Federal Court had found method and audit techniques unconstitutional
Update (8/25/16): On Aug. 23, 2016, a U.S. District Court judge approved a joint motion to dismiss Temple-Inland’s case against the state of Delaware due to a voluntary settlement agreement entered into by the parties. The district court case is closed—the judge never having an opportunity to address an appropriate remedy for the state’s unclaimed property audit procedure previously determined to ‘shock the conscience.’
It is expected that the Delaware Secretary of State will be releasing a communication within the next few weeks discussing the impact of Temple-Inland on the Delaware unclaimed property voluntary disclosure process and potential changes to that process. Unclaimed property holders soon entering into or seeking to close a voluntary disclosure agreement with the state may want to consider waiting until the Secretary of State releases his communication.
Update (8/22/16): On Aug. 5, 2016, Temple-Inland and the state of Delaware filed a joint motion to dismiss Temple-Inland’s challenge to Delaware’s unclaimed property audit techniques before the U.S. District Court. According to the motion, the parties entered into a settlement agreement that resolves all the claims asserted or could have been asserted. The terms of the settlement have not been publically released.
While the district court previously ruled that Delaware’s audit techniques violated substantive due process, a remedy was not provided by the court at that time of the decision. The motion to dismiss effectively resolves the case, and a remedy – that similarly situated businesses were eagerly awaiting, will therefore not be addressed by the district court. Once the motion is granted, subsequent challenges to the state’s audit procedures will need to be re-litigated to determine a remedy for the due process violations. At the time of publishing, the district court has not yet granted the motion to dismiss.
Delaware’s Finance Secretary Tom Cook wrote in an email that the state was “conducting a thorough review of the state’s escheat statutes, regulations, policies and procedures, with the intention of improving the program going forward.” He also wrote that “the department will continue to conduct audits and resolve pending examinations on a case by case basis and in accordance with the advice of legal counsel.” At this time, Delaware unclaimed property holders under audit should still be encouraged by the district court’s opinion and consider leveraging the decision in their own negotiations with the state. It is unclear when the state’s review of its current audit procedures will be complete, but property holders should not wait for any potential changes before speaking to their unclaimed property advisor.
ORIGINAL (6/30/16): On June 28, 2016, the U.S. District Court for the District of Delaware issued its opinion in Temple-Inland, Inc. v. Cook et al., No. 14-654-GMS, finding that Delaware’s unclaimed property estimation methodology and audit procedures violate substantive due process.
In 2008, the state of Delaware initiated an unclaimed property audit of Temple-Inland through the use of a third party audit firm, Kelmar Associates LLC, covering a 22-year audit period from 1986 to 2007. In response to a record request, Temple-Inland was only able to produce complete records back to 2003, resulting in Kelmar’s use of a sample period to extrapolate liability for years where records were not available. Due to a single $147.30 payroll check in the sample that was determined to be subject to escheat to Delaware, Temple-Inland was assessed almost $1.4 million in unclaimed property liability for the entire audit period.
After Temple-Inland filed suit against Delaware in 2014, the state filed a motion to dismiss, which was ultimately denied. For more information on the state’s motion to dismiss, please read our alert, US District Court declines to dismiss unclaimed property suit. In December 2015, Temple-Inland amended its complaint to limit its claims to due process, takings and ex post facto clauses. Soon thereafter, Delaware raised the abstention argument for the first time. Outlined below are the claims and related findings.
Abstention: Initially, the state requested the court abstain from hearing Temple-Inland’s claims until a state court had the opportunity to interpret 12 Del. C. section 1155, the provision permitting the state to examine an unclaimed property holder’s records, which the state asserted was ambiguous. The court dismissed that request finding the statute unambiguous in requiring unclaimed property holders to “reasonably estimate” what is due.
Due process violation: The court next addressed Temple-Inland’s substantive due process claims. The court determined that the standard of judicial review required to determine whether Delaware’s unclaimed property administrative process violated Temple-Inland’s substantive due process clause protections must 'shock the conscience.' While the court refrained from determining whether any single action rose to such level, the court did conclude that the state’s actions were sufficient in combination to shock the conscience.
Specifically, the court found that Delaware:
- Waited 22 years to initiate the audit
- Exploited loopholes in the statute of limitations
- Never provided proper notice of the need to maintain unclaimed property records longer than standard retention policies require
- Failed to articulate a legitimate state interest in retroactively applying their extrapolation requirement except for raising revenue
- Used an estimation methodology where characteristics in the sample that increased liability were replicated across the entire population while those that reduced liability were ignored
- Resulted in multiple liability (i.e., same amounts due to more than one state)
The court noted that in the aggregate, the above actions resulted in a game of ‘gotcha’ that violated Temple-Inland’s due process. However, the court deferred decision on the matter of an appropriate remedy until a later date.
Takings clause and ex post facto clause: The court also addressed Temple-Inland’s takings clause and ex post facto claims. The court, in not concluding on the takings clause claim, noted that issues of material fact still remain because the parties did not present evidence or arguments on the reasonableness of the state’s estimation approach. Additionally, the court denied Temple-Inland’s ex post facto clause claim on the basis that such violations are limited to criminal punishments and civil measures that are, in effect, criminal punishments in disguise. The court held that Delaware’s unclaimed property holder examination statute, 12 Del. C. section 1155, “does not have a criminally punitive purpose or effect.”
Takeaway and next steps
Due to the significance of this opinion and its potential impact on negotiations with state and third party auditors, it is likely that Delaware may appeal this decision. In that scenario, final resolution on the issues may take years. It is imperative that businesses with unclaimed property obligations carefully evaluate their positions on closed, current and future Delaware audits and voluntary disclosure agreements. Companies should discuss the potential impact with their unclaimed property advisors.