Delaware's New Unclaimed Property Law: Winners and Losers

Over the years, Delaware has rightfully gained the reputation as the most aggressive state in the nation pursuing corporations that are incorporated in Delaware and “perceived” as not in compliance with Delaware’s unclaimed property provisions. Delaware also engaged the services of various third-party, contingent fee audit firms to review the historical books and records of thousands of major corporations that required these companies to either (1) produce books and records that go back 25 to 30 years, or alternatively (2) succumb to the use of estimation techniques that often times created a liability ranging in the millions of dollars from individual sample items that may only be a $100 or less. 

Understandably, something was bound to happen when many of the most sophisticated companies in the world were facing audit assessments ranging in the tens of millions or more from the state of Delaware that professed to be the “most business friendly” jurisdiction in the country. Many of these entities historically chose Delaware as its State of Incorporation because of the ease of administration, flexible corporate laws and well established precedence that can minimize legal challenges.¹

As background, Delaware, although small in size and population, is legal home to over 800,000 businesses. Because of the unique manner in which unclaimed property laws are administered, unclaimed property collections have grown to amass over one-third of the state’s budget, averaging close to $500 million the last several years.  Corporate franchise fees on the other hand, an ongoing revenue source of an equal or greater amount, became jeopardized when these very companies came under unclaimed property audits and were subjected to unreasonable and unprecedented aggressive audit techniques. As a consequence, many businesses threatened to relocate their corporate charter elsewhere and the governor was forced to publicly defend the State’s rather tarnished image in the media.

On July 1, 2015, Delaware passed new legislation which will ease the chokehold that it was imposed on thousands of companies which had no connection whatsoever with the State, aside from having been incorporated in Delaware.
Under the new legislation there are several reforms which are intended to not only address the revenue concerns, but also rebuild Delaware’s tarnished image in the face of corporate America. 

Carrot Prevails over the Stick

Back in 2013, Delaware initiated a program intended to provide entities that were not yet subject to audit the opportunity to voluntarily come forward and commence unclaimed reporting with the state. Among the advantages included a reduced “look back” period in which a liability could be assessed, the elimination of penalties and interest, and most importantly, the elimination of any risk of audit from one of the contingent fee audit firms which were well known for their aggressive audit practices. The initial Voluntary Disclosure Agreement (“VDA”) program (initially scheduled to sunset June 30, 2015, but extended to June 30, 2015) proved to be so successful that the legislature has now permanently extended the program. Hundreds of corporations that signed up have settled with the state in a largely non-controversial manner relieving them of any looming.²

Despite this ‘carrot’, which was offered to hundreds of thousands of companies that were not under audit, the State simultaneously continued its rather aggressive audit campaign over the past several years - a battle that has been played out both in the national media and in the courts.³
 
Under pressure from the business community, and anticipating possible sanctions as result of pending litigation, Delaware’s new legislation accomplishes the following:

• Permanently establishes the Department of States Voluntary Disclosure program,
• Restricts the ability of third-party contingent fee audit firms to initiate an audit without first providing the selected company the ability to voluntarily come forward and participate in the expanded Voluntary Disclosure Program,
• Further reduces the “look back” periods in the event a Company voluntarily comes forward. For new entrants to the VDA program the look back period is 19 years versus 22 years. And even if subject to audit, the 22 year look back period is 13 years less than the prior 35 year audit look back period.⁴
• Creates “Annual Reminder” notices from the State Escheator to all of those Holders that have filed reports in the last five years, at least 120 days prior to the State’s March 1 unclaimed property report deadline, providing notification of “apparent obligation” to file a report based on past history. A designated company contact must also be identified and provided to the state in each report.
• Reinstatement of Interest-but with a reduced aggregate cap of 25%. The new law reinstates Delaware’s ability to impose interest on unpaid balances at the rate of .5% per month, but caps the amount at 25% of the amount ultimately required to be paid. This is down from the 50% cap that was previously included in the State provisions, until it was eliminated in 2014.⁵

Winners and Losers
Clearly the new Delaware legislation has widespread implications for all parties including:

• Companies currently under audit, and
• Companies that have not yet fallen under audit, but are contemplating entering into a VDA with one or more States, as well as, the State of Delaware and its hired third party representatives.

