The 2016 Act Continues to Violate the Fundamental Principle in State Unclaimed Property Laws That the State’s Right to Escheat Is Derived from the Owner’s Right to Claim the Property
In Delaware v. New York,the Supreme Court clarified that the federal common-law rules established in Texas “cannot be severed from the law that creates the underlying creditor-debtor relationships.” Thus, “[i]n framing a State’s power of escheat, we must first look to the law that creates property and binds persons to honor property rights.” Put more simply: “the holder’s legal obligations not only defined the escheatable property at issue, but also carefully identified the relevant ‘debtors’ and ‘creditors.’” Accordingly, a state’s right to escheat is defined by the legal obligation that is owed by the debtor to the unknown or absent creditor, and the debtor—and not any other person—has the legal obligation to comply with any applicable unclaimed property laws.
Accordingly, Delaware stands for the common-sense principle that the state can only escheat property that is actually owed to the creditor or owner. Indeed, if this were not true, then the state would be escheating property from someone who does not owe it for the purpose of giving it to someone to whom it does not belong. The principle that the state’s rights are derived from those of the absentee creditor, and thus limited to property actually owed to that creditor, has become known as the principle of derivative rights or as the “derivative rights doctrine.”Numerous courts have embraced this doctrine.
The court in Delaware clarified that in determining whether a state has the right to escheat unclaimed property, the first step is to “determine the precise debtor-creditor relationship as defined by the law that creates the property at issue.” Accordingly, the court found that the “holder” of unclaimed property with the potential obligation to report and remit such property to the state is the “debtor” or the “obligor.” As the court stated: “[f]unds held by a debtor become subject to escheat because the debtor has no interest in the funds.” Conversely, if a person does have an interest in the property the state seeks to escheat, then the person is not the legal debtor, and so cannot be the “holder” and cannot have an obligation to escheat the property.
The court’s analysis and conclusion is consistent with the age-old axiom that escheat is a right of succession, pursuant to which the state takes custody of property owed to another person who has failed to claim that property. Indeed, citing the Supreme Court’s earlier decision in Christianson v. King County, one federal district court more explicitly summarized the derivative rights principle as follows:
The United States Supreme Court has distinctly held that the right of escheat is a right of succession, rather that [sic] an independent claim to the property escheated. The result of that is this: ‘The State’s right is purely derivative; it takes only the interest of the unknown or absentee owner.’
The 2016 Act deviates from the federal common law principle of derivative rights—i.e., that the holder’s unclaimed property obligation must be based on “the precise debtor-creditor relationship as defined by the law that creates the property at issue”—in several important respects.
Perhaps most importantly, the 2016 Act, like the 1981 and 1995 Acts, includes a so-called antilimitations provision, which provides that:
Expiration, before, on, or after the effective date of this [act], of a period of limitation on an owner’s right to receive or recover property, whether specified by contract, statute, or court order, does not prevent the property from being presumed abandoned or affect the duty of a holder under this [act] to file a report or pay or deliver property to the administrator.
These antilimitations provisions were expanded from those in the 1954 and 1966 Acts to include “contractual” limitations. Thus, these revised provisions purport to override contractual restrictions on an owner’s right to claim property—even if those restrictions are valid and enforceable under applicable laws governing the debtor-creditor relationship. These provisions purport to change the underlying debtor-creditor relationship, rather than defer to it, in direct contravention of Delaware v. New York.
States have argued that the Supreme Court’s 1948 decision in Connecticut Mutual Life Ins. Co. v. Moore somehow overrides Delaware (decided 45 years later) and permits states to ignore contractual conditions that may prevent the property from being owed. However, Connecticut Mutual involved the narrow issue of whether New York’s escheat statute applicable to life insurance proceeds violated the contract clause of the U.S. Constitution. It did not address the derivative rights principle other than to suggest that a state cannot constitutionally alter substantive contract conditions existing between the parties.
