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In-Depth Coverage of Issues Surrounding State and Local Tax
INSIDE SALT
In-Depth Coverage of Issues Surrounding State and Local Tax
Unclaimed Property
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Breaking News: Federal Court Finds Delaware’s Unclaimed Property Enforcement “Shocks the Conscience”

by , and | Jun 29, 2016 | , , , , ,

On June 28, 2016, the much-anticipated memorandum opinion of the US District Court for the District of Delaware in Temple-Inland, Inc. v. Cook et al., No. 14-654-GMS was released on the parties’ cross-motions for summary judgment, finding Delaware’s extrapolation methodology and audit techniques collectively violate substantive due process.  According to Judge Gregory M. Sleet, “[t]o put the matter gently, [Delaware has] engaged in a game of ‘gotcha’ that shocks the conscience.”  The opinion also specifically called third-party auditor Kelmar Associates LLC’s formula used for estimation into question, noting that the use of a holder’s calendar sales as the denominator in the ratio used to estimate liability raises questions given the lack of connection between abandoned property and the economy.  In sum, this opinion is a “must read” for any unclaimed property advisor or holder going through a Delaware audit and is likely to have a drastic impact on both on-going and future unclaimed property audits.  Holders should contact their unclaimed property advisors immediately to begin discussing how to proceed based on this groundbreaking development.

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Unclaimed Property Hunger Games: States Seek Supreme Court Review in ‘Official Check’ Dispute

by , and | Jun 10, 2016 | , , , , , , , , , , , , , , , , , , , , , , , ,

Background

As detailed in our blog last month, MoneyGram Payment Systems, Inc. (MoneyGram) is stuck in between a rock and a hard place as states continue to duel with Delaware over the proper classification of (and priority rules applicable to) MoneyGram’s escheat liability for uncashed “official checks.”  The dispute hinges on whether the official checks are properly classified as third-party bank checks (as Delaware directed MoneyGram to remit them as) or are more similar to “money orders” (as alleged by Pennsylvania, Wisconsin and numerous other states participating in a recent audit of the official checks by third-party auditor TSG). If classified as third-party bank checks, the official checks would be subject to the federal common law priority rules set forth in Texas v. New Jersey, 379 U.S. 674 (1965) and escheat to MoneyGram’s state of incorporation (Delaware) since the company’s books and records do not indicate the apparent owner’s last known address under the first priority rule. However, if the official checks are classified as more akin to money orders under the federal Disposition of Abandoned Money Orders and Traveler’s Checks Act of 1974 (Act), as determined by TSG and demanded by Pennsylvania, Wisconsin and the other states, they would be subject to the special statutory priority rules enacted by Congress in response the Supreme Court of the United States’ Pennsylvania v. New York decision and escheat to the state where they were purchased. See 12 U.S.C. § 2503(1) (providing that where any sum is payable on a money order on which a business association is directly liable, the state in which the money order was purchased shall be entitled exclusively to escheat or take custody of the sum payable on such instrument).

In addition to the suit filed by the Pennsylvania Treasury Department seeking more than $10 million from Delaware covered in our prior blog, the Wisconsin Department of Revenue recently filed a similar complaint in federal district court in Wisconsin, alleging Delaware owes the state in excess of $13 million. Other states participating in the TSG audit (such as Arkansas, Colorado and Texas) also recently made demands to MoneyGram and Delaware.

It is interesting to note that in 2015, Minnesota (MoneyGram’s former state of incorporation) turned over in excess of $200,000 to Pennsylvania upon its demand for amounts previously remitted to Minnesota for MoneyGram official checks. Apparently not only do the states in which the transaction occurred disagree with but even a former state of incorporation took the majority path.   (more…)



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Unclaimed Property Litigation Update – Spring 2016

by , and | May 16, 2016 | , , , ,

Litigation over unclaimed property rules and obligations continues to accelerate. The first quarter of 2016 brought developments in several cases, including a much-watched contest over merchandise credits and a new battle between the states over which state gets the money.