There is no doubt, the State legislature has responded positively to complaints by companies and attempted to support a cooperative versus adversarial position with corporations on a prospective basis.

First the winners: Corporate America can pat itself on the back for applying sufficient pressure on the Delaware legislature to own up to the “emperor has no clothes” myth that they have perpetuated for years, implying that Delaware is a “friendly state in which to conduct business,” all while its third-party contingent fee audits were given a free hand to use aggressive audit techniques under the mistaken perspective that a company should be penalized for not keeping records going back 35 years.⁶

Corporations that have considered entering into a VDA, but have thus far hesitated to step forward will likely fare far better by voluntarily coming forward rather than being subject to audit. For many, the issue is whether or not to initiate a self-review BEFORE receiving a notice rather than await notice and then scramble to recover records that may already be slotted for destruction. Companies that tend to maintain records longer than most corporate formal record retention policies mandate generally are able to reduce their potential liability far more than those that are forced to estimate for years where records no longer exist.

The Secretary of State seems to also have won the tug of war battle over the Department of Finance and Delaware’s Revenue Department over which division will control not only the VDA program, but also those companies that are selected for audit. Delaware’s Department of Finance will seemingly be responsible for administration of audit procedures, but not in the selection of which companies are selected. Moreover, depending on the outcome of the pending legal challenges, the use of estimation techniques may be even further restricted.

Even those companies that are currently under audit can claim a partial victory, that being a five year reduced look back period, 1986 versus 1981 under prior law. And again, depending on the audit of the legal challenges, companies under audit may find themselves in considerably better position to successfully resolve issues for periods in which records no longer are available than may have existed prior to the law change.

As for the perceived losers, one does not have to look too far into the crystal ball to foreshadow the days where third-party contingent audit firms will no longer receive the huge annual paydays that they have grown accustomed to receiving in prior years. While there still are hundreds of unresolved audits in progress, under the new legislation, very few new audits will be initiated after July 1, 2015, unless a company is unwilling to voluntarily step forward after receiving a “60 day letter” from the SOS office advising the company of the risks of not responding within the requisite period.

Companies that are already under audit will still need to negotiate with the Dept. of Revenue to reach favorable settlements without going to court, or alternatively wait out as best they can, the pending litigation working itself through the Federal courts. However, several may be forced to reach a decision before the court cases are resolved and either agree to estimation periods that go back 30 years or suffer the risk and cost of taking their battle to court. There is no certainty when or how these pending decisions will be resolved, but any company currently under audit and facing a large potential assessment needs to carefully weigh the cost and benefits of settling or pushing forward.

^1.State of Delaware, official website at www.delaware.gov/aboutagency.html2 Initial projections are that during FY ending June 30, 2015 approximately 180 companies voluntarily remitted over $200 million in unclaimed property to the state as settlement of prior year’s liabilities. These collections far exceeded original estimates. 
^2.Among the most recent court challenges are Temple-Inland, Inc. v Cook, 1:14-cv-00654-SLR (D. Del.), 7/22/14; Osram Sylvania, Inc., v. Thomas Cook, 1:14-cv-01475-SLR (D.Del), 12/11/14 and most recently, Plains All American Pipeline L.P., which filed a complaint against Delaware in federal court before the audit even had commenced. 
^3.Delaware Senate Bill 141 (S.B. 141)
^4.The legislation actually prevents third party audit firms and the Delaware Division of Revenue from initiating ANY audits.  Rather, only those companies selected by the Secretary of State’s (“SOS”) office to voluntarily come forward could be subject to audit, if the Company does not enter the SOS program within 60 days of having been contacted.
^5.S.B. 141 establishes a 1986 lookback for pending audits versus the historic look back period to 1981. Audits beginning after July 1, 2015, but on or before December 31, 2016 would have a lookback to 1991. Audits beginning after January 1, 2017, would have a lookback of 22 years prior to the calendar year in which the holder receives an audit notice (three years longer than the corresponding period if the same holder participated in a VDA). Thus, for audits already in progress the look back is reduced from 1981 to 1986.
^6.For its efforts, the largest of the third-party audit firms, Kelmar is reported to have received over $104 million, in just the past 2 years as compensation for its contingent fee audit assessments.  See http://checkbook.delaware.gov and Plains All American Pipeline, LP, op. cit. at par.37., p.10.