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False Claims Act Risk for Unclaimed Property Holders

by Diann Smith, Stephen P. Kranz and Eric D. Carstens | Mar 15, 2021 | False Claims Act, Nationwide Importance

In what has become an unfortunate trend, unclaimed property holders continue to be subject to lawsuits under state false claims acts (FCA – also called a qui tam or whistleblower action) for alleged underreporting and remittance of unclaimed property obligations. More than 30 states have a false claims act with whistleblower provisions and nearly all are applicable to unclaimed property. While an honest mistake should not create liability under an FCA, a holder could be liable if its failure to report not only was done knowingly, but also if such failure to comply was done with deliberate ignorance or with reckless disregard. Actual fraud is not a necessary precursor to being subject to false claims act liability.

Potential liability under state FCA laws is far in excess of any liability under an unclaimed property audit. FCA laws impose treble damages (3x the value of the underreported property), penalties, interest and attorney’s fees. Successful claims under these laws are not just extremely punitive to the holder but also lucrative for the person bringing the lawsuit who can earn up to 30% of the ultimate recovery to the state. Liability under a FCA can turn a holder’s failure to be appropriately diligent in determining its unclaimed property compliance obligations into a multi-million dollar legal battle with long-term public relations implications. The fact that a holder has already been audited or that the State may have historically agreed with the holder’s position may not prevent a FCA case progressing.

A holder’s FCA unclaimed property horror begins with an investigation, which can be prompted by either claims by private parties (called relators) or the state attorney general’s office. A relator may be a disgruntled employee or any clever person with good research skills. The holder may not even know the claim has been filed and the investigation has been going on for years. These investigations may open closed periods and, once the holder is informed, are very interrogation-like, with the holder often knowing very little about the underlying claims until the case is unsealed. Eventually, these investigations may turn into a public court battle with a sometimes politically motivated state attorney general on the other side. Even if the state AG’s office declines to proceed with the case, the private party initiating the case may nevertheless proceed.

While frequently FCA cases are settled before becoming public, several recent cases provide some background for holders looking for FCA examples. In a series of Delaware qui tam cases, more than 25 retailers and restaurants were sued by a former disgruntled employee of a gift card issuance and management company alleging unclaimed property compliance violations. All but one settled or was dismissed by the court. In New York, a court recently dismissed claims by an audit firm against nearly a dozen life insurers in response to allegations under the false claims act that the companies failed to report life insurance policy funds – alleging more than $14.5 billion in damages. Regardless of industry, these lawsuits are a [...]

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DC Council Expands False Claims Act to Tax Claims

by Stephen P. Kranz, Diann Smith and Eric D. Carstens | Dec 1, 2020 | District of Columbia, False Claims Act, Nationwide Importance

The DC Council has passed an amended bill (the False Claims Amendment Act of 2020, B23-0035) that beginning as early as January 2021 will allow tax-related false claims to be raised against large taxpayers for up to 10 years of prior tax periods! This troubling legislation creates a real and imminent possibility of prior tax periods that are closed for assessment under the DC tax law pursuant to DC Code § 47-4301 being reopened by the DC attorney general and/or a private qui tam plaintiff.

While the introduced bill passed a first reading of the Committee of the Whole on Tuesday, November 17, 2020, by a vote of 8-5, the second reading (as amended) passed by a vote of 12-1 (a veto-proof supermajority) on December 1, 2020. The amended bill (as approved by the DC Council) will be sent to Mayor Muriel Bowser for consideration. If the mayor does not veto the bill or if her veto is overridden, the legislation will be assigned an Act number and sent to Congress for a 30-day review period before becoming effective as law. While extremely rare, Congress has an opportunity to reject the DC Council’s Act by passing a joint resolution, which must be signed by the president of the United States to prevent the Act from becoming law. Assuming this doesn’t happen, the Act will become law after the expiration of the 30-day Congressional review period. Assuming the Mayor quickly approves the legislation and Congress does not seek a joint resolution disapproving the Act, the legislation passed by the DC Council could take effect as early as next month!

