Update: SB 13 was signed by Delaware Governor on February 2, 2017. The bill, with the Senate Amendment, is now law.
What happens when a federal judge says that your state unclaimed property audits are unconstitutional? And you have been hammered for being business un-friendly? Delaware State Senator Bryan Townsend has introduced Senate bill 13 that would include a major overhaul of the state's entire unclaimed property laws. Many of the provisions and the structure of the bill will be familiar to practitioners that have worked with the model unclaimed property acts. Of course, there are a few twists and turns that will make Delaware unique. Here, we review the major points of concern in the unclaimed property bill and how they differ from the current law, as well as other states and concerns raised in recent litigation.
The standard Delaware dormancy periods remain at five years, except for securities and IRAs which are three years and travelers checks which are 15 years.
Some of the general provisions include:
- Clarification on the domicile of non-corporate holders The new bill specifies that for entities other than corporations which require a filing with the state, (this would include Limited Liability Companies) the state of the filing is the domicile for purposes of unclaimed property.
- Stored Value Cards: Loyalty cards that cannot be redeemed for money are also excluded. Gift cards and other stored-value cards are included and reportable as unclaimed property in an amount equal to the net card value minus the maximum cost of goods sold. Virtual currency is also included in the definition of reportable property.
- Goods Received/Invoices Received: In the definition of property, the bill excludes "uninvoiced payables" but also specifically says that it is not to be construed to create a business-to-business exemption of any kind regardless of whether a current business relationship exists. Uninvoiced payables is defined to include the historical exemption of GR/IR amounts.
- Death Master File Matching: The bill contains provisions that will require insurers to use the Social Security Death Master File to determine whether insureds are deceased and the policies escheated to the state. It also has provisions for knowledge of death for IRA owners.
- Claimants Not Entitled to Interest: Claimants and their attorneys have been successful in some states in obtaining court orders for the payment of interest on property between the report date and the payment of the claim. The bill specifically exempts the state from interest, unless the property itself was interest bearing. The bill also limits claims on the appreciation or depreciation of property value after it was reported as unclaimed property, probably in a nod to the lawsuit filed by foreign investors who have demanded compensation for the change in value of their wrongfully escheated stock.
Record Retention and Statute of Limitations
In a break from the current statutory framework, the bill proposes a specific record retention period of 10 years after the report was filed. Unfortunately, the requirement is very broad and vague as to specifically which records shall be retained. In addition to records to verify the items in the report, the bill says the "date, place, and nature of the circumstances that gave rise to the property right." This may be read to include all invoices, checks, bank statements and other underlying documentation. With a five year dormancy period and ten year retention period, companies would be required to hold onto records for 15 years, greatly in excess of standard record retention policies of seven to ten years. Records may be maintained by an agent, which is good for publicly-traded companies using a transfer agent for their securities or other companies that outsource various functions, including payroll, accounts payable and accounts receivable.
The State Escheator is also required to retain holder reports for ten years after the report was filed. Many holders have complained during audits and subsequent litigation that they have been held to a higher standard than the state itself when neither party has been able to produce reports or VDA agreements.
The new section 1157(b) says that the State Escheat may not commence an action or proceeding to enforce the unclaimed property laws 10 years after the duty arose to report, pay, or deliver property. The statute of limitations is tolled by the delivery of an audit notice, so that delaying an audit is not of benefit to the holder. The statute is also tolled if the State Escheator reasonably concludes that the holder filed a report with fraudulent or wilful misrepresentation.
In Section 1176(h), the State Escheator is limited in their examination to records 10 years prior to when the property was presumed abandoned. We assume that this is intended to prevent unlimited fishing expeditions by state auditors, to prevent hardships related to requests for documents that cannot lead to reportable property. A holder would need to be careful in this provision though because one reading could lead to a 25 year (5 year dormancy plus 10 year statute of limitation plus 10 year review) fishing expedition.
