Unclaimed Property: A Panacea for State Budget Woes?

Unclaimed Property Update

To view this Sidley Update as a PDF, click here.

The current economic downturn has taken a heavy toll on state governments, many of which were experiencing severe budgetary pressures even prior to the financial crisis. According to the National Conference of State Legislatures, state budget deficits are expected to exceed $55.5 billion for the fiscal year beginning on July 1.1 One way that states are seeking to narrow those deficits is by increasing their efforts to collect unclaimed property. While states do not ordinarily acquire actual ownership of unclaimed funds, the funds are used by states until such time (if ever) the property is claimed by its owner. Generally, the state will set aside a small amount to pay claims to owners, and use the balance for statutorily-designated purposes or as general revenue. Whatever its use, unclaimed property is an increasingly important part of state budgets. In Delaware, for example, the state currently estimates that unclaimed funds will provide approximately $374 million in revenue for fiscal year 2010 – its third highest source of revenue after personal income taxes and franchise taxes.2 As states undertake increasingly aggressive efforts to balance their budgets, they are also capitalizing on opportunities to increase the dollar amount of unclaimed funds they collect through legislative, judicial, and regulatory initiatives.

Legislative Initiatives – Shortening of Dormancy Periods

The most straightforward approach to accelerating state unclaimed property collections is to amend state statutes to shorten statutory dormancy periods – the amount of time that holders of unclaimed funds can retain custody before turning the property over to a state. In recent years, Delaware,3 Arizona,4 and Utah5 have shortened their dormancy periods for certain types of unclaimed property. Most recently, on March 17, 2010, the State of Indiana enacted a law shortening the dormancy period for most types of property from five years to three years.6

While shortening dormancy periods is a time-honored tradition in the history of state unclaimed property legislation, those laws are now potentially coming into conflict with federal regulations. For example, the most recent amendments to the Arizona Act shortened the dormancy period for securities to two years after an account statement sent to the owner of the security is returned to the sender as undeliverable.7 This reduced dormancy period is now seemingly at odds with the requirements imposed by the SEC upon securities transfer agents. Pursuant to Rule 17Ad-17 under the Securities Exchange Act of 1934, a transfer agent is required to conduct two database searches for “lost” security holders during timeframes specified by the SEC.8 The first search is conducted between three and 12 months after the security holder is deemed lost (generally, the return of a second “item of correspondence” as undeliverable), and the second search between six and 12 months after the first.9 In other words, a transfer agent is required to make two searches during a period of 10 to 25 months after the return of the first correspondence (the triggering event under the Arizona Act). Accordingly, transfer agents who comply with Rule 17Ad-17 may find themselves unknowingly violating the due diligence or reporting requirements of the Arizona statute.

In no small part because of current economic conditions, the trend of shortening statutory dormancy periods will undoubtedly continue. The states’ rights to amend unclaimed property laws in the cause of revenue generation are, however, not absolute. Last summer, a federal court rebuffed Kentucky’s effort to shorten the dormancy period for traveler’s checks.10 In so doing, the court reminded the legislature that the purpose of modern-day unclaimed property laws is to repatriate unclaimed property with its owners, not to raise revenue for the state. Because it was “clear that the state’s objective was to raise revenue rather than to reunite citizens with lost property,” the court ruled that the state’s effort to shorten the dormancy period was not rationally related to a legitimate government interest, and therefore violated the constitutional due process rights of the holder.11 It should be noted, however, that there was ample evidence in the legislative history that the amendment was intended solely as a revenue-raising measure; accordingly, the decision might be distinguishable from other states’ efforts to shorten dormancy periods.

Judicial Initiatives - The Emergence of Escheat Litigation

In addition to their legislative efforts, states are accelerating their attempts at judicial enforcement of unclaimed property laws. In particular, states – and holders — are showing an unprecedented willingness to litigate disputed legal and accounting issues.

