Important questions on the limits of state power in unclaimed property audits are currently under litigation. Specifically, what are the permissible limits of state authority in conducting an unclaimed property examination and assessing liability against a corporate holder? Last month, a federal court judge in Temple-Inland said that Delaware's estimation and assessment of liability "shock the conscience" and are unconstitutional.
Now, questions arise about the limits of the state's power to enforce a summons to produce documents. A court could be giving Delaware a free hunting license by granting the summons as it is requested. Or if denied, the case could provide additional ammunition for holders to curtail audit abuses by the most aggressive unclaimed property audit state. Recognizing the importance of the issue at stake, two additional holders, involved in other ongoing litigation, have already sought to join as amicus curiae to advance positions that have not been fully addressed by the holder in the case.
Summons: an official order to appear at a particular place
In prior litigation, Delaware has limited the subpoena power to its own advantage. In CA, Inc. v. Cordrey, CA, formerly known as Computer Associates, sued over a failed negotiation during a voluntary disclosure agreement and eventual audit. In that litigation, Delaware's position was that § 1156(b) limited "the Court of Chancery's jurisdiction solely to adjudicating interest and penalty payments." Delaware argued that the statute must be strictly construed to prevent holders from challenging any matters other than those explicitly listed in the statute. Therefore, the Court of Chancery had no jurisdiction over the principal liability that the holder was required to pay. When CA and Delaware finally settled, CA paid $17.65 million to the State, significantly more than the $684,000 initially proposed under the VDA.
Now, in Plains All-American Pipeline, LP v. Cook, the corporation is asking the federal courts to stop the audit of its books and records to determine compliance with the Delaware unclaimed property law. During oral arguments, the Delaware Department of Finance claimed that it would have the authority to enforce summonses issued by the State Escheator. Delaware Escheat Law provides in § 1155(a):
In other state statutes, the Delaware legislature has expressly provided the state agency administering the law the power to require the production of documents. In Plains, the State is relying on 6 DEL. CODE § 73-403, a provision of the Securities Act - not the Escheats Law, mind you - to say that if a person refuses to comply with a subpoena, that the Court of Chancery may order compliance with the subpoena. Notwithstanding the fact that it is a different law and does not apply to the Escheats Law, the subpoena power in the Securities Act is different than the powers granted by § 1155(a) of the Escheat Law. The Securities Act expressly provides for the production of books, papers, and other documents in its administrative subpoena powers. Contrast § 1155(a) with § 73-402, which grants the Director the authority to issue the subpoena to be enforced in § 73-403:
Note that the subpoena power in § 73-402 is only for the purpose of investigating "under this chapter," Chapter 73. Securities Act. Thus, it is expressly limited to actions covered by the Securities Act and not the Escheats Law in Chapter 11. Plains says that this provision, which Delaware relies on to enforce subpoena power in Chapter 11, demonstrates that the Delaware legislature treats the power to subpoena a witness for testimony differently from the power to require the production of documents. Unlike the Securities Act, the Escheat Law does not continue to require the production of documents.
When the Court asked Delaware whether it had actually enforced its subpoena power in a court of law, the state referred to the ongoing litigation with Blackhawk. The federal court in Plains has decided to wait until the Blackhawk case is resolved to determine the issues in Plains.
The Blackhawk Litigation
In late 2015, the Delaware Department of Finance, through the Attorney General's office, filed a lawsuit against Blackhawk Engagement Solutions (DE), Inc., formerly known as Parago, Inc. Parago is a rebate processor and fulfillment company, with customers among the Fortune 500. According to Delaware, Parago has more than 300 retail clients. Delaware is seeking information relating to the client contracts, rebates issued on behalf of those clients, rebates that remain uncashed, and the disposition of the money thereof. Parago refused to comply with the request, stating confidentiality concerns and that it would require a court order before it turned over any documents. Eventually, Delaware Department of Finance issued a summons and then the instant lawsuit for failing to comply with the summons. Delaware is now asking the Delaware Court of Chancery to issue an order "restraining Parago from engaging in its continued unlawful disregard of the Escheats Law, and . . . compelling the delivery by Parago of the requested information to the State." Finally, Delaware is asking the court to declare that it "properly and lawfully issued the Summons" and that "Parago has no legal authority to disregard the Summons."
Parago asserts that the order requested by the state is "nonspecific and wildly overbroad." Parago states that the requested documents is not pertinent to the investigation into whether Parago has complied with the Escheats Law, the summons is beyond the scope of the administrative subpoena power and therefore not enforceable. Parago says that the request relating to the clients is relating to whether the clients' have complied with Delaware escheat law and not whether Parago has complied. They also say that the information is confidential and thus should be given greater weight and protections in an analysis in whether the records should be produced.
Recognizing that many issues have been left unaddressed and it could affect their own cases, Plains All-American and Marathon Oil have joined as amicus curiae in the Blackhawk litigation. Blackhawk is relying on whether the documents are relevant to the investigation of Parago, which is a very specific fact pattern that would only apply to their case. Meanwhile, Plains and Marathon argue that there is no subpoena power, which is a more general application to all holders. Without the power to summons or subpoena the production of documents, it does not matter whether the documents are relevant to the investigation of Parago.
