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UNCLAIMED PROPERTY FOCUS is a blog written by and for UPPO members, featuring diverse perspectives and insights from unclaimed property practitioners across the U.S. and Canada. We welcome your submissions to Unclaimed Property Focus. Please contact Tim Dressen via tim@uppo.org with any questions about submitting a blog post for consideration and refer to our editorial guidelines when writing your blog post. Disclaimer: Information and/or comments to this blog is not intended as a substitute for legal advice on compliance or reporting requirements.

 

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A look at Delaware’s statute recognizing first priority states’ exemptions under S.B. 13, part 1

Posted By Mark Watters, Thursday, June 22, 2017

One of the key provisions of Delaware’s S.B. 13, 149th General Assembly (the 2017 revision of its unclaimed property act), is Del. Code Ann., tit. 11, §1141(b), honoring exemptions of all first priority jurisdictions.

 

Formerly, Delaware was known to take properties exempted by the first priority jurisdiction based upon its interpretation of the priority rules (discussed below). As a majority of business associations are incorporated or formed in Delaware, this was a significant frustration of purpose for many other jurisdictions’ exemptions and provided a sizable windfall to Delaware. 

 

The new Delaware statute now maintains the exemption of the state of first priority, a reversal of the former Delaware common law practice. All the same, is the new “broad brush” Delaware exemption as it appears, or will it be restricted in practice by the state escheator?

 

Priority Rules and Prior Delaware Application

Under Texas v. New Jersey, 379 U.S. 674 (1965), the U.S. Supreme Court settled competing claims to property, creating a set of priority rules between competing state claims to properties. Under those priorities, the state of the property owner’s last known address has first priority to take the property. The second priority, which applies if the state of first priority takes no claim to the property, fell to the state of the holder’s incorporation (and now, formation for unincorporated business associations). The third priority, which is less well defined and which is rarely applied, is essentially any state with an economic interest, such as the jurisdiction where the original obligation arose. 

 

Under these common law rules, Delaware has historically benefited by taking properties with no known owner and address, foreign properties (that had no “state” of last address) and properties that were not escheatable to the state of first priority for any reason.

 

Del. Code Ann., tit. 11, §1141(b) (S.B. 13, 149th General Assembly)

Under its new statute, it appears that this substantial source of Delaware’s historic unclaimed property has been proactively eliminated; properties, once exempt in the jurisdiction of first domicile but taken by Delaware, may no longer be escheatable in Delaware under Del. Code Ann., tit. 11, §1141(b):

 

(b) Property is not subject to custody of the State Escheator under subsection (a) of this section if the property is specifically exempt from custodial taking under the law of this State or the state of the last-known address of the owner.

 

Under previous application, other states’ exemptions were frustrated by requiring holders incorporated in Delaware to escheat properties under the second priority.

 

This new Delaware statute raises several complex issues of application and definition, which will be resolved over time through regulation, policy, and practical application:

  • What constitutes an “exemption”?
  • How should holders manage these exemptions?

This article seeks to create awareness of these questions for further discussion.

 

What constitutes an “exemption” under §1141(b)?

There is no statutory definition of “exemption” under S.B. 13, so initially state regulation, policy statements, and audit practice will provide parameters. Guidance is promptly needed, since many potential “exemptions” represent substantial and growing amounts on the records of holders and, thus, potential significant exposure.

 

The meaning of “exemption” should apply to any specifically-identified by that term in the law. Beyond the use in statutes and common law of that exact word, there are other statutory constructions that arguably act as exemptions, but are not so named or act as property value reductions only. These terms include:

