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Unclaimed Property

Extraordinary Turnout and Discussions at ULC Unclaimed Property Drafting Meeting

by Diann Smith and Stephen P. Kranz | Nov 10, 2014 | Delaware, Nationwide Importance, Unclaimed Property

Failing to attend last week’s Uniform Law Commission’s (ULC’s) Drafting Committee meeting to revise the 1995 Uniform Unclaimed Property Act (the Act) was worse than missing the 2012 Extravakranza. On November 7 and 8, 2014, the Who’s Who of the Abandoned and Unclaimed Property world (AUP for insiders needing abbreviations for texting) met in Washington, D.C. for a two-day marathon to modernize state unclaimed property law. The chair of the committee noted that several thousand pages of comments had been received so far and that attendance at the meeting was greater than any other issue the ULC pursued other than the Uniform Commercial Code.

The attendees hailed from a wide variety of stakeholders including: representatives from more than 20 states; major third-party auditors including several representatives of Kelmar; numerous trade associations including representatives of the securities and the life insurance industries, and general business associations such as the Council on State Taxation and the U.S. Chamber of Commerce. Several representatives from the state of Delaware were in attendance; Delaware is a state that has historically not adopted any of the Uniform Acts and is considered one of the most aggressive states in interpreting its unclaimed property laws to the detriment of holders.

As to the Act itself, no policy or language is set in stone at this point, but the Drafting Committee took votes on numerous issues in order to give the reporter (the person responsible for actually drafting potential language for the Act) guidance. The votes by the Drafting Committee were a mixed bag from a holder’s perspective, and a lot could still change before the final Act is adopted. Unfortunately, but not surprisingly, the Committee rejected banning states from using contract auditors as well as rejected banning states from using contingency fees to pay such auditors. The Committee also voted to allow both estimation and sampling in unclaimed property audits (though there was some confusion demonstrated by the Committee’s discussions and questions regarding the difference between these two). The Committee left discretion with the reporter regarding the inclusion of guidelines and limitations on use of such audit techniques. The Committee also rejected exempting from remittance low balance property – a proposal supported by the American Bar Association and a proposal that would be an administrative benefit to holders.

The Committee voted to change the interest provision on holders for unremitted balances from offering a flat rate option to solely a floating interest rate pegged to a T-bill + standard. Currently some states have interest rates of 12 percent and 18 percent. The National Association of Unclaimed Property Administrators lobbied to leave the interest rate up to the individual states because every state has different investment profiles. This was ultimately a losing argument as it was noted that if any state is currently getting 12 percent or 18 percent on its investments, everyone wanted to know what that state was doing so they could do the same. The Committee also voted to include, for discussion purposes only, a draft [...]

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You Do the Math: Unclaimed Property Lawsuit Filed Against Kelmar

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | Jun 9, 2014 | Constitutional Issues, Delaware, Nationwide Importance, Unclaimed Property

Mark McQuillen, president of Kelmar Associates, LLC, was misinformed when he was quoted as saying “I’ve never been sued” on May 26—less than one week after suit was filed against Kelmar and three Delaware state officials in a Delaware Federal District Court. See 72 State Tax Notes 455 (May 26, 2014). While the timing of this statement was an unfortunate – but likely honest – mistake, the lawsuit filed by Temple-Inland Inc. asserts the conduct of Kelmar in conducting an unclaimed property audit on behalf of the state of Delaware was anything but.

According to the complaint, Temple-Inland was initially asked to pay over $2 million to the state based on the “fatally flawed” extrapolation methodology used by Kelmar to calculate Temple-Inland’s liability (and Kelmar’s paycheck from Delaware). While the demand was reduced to $1.38 million after the plaintiff initiated administrative review, the result and details of how they got there remains alarming. Of note, Kelmar estimated that nearly $1 million was due to Delaware for the seven-year period of 1986 through 2003 after identifying a single unreported check for $147.30 during a subsequent six-year period (Complaint ¶ 84). The complaint contains countless examples of voided and reissued checks (even checks that escheated to other states) that were used in Kelmar’s extrapolation formula. Ultimately the result for Temple-Inland was a demand from Delaware alone of over $100,000 escheatable for prior year’s accounts payable, despite having only around $15,000 escheatable to all other states on these accounts for a five year period actually reviewed.

