In May 2013, the California State Controller sued American National Insurance Company (ANICO) for failing to comply or cooperate with audit requests. The audit was part of an industry wide series of multi-state audits of life insurers. The state demanded information relating to all life insurance policies that the company had written since 1992. ANICO gave the auditors information on about 20% of what the auditors expected, stating that the rest of the policies were in force and thus not subject to unclaimed property laws. The state disagreed and filed suit to compel ANICO to turn over the remaining records. The trial court granted a preliminary injunction.
Yesterday, a California Appeals Court reversed the grant of the preliminary injunction. The Court said that the trial court erred in granting the preliminary injunction because it granted the preliminary injunction without a trial on the merits. It also gave guidance on the "reason to believe" standard required for the Controller to initiate an audit. The case was remanded to the trial court for further proceedings.
The Court noted that the Controller asked for both a preliminary and a permanent injunction which would require ANICO to turn over all requested information. When this is the case, "order for a preliminary injunction does not determine the ultimate right to a permanent injunction unless the question before the trial court is one of law alone that can be resolved without resort to extrinsic or additional evidence." The Court was concerned that if extrinsic evidence is required, an order for a preliminary injunction would be a shortcut for plaintiff's succeeding in a lawsuit without really trying. By requiring a trial on the merits, the parties are able to introduce additional evidence to support or oppose a permanent injunction. The Court explained that the question of whether the Controller had "reason to believe" that ANICO had failed to comply with the California unclaimed property law was "not a question of law alone that can be resolved without resort to extrinsic evidence."
Reason to Believe
The Court discussed two cases to determine the standard to determine whether the Controller had "reason to believe" that ANICO was not in compliance with the state's unclaimed property law: (1) a 1992 Oklahoma unclaimed property case to that permitted an examination as part of a general administrative plan of enforcement based on neutral sources, and (2) a 1998 Maryland case that would justify an examine when there are "specific articulable facts that would justify a belief by a reasonable person, knowledgeable in the field of unclaimed property, that a person or business entity [is] not reporting [unclaimed] property as required by the [unclaimed property law]." The Court found the Maryland case to be more persuasive and established that as the standard for section 1571(a).
The State presented evidence of life insurance industry procedures that would erode the cash value of policies after an insured had deceased as well as the unclaimed property already identified in the ongoing audit by the state's third-party auditor. (It is important to note that California entered the audit three years after it began.) At the time it requested the preliminary injunction, California said that it had already initiated audits of 40 life insurance companies, reaching settlements with 18, and that each company had been found to have unclaimed property. The Court said that the State would meet the "reason to believe" standard if it could establish these facts at a trial on the merits.
Unclaimed Property Audit Defense
California is actively participating in many ongoing multi-state audits with a variety of third-party auditors, including Xerox Unclaimed Property Clearinghouse, Kelmar Associates, and Verus Financial. Many of these are part of the life insurance industry audits, although many of these audits are part of the larger enforcement activity by the state. Barganier does not see California slowing its audit activity in the near future; if anything, California will increase audits going forward. Holders should require California to provide the "specific, articulable facts" that justify the audit. California would be wise to include this information, as a matter of practice, in the notification letters it sends to holders to initiate an audit and assign the third party auditor, if any. If the holder disputes the sufficiency of the facts presented, the state would have to succeed at a trial on the merits in order to proceed with the audit.
Nothing in this week's decision changes the fact that the best defense against an unclaimed property audit is an active compliance program. A lack of consistently filed reports will remain one of the top triggers of an unclaimed property audit.