The law at issue in Connecticut Mutual permitted escheat of unpaid life insurance proceeds owed under preexisting policies even without satisfying the insurance policy conditions requiring proof of death and surrender of the policy. The insurance companies argued that these contract conditions served a substantive purpose—they were intended to provide information from which the companies could establish defenses to their obligation to pay. Consequently, the companies argued that New York’s attempt to require an insurance company to pay the policy proceeds to the state without satisfaction of these conditions materially changed the terms of its contracts with policyholders, and therefore substantially impaired the contracts in violation of the contract clause. In rejecting this argument, the court stated that the “enforced variations from the policy provisions” were not unconstitutional because otherwise “the insurance companies would retain moneys contracted to be paid on condition and which normally they would have been required to pay.” In explaining its holding, the court stated:
When the state undertakes the protection of abandoned property claims, it would be beyond a reasonable requirement to compel the state to comply with conditions that may be proper as between the contracting parties. The state is acting as a conservator, not as a party to a contract.
Nevertheless, the court did not hold that a state may simply ignore all contract conditions that exist between a debtor and creditor, and thereby claim as property an amount that is not owed. To the contrary, the court pointed out that the New York Court of Appeals had construed the escheat law to leave “open to the insurance companies all defenses except the statute of limitations, noncompliance with policy provisions calling for proof of death or of other designated contingency, and failure to surrender a policy on making a claim.”
Strikingly, none of the potential defenses cited by the court or the insurers was that the insured had not actually died. Thus, all of the parties and the court assumed that the insurers would have had actual knowledge of death before escheating—the standard later adopted in the 1981 Act. Given that the court did not place on the insurers any obligation to affirmatively determine whether insureds had died, such an assumption would have been quite reasonable. Therefore, the “proof of death” in question was the merely formalistic substantiation required by the policies. Indeed, given the highly restricted ability at that time to affirmatively determine deaths, insurers would have had no ability to escheat without having actual knowledge of death, which in most cases could arise only by having been provided with some reliable notice of the death, even if not in the exact form required by the policy and the insurance laws of the state.
In other words, the court addressed only formalistic contract conditions on property that was already classified as “abandoned” by the unclaimed property statute and “which normally [the insurance companies] would have been required to pay.” The court specifically recognized that nonformalistic conditions may be raised as defenses to escheat if those conditions have not been satisfied. Connecticut Mutual would therefore not support a state escheat law that provides that the state need not satisfy a substantive condition of ownership. Indeed, in distinguishing the Connecticut Mutual decision, one court stated that the Supreme Court excused compliance with contract conditions “which only go to formalism of interest, such as proof of death . . . but it is nevertheless held to compliance with matters that deal with substantive determination of ownership.”Furthermore, a number of courts have subsequently denied state claims to property where the purported owner of the property had not satisfied certain conditions to claim the property.
More importantly, even if a state could adopt escheat laws that would override other, more substantive conditions without violating the contract clause, that does not mean that such laws would not violate the federal common-law rules set forth in Delaware v. New York, the takings clause, substantive due process, or other laws. These issues were never considered by the Connecticut Mutual court; thus, that decision does not stand for the proposition that such escheat laws are valid. Indeed, the Delaware court, citing Connecticut Mutual, stated:
Unless we define the terms “creditor” and “debtor” according to positive law, we might “permit intangible property rights to be cut off or adversely affected by state action . . . in a forum having no continuing relationship to any of the parties to the proceedings.” Pennsylvania at 213. Cf. Connecticut Mut. Life Ins. Co. v. Moore, 333 U.S. 541, 549–550, 92 L. Ed. 863, 68 S. Ct. 682 (1948) (upholding New York’s escheat of unclaimed insurance benefits only “as to policies issued for delivery in New York upon the lives of persons then resident therein where the insured continues to be a resident and the beneficiary is a resident at . . . maturity”). Texas and Pennsylvania avoided this conundrum by resolving escheat disputes according to the law that creates debtor creditor relationships; only a state with a clear connection to the creditor or the debtor may escheat.