Owner's Address for Reporting Purposes
The U.S. Supreme Court has established priority rules for the reporting of unclaimed property. Under these rules, the first priority is to the state of the owner's residence, as determined by the holder's books and records. If the holder's books and records do not identify the owner or their address, then the property is reported to the domicile of the holder. In this bill, Delaware specifies that the last known address is a "description, code, or other indication of the location of the owner on the holder's books and records which identifies the state of the last-known address of the owner." This differs from the current administration of the unclaimed property law, where Delaware said that only full US mailing addresses were sufficient for the first priority rule. If there was not a name and full address, then it would be reportable to Delaware. Now, any indication of the state would be sufficient to trigger the first priority rule and prevent the property being sent to Delaware.
The bill also specifically says that when the holder is domiciled in Delaware, property with no last known address is reportable to Delaware, as is property reportable to a state that does not provide for custodial escheat. However, property is not reportable to Delaware if it is specifically exempt from custodial taking in Delaware or the state of last-known address of the owner. This is important for companies that rely on B2B exemptions to prevent reporting name and address property to other states. Along with the recognition of LLCs as domiciled in the state of organization, this provision is also important for gift card planning.
Finally, there is a provision for holders that change domicile. Delaware would follow the common practice that property is reportable to the state at the time the property was presumed abandoned.
Annual Filing Provisions
The reporting due date would remain March 1 for non-banking or insurance organizations. Reports will be required by November 10 for banking organizations and December 20 for insurance companies. Beginning with the report due March 1, 2018, holders would be required to submit their reports through a web-based system. The bill also explicitly permits holders to contract with third-party providers like Barganier to file reports on the holder's behalf. However, this does not relieve the holder of the duty to file or pay the required amounts. There are also the standard provisions for owner and property information, although there is a specific exception for information otherwise prohibited by federal law from disclosure.
Due Diligence Provisions
Remember how the Supreme Court noted that it would be receptive to a case on the notice provisions before a state takes property via escheat? It looks like Delaware listened. The bill contains the standard due diligence provisions common to other states and the model acts. Due diligence would include first-class mail between 60 and 120 days prior to reporting for all property over $50. The letter would include the caption required by the new model act and similar to the current California language.
The state will also be required to send out notices to owners after it receives property subject to liquidation (ie securities and other property that is not money). Newspaper advertisements will also be required to alert the public about unclaimed property and provide a means of contacting the department to initiate a claim. Such means shall include a website and phone number. The website will have a searchable database of all property over $10. Other state agencies are required to assist the State Escheator, at the State Escheator's request, in providing information to facilitate the identification and location of owners. In a separate provision, the State Escheator may pay claims of the owner in the State to other agencies for taxes, penalties and interest, child support arrearages, and court orders. The State Escheator may periodically consult with the other agencies to determine these claims even in the absence of a claim from the owner.
Voluntary Disclosure Agreements
The bill retains the Secretary of State Voluntary Disclosure Program. Interest and penalties will continue to be waived under this program. Both the Secretary of State and the State Escheator waive the right to seek payment for the VDA periods unless the Secretary of State reasonably concludes that there has been fraud or wilful misrepresentation. When no agreement is made, the Secretary of State may refer the holder for an audit. The look back period is ten years for all new VDAs. Companies that have been notified of an audit or are under audit by the State Escheator may not enter into the VDA, except as permitted at the initiation of an examination.
Liability After Reporting
The bill does contain provisions that indemnify the holder for reporting unclaimed property. The bill specifically states that when the property is reported, it terminates the legal relationship between the holder and the owner with respect to that property, including a release of liability from the owner and its successors. For securities, there is an additional provision that would grant relief of all liability when a duplicate certificate is issued to the state.
