The Holder’s Introduction to Unclaimed Property

Welcome to the wide world of unclaimed property.

You are probably here because your company received an audit letter and you’ve never heard of unclaimed property before.

Or perhaps someone heard some litigation horror stories and said “let’s stop them in their tracks!” and told you to figure out how to do it.

Or perhaps, you are new on the job with a company that already has an unclaimed property compliance program in place and you don’t want to look stupid in front of the new boss.

Whatever your case is, it is time to get an introduction to unclaimed property.

The Rationale Behind Unclaimed Property Laws

Before we get into the how, it is important to know the why.

Why do we have unclaimed property laws?

Take It Back to England

Escheat laws go back to feudal times in England, where all land belonged to the King. The King would then allow various tenants to take possession of the land to turn it into productive farm land, grazing land, or otherwise use the land.

When the tenant died without heirs, the land would revert back to the Crown. In other cases, the land would revert back to the government if the tenant was convicted of a felony or otherwise was outlawed.

Once there was no tenant, the government could then reissue the deed to the land to someone new. This meant that land was never left without someone to farm or tend to the land. The land was never left unproductive because there was no owner.

Keeping land productive was the original intention of the escheat laws in England.

However, a more modern reason soon became evident to the Crown.

Escheat Becomes Revenue Source for the Crown

Starting with Henry III, the escheat of feudal lands became a source of revenue.

When the rights to the land were granted, it would be at significant cost.

Obviously, the new land holders would pay to receive the deed. Unless it was rewarded for service to the King, such as in battle, then the payment could be quite significant.

Even in the case of land holders with heirs, the escheat system was profitable to the king. In many cases, the heirs had to pay a premium “feudal relief” in order to demand the new deed to the land.

Coming to America

While the concept of feudal lands never caught on here in the United States, escheat didn’t die in the journey. It just changed.

One way that land escheated in England was if a person was convicted of treason. However, the U.S. Constitution, in Article 3, Section 3, prohibited attainders for treason. This meant that, even if executed, the family could keep the property of the convicted person.

It is rare that land reverts back to the government here. When it does, it is under the legal concept of Bona vacantia, meaning land with no owner. The land reverts back to the government when there is no one in the line of intestacy and the decedent has no will leaving the property to someone else.

Intangible Financial Property

While the reversion of tangible real property is rare, it has become quite common for the escheat of intangible property.

Intangible property includes cash, stocks, bonds, uncashed checks, and basically everything that we are concerned with in the modern unclaimed property statutes.

Lost Corporate Shareholders

In the early 1900s, as modern business forms began taking shape, a problem emerged – lost shareholders and bond holders.

What does a company do with the profit shares of someone that they cannot find? Or debt repayment?

One idea is that the company can keep the money. They can forever hold the payments as a liability in case the owner comes to claim the money. But if enough shareholders are lost, the situation may deteriorate that the company will lose effective management.

Thus, the first abandoned property laws were written to handle the lost shareholders and bond holders so that companies could continue to effectively run.

Lost Insurance Beneficiaries

The other traditional intangible property type to be subject to abandoned property laws were life insurance proceeds.

The entire idea behind life insurance is that money is contracted to be paid to a decedent’s family members. But what if the beneficiaries never know about the life insurance contract?

Should the insurers be able to keep the money that it was paid to deliver? The states said no.

New York first instituted abandoned life insurance laws in 1939.

Evolution to Modern Unclaimed Property Laws

In 1954, the first model unclaimed property act was written. There have been several revisions since then, including the 1995 and most recently the 2016 versions.

The States claim that the modern unclaimed property statutes are consumer protection statutes. That the state is a better holder of the property until the true owner or their heirs can come to claim the property.

Their argument is that, in the absence of the true owner, the economic benefit should go to the public or all citizens and not to the benefit of a few lucky individual citizens.

It doesn’t hurt, at least for the states, that they get to use the money until the owner comes to make a claim. And if the owner has already been lost, what’s the likelihood that they will actually find someone for all that money?

Just as it was in the days of Henry III, the government has found a nice revenue source from unclaimed property, even if they technically hold it on the books as a liability.

True Escheat vs. Custodial Escheat

The legal terminology has morphed to abandoned or unclaimed property from escheat. Mainly because it is confusing.

Under feudal times, escheat meant that the property reverted back solely to the King. The property holder, nor his family, had any rights to the property after it was escheated. That’s true escheat.

But now, we work under a custodial escheat system. The states hold the property in custody until the owner can be found.


