Thu, Jan 31, 2013

Unclaimed, Does Delaware Really Get it?

Temple-Inland Federal District Court Decision Background Temple-Inland, a manufacturing company organized in Delaware with principal offices located in Tennessee the (“ the Company”), was subjected to a state initiated unclaimed property audit by the State of Delaware (“the State”) and its third party contingent audit firm, Kelmar Associates.  As is standard practice in such audits, the audit period extended back to 1981. Temple-Inland had a history of reporting unclaimed property with a number of jurisdictions, but as with most companies did not maintain detailed books and records for periods prior to 2003 for accounts payable and 2004 for payroll. At primary issue in the complaint was the State and Kelmar’s use of statistical sampling to estimate the Company’s liability for the earlier periods.  Based on the use of estimation techniques the State, through Kelmar, initiatially assessed a liability of $2.1 million that was subsequently reduced to $1.3 after review by the “independent reviewer” 1 during Temple Inland’s administrative appeal.

In May, 2014 Temple-Inland filed an action in Federal District Court seeking relief under federal law and the US Constitution by challenging the State’s use of statistical modeling to determine its liability. Simultaneously, Temple-Inland also filed a motion to enjoin the State from enforcing  the audit assessment as well as any continued examination of the Company’s records. The parties subsequently stipulated to a standstill on both of these latter issues. On October 14, 2014, the Court heard oral arguments on Temple-Inland’s motion for summary judgment and the State’s motion to dismiss the case from Federal court for  lack of jurisdiction and to also have the case dismissed for failure to state a claim. 

Federal District Court Decision On March 11, 2015, the Federal Court ruled as follows:

  • Temple-Inland’s request for summary judgment was denied: The Court concluded that Temple-Inland’s argument that the State violated the federal common law established and affirmed in a trilogy of Supreme Court decisions was not supported. Specifically, Temple-Inland’s argument that a precise debtor/creditor relationship is required to exist between the holder and the owner of the property in order for Delaware to assert its claim was rejected. Thus the federal common law was not violated.
  • The Court denied the State’s motion to dismiss the case: The Court found that Temple-Inland  satisfactorily demonstrated, that federal questions exist sufficient to give the Court federal question jurisdiction.
  • On the issue of whether Delaware’s 2010 adoption of 12 Del. C. Section 1155 (Section 1155) violates the Ex Post Facto Clause by imposing a retroactive application of the State’s authority to estimate, the Court found that a factual determination needs to be made regarding whether Delaware’s use of estimation was merely a codification of its existing practices or a change of practice. Further, with respect to Temple Inland’s argument that the use of exempt business-to-business property to estimate historic liabilities interferes with the interstate commerce in violation of the Full Faith and Credit Clause, the Court held that if true, these allegations may violate the Full Faith and Credit Clause.  

So, the outcome of this decision is that the Temple Inland case now will be heard in its entirety in a Federal, NOT Delaware court, which is a major blow to the State and puts at risk hundreds of millions of dollars in revenues that previously were secured from audits of major Fortune 1000 and other companies organized in Delaware.

However, there are several hurdles yet to overcome before Temple-Inland, and scores of other holders can claim victory.   The burden of proof will be upon Temple-Inland to prove that the use of estimates by Delaware violates the U.S. Constitution.

Delaware Secretary of State’s Office Announces Plans to Introduce Legislation to Permanently Extend its Unclaimed Property VDA Program

Separately, and coincidentally within hours of the Federal Court decision, the Secretary of State’s office at the Annual Unclaimed Property Professional Organization (“UPPO”) conference attended by over 500 representatives announced that it planned on introducing legislation that would extend its Voluntary Disclosure (“VDA”) Program permanently beyond the sunset date which currently is scheduled to expire on June 30, 2016 (for companies that elected to join in the program on or before September 30, 2014). Click here to learn more about the Delaware VDA program currently in place.

