Delaware is instituting an aggressive push forward on its controversial unclaimed property audit program, as indicated in two recent announcements. The Secretary of State has announced that his office will begin sending notices to non-compliant holders threatening them with an audit if they do not enroll in the voluntary disclosure agreement (VDA) program. Meanwhile, the Secretary of Finance has finalized new audit regulations that reaffirm the state’s use of disputed estimation techniques. Any company receiving a notice that does not enroll in the VDA program within 60 days “will be” referred for examination by a third-party auditor.
The resumption of Delaware audit activity is not unexpected, but the immediate and coordinated release of the audit regulations on estimation and the VDA notices suggests that the state intends to use all available tools to continue raising revenue for Delaware through unclaimed property. The VDA announcement came first, in an email from the Secretary of State on September 29, 2017, stating:
In two weeks, my office will begin mailing notices to Holders who have been identified as likely being out of compliance with Delaware law as it relates to reporting dormant abandoned or unclaimed property. Holders that do not enroll in the SOS VDA Program within 60 days of the mailing of this notice will be referred to the State Escheator for examination. If an audit notice is issued, the Department of State will have no legal ability to accept a Holder into the SOS VDA Program.
Because Delaware law no longer permits the state to initiate audits without first giving a company the opportunity to enter into the VDA program,1 the notices from the Secretary of State are the first step for Delaware to start a new round of audits. The short response deadline (60 days) will give companies limited time to consider their options upon receipt of a notice. (Other states that send similar notices typically give companies a longer time to elect to enter into a VDA.) For companies that do not enroll in the Delaware VDA program, any new Delaware audits will be conducted by third-party auditors.
Two days after the announcement by the Secretary of State, on October 1, 2017, the Department of Finance finalized new audit and examination regulations that have been under development since early 2017. Under the new regulations, Delaware and its third-party auditors will continue using controversial estimation techniques, even after a federal court found a virtually identical audit methodology to be unconstitutional in 2016. Indeed, the new regulations appear to have put into writing mostly the same process that has generated such controversy in recent years. And given Delaware’s reliance on unclaimed property as a significant source of state revenue, the newly promulgated regulations are likely to continue the state’s ongoing battles with the business community, with litigation the likely result. The Secretary of State has finalized similar regulations for the VDA program, which also incorporate the controversial estimation methodology.
The new regulations followed a wholesale revision to the Delaware unclaimed property law in early 2017, which came as a result of a federal court decision in 2016 holding that Delaware violated a holder’s constitutional due process rights by issuing an unclaimed property assessment based on an estimated liability back to 1986, in Temple-Inland v. Cook, 192 F. Supp. 3d 527 (D. Del. 2016).
The court held that the specific audit estimation method employed by the state’s third-party auditor, Kelmar Associates, 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 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.”
Although the lookback period has been shortened to 10 reporting years (15 years total), the new regulations mostly reaffirm Delaware’s commitment to continue using the same disputed audit methods. Most significantly, for companies incorporated in Delaware, the state continues to take the controversial position that the state has the power to review all of the company’s data, regardless of whether the property has a clear nexus to another state, and to issue an estimated assessment for a 50-state liability on behalf of only Delaware for the periods where complete records are no longer available.2 This method appears to be in direct conflict with the court decision in Temple-Inland. Any estimation method that awards all estimated property to Delaware—regardless of the addresses of the items in the sample—will continue to expose holders to a risk of double jeopardy if another state asserts the right to take custody of the same unclaimed property during the reach-back years.
For companies already under audit by the Department of Finance, the promulgation of the new audit regulations on October 1, 2017 starts the running of a 60-day deadline for a company to elect conversion of the audit to a VDA. Any company that received an audit notice before July 22, 2015, may choose between continuing the existing audit, electing an expedited audit or converting the audit to a VDA.
These twin developments—the promulgation of estimation regulations and the announcement of VDA notices—begin a new chapter for unclaimed property audits in Delaware. The recent lull in audit activity has ended with a bang, and the stage is set for future challenges to the state’s use of controversial estimation techniques. Delaware companies that are not up to date on unclaimed property reporting should keep an eye on the mailbox for a Delaware VDA notice. These companies may face decisions on whether to enter the VDA program and how to remediate any past non-compliance.
1 There are several exceptions to this restriction, for example, if Delaware is joining a multi-state examination that has been initiated by other states.
2 Both the audit regulations and VDA regulations state: “To the extent permitted by law, names and addresses identified in the Base Period shall not be used to determine which state has the priority claim to the abandoned property estimated to be due over periods where records of owners' addresses do not exist.”
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