California Merchandise Credits Not Subject to Remittance as Unclaimed Property; Implicit Application of Derivative Rights Doctrine Prevails

On March 4, 2016, a California superior court held in Bed Bath & Beyond, Inc. v John Chiang that unredeemed merchandise return certificates (certificates) issued by Bed Bath & Beyond (BB&B) to tis California customers are exempt “gift certificates” under the California Unclaimed Property Law—and not “intangible personal property” under the California catch-all provision. Like many retail stores, BB&B provides the certificates as credits to customers who return items without a receipt. While the certificates may be redeemed for merchandise at BB&B or one of its affiliates, they cannot be redeemed for cash. BB&B took the position that it mistakenly reported and remitted the unclaimed certificates from 2004 to 2012 and filed a refund claim with the California State Controller’s Office (Controller) in 2013 for the full amount remitted during that time period (amounting to over $1.8 million). The Controller denied the claim, and BB&B proceeded to sue John Chiang, both individually and in his official capacity as former California state controller. The relief sought by BB&B was the full refund request, plus interest. (more…)



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Delaware Court Denies Most of Defendants’ Motion to Dismiss Unclaimed Property Gift Card False Claims Action

by and | Dec 1, 2015 | , , , , ,

Two years ago, a former employee of Card Fact, LLC (subsequently purchased by Card Compliant), a company providing gift card issuance and management services to retailers, filed a false claims action in Delaware alleging that his former company and its retailer clients concocted a scheme to avoid remitting unclaimed gift card funds to Delaware. Last week, the judge in the case issued a memorandum opinion on the defendants’ Motion to Dismiss.  State of Delaware ex rel. French v. Card Compliant LLC, et al., C.A. No.: N13C-06-289 FSS [CCLD] (Del Sup. Ct. Nov. 23, 2015). While the opinion is likely disappointing to most of the defendants, it should not be read as a final victory for the state. There is still much to be decided in the case, as this was just a motion to dismiss and not a decision as to whether the plaintiffs will ultimately prevail.

The judge did however make several legal conclusions that are of import to Delaware companies. First, the judge determined that as to gift card liability that was initially incurred by the retailers but subsequently transferred to Card Fact (and its affiliates), the retailers remained the debtors with respect to the card owners, unless the customers consented to the delegation of debt. The judge found that the contractual agreements between the retailers and the Card Fact companies were not controlling. However, the judge did not specifically rule on gift card liabilities that were never transferred from the retailers to Card Fact, but instead were incurred directly by Card Fact after its relationship with the retailers began.

Second, the judge found that for defendants that were not C corporations, the second priority rule was to be applied based on the state of formation, not the principal place of business. This is contrary to most state laws and sets up a direct conflict between the states.

Finally, the judge found that because one of the retailers had previously been audited by Delaware (through Kelmar), it could not be a defendant in this false claims action. The judge dismissed this defendant entirely, even for claims that arose subsequent to the audit conclusion. The judge noted that “[i]f the auditor has given [the retailer] a bye, that is between the escheater and the auditor.” This is very good news for any company that has previously been audited by the state regarding the risk of a false claims action.

Practice Notes

  1. For companies that have been audited by Delaware, the risk of a false claims action has likely been significantly reduced if not eliminated;
  2. Unincorporated entities should investigate the indemnification provisions between their state of formation and state of principal place of business to determine the risk of choosing which state to remit to;
  3. Companies using gift card entities or other liability allocation arrangements should review their disclosures and agreements with customers to verify appropriate consent and understanding regarding which entity holds the actual liability.


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Q&A: Current Delaware Litigation & Potential Protective Claims

by | Aug 27, 2015 | ,

McDermott lawyers Stephen P. Kranz and Diann Smith recently engaged in a Q&A with Jon D’Amato and David Poehler of MarketSphere Consulting to expound upon the ramifications of the recent spate of litigation challenging Delaware’s unclaimed property enforcement. The timely and informative discussion includes both the procedural and substantive implications of these pending lawsuits.

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Straight Outta Delaware: JLI Invest S.A. et al. v. Cook et al.

by , and | Aug 25, 2015 | , , , ,

As soon as we start to think that Delaware’s unclaimed property practices and administration couldn’t possibly get any more egregious, another lawsuit like JLI Invest S.A. et al. v. Cook et al., Case No. 11274 surfaces. The facts alleged in the complaint highlight the fundamental issue of just how much “protection” state unclaimed property laws provide to owners. In this case, Delaware apparently protected two scientists out of $12,024,148.25. Yay Delaware. The scientists are not happy (we would be crying on the floor with either (a) a vat of Graeter’s ice cream or (b) a barrel of Sancerre) and have sued Delaware for their lost value.