CA, Inc. v. Pfeiffer

The most closely-watched escheat litigation in recent memory has provided holders with an expensive reminder that the onerous penalty and interest provisions of state unclaimed property laws are not a dead letter. The events giving rise to the CA lawsuit began in 2004, when CA entered into a Voluntary Disclosure Agreement (VDA) with the State of Delaware. Generally, a VDA allows the holder to avoid imposition of interest and penalties in exchange for the holder’s agreement to conduct a self-audit of potential unclaimed funds.12 Pursuant to the VDA, CA conducted an internal review of its potential unclaimed property exposure with the assistance of multiple consultants, and presented its results – a combination of documented liabilities and statistical extrapolation totaling $685,000 – to Delaware.13 Delaware rejected CA’s estimate, and after many months of settlement negotiations, CA’s own calculations of its potential liability rose to approximately $2.3 million.14 Delaware responded not only with an assessment of more than $7.6 million, but it also determined – notwithstanding the VDA agreement – to assess interest based upon its own calculations of the amount owed, ultimately demanding more than $8.2 million. After further unsuccessful negotiations, the parties sued each other in Delaware Chancery Court. While little information is publicly available concerning the proceedings before the court, CA apparently agreed to settle the case in late 2009 for more than $17.5 million – more than 25 times its initial offer to the state.15 And while the precise breakdown is not available, according to the settlement, this amount includes both interest and penalties authorized by the Delaware statute.16 Assuming that the liability amount is somewhere in the range of the state’s initial demand of $8.2 million, the final settlement amount includes a higher dollar amount for interest and penalties than for substantive liability.

McKesson v. Cook

Another case involving Delaware’s unclaimed property enforcement efforts is McKesson Corp. v. Cook, pending in the Delaware Court of Chancery. In August of 2002, Delaware commenced an unclaimed property audit of McKesson. As part of this audit, Delaware sought to recover funds from McKesson representing the value of goods (i.e., tangible property) that had been delivered to McKesson, where McKesson did not receive an invoice for the goods and, therefore, did not pay for them.17 Delaware’s claim is remarkable in that it seemingly represents the first time that a state has (publicly) taken the position that goods received and recorded on the recipient’s records as unbilled inventory gives rise to an unclaimed property obligation. On a more technical level, McKesson also claimed that Delaware violated certain jurisdictional rules established in U.S. Supreme Court decisions relating to which states have priority to escheat unclaimed funds that could potentially be claimed by more than one state.

As in CA, Delaware and McKesson ended up asserting claims against each other in court, in which McKesson sought to prevent Delaware from taking custody of the funds and from assessing penalties and interest for its failure to turn over the property.18, 19 At the end of September, McKesson and Delaware entered into a “standstill agreement,” so the ultimate resolution of whether un-invoiced goods can be treated as unclaimed property remains uncertain and may ultimately be buried in a confidential settlement agreement.20, 21

Fitzgerald v. Young America Corporation

In the past year, the prosecutorial efforts of more than two dozen states have racked up tens of millions of dollars in settlements relating to uncashed rebate checks. The litigation commenced in 2006 between a large number of states and Young America Corporation, a rebate fulfillment house. In subsequent years, the lawsuit was expanded to name certain customers of Young America’s, including T- Mobile, Sprint, and Walgreens, as additional defendants. The states’ primary contention has been that both Young America and its clients failed to report and remit the proceeds of uncashed rebate checks as required by the states’ unclaimed property laws.22 Young America allegedly offered discounted services to customers if they allowed Young America to keep any “slippage” – the value of rebate checks that remained uncashed by consumers. While the case against Young America continues, Sprint apparently settled with the state consortium for $22 million.23 The case is a signal to holders of unclaimed funds that states will take collective action to pressure companies to report and remit unclaimed funds, even if they fall into a category of property that has not traditionally been the subject of state enforcement efforts.

Regulatory Initiatives - Amnesty and VDA Programs

Some states are attempting to increase holder compliance by inducements that are less adversarial – at least in theory. Amnesty and VDA programs have long been offered by states to encourage voluntary compliance with state escheat laws. Indiana, for example, has recently announced a “one-time only” amnesty program to allow holders to report and remit past-due unclaimed property without the assessment of interest and penalties.24

In addition to temporary amnesty programs such as that currently offered in Indiana, formal or informal amnesty or voluntary compliance programs are available to holders of unclaimed funds in numerous other states, including Delaware, Florida, Illinois, Nevada, New York, and Texas. Given the states’ aggressive enforcement efforts and increased willingness to litigate, holders should seriously consider whether to avail themselves of these opportunities to remedy any historical noncompliance without imposition of interest and penalties.

