Unclaimed property audits and compliance changes will challenge many US companies in 2023. Any company that is not filing annual reports will be at risk of an expensive multi-year audit, and even long-time filers could be targeted by states and their contract auditors. Outrageous audit practices are spilling over into the courts, as companies push back on what they view as overbroad state enforcement positions. Some states view escheat as an important source of revenue, and state budget strains will create pressures for states to generate revenue through unclaimed property enforcement. On the legislative front, more than a dozen states have overhauled their laws in recent years, in some cases with retroactive implications, and at least several states are already considering major unclaimed property legislation for 2023. And last but not least, an unclaimed property case before the United States Supreme Court took a surprise turn after oral argument, and more turns are expected in the case in 2023.
Below we discuss several areas to watch in 2023.
1. The more things change . . . more audits and new legislation
Each year seems to bring a new round of state audits, legislation, and litigation, and 2023 will be no exception. States and third-party auditors are steadily initiating new audits targeting companies in all industries. Although multi-state audits are the norm, there are several emerging trends, including for states to open up single-state audits and for multi-state audits to be conducted even where the state of domicile is not involved. The most active state continues to be Delaware, which has already announced that it will be sending “invitations” to its Voluntary Disclosure Agreement (VDA) Program in February and July of 2023. Because Delaware law no longer permits the state to initiate audits without first giving a company the opportunity to enter into the VDA program, VDA notices from the Secretary of State are the first step for Delaware to start new rounds of enforcement. Companies that receive a VDA notice but do not enroll in the Delaware VDA program can expect to be audited by one of Delaware’s third-party contract auditors.
Third-party audits are extremely burdensome and can pose the risk of large liability. Private audit firms issue voluminous data and document requests, going back ten or more years, and then take a “guilty until proven innocent” approach to any items that meet their overbroad testing criteria. For example, under Delaware examination regulations, auditors will presume that any payment voided more than 30 days after issuance is “unclaimed property” unless a company can provide precise documentation to prove otherwise. These exacting standards are applied to payments issued many years ago. Some auditors are also now asserting that any returned electronic payment is also presumed to be unclaimed unless proven otherwise. Some companies are challenging these audit methods, such as in Michigan, where the state court of appeals recently held that an assessment going back to 2002 was outside the statute of limitations.1 The Michigan Court of Appeals reasoned that the state’s commencement of an examination in 2013 was not an “action or proceeding” that would toll the statute of limitations under state unclaimed property law. The court determined the legislature’s use of the words “action or proceeding,” rather than the term “examination,” was intentional, considering how the terms are used throughout the state law. Some other states have similar statutory provisions in their unclaimed property laws.
Meanwhile, state legislatures are likely to be active once again on the unclaimed property front in 2023. An ongoing trend is for states to enact wholesale replacements to their unclaimed property statutes modeled after the 2016 Revised Uniform Unclaimed Property Act (also known as RUUPA). The 2016 Uniform Act has now been enacted, in some form, by a dozen states in the past five years (a new law in Washington took effect January 1, 2023), and several states are already considering legislation in 2023. Any new enactments could create compliance challenges, and some states have asserted that changes apply retroactively. States to watch in 2023 include South Dakota, Nevada, and Montana.
2. False claims act litigation raises the stakes for compliance
State false claims act lawsuits, also known as qui tam cases, will be an area of concern for holders. In the unclaimed property context, these lawsuits allege that a company has knowingly and willfully underreported amounts owed to the state. State false claims acts often permit the recovery of treble damages, which raises the stakes for unclaimed property compliance and risk management. And these cases can be pursued by state attorneys general, private whistleblowers, or both.
In recent years, companies in a variety of industries have faced false claims actions alleging underreported unclaimed property, including gift card issuers, financial institutions, and life insurers. In May 2022, the New York Attorney General announced a $36 million settlement against a major retailer for alleged underreporting of unused gift cards to the state, saying the company had “lied” to the state when it said that a non-New York company was handling its gift card business.2 Around the same time, the California Attorney General brought a false claims action against a healthcare provider alleging failure to remit millions of dollars in unclaimed overpayments, refund checks, and other monies due to California as unclaimed property. The complaint alleged that these funds were deliberately concealed from California, and a press release accompanying the complaint asserted that the healthcare provider’s alleged non-compliance constituted “corporate fraud.” More recently in November 2022, a California appellate court allowed a case to proceed in which a plaintiff-relator alleged that two banks violated the California False Claims Act (the CFCA) by reporting unclaimed cashier’s checks to Ohio rather than California, and thereby allegedly underreporting amounts to California.3 These cases and other raise the stakes for unclaimed property compliance.
3. Audit litigation intensifies in Delaware
Delaware’s audit methods have faced numerous litigation challenges from companies in recent years, and the litigation currently pending in federal court could see key rulings in 2023. Court decisions could impact the direction of Delaware unclaimed property audits and the state’s use of controversial estimation methods. In Siemens U.S. Holdings Inc. v. Geisenberger,4 the holder’s challenge to Delaware’s methods was initially dismissed as premature, but a Third Circuit decision has allowed the case to proceed on the merits of the company’s constitutional challenge to the state’s audit methods.
