After four-plus years of litigation in a long-running dispute over unredeemed gift cards, a jury returned a verdict against Overstock.com, finding that the company violated the Delaware False Claims Act (FCA) by not reporting the balances of unredeemed gift cards to the state as unclaimed property. The jury’s finding covered four years of reporting and nearly $3 million in unredeemed gift cards. Although the trial only involved Overstock.com, the state had initially brought suit against more than two dozen retailers and restaurants, resulting in more than $25 million in settlements. The decision illustrates the potential risks of inadequate escheat planning structures and the toxic mix between the FCA and unclaimed property laws when false claims allegations are made for failure to report unclaimed property.
Delaware files suit against more than two dozen retailers
In 2013, the Delaware Attorney General’s office joined in a qui tam (whistleblower) lawsuit brought by a private party (the relator) challenging a third-party gift card structure as allegedly lacking in economic substance. In Delaware ex rel. French v. Card Compliant et al., the state and relator brought an action under the Delaware FCA against more than two dozen retailers and a card services company, CardFact. The retailers and CardFact had entered into contractual arrangements under which CardFact would serve as the issuer and holder of gift cards sold by and redeemable at each of the retailers.1 CardFact provided gift card issuance and management services and formed “Giftcos,” i.e., entities incorporated in states where unredeemed gift cards are not treated as unclaimed property, for various retailers incorporated in Delaware, which requires reporting of unredeemed gift cards as unclaimed property.
The complaint alleged that the defendants established a scheme to avoid escheatment of gift cards by entering into “sham” contracts purporting to identify CardFact as the holder of the gift cards, when, in fact, the retailers were the true holders. The complaint further alleged that (i) CardFact did not actually “issue” the cards and had limited involvement, if any, with the gift card programs; (ii) the arrangement lacked economic substance and “created a false paper trail” to conceal that the retailers were the true holders; and (iii) the gift cards were always within the possession, custody and control of the retailers, which managed their own programs no differently than they had before their agreements with CardFact. The complaint further alleged that unredeemed gift cards should have been reported to Delaware (as the state of incorporation of the retailers) and that the retailers could not legally avoid escheatment through contracts with various CardFact entities incorporated in states with gift card exemptions.
A consistent theme of the case was the relationship (and dispute) over which entity (the retailer or CardFact) was the issuer and holder of the gift cards. The retailers argued that under the agreements CardFact was the issuer, and therefore the holder. The state argued that CardFact was not really the issuer, because the agreements were “false” and lacked economic substance, and therefore the retailers were the true holders. The state also argued that the retailers were always in possession of the funds. The retailers vigorously contested each of these points.
In a motion to dismiss and later a motion for summary judgment, the retailers argued that the structure was valid under the unclaimed property priority rules established by the Supreme Court, that they were not the relevant debtors, that there was no false record, and that they did not knowingly violate Delaware’s FCA because the structure was objectively reasonable. The court denied both a motion to dismiss and a motion for summary judgment and was skeptical of the structure. The court stated that the relevant contractual relationship was between the retailers and the customers, irrespective of the card servicing contracts. In the court’s view, the retailers could not contract away their gift card obligations with the customers without their customers’ consent:
CardFact and the Retailers cannot contract amongst themselves to avoid obligations to their customers (or Delaware). The only relationship involving the creditor (the customer) is the one between the creditor and the Retailers, in contrast to the Retailers’ relationship with CardFact. Because the creditor-Retailer relationship is the relevant relationship, the Delaware-based Retailers are the relevant debtors for escheat purposes. Again, that is true even if the Retailers and CardFact have their [agreements].2
The case proceeds to trial
Although the case initially involved more than two dozen retailers and restaurants, only one retailer, Overstock, proceeded to trial. Various other defendants were dismissed based on fact-specific issues, and others settled in the lead-up to trial. Press reports have indicated that the settlements totaled $25 to $30 million.
The jury deliberated for just over an hour after a six-day trial, finding Overstock liable for almost $3 million in unredeemed gift cards. Including an adjustment to the liability for cost of goods sold, and after trebling the damages as provided by the FCA, total liability may exceed $7 million. Overstock has indicated that it is considering an appeal.
Qui tam and unclaimed property: A toxic mix
The state’s core theory—that underreporting of unclaimed property implicates the FCA—is a theory that has been pursued in a number of prior cases, although with mixed results. As background, and using Delaware’s FCA as an example, a violation occurs if a person knowingly makes, uses or causes to be made a false claim for payment, a false record related to a false claim, or a false record related to the transmission of cash or goods to a state governmental entity or its local governments (or conspires with another party to do any of the above).3 While the state may bring an FCA action on its own, the statute allows “any person” to bring a civil claim for a violation of the FCA.4 An action brought under such provision is known as a qui tam action.5 The qui tam provision is intended to encourage insiders to disclose fraudulent practices,6 resulting in qui tam plaintiffs being referred to as “whistleblowers.”7 If the state’s FCA claim is successful, the defendant may be penalized with treble damages between $5,500 and $11,000 per claim,8 plus costs and attorney fees can be awarded to the plaintiff.9
In the past, state unclaimed property FCA litigation has targeted a wide variety of holders. Some FCA litigation focused on holders that had made refunds available to their customers, such as utilities companies, or state agencies that had offered refunds for unclaimed tax exemptions.10 Since the entire amount of available refunds was seldom claimed due to unidentifiable or uninterested clients, or interested clients failing to cash their checks, holders routinely had some funds that remained unclaimed that whistleblowers viewed as unlikely to have been reported.