Plains and Marathon argue that the Escheats Law does not provide for court review and that the Court of Chancery does not have jurisdiction to enforce the subpoena. Plains and Marathon say that without a precompliance review, the statute is facially unconstitutional. The Plains brief cited two Supreme Court cases, City of Los Angeles v. Patel and Donovan v. Lone Steer which both required a precompliance reivew, including the ability to raise objections before suffering a penalty for non-compliance and when it is an administrative subpoena, the responding party must have the ability to move to quash the subpoena before the search takes place. Since there is no precompliance review, the Escheats Law is unconstitutional. Plains goes on to argue that the State Escheator only has the authority to require testimony and not the production of documents. The State is strictly limited to the powers granted to it in the statute.
Delaware responded to both Blackhawk and the amicus brief in it's reply to Blackhawk's opposition to the motion. In its reply, Delaware states that the "Escheats Law places no constraints or conditions upon the Escheator's examination beyond the condition that the exam take place "at reasonable times and upon reasonable notice."" Or in other words, Delaware says that Delaware can do anything that it wants to do in an unclaimed property audit. In addressing Blackhawk's concerns about the relevancy of the requested documents, the state uses broad, sweeping, and conclusary terms to state that the documents are relevant, basically because Delaware says that they are relevant.
Delaware continues in its reply brief to counter the amicus argument that the state has no authority to issue a summons or subpoena for the production of documents. The State relies on the terms "proof material" and then cites, not a Delaware case, but a North Dakota case on tax compliance (but remember, unclaimed property is not a tax). Even in its own recitation of the North Dakota law, Delaware shows that the North Dakota tax commissioner has authority to "summon witnesses to appear and give testimony and produce books, records..." This language is obviously missing in the Delaware Escheats Law § 1155(a). But alas, Delaware ignores that and continues with its own discussion of the North Dakota law.
Delaware says that having been granted the power to issue a summons, the State Escheator must have available a means to enforce it. Somehow, the State makes the logical jump that the Patel case did not require explicit precompliance review since the word "explicit" did not appear in the Supreme Court decision even though it concluded that the ordinance in question was unconstitutional because it failed to provide precompliance review. Delaware says that if the search was conducted pursuant to an administrative subpoena, the respondents would have the opportunity to move to quash the subpoena. Delaware now states, in contrast to its earlier position in CA, that the Chancery Court can in fact review the administrative subpoena it issues. Even though it is not limited to the assessment or waiver of penalties and interest.
Since § 1156 has been amended since CA, it may be helpful to review what the current options are available under § 1156. After an administrative review, the state or holder may appeal to the Court of Chancery, to review whether the assessment is supported by evidence on the record. Meanwhile, the State can also bring an action to enforce an assessment and the holder may bring a suit to obtain a waiver of penalties and interest. At no point in any of those conditions in § 1156 can a holder object that the request is unreasonable. Once the documents are produced, they are in the record and may be used to support the assessment. There is no provision for striking or disregarding documents produced that were overbroad, burdensome, or irrelevant. Let the fishing expeditions commence.
The Delaware motion is scheduled for a hearing on October 5, 2016.
What Happens If Delaware Gets It's Summons
Oh, the can of worms that will be opened if the Chancery Court grants Delaware's motion and orders Blackhawk to produce the records. Just in the proposed language "no legal authority to disregard the summons" you can see where Delaware will take this with other holders. Delaware will use the Chancery Court order to threaten other holders into the production of documents, using this Blackhawk case as precedence. With a "properly and lawfully issued" summons pursuant to 1155(a), Delaware will go on a fishing expedition, no matter if the requests are relevant to the examination. In cases like Marathon or Office Depot, where the State has no legal authority to claim under the second priority rule for a company incorporated or organized in another state, the State would nevertheless require the production of burdensome records including potentially records covered by the attorney-client privilege or records having no bearing on the identification of potential unclaimed property. These records, in the possession of a contract auditor, may then be subjected to disclosure in subsequent lawsuits, as has been the case in Prudential.
Already, Delaware is arguing in ongoing audits that the Temple-Inland decision does not apply to any holder except Temple-Inland. Without a precompliance review to a "properly and lawfully issued" summons, holders would not have a neutral third-party (judge) to determine whether the request "shocks the conscience" or the state is playing a game of "gotcha." The State would be free to continue to disregard the statute of limitations and apply any method of estimation, regardless of its reasonableness. By issuing the subpoena, Delaware would be able to request records without any recourse by holders for judicial review.
Looking at the history of Delaware's aggressive enforcement tactics, one can easily see a history of aggressive auditing, intended to wear down the holder. Eventually, the state will issue an assessment and when objected to will eventually settle for a lower, but still significant, amount. This happens when legally the holder is not legally liable for such an amount but instead just wants the audit to "go away." After nine years of audit, what would you be willing to pay to have Kelmar go away?
When asked what the alternative to enforcing a summons, Delaware responded, in Plains by saying that the only additional remedy that the Attorney General could currently take would be a False Claims Act. If Delaware believes that it needs the additional subpoena or investigative powers in the audit process, then the Delaware General Assembly should act to amend the law and thus grant these powers to the State Escheator.
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