Given the court’s emphatic requirement in Delaware that a debtor-creditor relationship exist under the positive law of the state, the court would not have cited Connecticut Mutual if that case stood for the broad proposition that states are not bound by contractual contingencies. Delaware v. New York does not allow the state to create a debtor-creditor relationship where none exists, and neither does Connecticut Mutual.
The 2016 Act (like the 1981 and 1995 Acts before it) also attempts to justify the contractual antilimitations provisions by citing three so-called private escheat cases. Each of these cases involved unusual factual situations in which the courts found that the holders of unclaimed property had unilaterally taken actions designed specifically to circumvent state unclaimed property laws by cutting off the rights of owners after a specified period of time. The private escheat actions are in stark contrast to most time-based contractual limitations provisions entered into between sophisticated business entities, which are entered into for valid business reasons, such as to provide certainty to the parties. Furthermore, all of the private escheat cases predate Delaware v. New York; thus, none of them considered the restraints imposed by federal common law on the state’s jurisdiction to escheat.
In limited recognition of the derivative rights principle, the 2016 Act includes narrow, optional exemptions for gift cards, store credits, and other similar obligations to provide merchandise or services rather than cash. Yet, even these narrow—and optional—exemptions appear to be merely a nod to political reality and do not adequately take account the fundamental constitutional issue that the state’s rights are based on the underlying debtor-creditor relationship; therefore, if cash is not owed to the creditor, the state should be constitutionally barred from demanding the escheatment of cash from the holder.
It is worth noting the 2016 Act does contain one helpful clarification regarding the definition of “holder,” which is consistent with Delaware. The official comments to the Act provide that:
In most instances, there should be only one holder of obligations for unclaimed property purposes—the exception being where there are multiple obligors directly liable on a specific obligation, such as co-borrowers on a loan. In circumstances where more than one party potentially meets the definition of holder, the party which is primarily obligated to the owner should be treated as the holder for purposes of application of unclaimed property laws. See, e.g., Clymer v. Summit Bancorp, 792 A.2d 396 (NJ 2002) (issuer of bonds, not trustee in possession of funds to be used to pay bondholders and having contractual obligation to issue such payments, is the holder for purposes of determining applicable dormancy period). Where one party has a direct legal obligation to the owner of the property, and another party has possession of funds associated with the property and an obligation to hold it for the account of, or to pay or deliver it to, the owner solely by virtue of a contractual relationship with the party who is directly obligated to the owner, but who has not assumed direct liability to the owner, it is the party who is directly obligated to the owner who is the holder for purposes of the act. For example, the issuer of stock or bonds, and not a third party transfer agent or paying agent contracted by the issuer, would, in such circumstances, be the holder of the obligation and any unclaimed dividends on the stock or interest on the bonds. On the other hand, where a party contractually assumes direct liability to the owner for an obligation and is in possession of the funds associated with such obligation, the assuming party becomes the applicable holder for purposes of application of unclaimed property obligations.
This language still leaves some ambiguity where a party contractually assumes direct liability to the owner, but is not in possession of the funds. Presumably, in that situation, the “holder” is still the obligor, consistent with Delaware, rather than the person in possession of property, but it would have been preferable if the 2016 Act had made that clear.
The 2016 Act Includes Some Improvements to Better Protect Securities Owners, but Does Not Go Far Enough to Satisfy Constitutional Requirements
The 2016 Act provides that the dormancy period for securities for abandonment purposes is not triggered until mail sent to the owner has been returned as undeliverable. This is commonly referred to as a Returned by Post Office (RPO) dormancy standard and has already been adopted by many (but certainly not all) states. Unlike the 1995 Act, this new RPO rule applies to all securities, not just nondividend-paying securities or securities enrolled in a dividend reinvestment account. This new rule is consistent with federal securities regulations promulgated in 1997 by the Securities and Exchange Commission, which were enacted specifically to protect security holders from having their shares escheated by requiring transfer agents, brokers, and dealers to exercise reasonable care to attempt to locate “lost security holders.”For this purpose, the regulation defines a “lost security holder” to mean a security holder to whom mail has been sent at the address of record and returned as undeliverable and for whom the transfer agent, broker, or dealer has not received information regarding the security holder’s new address. The RPO rule is consistent with this regulation because under this rule, the securities will not be escheated until mail has been returned as undeliverable and the issuer of the securities (or other party) has conducted the requisite due diligence under federal law to try to locate the missing owner.
