager a written protest of the Statement of

Findings and Request for Payment in which the holder shall set forth the property type or types and amount of abandoned or unclaimed property protested, and the specific grounds upon which the protest is based. The protest is intended to allow the holder to have its objections to the final request for payment reconsidered in the first instance internally within the Department of Finance by the Audit Manager as a means of expediting resolution of any dispute. If the holder elects to file a protest and to have its objections to the final request for payment reconsidered internally within the Department of Finance, as provided by subsections (b) through (k), the holder shall exhaust these administrative remedies before initiating any proceeding in any Delaware court of competent jurisdiction. (c) The only matters that the Audit Manager shall reconsider on a protest are those property types, amounts and issues related to the examination that are set out in the written protest of the holder. The holder shall remit with the protest any abandoned or unclaimed property liability attributable to property types for which payment is requested in the Statement of Findings and Request for Payment that are not protested and shall also remit with the protest the amount of abandoned or unclaimed property liability, if any, that the holder believes to be due and owing with respect to the property types or liability that are the subject of the protest. The pendency of a protest shall not prevent the accrual of interest on any protested amount finally found to be due and owing. Holders may remit the entire amount in the Statement of Findings and Request for Payment in order to prevent the accrual of additional interest without waiving any rights for reconsideration or review of protested amounts under subsections (a) through (j) of this section, and such remittance shall be subject to refund, without interest, to the extent not finally determined to be due and owing. Failure to remit amounts required by this subsection shall result in termination of the protest and the State Escheator may thereafter enforce any final determination in accordance with subsection (k). (d) The holder may submit additional documentation and written submissions to the Audit Manager in support of the protest, provided, however, that such additional documentation and written submissions shall be made no later than thirty days following receipt of the holder's protest. The Audit Manager may convene meetings with the holder to facilitate review of the Statement of Findings and Request for Payment and the protest thereof. (e) The Audit Manager shall, within sixty days of the receipt of the holder's protest, or if additional documentation is submitted, no later than ninety days after the receipt of the holder's protest, make a written determination on the protest setting forth the Audit Manager's basis of any determination that is

adverse, in whole or in part, to the holder, provided, however, that the time periods set forth in this subsection shall be subject to extension by the Audit Manager for good cause, but in no event shall any extension hereunder exceed five hundred forty days from the day the Audit Manager received the holder's protest. The Audit Manager shall mail the written determination on the protest to the holder by certified or registered mail at the address set forth in the holder's protest. (f) Thirty days after the date on which it is mailed, the determination by the Audit Manager of a holder's protest shall be final, unless within that time a holder files a notice of appeal with the Secretary of Finance. If the holder does not file a timely notice of appeal with the Secretary of Finance, the State Escheator may enforce any final determination in accordance with subsection (k). The notice of appeal shall set forth the holder's name, mailing address, telephone number, the name of the person or persons representing the holder, the mailing address and telephone number of such persons and the matters in which the holder asserts that the Audit Manager erred in the determination on the protest of the holder. (g) After receipt of a holder's written notice of appeal, the Secretary of Finance shall as soon as practicable, but in no event later than 90 days after receipt, appoint a person who is not otherwise currently employed by the Department of Finance to act as an Independent Reviewer to consider the appeal of the Audit Manager's findings and make a written report to the Secretary of Finance. The Independent Reviewer shall be a former member of the Delaware judiciary, an individual who has been previously appointed and served as a master of any Delaware court, or an attorney licensed in the State of Delaware who is qualified by experience or training to serve. (h) The appeal to the Independent Reviewer is de novo on the record. The record on the appeal to the Independent Reviewer shall be based solely upon documents submitted during the course of the examination to the Audit Manager or a person who conducted an examination on the Audit Manager's behalf, other non-privileged materials prepared by or for the Audit Manager during the conduct of an examination, expert reports submitted to the Audit Manager by the person filing a protest, other nonprivileged materials and expert reports prepared by or for the Audit Manager during the consideration of a protest. (i) The Independent Reviewer shall hold an oral hearing on the appeal, which shall be held, absent agreement of the parties, within ninety days after the date on which the Secretary of Finance appoints the Independent Reviewer pursuant to subsection (g). At least five days prior to the oral hearing date, or at such other time ordered by the Independent Reviewer, the holder and Audit Manager shall each submit to