Delaware derives great benefit from the state v. state priority rules that allow an organization’s state of incorporation to escheat unclaimed funds with unknown addresses. Because so many companies are incorporated in Delaware, escheatment has become a major source of revenue for the state, and Delaware’s enforcement methods have led to controversy. In 2016, a Delaware federal district court held that Delaware’s audit methods were a “gotcha” that “shocks the conscience,” and a violation of the US Constitution’s substantive due process clause.5 In response, the state overhauled its unclaimed property laws in 2017 to fix some of the problems identified by the court, such as adding a new 15-year statute of limitations and creating a voluntary compliance program. But in other key respects, Delaware has continued to follow a similar enforcement approach as before. In audits, Delaware continues to assert the authority to calculate an estimated liability on a 50-state basis and claim the full amount for Delaware, if a company no longer has “complete and researchable” records going back 15 years. The validity of this estimation method may ultimately need to be decided by the courts.
4. California working on a VDA program
California has enacted legislation authorizing a Voluntary Compliance Program (VCP), and the California Controller’s Office will begin to develop the program once an appropriation is made in California’s annual budget. For unclaimed property reported in accordance with the terms of the VCP, the Controller will waive the 12 percent interest assessment that California typically imposes on past due amounts.
Note that certain holders will not be eligible to participate in the VCP, including holders that (i) are already under audit in California; (ii) are the subject of a civil or criminal prosecution for unclaimed property noncompliance; (iii) have been notified of an interest assessment within the past five years that remains unpaid at the time of the VCP application; or (iv) have had a California interest assessment waived within the past five years, although such holders may still request to enroll to resolve unclaimed property arising as a result of an acquisition or merger.
Holders should begin assessing whether they have past due property in California and whether they will be eligible to enroll in the VCP once it becomes operative. For a holder that has identified potentially past due property in California, the VCP will be an opportunity to come into compliance and mitigate the risk of a state audit and the assessment of interest and penalties. We also expect that holders will have greater control of the VCP review process as compared to a state audit.
5. Unclaimed Property at the Supreme Court
The US Supreme Court this year is expected to issue a decision in Delaware v. Pennsylvania, a state-versus-state dispute between Delaware and thirty other states over which state has priority to claim hundreds of millions of dollars of uncashed “MoneyGram official checks.” The holder, MoneyGram, escheated the unclaimed checks to Delaware, based on the common law priority rule that allows a company’s state of incorporation to take custody of abandoned property for which the address of the owner is unknown. Other states, led by Pennsylvania and Arkansas, argue that for these instruments, a federal statue overrides the common law priority rules. This 1974 federal statute, the Federal Disposition Act,6 dictates that unclaimed funds from money orders or “other similar written instruments” are to be escheated to the state where the checks were purchased. Special Master Judge Leval, appointed by the US Supreme Court, initially agreed with Pennsylvania and the other states in his First Interim Report, finding that the federal statute and not the common law priority rules should apply to these disputed instruments.
Both parties had an opportunity to argue their case before the Supreme Court in October 2022. During oral argument, some of the Justices appeared skeptical about Delaware’s narrow reading of the statute, questioning the weight given to the labeling of the disputed instruments, and whether Congress intended the statute to cover them. Then in a surprise twist, after the Supreme Court argument, the Special Master changed his recommendation and partly sided with Delaware. The Special Master now found that some of the disputed instruments were not subject to the federal statute, because to the extent they were drawn by a bank as drawer, they would fall within the statute’s “third party bank checks” exception.7 By recommending that some of the instruments are not subject to the federal statute, the updated recommendation by Special Master potentially turns the case on its head, opening up the possibility that the Supreme Court may, at a future stage, be asked to revisit the longstanding federal common law priority rules that determine which state is entitled to take custody of unclaimed funds.
Conclusion
Holders must be prepared for the ever-evolving landscape of unclaimed property audits, compliance expectations, legal requirements, and litigation. The law in this area has developed rapidly over the past few years and more change is expected in 2023 and beyond.
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1 Disney v. Eubanks, No. 360291 (Mich. Ct. App. Jan. 19, 2023); Dine Brands v. Eubanks, No. 360293 (Mich. Ct. App. Jan. 19, 2023).
2 State of New York ex rel. French v. H&M Hennes & Mauritz, No. 101101/2016 (Sup. Ct of New York, County of New York, May 16, 2022).
3 JPMorgan Chase Bank, N.A. v. Superior Ct. of the City and Cty of S.F., State of Cal. ex rel. Ken Elder, No. A164519, A164521, 2022 Cal. App. LEXIS 953 (Cal. Ct. App. Nov. 18, 2022). Similar cases are pending in a number of other states.
4 Siemens U.S. Holdings Inc. v. Geisenberger, No. 20-2991, 17 F.4th 393 (3d Cir. 2021).
5 Temple-Inland, Inc. v. Cook, No. 14-654-GMS, 192 F. Supp. 3d 527 (D. Del. 2016) (“To put the matter gently, defendants have engaged in a game of ‘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 constitutional 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 six-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.”
6 The Federal Disposition of Abandoned Money Orders and Traveler’s Checks Act (the “Federal Disposition Act”), 12 U.S.C. § § 2501–03.
7 Second Interim Report of the Special Master at 2-3, Delaware v. Pennsylvania, No. 145, 146 (Dec. 13, 2022).
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