The 2016 Act also includes new notice provisions to owners of escheated securities. Specifically, the revised Act provides that the state must send written notice by first-class mail to the apparent owner and must maintain an electronically searchable website or database accessible by the public which contains the names reported to the administrator of all apparent owners for whom property is being held by the administrator. These provisions are generally an improvement over those in the 1981 and 1995 Acts; however, although such notice may satisfy constitutional requirements for certain types of escheated property, it is likely still constitutionally inadequate to permit liquidation of securities. First, the 2016 Act is conspicuously silent as to when such notice must be sent. Even the 1981 Act required notice to be published within the year following the year of escheat (although the 1981 Act was deficient in not requiring notice by mail and other means except by newspaper publication, which was almost certainly constitutionally inadequate). Second, the 2016 Act does not require the notice to inform the owner that the state will liquidate the securities, and thus fails to apprise the owner of the potential harm that could result from the escheatment of the securities. Third, the 2016 Act requires the notice to be sent to an address that is already presumed to be invalid because the securities are reported as unclaimed after the holder’s mail to the last known address is returned undeliverable. The Supreme Court has held that to satisfy due process, “[t]he means employed [for the notice] must be such as one desirous of actually informing the absentee might reasonably adopt to accomplish it.” Thus, “notice required will vary with circumstances and conditions.”A notice process that is a “mere gesture” is not due process.
To satisfy due process, therefore, the state must undertake further analysis of the type of reasonable action appropriate to attempt to locate the owner of unclaimed securities to provide notice of the impending sale of the owner’s property. Indeed, in Jones v. Flowers, the court expressly held that “when mailed notice of a tax sale is returned unclaimed, the State must take additional reasonable steps to attempt to provide notice to the property owner before selling his property, if it is practicable to do so.”The court explained that it did not think that “a person who actually desired to inform a real property owner of an impending tax sale of a house he owns would do nothing when a certified letter sent to the owner is returned unclaimed,” and “failure to follow up would be unreasonable, despite the fact that the letters were reasonably calculated to reach their intended recipients when delivered to the postman.”The court’s other rulings further support the conclusion that further notice is required if the regular mailing is known to be ineffective or if it would be unreasonable not to do so based on the other facts and circumstances involved. Indeed, in a recent concurring opinion issued by Justice Alito (joined by Justice Thomas) in the U.S. Supreme Court’s denial of certiorari in Taylor v. Yee, Justice Alito made clear that the constitutional issue of adequate notice before seizing private property is an “important” one. Justice Alito stated that “[w]hen a State is required to give notice, it must do so through processes ‘reasonably calculated’ to reach the interested party—here, the property owner.” Furthermore, Justice Alito specifically suggested that states should take advantage of changes in technology that make it easier to locate owners and return their property to them. Accordingly, we believe that the states should be required to utilize other records available to them, such as tax and real estate records, motor vehicle registration databases, the State Vital Statistics database, the U.S. Postal Service’s National Change of Address database, and other publicly available databases such as Accurint or Google to try to locate the missing owner and reunite him or her with the escheated securities. Such actions should be taken well before the securities are liquidated.
The escheat and liquidation provisions in the 2016 Act likely do not satisfy substantive due process and takings concerns. The 2016 Act prohibits the state from selling the owner’s securities within the first three years following the remittance of dormant securities, and requires the owner be “made whole” if the state liquidates the securities during the three years following this “no liquidation” period—thus effectively providing six years of protection. At the same time, the 2016 Act shortens the dormancy period in the 1995 Act from five years to three years. Thus, whereas the 1995 Act provided a total of eight years of protection, the 2016 Act provides a total of nine years of protection. To be sure, every year counts, and so the 2016 Act is at least moving in the right direction.