  • Exceptions. Exceptions differ from exemptions primarily by how they arise. While an exemption recognizes that such properties would generally be escheatable, by affirmative statutory construction an exception is created by carving out that property type from the general statutory base. There are two types: Those created by definition restriction; and those created by statutes of application. The former will be found in statutes of definition, typically in that for “property”; the latter in statutes requiring general escheatment of a property type “except for” certain properties falling under a particular fact pattern or other condition. These differences are not important to our survey; each can be identified by the word “except” and its derivatives in the statutory or common laws proper;
  • Minimal value “exemptions.” Minimal value exemptions restrict the escheatment of properties exceeding a certain minimal value; 
  • Business sector exemptions. A few jurisdictions have exemptions based solely on the holder’s industrial sector, applicable to certain property types;
  • De facto exemption through superseding statutes. Federal and state laws, especially in the consumer protection, banking, insurance and commercial sectors, superseding unclaimed property law;
  • Deferral “exemptions,” where the holder need not report property until there is a clean break in overall relationship with the (typically business) owner; and
  • Reductions and deductions. These are reporting value adjustments recognizing and relieving duties and burdens imposed on holders. Typically, these are cost reimbursements, actual or computed, for the management of properties, particularly for performance of due diligence and preservation of properties and their maintenance on the books and records of the holder. These reductions and deductions may apply to both holders and state property administrators, the latter as compensation for property advertising and preservation. 

These are discussed in the context of Delaware’s statute below. 

 

Exceptions in state codes are clearly purposed to withdraw certain properties from escheatment in their jurisdictions just like exemptions. Unlike exemptions, these generally are not discretionary but mandatory. One would hope by application and intent exemptions and exceptions would receive equal treatment.

 

Partial exemptions. Several states provide a partial exemption, typically exempting minimal values of specific properties; higher property values are fully subject to escheatment. This issue is very hard to predict, as minimal values under the reporting threshold but having a single owner could be consolidated by Delaware to pass the threshold of such minimal values, and even if analyzed alone, might not rise to the level of “exemptions” under Delaware’s statute. 

 

Business sector exemptions. A few states create special exemptions for cooperatives, certain preferred business sectors, and similar holder groups. These exemptions are usually also limited to certain property types. By practical application these should be recognized as exemptions

 

De facto exemption through superseding statutes. There are many areas where federal and state laws supersede those for unclaimed property; many state laws are universal. These include life insurance, gift cards and certificates, commercial paper, and many others. Such statutory preemption should expect to be recognized. Common law (through litigation) recognizes other circumstances of preemption, such as U.S. savings bonds, although the case law may not be recognized until litigated in courts of local jurisdiction. 

 

Deferral “exemptions.” These are not true exemptions, but rather stay or delay escheatment until certain conditions are met, typically when the holder breaks connection with the owner. While these may be titled or described as “exemptions”, these are rightly deferrals, where the state of first priority delays (“defers”) reporting until after a break between the holder and owner. These properties may be subject to Delaware escheatment, especially considering the 10-year statute of limitations (Del. Code Ann. tit. 11, §1156(b)), and the closing door of opportunity; likewise, Delaware could honor the deferral and allow the jurisdiction of first priority to take when it is appropriate to do so.

 

Reductions and deductions. These are generally modest amounts to recompense the holder for costs associated with property management and reporting compliance. One might expect Delaware to honor such allowances of its sister states. However, there is no clear statutory requirement that it do so except through the statutory authority cited in this paper. This author is unaware of any instance where Delaware has historically pursued such allowances under the old law. 

 

Holders should be careful to recognize that any applied “exemption” does not extinguish its obligations to the property’s owner; rather, exemptions only relieve the holder from reporting and remitting the property to the appropriate jurisdiction. Obligations to the property’s owner are never relieved. 

 

The ultimate duty of all holders is to return property held to its rightful owner or report and remit it to the state. In addition, rolling such properties back into P&L may violate accounting standards that are beyond unclaimed property laws. Thus, other than the important consideration as to who should have the right to hold and have use of the property until redemption, there is no permanent value to its possession. 

 

Part 2

Part 2 of this article will examine how holders should manage these exemptions.

 

About the Contributor

Mark Watters is technical director, unclaimed property, for DuCharme, McMillen & Associates Inc.

 

Disclaimer: Neither UPPO nor DMA, or any of their affiliated or related entities, by means of this summary, is rendering business, financial, legal, tax, reporting or compliance or other professional advice or services. This blog post is not a substitute for such professional advice.