Over the past two years over 700 companies have signed up to participate in Delaware’s Voluntary Disclosure Agreement (VDA) program which was initially introduced back in 2013 and extended in 2014. The current program is expected to sunset on June 30, 2016.
To date, the current VDA program being administered by the Secretary of State’s office has received very favorable feedback from the business community and applicants that have already reached settlement agreements as well as those currently in process and hoping to  close out their submission before the deadline of either June 30, 2015 (for those who entered prior to June 30, 2013) or by June 30, 2016  (for those who entered into it during the period July 1, 2013-September 30, 2014). Click here for more information on the existing DE VDA Program.

During a roundtable discussion by various state unclaimed property administrators at the Annual Unclaimed Property Professional Organization conference on Wednesday, March 11, 2015, Delaware’s representative who is charged with the responsibility of administering the VDA program, announced that the Secretary of State is planning on immediately introducing legislation that would permanently extend the program for those companies that wish to voluntarily come forward in order to qualify for favorable treatment including:

  • Reduced look back of years for which a liability is due
  • Elimination of interest and penalties
  • Eliminate the risk of audit by contingent fee auditors for periods covered under the VDA program
  • Ability to self control the review of prior years information and records

A word of caution, currently it is unclear whether or not the proposed legislation would extend the time for completing VDA submission for those companies that already have entered the VDA program. Also, in light of the recent Temple-Inland discussion, companies should consider the broad implications and risks of entering into the  VDA program, including finalizing any settlement negotiations while the decision is pending.  It has been rumored that the legislation may include a provision to extend the current date for completion of pending submissions, but currently there is no assurance that the legislation, if passed will include such relief.

Possible Implications of Yesterday’s Developments

Although Temple-Inland was denied its motion for summary judgment in its favor, the entire use of estimation…,at least for years prior to 2010 is now officially being called into question.  The case will likely take years to conclude, but in the end may alter Delaware’s ability to estimate liabilities back 20-30 years, or if Temple-Inland prevails on all points, prohibits the State to use estimation techniques what so ever in measuring a Company’s unclaimed property liability.

Companies that entered into a VDA on or before June 30, 2013, under existing law only have until June 30, 2015 to settle with the state, or risk audit should the State ultimately prevail in the Temple Inland case which surely will not be concluded within the next three months.

As such, the recent set of developments provides companies with a conundrum in term of pushing forward to finalize existing VDA’s in progress. While the June 30th date is looming, there is considerable risk if Delaware were to ultimately prevail in the Federal court decision and a favorable agreement is not reached prior to that date. In that situations companies that fail to conclude the VDA are exposed to considerable risk of audit.  Alternatively, if the plaintiff, Temple-Inland succeeds, as it seems currently there is some momentum leaning in their favor, VDA applicants may wish to ensure their rights are protected in the finalizing the settlement agreement,   pending outcome of the Federal court case. The problem is that the Federal decision will not be rendered until AFTER June 30, 2015, the date most companies need to finalize their VDA. (June 30, 2016 for Companies that entered the program between July 1, 2013 and September 30, 2014)

Timing is still of some importance because while the Secretary of State continues to push the VDA program its alter ego, the Dept. of Finance continues to aggressively audit companies that it believes are not in compliance with the state’s unclaimed property reporting guidelines. Just this year several hundred companies have received audit notices and the state continues to add to its ranks of third party contingent fee auditors that have prevailed in securing hundreds of millions in additional revenues for the state through its perceived aggressive audit practices.

Plenty of possible scenario’s and potential outcomes to consider.

1 Under laws initiated in 2013 the independent review was appointed by Delaware’s Secretary of Finance, who is the defendant in the case brought by Temple-Inland.  (12 Del. C. § 1156(j), enacted July 23, 2010.

2 Texas v. New Jersey,  379 U.S. 674 (1965), Pennsylvania v. New York, 407 U.S. 206(1972), and Delaware v. New York, 507, U.S. 490 (1993)

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