However, that does not mean there is no taking. To the contrary, a state’s escheat and liquidation of securities is a physical appropriation of property giving rise to a per se “taking” because the owner loses the entire “bundle” of rights in the securities. When a government “physically takes possession of an interest in property,” it has a “categorical duty to compensate the former owner,” regardless of whether it takes the entire property or merely a portion thereof.”The government “is required to pay for that share no matter how small.” Thus, the issue is how much compensation must be paid by the state. There is scant case law involving takings of securities; however, in United States v. Miller,the Supreme Court held that “[t]he owner is to be put in as good [a] position pecuniarily as he would have occupied if his property had not been taken.” In addition, in Seaboard Air Line Ry. Co. v. United States, the court specifically held that where the state seized land belonging to an owner, but the owner was not compensated until after the taking, the amount of just compensation to be paid to the owner was not limited to the value of the land at the time of the taking. Thus, any failure of the state to make an owner whole appears to contravene Seaboard, regardless of when the owner comes forward. Indeed, New York—which has a significant state interest in escheating securities—has adopted a permanent “make whole” provision for this reason.
States have argued that the escheat and liquidation of securities (or any property) does not constitute a taking based on Texaco, Inc. v. Short, in which the court held there was no taking where the former owner had abandoned his property and therefore “retain[ed] no interest for which he may claim compensation.”But this argument confuses “unclaimed” property with “abandoned” property. Modern custodial escheat laws do not involve abandoned property at all, as was the case in Texaco. They involve property that is merely “unclaimed” by the owner often because it has been temporarily forgotten, as opposed to “abandoned” property, which normally indicates an affirmative intent to relinquish rights in the property (or at the very least, a substantial lack of contact with the property such that it would be reasonable to presume the owner had intended to abandon it). That is why the Uniform Acts provide for much shorter dormancy periods for unclaimed property than for older laws involving property that was actually abandoned. One cannot reasonably contend that a person has relinquished all property rights in his or her securities simply because one has not affirmatively accessed his or her account for three, five, or even nine years. Indeed, in Texaco, the state law at issue assumed mineral interests were abandoned after those property rights were left unused by the owner for 22 years.
Furthermore, the court made clear that “[w]e need not decide today whether the State may indulge in a similar assumption in cases in which the statutory period of nonuse is shorter than that involved here, or in which the interest affected is such that concepts of ‘use’ or ‘nonuse’ have little meaning.” Securities are passive assets such that “concepts of ‘use’ or ‘nonuse’ have little meaning,” and no regular activity is expected. Thus, it is unclear that the court would sanction even a 22-year period for the escheat and liquidation of securities, particularly given the proliferation of target-date mutual funds, buy-and-hold strategies, and other investments or practices that encourage the investor not to touch the securities for decades. Indeed, in Cerajeski v. Zoeller, the Seventh Circuit specifically expressed that a three-year dormancy period for interest “present[s] a serious question whether it is consistent with the requirement in the Fourteenth Amendment that property not be taken without due process of law.”
Accordingly, the 2016 Act ultimately confuses the distinction between property that is merely “unclaimed” and not “abandoned.” The short dormancy period in the Act is consistent with the concept of unclaimed property, but the state’s ability to liquidate securities without recourse is more consistent with the concept of abandoned property. If a state wants to be able to liquidate securities and not make the owner whole, it must adopt a sufficiently long dormancy period after which it is reasonable to presume that the securities are in fact abandoned and the owner has relinquished his or her rights. Alternatively, if the state does not liquidate the securities (or is willing to make the owner whole), a shorter dormancy period may be reasonable.