The Vocabulary of Unclaimed Property

Now, let’s get a few terms straight in our heads. Yes, like every other area of law and accounting, unclaimed property has its own language. Or at least some unique terms to learn.

Property

Property is the generic term for the intangible property that is covered by the unclaimed property statute. Some common examples include, but are not limited to, uncashed vendor or payroll checks, accounts receivable credits, gift cards, rebates, bank accounts, stocks and dividends, oil and gas royalties, retirement accounts, and insurance proceeds.

In specific circumstances, property may also refer to the tangible property left behind in bank safe deposit boxes, at hospitals or funeral homes, and specific other institutions.

Escheat

Escheat is another name for the unclaimed property process. Or abandoned property. They typically are all used interchangeably. A “true escheat” means that the state (or governmental entity) takes full ownership of the property. A “custodial escheat” means that the state takes possession, but ownership rights remain with the rightful owner.

Holder

That’s you! The corporation. The entity that “holds” the unclaimed property until it is reported. Technically, that means the legal or commercial entity that is obligated to hold for the account of, or deliver or pay to the owner of the property.

Owner

That’s the check payee, the account holder, the shareholder. The person that “owns” the unclaimed property. As a corporate holder, you owe a liability to the property owner.

Annual Compliance

Each state, except Mississippi, requires an annual return (Mississippi requires a return once every three years) where the holder reports unclaimed property to the state. Compliance is the annual process that holders go through to prepare the state reports in accordance with state laws.

Dormancy Period

This is the time period that must elapse before the property is reported as unclaimed. Once the dormancy period has expired, the property is “dormant” and ready to be reported.

Last Known Address

The last known address is the address the holder has on its books and records of the property’s owner. This establishes which state has the right to escheat the property and the conditions under which it must be reported.

Domicile

For unclaimed property holders, domicile will be the state of incorporation or the principal place of business if not a corporation.

Due Diligence

This is the state-mandated process where holders send notifications to the owners that the holder has property that will soon be reported to the state as unclaimed unless the owner responds to the notification in a timely manner. Typically, due diligence requirements are satisfied by sending first class US mail to the last known address. Some states are updating their unclaimed property statutes to allow for electronic notification to satisfy the due diligence requirements.

Voluntary Disclosure Agreement (VDA)

A Voluntary Disclosure Agreement (VDA) is a process where a holder voluntary reports to the state past due or late reported property in exchange for a waiver or reduction in penalties and interest. Also referred to as a Voluntary Compliance Agreement (VCA).

Look-Back Period

In audits, voluntary disclosure agreements, and initial compliance reports, holders must consider the property that was reportable in a certain number of prior years, called the look-back period. Common look-back periods may cover 10 report years (plus the applicable dormancy period).


Annual Compliance Basics

All 50 U.S. States, as well as the District of Columbia (DC), Puerto Rico, Guam, and the U.S. Virgin Islands, all require holders to report unclaimed property.

Determining Where to Report

Unlike real property from feudal England, it is not obvious where intangible property resides. Does it actually exist anywhere other than a computer ledger?

After much conflict between the states, the U.S. Supreme Court stepped in, in Texas v. New Jersey to establish the reporting priority rules.

The reporting priority rules, as established by Texas v. New Jersey are:

  1. To the state of the apparent owner’s last known address
  2. If the address is unknown or the state of the owner’s last known address does not provide for the escheat of property, then property is reported to the holder’s state of domicile.

Many states and the 1995 Uniform Unclaimed Property Act provide a third priority rule, considered the transaction rule that would apply if neither the first two priority rules provide for the escheatment of the property.

However, attempts by several states to actually enforce such a priority rule have not been successful. The most notable example of unsuccessful enforcement was the New Jersey gift card law, which resulted in a Third Circuit Court of Appeals opinion overruling the law.

Foreign Property

One issue that is currently the subject of litigation is what to do with foreign property?

Assuming that the foreign jurisdiction does not have a similar unclaimed property law that provides for the custodial escheat of the property (some Canadian jurisdictions as well as others have similar laws), does the holder’s state of domicile have the right to claim the property?

Delaware claims that it has that right. However, that is currently in dispute in litigation by foreign investors that have lost $12 million from the lost appreciation of their shares.

Reciprocal Reporting

Reciprocal reporting allows property that was reported to one state to be transferred to another state.

There are usually limits to the use of reciprocal reporting, including dollar and property counts.

Reciprocal reporting is intended mainly for use by small companies that don’t have a large or significant number of properties to report to a state; a one-time event.

California does not allow reciprocal reporting due to the unique nature of its two report process and the state due diligence that it is required to conduct.