Tags:  Compliance  Delaware  priority rules  unclaimed property 

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Office Depot case takes on federal priority rules

Posted By Administration, Thursday, June 1, 2017

On May 4, 2017, UPPO filed an amicus brief with the U.S. Court of Appeals for the Third Circuit in the case of Office Depot v. Cook. The amicus brief supports the arguments of the plaintiffs, retailer Office Depot and its gift card management company, North American Card and Coupon Services (NACCS). 

 

Like many retailers, Office Depot established and uses a special purpose entity for oversight and management of its gift cards and gift certificates. The gift card management company, NACCS, was incorporated in 2002 in Virginia, which exempts gift cards from unclaimed property reporting. NACCS does not collect names and addresses of gift card or certificate purchasers. 

 

As part of an audit that began in 2013, Delaware’s third-party auditor, Kelmar, requested information from Office Depot that included detailed records regarding NACCS transactions. Office Depot declined to provide this information, arguing that NACCS transactions fall outside of Delaware’s jurisdiction under the priority rules established by the U.S. Supreme Court in Texas v. New Jersey

 

As a result of Office Depot’s refusal to turn over requested NACCS documentation, Kelmar subsequently referred the issue to Delaware’s attorney general for “enforcement action.” 

 

On July 18, 2016, Office Depot and NACCS filed suit  against Delaware unclaimed property officials, seeking a declaratory judgment that the state’s unclaimed property practices violate the Fourth Amendment and federal common law. The plaintiffs argue that:

  • The defendants’ information request amounts to unreasonable search and seizure.
  • Delaware’s unclaimed property laws violate the federal priority rules established in Texas v. New Jersey.

On March 3, 2017, the U.S. District Court of Delaware dismissed the case, saying that the priority rule cases cited by Office Depot apply only to interstate disputes, but not disputes between private entities and states. Office Depot appealed the ruling to the Third Circuit Court of Appeals.

 

“Delaware is arguing that holders can’t rely on the federal common law rules and that the state has the right to essentially demand any and every bit of documentation or information concerning how a retailer set up its gift card structure,” says Ethan Millar, partner with Alston & Bird. “If Office Depot prevails in this case, then Delaware will be significantly limited in its ability to challenge these structures.”

The priority rules permeate many aspects of unclaimed property compliance—beyond just the retail industry. On a larger scale, the Office Depot case takes aim at any holder’s ability to rely on the federal priority rules to determine the states to which they should escheat unclaimed property.

 

“If the court determines the federal common law rules do not apply to disputes between a holder and a single state, that will invite chaos as a matter of compliance because holders will have to try to anticipate claims by states that wouldn’t normally have a claim under those rules,” Millar says.

 

In addition, invalidating the priority rules in disputes between single holders and states could affect states’ use of estimation. Losing the weight of the priority rules would make it much more difficult for holders to argue that estimation is impermissible because the state is trying to escheat something other than the actual debt that’s owed. Also, because the priority rules are the foundation for the argument against having to escheat foreign-owned property to a state, this case’s decision could affect how holders deal with such property.

 

UPPO’s amicus brief raises several arguments in support of Office Depot and points to a previous Third Circuit Court of Appeals decision as one of the reasons Office Depot should prevail. The 2012 case of N.J. Retail Merchants v. Ass’n v. Sidamon-Eristoff case similarly involved a state’s attempts to escheat gift cards by taking a position different from what the federal common law rules required.

 

The Third Circuit held that the federal common law rules were intended to be rules of general application. Even though they were created under the U.S. Supreme Court’s jurisdiction to resolve disputes between states, that doesn’t mean they’re limited to interstate disputes.

 

The N.J. Retail Merchants case is not an outlier. The Tenth Circuit reached a similar conclusion in the 1986 American Petrofina Co. of Texas v. Nance case, and several lower federal court and state supreme court decisions concur.