the Independent Reviewer and each other a brief containing argument and referencing supporting documentation from the record before the Audit Manager or an explanation as to why such supporting documentation is not available. A decision in writing by the Independent Reviewer setting forth findings of fact and conclusions of law shall be submitted by the Independent Reviewer to the Secretary of Finance within ninety days from the date of the conclusion of the oral hearing or the completion of any posthearing briefing requested by the Independent Reviewer, whichever is later. The Independent Reviewer shall assess costs, including the Independent Reviewer's fee, against a party or between the parties in the Independent Reviewer's discretion. (j) The Secretary of Finance may adopt or reject the Independent Reviewer's determination in whole or in part. If the Secretary of Finance modifies or rejects, in whole or in part, the determination of the Independent Reviewer, the Secretary of Finance shall issue a decision in writing setting forth the basis of any rejection or modification of the determination of the Independent Reviewer. Within sixty days of the receipt by the Secretary of Finance of the Independent Reviewer's decision, a copy of the Secretary of Finance's determination, if any along with, the Independent Reviewer's written decision shall be sent to the holder by certified or registered mail at the address set forth in the holder's notice of appeal. The determination of the Secretary of Finance as to those liabilities that are the subject of the appeal shall be final as to the Department of Finance, and amounts determined to be due and owing shall be subject to collection by the State Escheator under subsection (k) below if unpaid after the review. The holder may, within thirty days after the Secretary's written decision was mailed, appeal the Secretary's determination to the Court of Chancery. The Court's review shall be limited to whether the Secretary's determination was supported by substantial evidence on the record. If the Court determines that the record is insufficient for its review, it shall remand the case to the agency for further proceedings on the record. (k) If any person refuses to pay or deliver property, including penalty or interest thereon, to the State Escheator as required by this chapter, the State Escheator may bring an action in the Court of Chancery in the county wherein the holder resides or has a principal place of business (or if none such exists, in New Castle County) to enforce such payment or delivery. (l) Whenever a holder disputes whether reasonable cause exists for abating penalty or interest determined by the State Escheator to be due under this chapter, such holder may bring an action in the Court of Chancery for the purpose of showing an abuse of discretion by the State Escheator in making the determination that penalty or interest was due.

ENDNOTES

1

For additional background on the issue see, e.g., Gebert and Hopkins, "Unclaimed Property: The Nontax State Revenue Generator," The Tax Advisor, pages 587-589 (September 2011). See also The Journal's prior coverage of escheat generally; most recently in Shop Talk, "Enforcement Trends in Unclaimed Property: What Companies Need to Know," 19 J. Multistate Tax’n 34 (February 2010). Also, for one state's take on one aspect of escheat, see Hall, Ryan, Turner, Browdy, and Elzholz, "Delaware's Authority to Claim Abandoned Property Owed to a Non-U.S. Last-Known Address," 20 J. Multistate Tax’n 24 (January 2011).

2

The authors recognize that estimation is not the only method of determining an assessment, and that property for which there is an actual owner also may be identified in an unclaimed property audit. The large assessments that are the focus of this article, however, generally are based on an estimate.

3

For more on this issue, see Smith and Hedstrom, "Unclaimed Property Administration—Taking Advantage of Uncertainty," 54 State Tax Notes 887 (12/21/09) (electronic cite: 2009 STT 242-4).

4

341 US 428, 95 L Ed 1078 (1951).

5

Older statutes—true "escheat" laws—did vest actual ownership in the state and raised different issues. Modern unclaimed property statutes generally are custodial in nature. Such custodial statutes have the common feature that title to unclaimed property never passes to the state but rather remains with the actual owner. The state simply steps into the shoes of the owner until the owner claims the property.

