In Temple-Inland, Inc. v. Cook, Civ. No. 14-654-GMS (D. Del. June 28, 2016), the United States District Court for the District of Delaware ruled that the State of Delaware’s enforcement of its unclaimed property laws was unconstitutional. All states have unclaimed property laws and go to different lengths to enforce them; Delaware is known as the most aggressive. Many businesses decide to incorporate in Delaware because of the state’s favorable tax benefits; however, these same businesses are looked at as a cash cow when it comes to unclaimed property. Unclaimed property is the third-largest revenue generator for Delaware.
On Dec. 22, 2008, Temple-Inland received an unclaimed property audit notice. Over the next several years, the audit was conducted by a third-party firm, Kelmar Associates, LLC, which audited two check-writing bank accounts for accounts payable and payroll. The audit covered a 22-year span. During the audit, Temple-Inland was only able to produce complete records back to 2003 because of a seven-year record retention policy, but it did have unclaimed property reports for 10 years. Because Temple-Inland could not produce complete records dating back to 1986 and all requisite unclaimed property reports, Delaware calculated the liability amount, using its long-standing, controversial estimation techniques. At the conclusion of the audit, Delaware proposed to increase Temple-Inland’s unclaimed property liability by nearly $1.4 million. On May 21, 2014, Temple-Inland filed a suit against Delaware to challenge the proposed liability, which was estimated for two property types, payroll and accounts payable.
The statute of limitations and record retention
Temple-Inland alleged that Delaware violated federal common law and several provisions of the U.S. Constitution. The statute of limitations was a critical issue. Under Delaware law, the state has three years from the date a report is filed to bring an action to enforce payment of a deficiency and six years if the deficiency is greater than 25 percent of the property amount reported. The state can bring an action at any time if no report is filed or a fraudulent report is filed. Delaware assumes no report was filed if a holder cannot produce a report, even if a holder can produce other reports consistent with a reasonable record retention policy. It should be noted that the State of Delaware destroyed its own copies of unclaimed property records so Delaware itself could not prove that Temple-Inland had not filed unclaimed property reports.
Many states have statutory requirements on unclaimed property record retention. Delaware, however, has no record retention requirements; therefore, the court concluded that Temple-Inland did not receive proper notice it needed to retain all Delaware-related unclaimed property records indefinitely. During litigation, the State Escheator agreed companies typically have document retention policies of seven years. The court held that Delaware did not provide Temple-Inland with sufficient notice regarding record retention requirements and that the statute of limitations was closed.
Delaware’s estimation techniques
In addition to challenges under the statute of limitations, the court also rejected Delaware’s estimation technique. The Court held that the State of Delaware’s application of Escheat Law Section 1155 violated substantive due process. Section 1155 requires estimation techniques be reasonable. Ultimately, Delaware offered no credible reason for using its estimation other than to raise revenue, and the techniques were, therefore, deemed arbitrary. Delaware extrapolated a liability using property that was addressed and escheated to other states. Temple-Inland claimed it was subject to at least $299,085 in “multiple liability.” The court cited Texas v. New Jersey, 379 U.S. 674 (1965), for the proposition that property cannot constitutionally be escheated to more than one state. Temple-Inland was previously audited by Texas for the same period and, as a result, had escheated uncashed payroll checks to Texas for the years of 1996 to 1998. Delaware tried to collect money stemming from property that was properly escheated to Texas. Moreover, Delaware ignored all evidence that reduced Temple-Inland’s liability.
In its summary, the court cited several “troubling” actions by the State of Delaware: an audit conducted 22 years after the report’s due date, exploitation of the statute of limitations, failure to notify holders regarding the need to maintain unclaimed property records indefinitely, failure to articulate any legitimate state interest in retroactively applying Section 1155, and arbitrary estimation techniques. In spite of the court’s powerful rebuke, Delaware will most likely appeal.
State-initiated unclaimed property audits are expensive and time-consuming. A typical unclaimed property audit period is three to five years and disputes are often handled by aggressive third-party auditors. Certain industries are at higher risk for audit; in recent years, life insurance, banking, and healthcare have been targeted. Unclaimed property laws are complex and unique in nature. Compliance with unclaimed property laws can be complicated and the impact of noncompliance can be costly. It is highly advisable for holders to engage with a knowledgeable service provider, along with their legal departments, whenever dealing with unclaimed property matters.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.