 

UPPO will continue to monitor and report on this case as developments occur. UPPO’s amicus brief was written and submitted on behalf by Ethan Millar and John L. Coalson Jr. from Alston & Bird; James G. Ryan and Jameel S. Turner from Bailey Cavalieri; and Michael Rato from McElroy, Deutsch, Mulvaney & Carpenter.

 

 

Tags:  compliance  Delaware  Office Depot  priority rules  unclaimed property 

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Texas responds to UPPO’s request for clarification of H.B. 1454

Posted By Administration, Thursday, May 18, 2017

Passed in June 2015, Texas law H.B. 1454 goes into effect on Sept. 1, 2017. The law allows property owners to designate a “representative for notice,” which triggers a requirement that the holder must mail or email the required due diligence notice to both the representative and the owner.

 

Representatives may not claim or access the owner’s property, but can stop the dormancy period by communicating with the holder knowledge of the owner’s location and confirmation that the owner has not abandoned the property. The new requirements also require holders to include the name and last-known mailing or email address of the representative when reporting unclaimed property.

 

In December 2016, UPPO posed several questions to Texas unclaimed property officials in an effort to receive clarity about the new requirements for the holder community. On April 24, 2017, Texas responded. The letter from Texas is prefaced with a statement advising that the letter is intended to provide general guidance and that no formal changes have been adopted by the Texas Comptroller of Public Accounts (comptroller).

 

Covered property types

UPPO sought clarity regarding which property types are covered by the law, specifically asking if IRAs and both open-end and closed-end mutual funds are covered. In its response, Texas specified that funds deposited with a bank or other financial institution in an interest-bearing account, checking account or savings account are included. This includes mutual funds held in an IRA, but those “would not be subject to abandonment until they would normally be reportable as unclaimed property.”

 

Methods to obtain representative information

Texas clarified that although the comptroller will provide a form holders may provide to owners to designate a representative it is not required and therefore other methods used to collect this information are acceptable. Texas expects to make the form available before Sept. 1, 2017, and “anticipate[s] that holders will inform customers of the option to designate a representative.”

 

Criteria for becoming a representative

UPPO requested clarification regarding specific criteria for being designated a representative and whether the designated person has to provide consent. Texas responded that it anticipates requiring that the representative be an individual over 18 years old who does not own the account. The state doesn’t anticipate requiring a legal relationship between the owner and representative, or requiring consent.

 

Duration and reporting of representative appointment

Texas anticipates its representative designation form will give holders the ability to specify the duration of the designation, according to the letter. Without such stipulation, the designation would be perpetual unless revoked. It seems likely that the form will actually give the ability to specify the duration of the designation to owners—not holders—and that the wording in the letter was an error.

 

Holders would not need to notify the comptroller of changes to designated representatives, only to list them when reporting unclaimed property. The comptroller is updating its electronic holder report format to accommodate representative details. The updated format should be announced before Sept. 1, 2017.

 

Multiple accounts

The state clarified that the representative designation form will give owners the ability to specify the accounts for which the representative is a designee. There will be an “all accounts” option. Communication from the representative regarding one account does not affect the abandonment period for any accounts for which that person is not designated as a representative.

 

UPPO will continue to monitor implementation of H.B. 1454 and will report on additional developments as needed.

 

 

Tags:  compliance  due diligence  Texas  unclaimed property 

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Diving deeper into the world of exemptions

Posted By Administration, Thursday, May 11, 2017

Exemptions provide holders with the ability to significantly reduce their unclaimed property liability. Unfortunately, identifying, understanding and applying available exemptions are not simple.

 

“There’s no uniformity in terms of their application or meaning,” says Freda Pepper, counsel for Reed Smith LLP. “For example, the business-to-business exemption isn’t addressed by every state or offered by every state. Among states that do offer it, the B2B exemption comes in a variety of shapes and colors. Some are full exemptions, some are partial exemptions and some have qualifications that others don’t.”

 

B2B exemptions are based on the idea that businesses don’t require the same protection as consumers because they have the resources and knowledge necessary to protect and recover their property from another business. While many states agree on this premise, they differ in their execution of the exemption.