6

The NCCUSL is a nonprofit, unincorporated association created in 1892 and comprised of more than 300 "uniform law commissioners," all members of the bar qualified to practice law. The commissioners are practicing lawyers, judges, law professors, and legislators who are appointed by the states (as well as by the District of Columbia, Puerto Rico, and the U.S. Virgin Islands) to draft proposals for uniform and model laws on subjects where state uniformity is desirable and practicable, and they work toward enactment of those models by the state legislatures. See the NCCUSL website at www.nccusl.org.

7

See, e.g., District of Columbia v. AT&T Corp., D.C. Super. Ct., Civ. No. 9655-09, filed 12/31/09 (discussed further in the text below).

8

See www.naupa.org and click on "What Is Unclaimed Property?". As described on its website (click on "About NAUPA"), the Association is a nonprofit organization affiliated with the National Association of State Treasurers and the Council of State Governments. Members represent all 50 states and the District of Columbia. NAUPA provides a basic forum for continuing discussions on interstate cooperation, education, training, uniform laws, reporting requirements, and increasing public awareness of the role the states play in protecting their property.

9

12 Del. Code Ann. §1131(a).

10

Delaware Fiscal Notebook, 2010 Edition, available on the state's Department of Finance website at http://finance.delaware.gov (click on "Financial Reports," "Delaware Fiscal Notebook," and "Table of Contents"). The figures cited in the text are in "Section 2: Revenues." According to the website, the Notebook is a "user friendly guide providing policymakers and interested citizens with useful revenue, expenditure, pension, debt, and budget information." Note: Delaware does not have a state sales tax.

11

Smith, "Delaware & Unclaimed Property: One States Aggressive Revenue Pursuit And How Targeted Businesses Can Respond" (Washington Legal Foundation, Critical Legal Issues Working Paper Series,

Number 171, March 2010), available online via the Washington Legal Foundation website at www.wlf.org/publishing/publication_detail.asp?id=2145.

12

See, for example, State ex rel. McCann v. Bank of America, N.A., 191 Cal App 4th 897, 120 Cal Rptr 3d 204, 2011 WL 72177 (1st Dist., 2011) ("The [state] Controller ... succeeds, subject to UPL [unclaimed property law] provisions, to whatever rights the owners of the abandoned property may have," citing Bank of America Nat'l Trust & Sav. Ass'n v. Cranston, 252 Cal App 2d 208, 60 Cal Rptr 336 (1st Dist., 1967)); see also State by Parsons v. Standard Oil Co., 74 A2d 565 (N.J., 1950), aff'd sub nom. Standard Oil Co. v. State of New Jersey, 341 US 428, 95 L Ed 1078 (1951).

13

379 US 674, 13 L Ed 2d 596 (1965).

14

American Express Travel Related Services Company, Inc. v. Hollenbach, 630 F Supp 2d 757 (DC Ky., 2009), reconsideration den. 7/30/09, vac'd and rem'd 641 F3d 685 (CA-6, 2011).

15

See Smith and Hedstrom, "Where We've Been and Where We're Going—Taking Stock," 55 State Tax Notes 781 (3/15/10) (electronic cite: 2010 STT 49-6).

16

DC Cal., No. Civ. S-01-2407 WBS GGH, 6/1/07, 2007 WL 1628050 .

17

See also, e.g., McKesson Corp. v. Cook, Del. Ch. Ct., Case No. 4920, filed 9/25/09, and discussed in the text below.

18

The 1981 Act (in §30(e)) and 1995 Act (in §20(f)) authorize reasonable estimations where a holder fails to maintain records from prior periods as required by the Uniform Acts.

19

Interestingly, in contrast to a majority of states (see, for example, N.J. Rev. Stat. §46:30B-95, "Maintaining records; generally: Every holder required to file a report ... as to any property for which it has obtained the last known address of the owner, shall maintain a record of the name and last known address ... for five years after the holder files the report...."), Delaware generally has no statutory requirement for the retention of unclaimed property-related records, and does not require the filing of negative reports, which would start the running of a statute of limitations for reports filed or required to be filed on or after 7/22/02. See 12 Del. Code Ann. §1158. No statute of limitations applies to earlier report years. A banking organization, however, must file an annual report of abandoned property, including a report verifying that it neither holds nor owes any such property. 12 Del. Code Ann. §1171.