Other states may also impose interest and penalties for late reporting of the property. This often occurs when the proper state has a shorter dormancy period that the state you are reporting the property to.

This is another example where technology, specifically electronic and online reporting, has lowered the burden on holders to report to the states where the property is due and it has fallen out of favor.

Best practices for reporting unclaimed property are to not rely on reciprocal reporting and to report property directly to the state where it is due.

When to Report

Property is presumed abandoned if the property has been unclaimed by the owner for the dormancy period. This triggers the reporting obligation.

The easiest example is to use an uncashed check – the date on the check is generally the date that we use to calculate dormancy.

First, we must determine what kind of check it is – is the check to a vendor or an employee for wages? Each may have a different dormancy period, depending on the state. Here in Georgia, the dormancy period for wages in 1 year, while the dormancy period for vendor checks is 5 years.

Second, we add the applicable dormancy period to the check date to find the dormancy date. If the check was written on January 1, 2014, then the dormancy date for a vendor check would be January 1, 2019.

Third, you apply the cut-off date for the reporting period to determine the report year. In Georgia, the reporting period for all corporations except insurance companies is July 1 through June 30. So a property with a dormancy date of January 1, 2019 would be reportable in the July 1, 2018 – June 30, 2019 reporting period.

Fourth, properties dormant in the July 1, 2018 to June 30, 2019 reporting period are due to the state by November 1, 2019. Properties with a dormancy date on or after July 1, 2019 are future reportable, while the properties with a dormancy date on or before June 30, 2018 are past due. The majority of reports are due on October 31 or November 1 of each year and are considered “fall filing” states.

Some states have a calendar year reporting period are those reports are typically due in the “spring” – between March 1 and May 1. Texas and Michigan have March cut-off dates and are due July 1.

It is also important to note that some states have different reporting periods and deadlines depending on the type of holder. State laws generally divide holders into three categories: general corporations, insurance companies, and financial institutions. The dates may vary by holder type, so be sure to check each state for the applicable rules.

California Reporting

California has to be different than everyone else.

It’s not really their fault, as much as it is the product of litigation. But we blame them anyways.

Similar to the Georgia fall reporting process, California has a cut-off date of June 30. Due diligence must be completed prior to filing on October 31. The report date for life insurance companies is May 1.

However, the fall filing is only the report. Unlike other states, you do not send money with the fall report!

After the state receives the report, it will load the properties into its database and send letters to the owners. Often, California is able to find updated addresses based on franchise tax filings and other similar state databases. The letters instruct the owners to notify the holder by May 31 that they would like to claim the property.

Then, in June of the next year, the holder reconciles the owner responses to the fall notice report and submits a new report. This time, the holder submits the remittance of the properties that remain unclaimed. The remit report is due between December 1 and December 15 for life insurance companies.

Read more about the litigation that created this two-step reporting process

Exemptions and Deferrals

Some states have exemptions to the reporting requirement in the unclaimed property statutes.

The first set of properties exempt from reporting are considered “de minimis exemptions” for certain small dollar properties. For example, Florida has a de minimis exemption for properties under $10 for certain property types.

A second set of exemptions are “B2B exemptions” for properties where the owner and the holder are both business entities. The B2B exemptions are often limited to only certain property types. For example, North Carolina has a B2B exemption for accounts receivable credits.

Exemptions may be true exemptions while others may be deferrals, meaning that the trigger for the dormancy period is delayed until some future time. This trigger is usually based on continuous business relationships – the trigger starts when the business relationship ends. One example of this type of continuous business relationship deferral is Texas.

Deductions

Some states permit holders to make certain deductions to the value of the properties being reported.

A common deduction is for the cost of postage required for due diligence mailings, in particular for those mailings that are required to be sent certified mail, return receipt requested. New York is an example of a state with a deduction for certified due diligence mailings.

Until 2019, Colorado permitted a deduction of $25 or 2% per property owner by property type by year. However, with the introduction of new legislation in 2019, this deduction is no longer available.

Due Diligence Requirements

Due diligence is the process that holders undergo prior to reporting to attempt to locate and notify owners that their property may be reported to the state.

Each state has its own rules regarding how and when the due diligence process must take place. The most common requirements are:

  • A letter must be sent via first class US Mail,
  • Typically 90 to 180 days prior to reporting,
  • Must give the owner an opportunity to contact the holder to stop the reporting of unclaimed property, either through reactivating an account or receiving the property.

Some other requirements may include specific language that must be on the letter and certified mailing requirements.

Many, but not all states, have a threshold requirement – if the dollar amount is below the threshold, then due diligence is not required.

