Federal District Court Holds Delaware’s Unclaimed Property Estimation Methods Violate the Constitution
July 6, 2016
The State of Delaware regularly audits Delaware corporations with regard to unclaimed property liability. As part of such audits, for periods when such corporations did not have the necessary books and records, Delaware would estimate such corporation’s unclaimed property liability to Delaware and assess that amount. However, on June 28, 2016, the U.S. District Court for the District of Delaware held that the State of Delaware’s method of estimating unclaimed property liability in the case of a Delaware corporation violated the substantive due process requirements of the Fourteenth Amendment of the U.S. Constitution. Temple-Inland, Inc. v. Cook, et al., Civ. No. 14-654-GMS (D. Del. June 28, 2016).
In general, the U.S. Supreme Court cases of Texas v. New Jersey and Delaware v. New York established priority rules regarding a state’s entitlement to escheat unclaimed property. Pursuant to those cases, the state of the address of the rightful owner (as such address appears on the books and records of the holder) has the first priority to escheat dormant unclaimed property (“address property”). If the holder’s books and records do not show an address of the rightful owner of the dormant amount, then the state of incorporation of the holder may escheat such dormant unclaimed property (“non-address property”). Accordingly, while Delaware may not be entitled to a significant amount of address property, as the primary state of incorporation, it might be entitled to escheat a significant amount of non-address property.
Historically, the State of Delaware has audited Delaware corporations without a statutory limit to the number of years included in the audit.1 As most holders only retain records for a period approximating seven years, Delaware would generally “estimate” unclaimed property for any year for which the audited holder did not have sufficient books and records. In general, this estimate was calculated by applying the holder’s unclaimed property experience to a metric (such as gross revenues, total payroll, etc.) that was available for all periods under review. However, in calculating such estimated unclaimed property liability, Delaware would consider both Delaware escheatable items and non-Delaware escheatable items, thus calculating more in the nature of “total” unclaimed property liability for the period for which a holder did not have books and records. Delaware would then assert the entitlement to take all such estimated liability as non-address property under the rule of Texas v. New Jersey.
In Temple-Inland, Inc. v. Cook, et al., the plaintiff asserted that this estimation technique was both (i) a violation of the substantive due process requirements of the Fourteenth Amendment of the U.S. Constitution, and (ii) an impermissible ex post facto law. The plaintiff and the defendant State of Delaware both filed cross-motions for summary judgment on the issues presented. On June 28, 2016, the U.S. District Court for the District of Delaware decided that although Delaware’s unclaimed property estimation technique is not an impermissible ex post facto law, it does “shock the conscience” and thus violates the substantive due process requirements of the Fourteenth Amendment of the U.S. Constitution. However, the opinion expressly indicated that it was not prescribing a particular appropriate remedy at this time. It is expected that the State of Delaware will appeal the decision.
If you would like to discuss the implications of Temple-Inland, Inc. v. Cook, et al. or any aspect of Delaware unclaimed property law, please feel free to contact a Richards, Layton & Finger attorney to discuss further.
1 Delaware does have an applicable statute of limitations with respect to a filed Delaware annual unclaimed property report. However, as Delaware only requires that an annual report be filed if the holder has something to report, only a small percentage of Delaware-incorporated holders ever file annual reports. Accordingly, such statute of limitations rarely applies. In 2015, Delaware enacted a statutory look-back period of 22 years for audits initiated on or after January 1, 2017. See 12 Del. C. § 1155(e).