20

New Jersey v. Chubb Corp., 570 A2d 1313 (N.J. Super. Ct. Ch. Div., 1989).

21

The implications of the court's decision in State of New Jersey v. Chubb, supra note 20, while interesting, are beyond the scope of this article.

22

See CA, Inc. v. Cordrey, Del. Ch. Ct., No. CIV.A. 4111-CC, "First amended verified complaint for equitable, declaratory, injunctive, and other relief," filed 12/24/08; Cordrey v. CA, Inc., Del. Ch. Ct., No. CIV.A. 4195-CC, 2/2/09, 2009 WL 296258 (concerning the state's request for documents). The dispute ultimately was settled out of court and thus failed to provide precedent on the sampling issue.

23

S.B. 272, 7/23/10 (Laws 2010, ch. 417, effective 7/23/10), amending 12 Del. Code Ann. §1155. Specifically, §4 of the legislation added the following sentence at the end of the existing §1155: "Where the records of the holder available for the periods subject to this chapter are insufficient to permit the preparation of a report, the State Escheator may require the holder to report and pay to the State the amount of abandoned or unclaimed property that should have been but was not reported that the State Escheator reasonably estimates to be due and owing on the basis of any available records of the holder

or by any other reasonable method of estimation." Prior to the enactment of this legislation, there was no statute or regulation that permitted the state to estimate an unclaimed property liability during an audit.

24

The actual length of most unclaimed property audits conflicts with Delaware's regulations. Under Code Del. Regs. 31-200-2000, §5, "the time to complete a typical [unclaimed property] audit should not exceed twelve (12) months." Adopted at 10 Del. Reg. 669, 10/1/06.

25

As described on its website (www.cost.org.), COST is a nonprofit trade association consisting of nearly 600 multistate corporations engaged in interstate and international business. COST's objective is to preserve and promote equitable and nondiscriminatory state and local taxation of multijurisdictional business entities.

26

Leslie, "The Best and Worst of State Unclaimed Property Laws—Scorecard on State Unclaimed Property Statutes: The Holders' Perspective," (Council on State Taxation, January 2009), available online via the Council's website at www.cost.org (click on "State Tax Library: Cost Studies, Articles & Reports").

27

See note 7, supra.

28

The AT&T dispute was settled in May 2010; the similar dispute with Verizon Communications, Inc. was settled in August 2010. Both disputes were discussed in "District Settles with Verizon Over Unused Calling Card Balances" (Press Release, D.C. Office of the Attorney General, 8/17/10), available online via the OAG website at http://dc.gov/DC/OAG/About+OAG/News+Room/Press+Releases.

29

See note 17, supra.

30

McKesson was discussed in a bit more detail in Shop Talk, "Enforcement Trends in Unclaimed Property: What Companies Need to Know," supra note 1.

31

S.B. 272, 7/23/10 (Laws 2010, ch. 417), §2, enacting new 12 Del. Code Ann. §1211, effective 7/23/10 and applicable "with respect to all uncompleted examinations being conducted by the State Escheator as of the date of enactment and to all litigation pertaining to the subject matter thereof that is pending as of the date of enactment." Id., §13(b).

32

A revised regulation (effective 5/1/06) limits the period within which Delaware may audit a voluntary disclosure submission to 18 months (reduced from three years) "from the date that a Holder has received a demand for payment from the abandoned property administrator and paid over property under a VDA." Code Del. Regs. 31-200-2000, §4. Adopted at 10 Del. Reg. 669, 10/1/06. The italicized language was added to make clear that the audit period begins to run from the date when VDA forms AP DE-2 "were executed, accepted and where payment was made...." Id., §6. Merely submitting a form accompanied by a payment will not start the running of the 18-month period. 10 Del. Reg. 669, 10/1/06. The authors note that the period of time between when a voluntary disclosure submission is made and when the state signs form AP DE-2 often is lengthy.