The 2016 Act’s Provisions Permitting the Use of Contingent-Fee Audit Firms Also Raise Significant Constitutional Concerns
The 2016 Act expressly permits states to use a third-party audit firm that is compensated on a contingent-fee basis. The official commentary explains that “while use of contingent fee auditors can be viewed as controversial, state administrators contend these auditors are necessary for audits to be undertaken.” The 2016 Act does, however, include some minor limitations on the use of such auditors. The official commentary summarized these provisions as follows:
this section limits any actual conflict of interest, or the appearance of conflict of interest, between the administrator and the contractor conducting the examination by precluding the administrator from contracting with related persons, and requiring that such third party auditing contracts be awarded on a competitive bid basis. This provision mandates that a person who is to undergo an examination or be audited by a third party contractor be given unredacted copies of the contract.
These provisions avoid the core issue, however, which is whether the use of contingent-fee auditors violates due process or public policy.
Since the early 20th century, the Supreme Court has held in Tumey v. Ohio that there is a violation of due process by a system that permits a person to be fined by someone who has direct pecuniary interest in the fine that is imposed. Although the Supreme Court has never considered the validity of using private contingent-fee audit firms, other courts have found that the use of such firms violates due process or public policy. For example, in Sears, Roebuck & Co. v. Parsons, the Georgia Supreme Court held that a contract to use a contingent-fee tax audit firm was void, reasoning that:
The power to tax rests exclusively with the government. . . . In the exercise of that power, the government by necessity acts through its agents. However, this necessity does not require nor authorize the creation of a contractual relationship by which the agent contingently shares in a percentage of the tax collected, and we hold that such an agreement offends public policy. The people’s entitlement to fair and impartial tax assessments lies at the heart of our system, and, indeed, was a basic principle upon which this country was founded. Fairness and impartiality are threatened where a private organization has a financial stake in the amount of tax collected as a result of the assessment it recommends.
The Wyoming Supreme Court reached a similar conclusion in MacDougall v. Board of Land Commissioners of the State of Wyoming. The court reasoned as follows:
No rule of law can be sound which encourages officials to neglect their duty. If state officials, charged with the collection of money due to the state under contract, were permitted to act merely perfunctorily, fail to ascertain the amount due, and in a month or a year or other time, were allowed to hire experts at large expense to do what they themselves should have done, they might deprive the state of large amounts of money, which could, by their own proper efforts made at the time, have been easily saved. Not alone would this encourage neglect of duty on their part, which is against public policy, but it might easily open wide the door to fraud, which cannot be countenanced.
In Yankee Gas Co. v. City of Meriden, the Connecticut Superior Court, relying on Tumey, held that a city’s agreement with a contract audit firm violated due process where the firm was compensated based on a percentage of the additional tax collected as a result of the audits. The court held that “the risk of a due process violation is inherent” when the person determining the tax liability has “a direct financial interest in the amount of tax assessed.”
To be sure, there are also a number of cases that have reached the opposite result, upholding the use of contingent-fee tax audit arrangements. For example, in Appeal of Philip Morris U.S.A., the North Carolina Supreme Court held that a contingent-fee tax auditor’s contract with a local county did not violate public policy. Similarly, the Kansas Supreme Court upheld a contingent-fee “tax ferret” arrangement (in which the firm is hired to identify taxpayers that have a high probability of underreporting taxes) in Dillon Stores v. Lovelady.
These cases cannot easily be reconciled, and the due process and public policy concerns are magnified in the case of unclaimed property audits, which are almost always conducted on a multistate basis (often involving over 30 states at once). Thus, to withstand scrutiny, it appears that the administrator must, at a minimum, exercise oversight and control over the contractor and must make all material decisions regarding the potential liability of the putative holder. As a practical matter, this may prove difficult in that many state administrators currently lack the necessary expertise in unclaimed property matters, and thus give substantial deference to the contract audit firm. Although it is understandable for the states to operate in this manner, it is this type of deference that is precisely the problem.
