Marathon Oil has been the subject of a nine year audit by Delaware and it's third-party auditor, Kelmar Associates. Earlier this year, they filed lawsuit to stop overbroad and burdensome requests relating to the inquiry into its gift card program and entities not incorporated in Delaware. On Friday, the federal district court dismissed the lawsuit saying that Marathon did not state plausible claims for preemption or violations of the Fourth Amendment.
Court Agrees that Audits are Harmful for Holders, Process Possibly Unconstitutional
Holders have long complained about the arduous process of an unclaimed property audit that lasts years, ties up employees and other resources, and hangs a dark cloud over financial reserves. The Court agreed that holders suffer "real and detrimental effects" through the audit process and that Marathon Oil was in fact suffering real harm from the audit and threatened enforcement action. The Court said Marathon could "either cooperate with an intrusive, lengthy, and potentially insatiable audit, or they can resist the audit and risk an "enforcement action" from the Attorney General and, potentially, large penalties." The Court said that the State's arguments that they cannot punish the holder without first allowing them to present a defense "ignore the real and detrimental effects of the audit process, the uncertainty regarding the Plaintiffs' operating funds, and the harm caused by the ongoing, and possibly unconstitutional, audit process."
Further, the Court said that this Marathon audit is not an isolated event and that multiple challenges to the Delaware escheat law are moving through the courts. The Court compared the Marathon audit to the "similar, if not identical, audit process" in Temple Inland, where due process rights were violated by various aspects of the Delaware audit process. The Court distinguished the Marathon Oil audit from the Plains All-American lawsuit since the Marathon Oil audit has been ongoing for nine years, unlike Plains where the audit had not yet begun.
Court: Priority Rule Preemption Doesn't Apply in Audits
In Texas v. New Jersey and subsequent cases, the U.S. Supreme Court established a set of priority rules to determine which states is entitled to claim unclaimed property. In Temple-Inland and in Marathon Oil, the Courts have now ruled that these cases only apply to disputes between the states and not to a conflict between a holder and a state. In doing so, the Court concluded that Marathon Oil failed to state a plausible preemption claim.
The Court had to stretch to distinguish the application of the preemption in the Third Circuit opinion relating to New Jersey gift cards. The Court, again in a footnote, says that here there are allegations of fraudulently using non-Delaware special purpose entities to avoid escheat in Delaware. In New Jersey gift card cases, there was no allegation of fraud against the holders in the state's attempt to upset the priority rules and thus the preemption applies. This follows many of the arguments in the Card Compliant qui tam lawsuit being pursued by Delaware, where companies established special purpose entities for the purpose of avoiding Delaware unclaimed property laws.
Did the Court Invite Holders to Not Cooperate with Audit Requests?
The Court said that the audit requests do not constitute a search under the Fourth Amendment because there are no mechanisms for enforcement by Delaware against a holder that refuses to cooperate with an audit. Thus, turning over information to the auditor and the State is akin to giving an officer permission to search.
If Marathon succeeds in this argument that the state has no means to enforce a request, then it is free to ignore requests. Remember, in the Plains All American dismissal, the court did not order the company to comply with audit requests but rather dismissed the case because it was not yet ripe.
The Court, in a footnote, says that if the holder is wrong and that the State does in fact have enforcement powers then the "enforcement mechanism would provide them with a chance to be heard and to contest the validity of the audit, meaning they would have the opportunity to challenge the basis for the search before they would be required to comply with it." Interestingly enough, the Court does not address the point that the holder would be harmed by this process as it did during the ripeness discussion.
Alternatively, the Court concluded that if it is a search then the judicial review is "strictly limited." An administrative document request survives constitutional challenge if it is 1) within the scope of the agency, 2) not too indefinite, and 3) reasonably relevant. Without discussion, the Court concluded that these requirements are satisfied, particularly in light of its earlier discussion on preemption. By not limiting Delaware's power to request and require the production of documents, even when they cannot lead to the identification of property reportable to Delaware, the Court may have just gave the state a license to conduct fishing expeditions during an audit. At this juncture, this is no mechanism for the holder to request judicial review of an overbroad and burdensome audit request. Instead, the company would have to wait until the state takes enforcement action, leaving the specter of a prolonged audit and accruing penalties and interest hanging over the company's head. The State could presumably use this power to pressure companies into unfavorable settlements to end the pain and suffering.
Recently, the differentiation between a winning case and a dismissal on various grounds has been an assessment or demand for payment from Delaware. Without that demand, so far the courts have been reluctant to rule entirely in favor of the holder, despite the acknowledged harm that the holder receives under the audit process. Will the Third Circuit or possibly even the Supreme Court have to step in and say that the courts need to reign in the overbroad and burdensome audit requests? Or will the state try a traditional enforcement mechanism and be rebuffed by the courts, leaving companies free to ignore audit requests? In many ways, these answers can be provided by the state legislature and an amendment to the state unclaimed property laws.
One thing that is clear is that it takes a steady and practiced hand to navigate through a Delaware unclaimed property audit. Barganier has the experience, in both annual compliance and multi-state audits, to help guide you through the murky waters and the constant changes in unclaimed property. Contact us if you have been notified or are currently the subject of a Delaware unclaimed property audit for expert guidance through these difficult times.