33

The Delaware regulation merely requires that a holder disclose any estimation technique used: the voluntary disclosure agreement submission "shall identify in detail the work performed, the property types reviewed, any estimation techniques employed, and a calculations [sic] showing the potential amount of property due under the VDA." Code Del. Regs. 31-200-2000, §3.

34

This argument is particularly compelling in the case of a compliant holder, as opposed to a holder that intentionally disregards its reporting obligations. We note that, often, holders fall somewhere in between. We acknowledge that estimation could be appropriate in certain circumstances if properly restrained, but current aggressive estimation techniques often are untenable.

35

430 US 274, 51 L Ed 2d 326 (1977).

36

To pass muster, the tax must satisfy the following requirements: (1) be applied to an activity that has substantial nexus with the taxing state; (2) be fairly apportioned among the states where the activity occurs; (3) not discriminate against interstate commerce; and (4) be fairly related to the services provided by the state. For a more detailed discussion of the Complete Auto standards, see Lieberman, "Complete Auto Transit, Inc. v. Brady: How Many Parts Are There?," 3 J. Multistate Tax’n 4 (Mar/Apr 1993) .

37

See, e.g, Hans Rees' Sons, Inc. v. North Carolina, 283 US 123, 75 L Ed 879 (1931); Goldberg v. Sweet, 488 US 252, 102 L Ed 2d 607 (1989); Oklahoma Tax Comm'n v. Jefferson Lines, Inc., 514 US 175, 131 L Ed 2d 261 (1995) (analyzed in Haynes, Schultz, and Stromen, "Jefferson Lines: Will the U.S. Supreme Court's Decision Be Extended to Other Services?," 5 J. Multistate Tax’n 100 (Jul/Aug 1995)).

38

See Quill Corp. v. North Dakota, 504 US 298, 119 L Ed 2d 91 (1992) (analyzed in Eule and Richman, "Out-of-State Mail-Order Vendors Need Not Collect Use Taxes—Yet!," 2 J. Multistate Tax’n 163 (Sep/Oct 1992); also see Nolan, "Crossing the Bright Line: Evaluating Physical Presence in Quill's Shadow," 7 J. Multistate Tax’n 244 (Jan/Feb 1998) ).

39

Boston Stock Exchange v. State Tax Comm'n, 429 US 318, 50 L Ed 2d 514 (1977) (holding that a New York transfer tax on securities transactions was unconstitutional because transactions involving an out-ofstate sale were taxed more heavily than most transactions involving a sale within the state); South Central Bell Telephone Co. v. Alabama, 526 US 160, 143 L Ed 2d 258 (1999) (striking down an Alabama tax that favored entities incorporated under the laws of Alabama over entities incorporated elsewhere) (analyzed in Compton and Compton, "Taxpayers Await Remedies After U.S. Supreme Court Voids Alabama Corporate Franchise Tax," 9 J. Multistate Tax’n 6 (August 1999) ; see also Shop Talk "Alabama Deals With Unconstitutional Franchise Tax ... and Remedies," 10 J. Multistate Tax’n 38 (Mar/Apr 2000) ).

40

311 US 435, 85 L Ed 267 (1940).

41

Hans Rees' Sons, supra note 37.

42

In July 2010, Delaware adopted an unclaimed property administrative appeals process with the enactment of S.B. 272, 7/23/10 (Laws 2010, ch. 417), §1, which added new 12 Del. Code Ann. §§1156(b) through (j). As of the date this article is written, the authors are not aware of any holder making use of this appeals process. Section 1156 is reproduced in a sidebar accompanying this article.

43

See "Unclaimed Property: Policy Position," available online via the Council's website at www.cost.org (click on "State Tax Library: COST Policy Statements"). END OF DOCUMENT - © 2012 Thomson Reuters/RIA. All rights reserved.

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