A recent case, Temple-Inland, Inc. v. Cook, would appear to present a textbook example of what can go wrong where an audit is conducted by a private firm on a contingent-fee basis. That case involved the issue of whether Delaware’s audit practices, including its methods for estimating unclaimed property liability, were unconstitutional. The court concluded that during the course of Temple-Inland’s audit, Delaware and its audit firm “engaged in a game of ‘gotcha’ that shocks the conscience” sufficient to violate Temple-Inland’s substantive due process rights because Delaware:
(i) waited 22 years to audit [Temple-Inland]; (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) [sic] subjected [Temple-Inland] to multiple liability.
The Temple-Inland decision rejected Delaware’s audit practice of estimating unclaimed property owed to Delaware in years for which the holder lacks complete records based on unclaimed property owed by Temple-Inland to persons in all states in the base years. The court held that such a methodology “is contrary to the fundamental principle of estimation,” which requires both the existence and the characteristics of property from the base years to be extrapolated into the reach-back years. The court then made abundantly clear that “[i]f the property in base years shows an address in another state, then the characteristic of that property has to be extrapolated into the reach back years.” Delaware’s methodology was therefore invalid because it “created significantly misleading results” by not replicating the “characteristics and qualities of the property within the sample . . . across the whole.” Put more simply, Delaware was improperly trying to escheat vastly much more property through the use of estimation than it would have received had the holder reported the property in the first place. The court also held Delaware’s “purported reasons for applying [the estimation statute] retroactively [i.e., to raise revenue] do not withstand scrutiny.” The court explained that “unclaimed property laws were never intended to be a tax mechanism whereby states can raise revenue as needed for the general welfare.”Thus, “[s]tates violate substantive due process if the sole purpose of enacting an unclaimed property law is to raise revenue.”
Of course, some of this improper behavior may have been the fault of the state itself, rather than its auditor, because Delaware is notorious for assessing huge sums against companies that conduct little or no business in the state. On the other hand, the two are perhaps inextricably linked, with the audit firm earning over $200 million from its contingent-fee arrangement with Delaware over the course of a decade, and providing lucrative retirement deals for several former high-level unclaimed property officials, including the Delaware State Escheator himself and a Deputy Attorney General.
In any event, it appears that a court will soon weigh in regarding the validity of a contingent-fee multistate unclaimed property audit arrangement. In Plains All American Pipeline, L.P. v. Cook et al., the Third Circuit recently held that the use of a contingent-fee auditor in such an audit raises significant due process concerns, given the financial stake that the auditor has in the outcome of the audit, and has remanded the case to the district court to address that issue on the merits.
The 2016 Act Does Include Certain Improvements Compared to the 1981 Act and 1995 Acts
It should be noted that, notwithstanding these constitutional infirmities, the 2016 Act does include some notable improvements as compared to the 1981 and 1995 Acts. Perhaps the most substantial improvement is the statute of limitations provision. The 2016 Act restores the 10-year statute of limitations from the 1981 Act and provides for a five-year statute of limitations if the holder has filed a nonfraudulent report with the administrator. There are several benefits to this bifurcated approach. First, it encourages businesses to file nonfraudulent returns so that they can trigger the earlier statute of limitations. By contrast, under the 1981 Act’s rule, the statute of limitations is the same (10 years), regardless of whether a return is filed. This creates a disincentive to file a return. Another benefit of this bifurcated approach is that it encourages states to review returns and issue assessments against delinquent holders more promptly. This will serve the primary goal of these laws in returning property to the rightful owner.
The 2016 Act also includes an optional administrative appeals procedure for the first time; however, the procedure merely provides that a putative holder may initiate a proceeding under the state’s administrative procedures act for review of the administrator’s audit determination in an audit.
State unclaimed property laws have been trending in the wrong direction for over 30 years in that such laws have been greatly expanded in unconstitutional ways for the purpose of generating revenue for states at the expense of both owners and putative holders of unclaimed property. The 2016 Act—while containing some notable improvements from the 1981 and 1995 Acts—does little to reverse this alarming trend and continues to include provisions that are likely unconstitutional. Accordingly, we urge the American Bar Association not to endorse the 2016 Act until these constitutional infirmities are adequately addressed.