As amended, the False Claims Amendment Act of 2020 passed by the DC Council will:

Remove the taxation bar that exists as part of current law (see DC Code § 2-381.02(d)) and replace it with explicit authorization allowing by the DC attorney general and private qui tam plaintiffs to pursue taxpayers for claims, records or statements made pursuant to Title 47 that refer or relate to taxation when “the District taxable income, District sales or District revenue of the person against who the action is being brought equals or exceeds $1 million for any taxable year subject to any action brought pursuant to this subsection, and the damages pleaded in the action total $350,000 or more.”
Require that the DC attorney general “consult with the District’s chief financial officer about the complaint” when tax-related claims are filed by a qui tam
Prohibits a claim by a qui tam plaintiff “based on allegations or transactions relating to taxation and that are the subject of an existing investigation, audit, examination, ruling, agreement or administrative or enforcement activity by the District’s chief financial officer.”
Not require the District’s chief financial officer “to produce tax information, or other information from which tax information can be inferred, if the production thereof would be a violation of federal law.”
Increase the maximum statutory reward for informants under the Taxation [...]

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AB 2570: Déjà vu All over Again as California Attempts to Amend CFCA

by Charles Moll, III, Elle Kaiser and Troy M. Van Dongen | Feb 24, 2020 | California, False Claims Act, Interest and Penalties, Nationwide Importance, Procedure

California’s Attorney General, Xavier Becerra, and Assembly Member Mark Stone have again advanced legislation that would amend the California False Claims Act (CFCA) to enlist private bounty hunters to go after California taxpayers. Becerra described the latest bill, AB 2570, as an additional tool to combat against “corporate cheats” whom Becerra claimed cost the state billions in lost revenue in 2019. Of course, the state already possesses an arsenal of tools to combat any underreporting: currently, the power to investigate cases of suspected tax fraud rests with the California Franchise Tax Board (FTB) and the California Department of Tax and Fee Administration (CDTFA). Thus, as many of the predecessor bill’s critics have adeptly noted, AB 2570 is more appropriately characterized as a “solution in search of a problem.”

The text of AB 2570 is almost identical to its predecessor, AB 1270, which failed to make it out of the legislature last year, and has likely given California’s business-savvy taxpayers a sense of dread-filled déjà vu. AB 1270 came under intense opposition last summer because, as seen in other states, allowing qui tam plaintiffs to initiate civil suits for state and local tax issues leads to abusive practices and undermines the goal of voluntary compliance in tax administration.

Like AB 1270, AB 2570 is replete with problematic provisions, including: (1) the imposition of a separate statute of limitations that will arguably trump any shorter limitations periods imposed by the Revenue & Taxation Code (See Cal. Gov’t Code § 12654(a) which permits claims under the CFCA to be pursued for up to 10 years after the date the violation was committed, compared to standard three or four years for tax audits); (2) a more lenient burden of proof for elements of an alleged violation; and, (3) extremely punitive damages—violators are subject to treble damages (i.e., three times the amount of the underreported tax, interest and penalties), an additional civil penalty of $5,500 to $11,000 for each violation, plus the costs of the civil action to recover the damages and penalties including attorney’s fees.

Unfortunately, private enforcement of state tax code violations has erupted over the past few years after whistleblowers in New York and Illinois purportedly have racked up multimillion dollar settlements as the result of such claims. If enacted, AB 2570 will open the floodgates to a slew of financially incentivized plaintiffs’ attorneys who are eager to enter the litigation lottery in hopes of winning a jackpot settlement payout from California’s taxpayers.

As discussed in our blog post from August 26, 2019, Vultures Circling as Bill to Expand California FCA to Tax Looms in Legislature, regarding AB 1270, when a false claims suit is filed by a private plaintiff (or relator) in a qui tam action, the recovered damages or settlement proceeds are divided between the state and the relator, with the relator permitted to recover up to 50% of the proceeds. See Cal. Gov’t Code § 12652(g)(3). Thus, this practice can be very lucrative for aggressive plaintiff’s attorneys.

Even [...]