Based on these practices, Temple-Inland asserts that Kelmar and the state auditing officials have unconstitutionally applied the amendment to Delaware Escheat Law allowing for estimations of unclaimed property liability to years prior to its enactment in violation of the Ex Post Facto Clause. Along those same lines, the state penalized Temple-Inland for failing to maintain records for periods prior to 2010, when a substantive document retention requirement was imposed in the state (see S.B. 272 § 4). Nonetheless, Temple-Inland asserts that the methodology used by Kelmar violates federal common law, the Full Faith and Credit Clause, Commerce Clause and Takings Clause of the U.S. Constitution.

The opening brief filed on behalf of Temple-Inland is available here

Practice Note: While Delaware has settled every suit raising these questions and has an economic incentive to keep them from reaching what would likely be an adverse decision to the state’s (and Kelmar’s) financial interest, the discussion should not end there. Temple-Inland Inc. had a long history of solid compliance with the unclaimed property laws across several states, yet still was the target of a flawed and likely unconstitutional audit by Kelmar on behalf of the state of Delaware. The company was forced to hire counsel and litigate against Kelmar’s questionable practices. While two new Delaware bills have been introduced in an effort to eliminate unclaimed property contingent fee auditing practices (S.B. 215 and S.B. 228), holders should stand firm in opposition to Kelmar’s aggressive extrapolation methods and keep [...]

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An End to the Madness? Delaware Bill Introduced to End Contingent Fee Unclaimed Property Audits

by McDermott Will & Emery, Diann Smith and Stephen P. Kranz | May 20, 2014 | Delaware, Unclaimed Property

Any holder who has been involved in an unclaimed property audit has experienced frustration when dealing with third party contingent fee auditors. Delaware’s increasing aggressiveness in collecting unclaimed property has been inextricably tied to the use of these auditors, who are known for taking liberties with unclaimed property laws, harassing holders and inflating the values of assessments. The state’s reputation as a friendly home to business has started to take a hit because of these practices. Hearing complaints about these auditors, some Delaware legislators have introduced a bill to end the practice. On May 8, Delaware Senate Bill 215 was introduced in the Senate and assigned to the Senate Banking Committee. S.B. 215 would prohibit third party auditors from being paid on a contingent fee basis and would require state contracts with auditors to not extend beyond three years.

Contingent fee audits are rarely used in state and local tax audits, and for good reason. Although taxes are imposed to raise revenue, the purpose of a tax audit is not to raise more revenue, but to make sure that the correct amount of tax is paid. In the unclaimed property world, where contingent fee audits are the norm, auditors are incentivized to assess as much liability as possible to inflate their own compensation. S.B. 215 would allow Delaware to continue to use third party auditors, but only if they are paid on a fixed scale.

S.B. 215 is particularly notable because Delaware is the most important and influential state with regard to unclaimed property. Because unclaimed property lacking owner address information escheats to the holder’s domicile (see Texas v. New Jersey, 379 U.S. 674 (1965)), Delaware (the most popular state of incorporation) receives an unclaimed property windfall each year representing about a third of the state’s budget. S.B. 215 signals that at least some in the Delaware legislature are growing concerned that companies will begin incorporating in other states, causing major problems for the state both politically and economically. We applaud the sponsors of S.B. 215.

There is one more part of S.B. 215 that needs to be mentioned. In a very rare, and very strange, move, the bill not only eliminates contingent fee audits, but also states that it “may be necessary to point out certain existing restrictions” in the Delaware Code. The bill then recites Section 5805 of Title 29:

No person who has served as a state employee, state officer or honorary state official shall represent or otherwise assist any private enterprise on any matter involving the State, for a period of 2 years after termination of employment or appointed status with the State, if the person gave an opinion, conducted an investigation or otherwise was directly and materially responsible for such matter in the course of official duties as a state employee, officer or official. Nor shall any former state employee, state officer or honorary state official disclose confidential information gained by reason of public position nor shall the [...]