In addition, some states are now allowing for electronic notification, through email or secure web interface (think your online banking portal).

When Pennsylvania updated their laws in 2016, the state became the last to statutorily require due diligence prior to reporting unclaimed property.

Aggregate Reporting

In the early days of reporting, when everything was either hand-written or typed, it was quite burdensome for both the holders and the states to report a large number of properties for small dollar amounts.

As a result, aggregate reporting was allowed. With aggregate reporting, companies can lump together all properties under a certain dollar figure and report as one line item.

That burden has decreased dramatically with the advent of modern computer and software programs. Now, it is not much more difficult to produce a report with hundreds of thousands of properties, no matter how small or large the dollar value is.

As a result, aggregate reporting is falling out of favor with the state administrators. Most administrators prefer that holders report details on all reported properties, no matter how small the dollar value.


Unclaimed Property Audit Basics

While all states require annual reports, the states estimate that the vast majority of companies are not in compliance. While holder education may be one way that states increase compliance, the biggest threat is the unclaimed property audit.

For those that have been through an unclaimed property audit before, they can tell you how horrible the process is and how they will do just about anything to avoid another audit.

Audits can last years. Marathon Oil has been under audit or audit litigation for over a decade now.

They can be intrusive, with voluminous audit requests going back decades. The entire process appears punitive in nature, especially for companies that have been filing reports for years, like Select Medical’s audit. Or when the audit finds little to no direct liability but millions in an estimated liability, like the Temple Inland audit.

Audit Risk Factors

How will a company be chosen for audit?

While no one factor may be determinative at all times, here are some risk factors that may increase your chances of an unclaimed property audit:

  1. State of Incorporation
  2. Lack of prior VDAs
  3. Lack of filing history
  4. Prior filing history that stops or changes dramatically
  5. Under-reporting in an expected property type
  6. Inclusion in a targeted industry
  7. Major acquisitions that have not previously filed
  8. Change in enterprise system that may lead to a lack of records
  9. News of financial improprieties
  10. Continued and frequent mistakes in reports, such as improper dormancy periods or deductions
  11. Owner claims that show you failed to complete due diligence prior to reporting
  12. Claiming unclaimed property as an owner but not reporting it as a holder

Record Retention Requirements

Holders are required to retain records necessary for the state to complete an audit to determine the holder’s compliance with the state unclaimed property laws.

While the requirements vary by state, general recommendations include keeping the following records:

  • Filed annual unclaimed property reports
  • Proof of payment for annual reports
  • Copies of all sent due diligence letters
  • Copies of all due diligence responses received
  • Check listings or other data sources reviewed to determine reportable property
  • Copies to show remediation for any property that met the dormancy period but was determined to not be reportable

In addition to the reporting related records, holders should also maintain certain other records that will be useful in an unclaimed property audit, including, but not limited to:

  • Annual state and federal income and payroll tax returns
  • Annual apportionment schedules for state tax filings
  • Monthly bank reconciliations and banks statements
  • Customer account histories
  • Customer, vendor, and employee contracts

Special considerations should also be made for record retention in the following situations:

  • Closing bank accounts
  • Changing or retiring ERP systems
  • Acquisition of an existing company

These records should be retained for the duration of the dormancy period plus the applicable look-back period. Since the look-back period varies by state, a general recommendation is to comply with the state of incorporation’s look-back period. If that is Delaware, it would be a 5 year dormancy plus the 10 year look-back period for a total of 15 year record retention.

That’s much longer than the standard record retention policies put in place for tax audit purposes! Most record retention policies are either 7 or 10 years.

Estimation When Records Are Incomplete

So that leads to the billion dollar question – what happens during an audit when a holder has incomplete records?

The answer is that the states will estimate your unclaimed property liability.

That’s easy to say but hard to implement. Mostly because everyone disagrees on what a proper estimation methodology looks like. There are even disagreements on what “complete records” means.

Some of the issues surrounding the estimation include:

  • Can a state estimate on first priority property if it is not the state of incorporation?
  • Can a state estimate the second priority property when it is the state of incorporation?
  • Can the estimation use records from periods that have not yet reached dormancy?
  • What is included as unclaimed property in the base period?
    • Is all unclaimed property nationwide included or is it limited to the state doing the estimation?
    • Should the estimation include properties that are exempt in other jurisdictions?
    • How are items that have been previously reported credited in the calculation?
    • What is considered “ordinary course of business”?
    • Do special clean-up projects count, even if conducted prior to the audit and estimation? Or will these resolved items be included in the estimation?
  • What is the constant used for extrapolation to the years with incomplete records?
    • What sources should the auditor use? Annual revenue? Cost of goods sold? Total payroll? Something else?