An interesting possible twist to an FCA claim commenced in the unclaimed property area is the potential for collateral consequences for a holder, such as a shareholder derivative suit.11 For example, in Robbins v. Alibrandi, the plaintiffs, shareholders of a local bank, brought a shareholder derivative suit against the bank’s former board members for mismanagement that resulted in the settlement of a separate qui tam suit, in which the bank and another corporate defendant paid California $187.5 million to settle claims that it failed to escheat to the state of California more than $1 billion in unclaimed property.12
Another interesting twist occurred when California brought an FCA claim against tax return preparers who helped the holder prepare the false records.13 In California ex rel. Harris v. PricewaterhouseCoopers, LLP, after the trial court awarded the City and County of San Francisco damages for a company’s FCA violation, the complaint was amended to include PricewaterhouseCoopers (PwC), alleging a conspiracy to violate the FCA, since PwC had been the accountant for the liable company during the years in question.14
These cases demonstrate both the breadth of companies potentially at risk for being targeted with FCA claims, as well as the collateral risks to companies and their representatives. As the spotlight on unclaimed property matters has increased, and with whistleblower actions becoming more prevalent, the risks to companies have likewise increased.
Key takeaways
The jury verdict in this gift card litigation may impact the frequency and tenor of FCA litigation to come. Holders not only need to be prepared to defend their escheatment and reporting decisions against state revenue departments and third-party auditors, they now may also face lawsuits under FCA laws. FCAs invite a new class of potential opponents—state attorneys general and the plaintiffs’ bar—who may be driven by incentives that do not necessarily align with the purpose of unclaimed property laws.
Providing an additional avenue of litigation that produces excessive qui tam awards departs from the purpose of the escheatment laws, i.e., to protect the rights of absent owners. FCAs are intended to provide the government remuneration for fraudulent takings (or withholdings), and thus, we maintain, are generally inappropriate vehicles for unclaimed property claims. While it can be argued that FCA and qui tam provisions should not be applied in the context of unclaimed property administration, companies should be aware of that possibility and should be prepared for the prospect of such claims being brought. Given the potentially high stakes to holders, companies should understand and evaluate their unclaimed property exposure and how that risk is affected by state FCAs.15
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1Delaware ex rel. French v. Card Compliant et al., No. N13C-06-289-FSS (Del. Super. Ct. New Castle County, filed 2013).
2Delaware ex rel. French v. Card Compliant LLC, No. N13C-06-289 FSS [CCLD], 2015 WL 11051006 (Del. Super. Ct. Nov. 23, 2015).
3 6 Del. Code Ann. § 1201.
4 6 Del. Code Ann. § 1203(b)(1). Prior to 2009, the Delaware FCA allowed only an affected person to bring an action under the FCA. On July 16, 2009, the FCA was amended and “any person or labor organization” can now bring a suit under the FCA. The amendment also eliminated the requirement that, if the state government decides not to intervene, the Delaware Attorney General must determine that there is substantial evidence of a violation in order for qui tam plaintiffs to proceed. Now, if Delaware declines to proceed with the action, qui tam plaintiffs can proceed without the need for a determination by the Attorney General that substantial evidence of the violation exists.
5Qui tam is short for: qui tam pro domino rege quam pro seipso, which roughly translates to “he who as much for the king as for himself.” United States ex rel. Springfield Terminal Ry. Co. v. Quinn, 14 F.3d 645, 646 n.1 (D.C. Cir. 1994).
6See, e.g., California ex rel. Bartlett v. Miller, 243 Cal. App. 4th 1398, 1411 (Cal. Ct. App. 2016).
7See, e.g., Jack Trachtenberg, Jeffrey A. Friedman & Eric S. Tresh, Applying False Claims Acts in State Taxation, State Tax Notes 373, 374 (May 7, 2012).
8 6 Del. Code Ann. § 1201(a)(7).
9Id.
10See California ex rel. McCann v. Bank of America, 191 Cal. App. 4th 897, 902 (Cal. Ct. App. 2011) (rejecting qui tam plaintiffs’ claim that Bank of America failed to remit unclaimed credits from its check clearing business, holding that such amounts were not property subject to escheat and were not liquidated and certain obligations); Ball v. County of Cook, 385 Ill. App. 3d 103 (Ill. App. Ct. 2008) (rejecting taxpayers’ claim that monies attributable to unclaimed homestead exemptions constituted unclaimed property under the Illinois Unclaimed Property Act allowing them to obtain refunds beyond the statutory statute of limitations for claiming refunds under the real estate tax provisions); Alvarez v. Pappas, 374 Ill. App. 3d 39, 41 (Ill. App. Ct. 2007) (rejecting taxpayers’ claims that duplicate real estate installment payments were unclaimed property under the Illinois Unclaimed Property Act allowing them to claim refunds beyond the statute of limitations period for claiming refunds under the real estate tax provisions); Oklahoma ex rel. Harvey v. Oklahoma ex rel. Corp. Comm’n, 969 P.2d 367, 368-69 (Okla. Civ. App. 1998) (rejecting qui tam plaintiffs claim that unclaimed utility company refunds should have been turned over to the State under Oklahoma’s Unclaimed Property Act because the utility was required by order of the Corporation Commission to retain such unclaimed amounts).
11Robbins v. Alibrandi, 127 Cal. App. 4th 438, 445 (Cal. Ct. App. 2005).
12Id.
13California ex rel. Harris v. PricewaterhouseCoopers, LLP, 48 Cal. Rptr. 3d 144, 147 (Cal. Ct. App. 2007).
14Id.
15 Participating in state voluntary disclosure programs may be one option for businesses with potential liabilities to consider. However, many states—particularly Delaware—have used voluntary disclosures as a “starting point” for determining liability. See, e.g., Select Med. Corp. v. Cook, No. 1:13-CV-00694 LPS (D. Del. filed Apr. 17, 2013); CA, Inc. v. Cordrey, No. 4111-CC (Del. Ch. filed Oct. 22, 2008).
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