Facts

Dr. Gilles Gosselin and Dr. Jean Louis Imbach are the two Belgian scientists who headed the research team responsible for creating a Hepatitis B drug. Idenix Pharmaceuticals, Inc. was established to commercially develop this drug. As the creators of the drug, Dr. Gosselin and Dr. Imbach were given an ownership interest amounting to approximately 10 percent of the Idenix shares. These shares were held by JLI Invest S.A. and LIN Invest S.A. (the plaintiffs), two Belgian companies established for this purpose.

Despite the facts that (a) both Idenix and Computershare (their transfer agent) had record of the mailing address of each plaintiff and no mail was ever returned undeliverable—as required by Delaware law at the time for property to be deemed abandoned— and (b) that scientists both continued to perform professional services for Idenix, Computershare reported the Idenix shares to Delaware in November 2008 and delivered all of the shares to Delaware on January 2, 2009.  Three days later, Delaware sold the shares for a total of $1,695,851.75 (approximately $3.03 per share). At the time, Idenix had approximately 50 shareholders, and the market for the shares was illiquid.

After making an inquiry concerning the stock to Computershare three years later in 2012, the plaintiffs learned that their shares had been escheated to Delaware. Upon contacting the Delaware Office of Unclaimed Property to claim their property, the plaintiffs were forced to provide substantial documentation verifying their status as the rightful owner, which they did in October and December 2012. After over a year of “pending” status, the plaintiffs were directed to complete a “Request Form” in May 2013, at which time it was noted that a response could take another 12 weeks.

On June 9, 2014, Merck and Idenix announced that Merck would acquire Idenix via a cash tender offer for $24.50 per share. Because the plaintiffs’ shares had been escheated to (and immediately sold by) Delaware in 2009, they were not able to participate in the tender offer despite their desire to. Had they been able to participate, the plaintiffs would have been entitled to receive a total of $13,720,000 for their shares. Meanwhile, Delaware had still not responded regarding the status of their claim. Notably, it was not until October 2014 (over two years after their initial request) that the Delaware Office of Unclaimed Property confirmed that the plaintiffs Idenix shares were [...]

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Uniform Law Commission Completes First Reading of the Revised Uniform Unclaimed Property Act

by , and | Jul 20, 2015 | , , ,

On Tuesday, July 14, 2015, at their Annual Meeting the Uniform Law Commission (ULC) completed their first reading of the Revised Uniform Unclaimed Property Act (RUUPA or the Act). While over half of the sections comprising the current draft of the Act were passed over due to strict time constraints imposed by the ULC President Harriet Lansing, the RUUPA Drafting Committee (Committee) did their best to focus the time they did have on sections they felt were most in need of feedback from the ULC Commissioners (Commissioners) as a whole. The Committee even went so far as to invite discussion by allowing American Bar Association (ABA) Advisors and National Association of Unclaimed Property Administrators (NAUPA) to explain their stances on hot button issues such as the derivative rights doctrine, life insurance provisions and the inclusion of a business-to-business exemption. Despite this attempt, Commissioner feedback was sparse (to non-existent) for a majority of the reading and was often technical in nature when provided. While over 250 of the 400 Commissioners were present at the Annual Meeting, only about half of those present attended the morning session of the RUUPA reading. After a lunch break, the afternoon session of the reading was even more sparsely attended, with less than 100 Commissioners present. While the turnout and participation was not ideal, the Committee provided some guidance to the Commissioners that may be useful to interested parties going forward.