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Vultures Circling as Bill to Expand California FCA to Tax Looms in Legislature

by Charles Moll, III, Diann Smith, Stephen P. Kranz and Troy M. Van Dongen | Aug 26, 2019 | California, False Claims Act, Interest and Penalties, Nationwide Importance, Procedure

Legislators in Sacramento are mulling over one of the most (if not the most) troubling state and local tax bills of the past decade. AB 1270, introduced earlier this year and passed by the Assembly in late May, would amend the California False Claims Act (CFCA) to remove the “tax bar,” a prohibition that exists in the federal False Claims Act and the vast majority of states with similar laws.

If enacted, this bill will open the door for a cottage industry of financially driven plaintiffs’ lawyers to act as bounty hunters in the state and local tax arena. California taxpayers would be forced to defend themselves in high-stakes civil investigations and/or litigation—even when the Attorney General’s Office (AG) declines to intervene. As seen in other states, this racket leads to abusive practices and undermines the goal of voluntary compliance in tax administration. (more…)

Litigation Alert | Third Circuit Reaffirms Scope of Federal Priority Rules

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | Dec 7, 2017 | Audits, Delaware, Procedure, Unclaimed Property

On December 4, 2017, the US Court of Appeals for the Third Circuit issued its much-anticipated precedential opinion in Marathon Petroleum Corp. et al., v. Secretary of Finance et al., No. 16-4011. The opinion affirms the Third Circuit’s existing view (described in its 2012 New Jersey Retailers Association decision) that US Supreme Court precedent permits a private cause of action to enforce the federal priority rules, overruling the federal district court’s conclusion (in this case and Temple-Inland) that the priority rules only apply to disputes between states. (more…)

DC Council Introduces False Claims Expansion – Taxpayers Beware!

by Diann Smith, Eric D. Carstens and Stephen P. Kranz | Apr 24, 2017 | District of Columbia, False Claims Act, Michigan, Nationwide Importance, Procedure

Last month, a bill (The False Claims Amendment Act of 2017, B22-0166) was introduced by District of Columbia Councilmember Mary Cheh that would allow tax-related false claims against large taxpayers. Co-sponsors of the bill include Chairman Jack Evans and Councilmember Anita Bonds. Specifically, the bill would amend the existing false claims statute to expressly authorize tax-related false claims actions against persons that reported net income, sales, or revenue totaling $1 million or more in the tax filing to which the claim pertained, and the damages pleaded in the action total $350,000 or more. The bill was referred to the Committee of the Whole upon introduction, but has not advanced or been taken up since then. Nearly identical bills were introduced by Councilmember Cheh in 2013 and 2016. (more…)

Cook County Circuit Court Dismisses 201 False Claims Act Lawsuits

by Mary Kay McCalla Martire | May 24, 2016 | Constitutional Issues, False Claims Act, Illinois, Nexus, Sales Tax

At a hearing yesterday, Cook County Circuit Judge James Snyder granted the State of Illinois’ (State) Motion to Dismiss 201 Illinois False Claims Act (FCA) cases filed by the law firm of Stephen B. Diamond, PC (Relator) against out-of-state liquor retailers. The lawsuits alleged that the defendants were obligated to collect and remit sales tax on their internet sales of alcohol shipped to Illinois customers. The complaints admitted that the defendants lacked any physical presence in the state, and would not qualify for any Illinois liquor retail license, but nevertheless asserted a tax collection obligation for sales and a tax remission obligation for gallonage tax arising under the 21st Amendment of the US Constitution and the Supreme Court’s decision in Granholm v. Heald, 544 U.S. 460 (2005).

In its motion to dismiss and at oral argument, the State relied upon the favorable standard for consideration of motions to dismiss False Claims Act cases filed by the State established by the Illinois Appellate Court in two prior cases: State ex rel. Beeler, Schad & Diamond v. Burlington Coat Factory Warehouse Corp., 369 Ill. App. 3d 507 (1st Dist. 2006) and State ex rel. Schad, Diamond & Shedden, P.C. v. QVC, Inc., 2015 IL App (1st) 132999 (Apr. 21, 2015). In both cases, the appellate court held that when the State moves to dismiss a qui tam action allegedly filed on its behalf, its motion should be granted absence evidence of “glaring bad faith” on the part of the State in moving to dismiss. The State argued that it had concluded that the Relator’s claims were weak, based in part on the Relator’s admission that the defendants lacked nexus. In response, the Relator argued that the State had acted in bad faith by relying on Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and other commerce clauses nexus rulings and, according to the Relator, ignoring the 21st Amendment and Granholm, which the Relator alleged supplanted any nexus analysis (a point the State and the defendants vigorously disputed in briefing prior to argument).