 

Some, including Illinois, Kansas, Ohio, Maryland, and Virginia, offer broad B2B exemptions with few conditions. Others, including Indiana, Iowa, Massachusetts, Michigan and North Carolina, offer limited B2B exemptions that are still holder-friendly but may include exclusions. Others offer what appears to be a B2B exemption, but it is really a deferral, requiring an ongoing business relationship.

 

“Holders may not understand whether an exemption is outright or more of a deferral,” says Chris Jensen, director of abandoned and unclaimed property compliance for Ryan. “Sometimes the liability is delayed or deferred from reporting until the relationship you have with another business no longer exists. The definition of an ‘ongoing business relationship’ differs by jurisdiction, so it is important to review the state’s requirements before applying the deferral.”

 

Some states may not include a B2B exemption or deferral in their unclaimed property statutes, but do so administratively. These present greater risk and diligence, as they may change when a new administration is installed.

 

The B2B exemption is one of the more common exemptions, but many others are available. Gift cards represent another opportunity in many jurisdictions. More than 30 states offer some form of gift card exemption, depending on card variables including expiration date, fee inclusion and type of merchant (retailer or other). Other retail exemptions include merchandise return credits, loyalty cards, layaway deposits and rebates—each with their own restrictions, rules and application standards, depending on the state and other factors.

 

While holders are generally accustomed to reporting property regardless of its value, a few states offer de minimis exemptions. Michigan, for example, does not require escheatment of property valued at $25 or less. Similarly, Florida and Arizona exempt select property types below $10 and $50, respectively.

 

Because exemptions vary so widely, it takes some effort to identify and understand them. Even locating exemption language in state statutes can prove challenging.

 

“Locating where exemptions actually appear in the statute varies by state,” Pepper says. “Sometimes there’s an outright exemption addressed in the area covering the presumptions of abandonment. Often, the exemption can be found in the definitions section of the statute. For example, when defining ‘property,’ there may be a passage listing that is not considered reportable property. So, finding the exemptions can be a hunt.”

 

In addition, taking an exemption doesn’t relieve a holder from all responsibilities for that property.

 

“If the holder determines an asset is exempt from reporting, it doesn’t necessarily extinguish the liability on their books and records,” Jensen says. “There remains an expectation that you adjudicate the asset with the owner and resolve it on your books and records. Don’t automatically take it as income. Having conversations internally about how property is managed after its determined to be exempt cannot be understated.”

 

With so many variables and sometimes murky definitions at play, applying exemptions presents some challenges. Holders may need to examine how their reporting software accounts for available exemptions and consider their level of risk. When an exemption is offered administratively but not statutorily, a holder applying the exemption takes on some risk. Likewise, when definitions related to exemptions are vague and open to holder interpretation, risk increases. Holders should document their interpretation, apply it consistently and keep track of when it is applied. Doing so may prove useful if faced with an audit.

 

Holders seeking to minimize their unclaimed property liability have the ability to do so via exemptions. The lack of uniformity from state to state presents numerous challenges. Identifying, understanding and correctly applying available exemptions may not be easy, but can be worthwhile.

 

To help holders dive deeper into the world of unclaimed property exemptions, Jensen and Pepper will lead UPPO’s An Advanced View of Exemptions webinar on Wednesday, May 17. This informative webinar will focus on various exemptions offered by the states and will help holders determine when and how to apply them. Unclaimed property professionals with customers or vendors located in states that offer exemptions should not miss this in-depth educational session. Register now.

 

 

Tags:  audits  compliance  exemptions  unclaimed property 

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Delaware’s proposed audit regulations raise many questions

Posted By Administration, Thursday, May 4, 2017

Earlier this spring, the Delaware secretary of finance, in consultation with the secretary of state, published a proposed Department of Finance Abandoned or Unclaimed Property Reporting Examination Manual, as required by S.B. 13. The proposed regulations provide some clarity regarding the finance department’s approach to administration and enforcement of the law. However, they also raise noteworthy questions regarding language that may contradict S.B. 13, exceed the department’s authority and fail to clarify murky language in the statute.