Highlights

  • Committee Co-Chair Rex Blackburn made it clear that they would be considering the application of the derivative right doctrine, which generally stands for the proposition that state unclaimed property administrators cannot receive greater rights than those of the true owner, on a property-type basis (as opposed to a blanket inclusion or exclusion). Aside from the short ABA-NAUPA debate on the issue, there was no substantive discussion of the derivate rights doctrine.
  • A return to the 1981 Act’s 10-year statute of repose was discussed. Commissioner Raymond Pepe noted that the Committee reverted back to this based on the widespread abuse of statistical sampling. Several Commissioners were supportive of this change, and even encouraged the Committee to shorten this period further since the statute does not begin running until after the report was due. Nebraska Commissioner Harvey Perlman suggested that the Committee simply limit the use of abusive statistical sampling instead of establishing a statute of repose. The Committee responded that a bright-line rule is necessary here to provide certainty.
  • The Committee confessed that the current section on the conduct of audits (Section 20) needs to be broken out into four distinct sections in the next draft. A majority of the discussion in this area was on the use of contingent fee contract auditors—which is permitted in the current draft with numerous protections that seek to enhance the transparency of this process. Connecticut Commissioner David Biklen suggested that his state would not be able to audit holders without the use of contract auditors and expressed concern [...]

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Delaware Senate Passes Unclaimed Property Reform Bill

by , and | Jun 23, 2015 | , , , ,

On June 18, 2015, a bill (S.B. 141) was unanimously approved by the Delaware Senate that would place limits on the look-back period and permanently extend the Voluntary Disclosure Agreement (VDA) program. This represents the second bill this year that seeks to implement the recommended changes contained in the Unclaimed Property Task Force’s (Task Force) December 2014 final report (the first, S.B. 11, was signed by Governor Jack Markell on January 29, 2015). If passed by the House, the legislation would offer several additional protections to holders; however, it also contains a number of traps for the unwary that should not be overlooked.

Look-back Period Shortened

First, and most significantly, the bill would limit the examination look-back period in Delaware to 22 years, starting in 2017. For periods before 2017, the bill would limit the look-back period to 1986 (if currently under examination) or 1991 (for any examinations initiated after enactment).  While this proposed look-back period decrease would be a significant improvement from the status quo (which allows Delaware to look-back to any period after 1980), it would still represent one of the longer look-back periods in the country. Notably, the proposed 22-year look-back period would remain over twice as long as most state unclaimed property look-back periods (which are usually 10 years or less).

Permanent VDA Program

Second, the VDA program is amended to authorize the Secretary of State to request that any potential holder enter into an unclaimed property VDA. If the potential holder does not agree to the VDA within 60 days, they will be referred to the State Escheator for examination. The bill provides for a 19-year (reduced) look-back period for any holder than enters the VDA program on or after January 1, 2017, and allows two years to complete the VDA process. Additionally, S.B. 141 would strike the sunset provision for the VDA program, which is currently scheduled to expire July 1, 2016. Certain holders are not permitted to participate in the VDA program, including those that: (1) formally withdrew from the voluntary disclosure agreement program, or (2) were removed from the VDA program for failure to work in good faith to complete the VDA program as soon as practicable.

Interest

The bill would also amend the governing statute to allow interest of 0.5 percent per month (up to 25 percent of the amount due) to accrue from the due date for any late-filed unclaimed property reported and remitted on or after March 1, 2016. The current unclaimed property statute in Delaware does not have a provision permitting the accrual of interest (former interest provisions were repealed in June 2014 with the enactment of S.B. 228). Even before their repeal, the interest provisions were largely unenforced. Because the look-back period would remain over 20 years in Delaware, the added costs associated with the proposed interest increase (and actual enforcement) will likely be more than the amounts no longer owed due to the proposed look-back period reduction.

Mandatory Holder Contact

One procedural change [...]

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Delaware’s Unclaimed Property Audit Program Dealt Blow

by , and | Mar 13, 2015 | , ,

The judge in a case challenging Delaware’s use of sampling and extrapolation to determine unclaimed property liability denied the state’s motion to dismiss and in doing so, seriously questioned the State’s approach.  Temple-Inland v. Cook, U.S. Dist. Ct. (DE), Civ. No. 14-654-SLR (3/11/2015).  Temple-Inland brought a suit against the State following an unclaimed property audit of its accounts payable balances and before the audit of other property types was completed.  Delaware found Temple-Inland liable for unclaimed property going back to 1986 based on the use of sampling and extrapolation.  On March 11, 2015, Judge Robinson ruled on the Temple-Inland’s summary judgment motion and the State’s motion to dismiss for failure to state a claim.  While the State won one issue, Temple-Inland certainly came out ahead overall.