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Retailers Should Examine Gift Card Practices in Light of a Recent Unclaimed Property False Claims Action

by Diann Smith | May 14, 2014 | Delaware, Nationwide Importance, Unclaimed Property

A complaint in the Superior Court of Delaware alleges that numerous retailers “schemed to deprive the State of Delaware of hundreds of millions of dollars due to the State under the Abandoned Property Law” (emphasis added). Delaware v. Card Compliant et al., Del. Sup. Ct (New Castle County), Case No. N13C-06-289 FS (6/2013). The complaint asserts that the retailers were all incorporated in Delaware and, under the second priority rule, unclaimed gift card funds should have been remitted to Delaware after five years of inactivity. According to the complaint, the defendants attempted to avoid this rule by setting up and using companies incorporated in states that exclude gift cards from the definition of unclaimed property for purposes of gift card issuance and management; however, the arrangements “are without substance as the value of all unredeemed gift cards remains within the possession, custody and control of the Delaware Defendants.”

The financial risk is considerable. A qui tam lawsuit such as this one allows for triple damages plus a per violation civil penalty of $5,500 to $11,000. The defendants included 15 retailers, primarily restaurants, a third party gift card company and its affiliates, and a trade association that allegedly promoted the gift card company business. As the action is under Delaware’s qui tam statute, it was filed under seal in June of 2013 and only recently became public. The defendants are only now becoming aware of the suit.

The complaint is definitely worth reading for anyone involved in gift card unclaimed property issues. There are several interesting points to note:

The original plaintiff bringing the suit (the relator) acted as controller and then vice president of client relations for the original gift card company offering the services to the defendants. The business was operated out of the relator’s basement. After the original gift card business was purchased by another company, the relator was a sales and support representative for the business. The relator appears to have kept records of the company’s business arrangements with the retail defendants and now uses those records to bring a law suit against his former employer’s clients.
One of the law firms representing the relator is a well-known political powerhouse in Delaware.
The relator has asked for jury trial of this case.

Important take-away issues: Any company involved in the use of gift cards should take a serious look at this complaint and initiate a review of gift card procedures. This review should include consideration of the following:

If using a gift card company, verify that there is economic substance to the structure. This applies both to the use of third party providers and captive gift card companies. While there are certainly legal arguments regarding the level of economic substance necessary, it is better safe than sorry. Furthermore, for any company relying on a captive gift card company, the risk of a piercing the corporate veil argument (or its equivalent) should be a consideration in how the relationship is structured.
Review and strengthen confidentiality [...]

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Best Practices for State Engagement of Private Unclaimed Property Auditors

by Diann Smith and Stephen P. Kranz | Apr 29, 2014 | Delaware, Nationwide Importance, Unclaimed Property

The U.S. Chamber Institute for Legal Reform has released a report detailing current problems with states using private companies for unclaimed property audits and paying those auditors based on the amount recovered. The report begins with an example of what can go wrong when private auditors are paid on a contingent basis. The nightmare story of what many life insurance companies recently experienced is well worth the read by anyone who thinks that because their company has been diligently complying with unclaimed property laws, there can’t be any risk from an audit.

After reviewing the issues, the U.S. Chamber suggests several, eminently achievable, reforms. These reforms include:

Prohibiting contingency fees;
Requiring all state contracts for private audit services to be subject to an open, competitive bidding process;
Requiring all such contracts to be posted on the unclaimed property administrator’s website; and
No delegation of state authority to private contractor on substantive decision-making, such as legal theories.

The report also offers suggestions that states provide voluntary disclosure programs with certain protections for participating holders.

Practice Note: Over a decade ago, several attorneys with McDermott’s SALT practice, while working at the Counsel On State Taxation (COST), drafted a Holder’s Bill of Rights. While Delaware was one of the main proponents of the concept, it did not get any traction in other states. The current negative impression many holders have regarding third-party contingency fee unclaimed property auditors could have been limited, and perhaps prevented, if states had embraced this idea. It is probably time to consider this concept. If third-party auditors offered such a pledge to holders, audits would be far less adversarial and be completed much faster.