 

Noteworthy issues include:

 

Foreign property: S.B. 13 indicates that Delaware has jurisdiction over unclaimed property if the jurisdiction with primary authority has no unclaimed property law. The proposed regulations, however, addresses only states, but not other countries that have the authority to escheat.

 

Stored value and gift card maximum cost: The proposed regulation would dramatically increase the amount reportable with respect to unredeemed gift cards and other stored value cards to the issuer’s “cost of goods sold [reflected on its federal income tax return for the year] plus total deductions less charitable contributions, depreciation and depletion.” This interpretation expands the amount reportable by an issuer far beyond the cost to the issuer of the merchandise, goods or services represented by the card, in violation of the statutory language.

 

Record retention: Language in the proposed regulations requires holders to retain records not only for property reported to Delaware, but also for property not reported. This requirement exceeds the record retention requirements set forth in the Delaware Code.

 

Examination scope: The scope of examination in the proposed regulations allows the state to begin an examination without having identified the specific entities under audit and provided notice to those entities. The Fourth Amendment prohibits such “fishing expeditions” for the purpose of identifying whether or not a company may be a proper target for audit.

 

In addition, Delaware law allows the state to examine the records of a purported holder “upon reasonable notice.” Once notice is given, the statute authorizes examination of the holder’s own records, and may even extend to certain records in the possession of a third party or an affiliate. However, the proposed regulations attempt to expand that authority by deeming all entities “related” to the holder as under examination themselves, without the required, reasonable notice.

 

Certification/record availability: The proposed regulation assumes fraudulent intent on behalf of holders and fails to account for the realities of corporate life. The proposed requirement that holders “certify” to the “availability” of “records,” on a strict liability standard of fraud appears to be based on the inaccurate assumption that companies operate through a single software system, which houses all information for all years and all operating divisions. As a result, failure to provide information must be based on malicious intent. This is simply not accurate for most holders.

 

Without any limitation on the terms “availability” and “records,” personnel involved with the audit will have difficulty convincing any officer to certify to such a vague and ambiguous statement under the threat of strict liability for fraud, creating unnecessary conflicts within the audit process. In addition, deeming even inadvertent errors to be “willful misrepresentation” on the part of the holder undermines any purported desire of the State to work collaboratively with holders.

 

Sampling: The Temple-Inland decision and order specifically required that, in the department’s estimates, the sample must be a surrogate of the property that was being estimated. To that end, if Delaware intends to estimate what was due to the state for years in which records are not complete, the sample must include only property that would be due to Delaware. Unfortunately, the proposed regulations simply memorialize the process the judge rejected in Temple-Inland.

 

Complete and researchable records: The proposed minimum standard for what constitutes “complete and researchable” records is unclear. It suggests that a complete and researchable record shall include items that contain a last known address of the property owner. However, this standard has not always been an accurate test to determine researchability. An address alone does not make a transaction researchable.

 

Remediation: The proposed regulations dictating the terms of what can be considered remediated extend far beyond any authority granted to the department or its auditors by S.B. 13. While it may be appropriate to indicate certain elements that are required or desirable in correspondence to Delaware owners, it is beyond the department’s jurisdiction to require the language proposed in the proposed regulations.

 

Omitted issues: The proposed regulations fail to clarify or include issues including the expedited audit examination created under § 1172 (c); the 10-year statute of limitations set forth in § 1156 (b); and interest and penalty provisions in § 1183 and § 1184.

 

On behalf of its members, UPPO has raised questions related to these and other sections of Delaware’s proposed regulations via a letter to State Escheator David Gregor , submitted this week. UPPO will continue to monitor implementation of S.B. 13 and Delaware’s proposed regulations, and will report on additional developments.

 

 

Tags:  audits  compliance  Delaware  examinations  S.B. 13  unclaimed property 

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