Temple Inland For the Win!

In a surprise move today, the newly assigned judge in Temple-Inland, Inc. v. Delaware issued an opinion and order granting Temple Inland’s motion for summary judgement. In 2015, the company survived a motion to dismiss. The Court found that the state's actions were troubling, to say the least.

The Court began its analysis on the substantive due process claims by stating:


"[Delaware] waited 22 years to conduct an audit, avoided the otherwise applicable 6 year statute of limitations under dubious circumstances, gave holders no notice that they would need to retain unclaimed property records to defend against unmeritorious audits, applied Section 1155 for a prolonged retroactive period for no obvious purpose other than to raise revenue, and failed to follow the fundamental principle of estimation where the characteristics of the sample set are extrapolated across the whole, which also puts plaintiff at risk of multiple liability."

Court OrderStatute of Limitations

The Court discusses Section 1158, which generally provides for a three year statute of limitation unless holders materially underreport unclaimed property where a six year statute of limitation applies. The Court rejected Delaware's interpretation that Section 1202, which says statute of limitations are not a bar, provides for a longer statute of limitations against holder reporting obligations. The Court distinguished between the two sections, saying that 1202 was to prevent private escheat while 1158 limits the state's authority to assess and bring actions against the holder.

While Section 1158 provides a statute of limitation if reports are filed, it also provides that there is no statute of limitation if no report is filed. The Court said that this provision was not applicable because of two plausible assumptions: 1) did not file a "negative" report, per Delaware's guidance to holders not to file negative reports or 2) the reports were filed but are no longer available. The Court reasoned that Temple Inland was able to provide all reports during the record retention period and a couple from prior years. Thus it was likely that the company had no unclaimed property to report and relied on the instructions not to file or in fact filed reports that are now missing.

The Court found it "troubling" that the State would seek a deficiency beyond six years based on only one explanation that they had unclaimed property and did not file. Further, the Court was not persuaded by Delaware's actions in telling holders not to file, putting the burden on the holder to prove that they did file, and not informing holders to keep their records forever.

Notice That Estimation Would Be Used

Temple Inland successfully argued that it was not on notice that estimation would be used against it if the company did not retain its records beyond standard record retention periods. The Court's research showed that Delaware was one of only four states that did not have a statutory record retention requirement as of December 2008, when it initiated the audit. It also noted that of the 46 states with record retention requirements, no state had a requirement longer than 15 years. The Court said it "cannot help but wonder at Delaware's sense of cadence" when the State suggested the company took a "calculated risk" for failing to anticipate an audit of 22 years.

The Court did not go so far as to say that estimation could not be used. However, the holder must have the opportunity to rebut the presumption that amounts are unclaimed property and they would only be able to do so if they were on notice to retain records that the estimation is designed to represent.

Retroactivity

In an argument that could only be presented by Delaware, the State tried to argue that their authority to estimate was not rooted in Section 1155, the estimation provision. Further, the Delaware Audit Manager told the holder that it was relying on Section 1155 as its authority to estimate. As the Court noted, "what would have been the point of enacting Section 1155 if not to give defendants' actions the cover of legitimacy? It would certainly make defendants actions appear even more arbitrary if they did not have a statute authorizing an estimation that can reach back twenty-two years."

The Court rejected many of the State's arguments that shifting the benefits and burdens between different public constituencies is "presumptively constitutional." The Court noted that the State could not show a one-to-one shift between holders and owners when estimation is used. The unclaimed property owner is only entitled to the amounts that the specific owner abandoned, "no more, no less." Further, since the Delaware unclaimed property fund is not experiencing a shortfall, there is little risk to the overall viability of the program, thus alleviating the need for burden shifting. The Court further rejected that even if an owner is not available to claim the property, the money should be used for the general welfare of the state.


"It is true that unclaimed property should not become a windfall for holders... But, at the same time, unclaimed property laws were never intended to be a tax mechanism whereby states can raise revenue as needed for the general welfare... [D]efendants offered no credible reason for using estimation as it did in plaintiffs audit other than to raise revenue."