1 A. Merrick, Cash-Starved States Put Tax Scofflaws in Crosshairs, Wall St. J., Mar. 12, 2010, at A3.

2See Minutes of September 21, 2009 Meeting of the Delaware Economic & Financial Advisory Council (DEFAC) at p. 3, available at http://finance.delaware.gov/defac/min_0909.pdf. (last visited April 10, 2010). Indeed, Delaware’s aggressive activity on this front appears to be paying off. DEFAC’s most recent estimates include an increase in revenue of $39 million for this year and $64.6 million for next year. According to reports, “[t]he increases were fueled by improvements in two tax areas, the abandoned property, or escheat, taxes [sic] and the corporate income tax.” G. Gibson, Revenue Gains Likely to Help Delaware State Workers, Wilmington News Journal, Apr. 17, 2010 available at http://www.delawareonline.com/article/20100417/NEWS02/4170351/Revenue-gains-may-help-state-workers (last visited Apr. 19, 2010).

3See 2008 Del. S.B. 334 (enacted June 30, 2008, shortening the dormancy period for securities-related property from five years to three years).

4See 2009 Ariz. S.B. 1003 (enacted Nov. 23, 2009, shortening dormancy periods for various property types).

5See 2007 Utah H.B. 219 (enacted Feb. 27, 2007, shortening dormancy periods for various property types).

6See 2010 Indiana H.B. 1083 (signed by Governor March 17, 2010, effective July 1, 2010).

7 Ariz. S.B. 1003, amendments to Ariz. Rev. Stat. § 44-302(3). The Arizona House and Senate later both approved a bill that would extend the dormancy period for securities related property to three years. As of April 17, 2010, that bill was awaiting gubernatorial action. See 2010 Ariz. H.B. 2453.

8See Rule 17Ad-17. The Rule generally defines a security holder as “lost” if a notice is returned as undeliverable and the transfer agent has not received information concerning the security holder’s new address. Rule 17Ad-17(b)(2).

9Id.

10American Express Travel Related Servs. Co. v. Hollenbach, 630 F. Supp. 2d 757 (E.D. Ky. 2009).

11Id. at 764.

12 Stipulation of Settlement in Pfeiffer v. CA, Inc., Case Nos. 4111-CC, 4195-CC (Del. Ch. Filed Feb. 12, 2010) at p. 2.

13Id. at 3.

14Id. at 4-5.

15Id. at 9.

16Id.

17 Complaint in McKesson Corp. v. Cook, Case No. 4920 (Del. Ch. filed Sept. 25, 2009) at ¶¶ 87-106.

18 State’s Answer and Counterclaim, McKesson Corp. v. Cook, Case No. 4920 (Del. Ch. filed Oct. 30, 2009).

19 McKesson Response to Counterclaim, McKesson v. Cook, Case No. 4920 (Del. Ch. filed Nov. 23, 2009).

20 Standstill Agreement, McKesson v. Cook, Case No. 4920 (Del. Ch. filed Sept. 30, 2009).

21Id. 22 Third Amended and Substituted Complaint, Fitzgerald v. Young America Corp., Case No. 6030 (Iowa Dist. Ct.) at ¶ 13.

23 Press Release, Iowa State Treasurer’s Office, State Treasurer and Attorney General Settle with Sprint over Iowans’ Uncashed Rebate Checks (Feb. 12, 2010), available at http://www.treasurer.state.ia.us/about/news.cfm?action=view&PressReleaseID=184(last visited Apr. 10, 2010).

24 Indiana Attorney General, Unclaimed Property Amnesty Program, http://ucp.indianaunclaimed.com/attorneygeneral/ucp/amnesty.html(last visited Apr. 10, 2010).

Sidley Austin LLP’s Unclaimed Property Law Group

Sidley’s Unclaimed Property group is a cross-disciplinary team that includes lawyers from our regulatory, securities, tax and litigation groups. This mix allows us to provide clients with unclaimed property advice and audit defense legal support, with a nuanced understanding of the day-to-day practices and challenges faced by holders of abandoned property. We regularly counsel both financial institutions (e.g., broker-dealers, banks, mutual fund complexes, insurance companies) and “brick and mortar” companies (consumer products, manufacturing, Silicon Valley) on escheat law compliance. In addition, we have years of experience dealing with state unclaimed property regulators and the third-party audit firms that represent them.

To receive future Unclaimed Property Updates via e-mail, please click here.

This Sidley Update has been prepared by Sidley Austin LLP for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers.

Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, 212.839.5300 and One South Dearborn, Chicago, IL 60603, 312.853.7000. Prior results do not guarantee a similar outcome.