After hearing argument, Judge Snyder ruled from the bench that the Diamond firm had failed to meet its burden of proving bad faith by the State in moving to dismiss the 201 lawsuits.

The Diamond firm will have 30 days from the date of entry of the Circuit Court’s dismissal orders to either seek reconsideration or appeal from the trial court’s ruling.

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

by Diann Smith and Stephen P. Kranz | Dec 1, 2015 | Audits, Delaware, False Claims Act, Nationwide Importance, Procedure, Unclaimed Property

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

For companies that have been audited by Delaware, the risk of a false claims action has likely been significantly reduced if not eliminated;
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;
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.

Illinois Department of Revenue Issues Proposed Amendments to Shipping and Handling Regulations

by Catherine A. Battin and Mary Kay McCalla Martire | Sep 14, 2015 | False Claims Act, Illinois

The Illinois Department of Revenue (Department) recently proposed amendments to its regulations governing the taxability of shipping and handling charges. The Proposed Amendments to 86 Ill. Admin Code §§ 130.415 and 130.410 (Proposed Amendments) are intended “to incorporate the holding of the Illinois Supreme Court in Kean v. Wal-Mart Stores, Inc., 235 Ill. 2d 351 (2009) … [and to] clarif[y] when transportation and delivery charges are considered part of ‘gross receipts’ subject to the Retailers’ Occupation Tax Act or the Use Tax Act.” The Proposed Amendments state that they are retroactive to November 19, 2009, the date of the Kean decision.

Delivery charges taxable when they are “inseparably linked” to the taxable sale of property

In Kean, the Court held that delivery charges for products purchased over the internet and shipped to Illinois customers are taxable when “an ‘inseparable link’ exists between the sale and delivery of the merchandise plaintiffs purchased.”… 235 Ill. 2d at 376. Citing Kean, the Proposed Amendments adopt that rule (Prop. 86 Ill. Admin. Code § 130.415(b)(1)(B)(i)) and provide two examples of an “inseparable link”:

When delivery charges are not separately identified to the customer in the contract or invoice; or
When delivery charges are separately identified to the customer, “but the seller does not offer the purchaser the option to receive the tangible personal property in any manner except by delivery from the seller (g., the seller does not offer the purchaser the option to pick up the tangible personal property).”

Prop. § 130.415(b)(1)(B)(ii)

The Proposed Amendments provide that if a product can be sold without rendering the delivery service, the service is not taxable. Prop. §130.415(b)(1)(B)(ii). Although this language is not limited to a circumstance in which a pickup option is offered, all of the examples provided by the Department focus on that fact pattern. Notably, the pickup option need not be at an in-state location. This is consistent with the Department’s recent private letter rulings concluding that when a pick up option is offered, even if it is out-of-state, the delivery charges are not taxable. ST-15-0011-PLR (7/16/15); ST-15-0012-PLR (7/27/15).

In a change from the Department’s prior practice, the Proposed Amendments provide that separately stated shipping charges not found to be inseparably linked to the sale of goods are not taxable even if they include a profit component (i.e., exceed the actual cost of shipping). Cf. the current regulation, at 86 Ill. Admin. Code §130.415(d), with Prop. §§ 130.415(b)(1)(C) and (b)(1)(D)(iv).

Practice Note:

Sub-part (b)(1)(B)(ii) of the Proposed Amendments supports the conclusion that offering customers free standard shipping evidences that any other shipping service for which a seller charges customers (i.e., expedited shipping) are separately contracted for and thus nontaxable. Arco Industrial Gas Division, The BOC Group, Inc. v. Department of Revenue, 223 Ill. App. 3d 386, 392 (4th Dist. 1991), which is cited in the Proposed Amendments, also supports this conclusion. Several defendants have successfully raised this defense in response to Illinois False Claims Act litigation alleging a failure to collect [...]

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