If a claim is made by another person or state after reporting it, Delaware will be required to defend the holder against the claim and indemnify the holder of any liability on the claim. The holder must report in good faith, which means that the holder cannot be in breach of any fiduciary duties and it must meet "reasonable commercial standards of practice in the industry." Of course, holders must ask themselves if they want Delaware defending them. I can see that Delaware could argue against indemnification based on "reasonable commercial standards" in many cases. So far, it has cost Moneygram a lot in legal fees to defend the current audit and litigation surrounding the company's reporting of "Official Checks."
Miscellaneous Reporting Provisions Worth Noting
The bill also specifically states that a holder may not assign or transfer obligation to report or pay unclaimed property other than to a parent, subsidiary, or affiliate of the holder. This would appear to be in response to the ongoing Card Compliant litigation in state court. In that case, retailers transferred the obligation to a third-party out-of-state entity. Delaware is currently fighting to bring those cards back into the state for reporting purposes, calling the transactions shams and fraudulent.
In the case of merger or acquisition, the new or resulting holder is responsible for reporting unclaimed property and otherwise comply with the unclaimed property law. This includes asset purchases of "substantially all of the holder's" assets.
And drum roll please, the part many of you have been waiting for...
Audit Provisions in Delaware SB 13
There are two different audit tracks - a compliance review and an examination. A compliance review is limited to sections 1142, 1143, and 1174(a). These are the sections requiring a report and the contents thereof. Section 1174(a) is the section for a verified report, which includes an inquiry about property not previously reported or property in dispute. Under a compliance review, the state has one year to issue a notice of deficiency. The state may also refer to the holder to the Department of State for a full voluntary disclosure agreement. Expect this to be limited in practice because the real crux is the examination provisions.
Examination to determine compliance with chapter
The state maintains the authority to conduct a full examination of the "records of a person or the records in the possession of an agent, representative, subsidiary, or affiliate" to determine compliance. This includes the authority to take testimony and to issue an administrative subpoena to require records. The state may also bring an action in the Court of Chancery to enforce the administrative subpoena. These two provisions regarding administrative subpoenas would render current arguments by Marathon Oil and Blackhawk moot.
The new bill maintains the current requirement that the state offer a voluntary disclosure agreement prior to initiating an audit. This provision of the current law became effective on July 1, 2015, in response to the outcry by the corporate community in the wake of Mark Udinski's approval of hundreds of audits and then immediate departure for Kelmar Associates. However, this notice is not required if the audit is a multi-state audit and the Secretary of State is consulted. Other provisions, relating to the number of outside auditors and how many audits each may have, also carryover from the current law. The contracts with these auditors must also prohibit the auditors from hiring certain key state employees for two years after they leave state employment.
At the conclusion of the audit, the State Escheator shall provide to the holder a closing report. This is to identify the property reviewed, the estimation used, if any, the property reported, and any other findings. This can be used in the appeals process as well as against future claims by Delaware or other states.
Unclaimed Property Audits Commenced Prior to July 2015
If you are currently under audit, it is likely that your audit began before July 22, 2015. There are approximately 400 ongoing audits, with about 330 of them initiated before this date. These companies need to pay special attention to this bill and the amendments thereto. These companies will have the opportunity to convert their audit to a voluntary disclosure agreement under the Secretary of State program. The company will have until July 1, 2017 to make this election. Under this VDA, the look-back period will be 10 years from the audit notice (not 2017).
Another alternative is to apply for the expedited completion of an audit. For all audits currently ongoing, including those commenced after July 22, 2015, the company may apply by July 1, 2017. The State Escheator will be required to complete the audit within two years from the date of the company's notice and will waive interest and penalties. The auditor must make all requests within 18 months of the election. The company must respond timely, generally expected to be within 30 days of the request. The State Escheator has the sole discretion on determining whether the responses were timely to justify whether to terminate the expedited audit process.
