The long-running dispute between states and the business community over the expansive nature of unclaimed property audits has taken a new turn, with a Delaware state court quashing a subpoena served in the course of an audit conducted by a contingency-fee auditor, in State of Delaware, Department of Finance v. AT&T Inc. (Del. Ch. July 10, 2020).¹ Although the court acknowledged the state’s power to subpoena records, the court found that the subpoena was so overly broad and unreasonable that enforcing it would constitute “an abuse of the court’s process.” Significantly, the information sought by the state and its auditor, Kelmar Associates, was similar to the standard data request that Kelmar has pursued on the state’s behalf in the normal course of audits of hundreds of large companies.

It was a combination of the following factors that caused the court to find that enforcing the subpoena would be an abuse of process, with no one factor alone being determinative:

1. Exceeding the statute of limitations by seeking records back to 1992;
2. Exceeding Delaware’s jurisdiction by seeking records of property that would be due, if at all, to other states;
3. Requesting overly broad data on records for “all checks,” when paid checks could not possibly be unclaimed property; and
4. Allowing a contingency-fee auditor to control the investigation with minimal state oversight.

Audit background

Similar to audits currently being conducted against hundreds of other companies, the Delaware Department of Finance opened an audit of AT&T in 2012 using its primary third-party auditor, Kelmar Associates. Consistent with its standard audit method, Kelmar requested voluminous data from the holder in a range of areas. The holder responded to many of the requests, but resisted providing the full scope of information in selected areas, including the “Disbursements Request” in which Kelmar requested “information concerning every check AT&T had issued from twenty-seven accounts since June 1992,” including checks written to payees in every state, not just to payees in Delaware. Given the size of the company under audit, the number of accounts, the time period, and the geographic scope, the request covered millions of payments made by the holder. When the holder refused to comply in full, the Department converted Kelmar’s information request into a subpoena by merely attaching the Kelmar data request to a form subpoena, with no modifications. Delaware then filed a lawsuit to enforce the subpoena in the Delaware Chancery Court. On a parallel track, the holder sued Delaware in federal court alleging that Delaware’s audit and extrapolation method is unconstitutional.²

Findings of the court

After briefing and a hearing, the Delaware Chancery Court quashed the subpoena, finding that the scope of the subpoena was so expansive that enforcement would constitute an abuse of the court’s process. The court identified multiple problematic aspects of the subpoena, though from the court’s view, the overarching problem seemed to be that the subpoena “will sweep in a vast amount of irrelevant data.”

1. Statute of limitations. First, the court found that the subpoena sought records far beyond the statute of limitations. Specifically, the subpoena sought records back 20 years to 1992, when current Delaware law has a 15-year statute of limitations. More significantly, however, the court rejected Delaware’s argument that the state’s current unclaimed property statute, enacted in 2017, applies retroactively to extend the shorter, 3-year statute of limitations under the prior version of the escheat law to the ongoing audit. Although the court declined to apply a “bright-line” rule barring the Department from seeking information beyond the statute of limitations, the court found that the expansive request made it likely that the subpoena was improper, or at a minimum, requiring further explanation from the Department as to whether the request was appropriate.

2. Geographic scope. Second, the court found it problematic that the subpoena sought records for checks issued to payees in other states, which would never result in escheatable property due to Delaware. Again the court did not find that such a request was categorically improper in all circumstances; rather, the court stated that “[a]ll else equal, however, a broad request for information concerning property that does not fall into any escheatable category makes it more likely that enforcing a subpoena would be an abuse of this court’s process.”

3. Records of cashed checks that cannot be unclaimed. Third, the court was concerned with the breadth of the request in another area: that the subpoena asked for every single check issued by the holder, regardless of disposition. Most checks had been cashed and therefore could not possibly result in unclaimed property. Although the court speculated that this information might be relevant to verify the accuracy of data, the court considered the expansive nature of the request as part of its evaluation.

4. Control by the contingency-fee auditor. Finally, the court expressed significant concerns about the scope of authority delegated by the Department to the third-party auditor, Kelmar. The court noted that the requests appeared on Kelmar letterhead, and that Kelmar “appears to have conducted the investigation,” with “no indication that the Department had any meaningful involvement.” In light of Kelmar’s contingency-fee compensation, the court viewed the arrangement as creating a potentially “pernicious incentive” for Kelmar to “engage in aggressive enforcement tactics” and “engage in expansive audit tactics that impose substantial burdens on companies.” The court was also concerned with Kelmar’s relationships with other states, viewing this as “a potential motivation for Kelmar’s insistence on obtaining records for all checks and rebates, regardless of whether or not the last-known address on [the holder’s] records indicates that the property would be escheatable to Delaware.” In the court’s view, “the breadth of the Subpoena in this case is suggestive of such tactics.”

For this combination of reasons, the court quashed the subpoena in its entirety. The court indicated that it would have preferred to give deference to the Department, and to have enforced a narrowed version of the subpoena, but the Department had declined to suggest a narrower path for the court to follow. The Department has filed a motion for rehearing, arguing among other things, that Kelmar is no longer compensated on a contingency basis by the State of Delaware.

Audit estimation methods again under assault

The Chancery Court decision quashing Delaware’s subpoena is one piece of a long-running dispute over the expansive auditing techniques employed by Delaware and other states, and specifically the use of controversial estimation techniques to impose large assessments for alleged non-compliance. In late 2019, four holders, including AT&T, initiated litigation against Delaware in federal court challenging the audit methodologies as unconstitutional.³ Delaware’s estimation techniques, pioneered by Kelmar, are controversial because they can result in wildly disproportionate assessments due to Delaware. Because the lookback period for an audit often exceeds typical record retention periods, auditors will use estimation techniques to estimate a liability for periods where records are not available. Most significantly, for companies incorporated in Delaware, the state continues to take the aggressive position that it has the authority to review all of the company’s data, regardless of jurisdiction, and to issue an estimated assessment for a 50‑state liability, payable only to Delaware, for the periods where complete records are no longer available.

The new round of litigation against Delaware follows many of the themes of the 2016 federal district court decision striking down Delaware’s prior estimation method as unconstitutional. In Temple-Inland v. Cook,⁴ the court held that the estimated assessment at issue was a “gotcha” that “shocks the conscience.” Specifically, the court in Temple-Inland identified six “troubling” aspects of the assessment and held that Delaware violated the holder’s substantive due process rights by (1) waiting 22 years to audit Temple-Inland and then issuing an audit assessment for a 17-year period back to 1986; (2) avoiding the 6-year statute of limitations by “exploit[ing] loopholes” under dubious circumstances; (3) giving holders no notice that they needed to retain unclaimed property records for periods beyond standard retention periods to defend against “unmeritorious audits” using estimation; (4) failing to articulate a reason other than raising revenue for retroactively applying a 2010 statute that authorized the use of “reasonable estimates”; (5) calculating an estimate on a 50-state basis and claiming the full amount for Delaware; and (6) subjecting Temple-Inland to potential “multiple liability” on the same property from various states. In the wake of the Temple-Inland decision, Delaware overhauled its unclaimed property statute and promulgated new regulations governing audits. Although Delaware made some changes in response to that court decision (such as shortening the state’s lookback period to 10 reporting years plus dormancy), the new regulations mostly repackaged the same disputed audit method as before.⁵

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