Let’s start with the bad news first: the one dark spot in the opinion for holders is that the judge decided that the U.S. Supreme Court’s priority rule cases (Texas v. Delaware and its progeny) only applied to disputes over custody between states, not between a private holder and a state.  This decision seems to conflict with a precedential Third Circuit case, Retail Merchants Ass’n v. Sidamon-Eristoff, 669 F.3d 375 (3rd Cir. 2012).  The judge also did not seem to take to heart the role of the U.S. Supreme Court.  The judge oddly stated that “finding that the Supreme Court’s holding in Delaware preempts the State’s valid exercise of regulatory power . . . would be contrary to the well-established principle that federal courts may not ordinarily displace state law.”  That is exactly what the U.S. Supreme Court is supposed to do (in fact, last week the Court ruled federal courts have just such authority in Direct Marketing Association v. Brohl).

With the bad news out of the way, the good news is that not only does the judge agree to move forward with all of Temple-Inland’s other claims, but expresses significant doubt as to the validity of the State’s position regarding the authority to use estimation prior to a 2010 statutory change.  The judge appears to be ready to move forward on hearing factual support for the following claims asserted by the plaintiff:  substantive due process, Ex Post Facto Clause, Takings Clause, Commerce Clause and Full Faith and Credit Clause.

The really good news for holders is that the judge seems to have backed the State into a corner.  In analyzing the due process and ex post facto claims, the judge noted that “[the] defendants are faced with a dilemma:  “If §1155 [the 2010 provision authorizing estimation] 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.”  With this opinion, Delaware may finally be feeling the walls closing in and a giant alien cephalopod reaching up [...]

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Currency Conversion Concerns: New York Issues Guidance on Virtual Currencies

by | Dec 23, 2014 | , , , , ,

On December 5, 2014, the New York Department of Taxation and Finance (Department) released TSB-M-14(5)C, (7)I, (17)S.  This (relatively short) bulletin sets forth the treatment of convertible virtual currency for sales, corporation and personal income tax purposes.  The bulletin follows on a notice released by the Internal Revenue Service (IRS) in March of this year, Notice 2014-21.

The IRS Notice indicates that, for federal tax purposes, the IRS will treat virtual currency as property, and will not treat it as currency for purposes of foreign currency gains or losses.  Taxpayers must convert virtual currency into U.S. dollars when determining whether there has been a gain or loss on transactions involving the currency.  When receiving virtual currency as payment, either for goods and services or as compensation, the virtual currency is converted into U.S. dollars (based on the fair market value of the virtual currency at the time of receipt) to determine the value of the payment.

The IRS Notice only relates to “convertible virtual currency.”  Virtual currency is defined as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”  Convertible virtual currency is virtual currency that “has an equivalent value in real currency, or that acts as a substitute for real currency.”

The Department’s bulletin also addresses only convertible virtual currency, and uses a definition identical to the IRS definition.  The Department indicates that it will follow the federal treatment of virtual currency for purposes of the corporation tax and personal income tax.

For sales and use tax purposes, the bulletin states that convertible virtual currency is intangible property and therefore not subject to tax.  Thus, the transfer of virtual currency itself is not subject to tax.  However, the exchange of virtual currency for products and services will be treated as a barter transaction, and the amount of tax due is calculated based on the fair market value of the virtual currency at the time of the exchange.

The Department should be applauded for issuing guidance on virtual currency.  It appears that these types of currencies will be used more and more in the future, and may present difficult tax issues.

However, the Department’s guidance is incomplete.  There are a couple of unanswered questions that taxpayers will still need to ponder.

First, the definition of convertible virtual currency is somewhat broad and unclear.  The Department and the IRS define “convertible” virtual currency as currency that has an “equivalent” value in real currency, but equivalent is not defined in either the IRS Notice or the bulletin.  Many digital products and services use virtual currency or points that cannot be legally exchanged for currency to reward users, and the IRS and the Department should be clearer about the tax treatment of those currencies.

Second, although the Department will follow the federal treatment for characterization and income recognition purposes, the bulletin does not discuss apportionment.  This is likely a very small issue at this point in time, but the Department will, [...]

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