Estimation Not Going Away Just Yet
Any record that shows an "unpaid debt or undischarged obligation" is prima facie evidence of the obligation. Once the state shows that there is such a record, their burden of proof is satisfied. It is on the holder to determine, by a preponderance of the evidence, that the obligation or record was unaccepted offer in settlement, reissued, intra-company transaction, paid or satisfied, or issued in error or without consideration. However, if the company does not retained the required records to allow this review to take place, then they will be subject to a determination of "the amount of property due using a reasonable method of estimation based on all information available to the State Escheator, including to extrapolation and the use of statistical sampling when appropriate." The state has until July 1, 2017 to promulgate rules to create a consistent estimation methodology for both VDAs and audits.
Even though a federal court has found that the application of estimation and the methodology used by Delaware to be unconstitutional, the same estimation methodology will be used in the new bill. Based on what we have heard so far, the estimation methodology will not change going forward, unless a federal court requires otherwise.
However, if a company has records and has timely filed the required reports, estimation may only be used with the consent of the company. This is an incentive to companies to file the required annual reports.
See Also: Lost That Loving Feeling in Delaware
Administrative Appeals and Judicial Review
The State Escheator will issue a statement of findings and request for payment after the audit. At 90 days, this request becomes final. Before the 90 days is up, the holder may file an action the Chancery Court or pay the amount and seek a refund in the Chancery Court. The Chancery Court is required to "take due account of the experience and specialized competence of the State Escheator." (OK holders, please contain your laughter now!) The findings and request for payment should be the product of an "orderly and logical deductive process rationally supported by substantial, competent evidence." The Court shall review errors of law de novo. There are no provisions for administrative appeals or review of the determination of the State Escheator.
Confidentiality of Examination Materials
One very important consideration for holders will be the new provisions relating to the confidentiality of company records reviewed by auditors during an examination. Records are not a "public record" subject to disclosure requirements. They may be used in conjunction with multi-state audits if the other states or jurisdictions are also bound to keep records confidential. However, the records must be produced by the State Escheator under an administrative or judicial subpoena or administrative or court order or upon the request of the person subject to the exam. There are no provisions for releasing the records to a claimant, beyond a court order.
Penalties and Interest
Interest is back on the books if this bill becomes law. Interest is calculated at 0.5% per month of the outstanding unpaid amounts. Interest may not exceed 50% of the amount required to be paid. Interest may be assessed against any late filed property reported or remitted on or after July 1, 2017. So, holders, get your late property in now! The State Escheator may waive up to 50% of the interest for good cause.
Penalties will be 5% of the unpaid amount for each month or fraction thereof, not to exceed 50% in the aggregate. A civil penalty of $100 per day, not to exceed $5,000, may be assessed in the alternative to the 5% calculation. Failure to pay is another 5% penalty per month, not t o exceed 25%. If fraud is shown, then a 75% penalty can be assessed. Penalties may also be assessed against holders that enter into contracts for the purpose of evading unclaimed property obligations in Delaware, up to $25,000 and 25% of the value of the property. The State Escheator may waive all the penalties for good cause.
What's Next for Delaware Unclaimed Property
S.B 13 has been assigned to the Banking, Business & Insurance Committee in Senate. There is a major push underway to get this through committee, the Senate, and the House before January 31 and the legislative work on the 2017-18 budget begins. If this bill doesn't pass by January 31, it may be months until it can be addressed again.
Even when this bill becomes law, we expect a push to settle many of the ongoing audits or convert them to the voluntary disclosure program. Delaware is still at risk because of the unconstitutional estimation methodology it employs. They do not want to risk an adverse decision and have in the past settled to save the estimation for other companies. Companies will have to make some major decisions by July 1, 2017 on whether to convert and probably lose rights to challenge the estimation methodology.
In the meantime, holders should continue to maintain strict compliance with annual reporting requirements. Many of the provisions herein will be beneficial to holders that have a filing history when they are under audit. As always, compliance is your best defense in an audit.
Contact Patricia Barganier or Kimberly DeCarrera if you want to discuss how SB 13 could affect your company's compliance program or ongoing audit. Or if you want to establish a compliance program. Barganier has some great out-of-the-box options for companies that are working through compliance and voluntary disclosures.