Estimation as Applied

While estimations are generally permitted, if reasonable, they must by properly performed. Notably, the estimation in the reach back years must have "all the same qualities and characteristics" as unclaimed property in the base-years. If the estimation methodology creates misleading results, due process violations occur. Delaware has often, and did in this case, base their estimation for the reach back period on the unclaimed property due to all states in the base periods. Even though Delaware cannot escheat properties with addresses in other states in the base years, it used these amounts for the reach back years. It relies on the premise that if there are no records, the properties are address unknowns. The Court said that "Defendants' logic stretches the definition of address unknown property to troubling lengths." The proper methodology would be only to include property in the base years that would be reportable to Delaware.

Multiple Liability

As we noted in our earlier coverage of the Temple Inland case, the final liability assessment was close to the amounts that the company had actually reported to all other states for the reach back period. This setup a beautiful illustration on multiple liability, where the U.S. Supreme Court has said that "the same property cannot constitutionally be escheated by more than one State." The Court found it persuasive that Texas had already performed its own audit and estimated liability for certain periods. Thus, if Delaware was to again estimate using its methodology, the holder would be subject to multiple liability. The Court also rejected Delaware's premise that only the state of incorporation, under the second priority rule, could use estimation and no states could estimate under the first priority rule.

The Court also found that the indemnification provisions were not adequate protection for the holder against multiple liability. No other state could prove a superior right to escheat based on estimation. This would leave the holder with an unconstitutional multiple liability.


"In summary, defendants: (i) waited 22 years to audit plaintiff; (ii) exploited loopholes in the statute of limitations; (iii) never properly notified holders regarding the need to maintain unclaimed property records longer than is standard; (iv) failed to articulate any legitimate state interest in retroactively applying Section 1155 except to raise revenue; (v) employed a method of estimation where characteristics that favored liability were replicated across the whole, but characteristics that reduced liability were ignored; and (viii) subjected plaintiff to multiple liability. To put the matter gently, defendants have engaged in a game of "gotcha" that shocks the conscience."

The Court did leave the remedy portion to another day.

Takings Clause

The Court quickly and summarily rejected the argument that the estimation is an unconstitutional taking of private property for public use. Since the holder generally has no rights in abandoned property, the holder cannot show a "legally cognizable property interest." Estimation, if properly employed, can satisfy the state's burden to show that the property is unclaimed. Thus, so long as the estimation is reasonable, it is not an unconstitutional taking.

Ex Post Facto Laws

The Court did some analysis on whether estimation is an ex post facto law that imposes or increases punishment when the act was not punishable at the time it was committed. The prohibition generally applies to criminal laws and certain civil measures that are criminal punishments in disguise. The Court analyzed the Mendoza-Martinez factors and found that the estimation statute was not so punitive that it should be deemed criminal.

Conclusion

This is a BIG win for holders, particularly those currently under audit by Delaware and potentially subject to estimations. This decision will have such wide ranging effects on Delaware's current operations that it is sure to be appealed by the state. Holders should consult with their attorneys and subject matter experts to determine how this may affect their audits and compliance programs.

It's been a tough go of it lately for Delaware, with this and other litigation (including Idenix foreign shareholders and 25 states already lining up for Moneygram official checks) and recent pressure by holders to implement changes (Secretary of State Voluntary Disclosure, audit look back periods). The State had already pushed certain audit revenue to next fiscal year. However, it is never wise to count Delaware out of the game. They will continue to fight this and other unfavorable decisions. Even if Delaware loses all of them, do not expect unclaimed property or the third part auditors to go away - the states and the auditors will continue to fight for this source of cash. The players may change, but the game will remain.

See Also:
US Supreme Court Denies Petition in Taylor Case, Signals Potential for Future Cases
Oklahoma Supreme Court: Unclaimed Property Not a Ponzi Scheme
Nine Year Audit Leads to Federal Lawsuit