Depending on the answers to these questions, the results can vary dramatically. These estimations are often the cause of litigation in Delaware.

Sampling in an Estimation

Another big issue in the estimation process is the use of sampling.

For many modern corporations, with shared service centers, the population of potentially reportable unclaimed property items is unmanageable. It would take significant resources for all parties involved to review each potentially reportable item.

The result is a sampling of items, typically by different strata by property type. In practice, this means that a selection of low dollar, medium dollar, and every high dollar item will be researched to determine whether it is unclaimed property or not. Then the estimation will apply to determine that period’s total unclaimed property liability.

The parties can argue over the number of strata, the confidence intervals, and the selection of items in the sample.

Appeal Rights

Once the audit and estimation, if applicable, is complete, you may be quite dissatisfied with the results.

Prior to any assessment being made, holders should negotiate with the audit team and the state administrators to come to an amicable solution.

In the absence of an agreement with the state administrators, some states have an administrative appeals process where an outside government official or panel will review the audit workpapers and assessment and hear arguments from both the holder and the state.

If a holder is still not satisfied with the administrative appeal, or if the state does not have an administrative appeals process, the next step is generally litigation. This may be in state or federal court, depending on the specific issues that are at play in the particular audit.

States May Use Third-Party Auditors

State unclaimed property administrators are often working with small and limited staff. Their primary functions are receiving reports and managing the claims process. Their budgets often don’t allow them to have in-house audit staff.

As a result, many states have turned to outside audit firms to conduct audits on their behalf. To gain efficiencies of scale, these audit firms will contract with as many states as they can to conduct a single audit.

The biggest criticism in the use of third-party auditors is that they are often paid on a contingency basis – the audit firms are paid based on how much they collect from you, the holder.

When property is reportable on a first priority, name and address basis, there is often little to dispute. But when the auditor uses aggressive estimation techniques, often with a significant self-interest, then the process is subject to criticism.

At a minimum, there is a significant appearance of conflict of interest by using third-party contingent fee auditors. At worse, the process is excessive and abusive.

Confidentiality of Records

An unclaimed property audit will look at every financial aspect, and many non-financial aspects, of a corporation. A very concerning issue, particularly for companies in sensitive fields like health care or banking, is the confidentiality of records in the audit.

And while many states may have some limited protections from disclosure under FOIA or similar open government statutes, what about the third-party auditor?

Depending on the participating states, it is wise to negotiate a confidentiality and non-disclosure agreement as the audit is commenced to protect your sensitive information.

Because one unintended consequence that we have seen as a result of these audits are additional lawsuits. Shareholder derivative and class-action owner lawsuits have become while not commonplace, frequent enough to be of major concern.


Voluntary Disclosure Agreement Basics

The Voluntary Disclosure Agreement (VDA) is designed to bring companies that are currently out-of-compliance into compliance. It is the carrot to the audit stick. It is typically a kinder, gentler process than an audit.

How a VDA is Different than an Audit

The VDA process varies by state, in the intsenity and the breadth of the self-audit. Some states may allow you to simply disclose what is past due on a report and move on to annual compliance.

Meanwhile, in other states, like New York and Delaware, the process is much more intensive and looks very similar to an audit. The state administrators, and even third-party administrators acting on behalf of the state, will expect to see much of the same work in a VDA that you would see in an audit.

This would include a review of all bank accounts, general ledger accounts, AR and AP files, corporate history, and tax returns. The states may highly scrutinize your work, particularly if you must complete any estimation or sampling processes during the VDA. Any conclusions you make will be reviewed by the state prior to accepting the VDA.

Pros and Cons to the VDA

The VDA process typically ends with a waiver or a reduction of penalties and interest from the state on all your past due property. Some states will also waive their rights to audit for the property types and look-back period covered by the VDA.

In exchange, the holder promises to continue to report and remain in compliance.

As discussed above, depending on the state, the VDA process can be as intensive as an audit. However, the VDA process does allow for more self-guided timelines that may work better with your core business functions, allowing you to focus on tasks like year-end close when it is most needed instead of responding to an auditor’s requests.

Not all states have a VDA process. Notably, California does not currently have a VDA process and will assess penalties and interest on late reported property.

When states do have VDAs, typically companies have only one chance to participate, at the beginning of their compliance history.


Claiming Unclaimed Property

At the end of this rainbow, there could be a pot of gold – the state could be holding property that is due to your company!

And after all the expense and pain of compliance, and possibly audits and VDAs, wouldn’t it be nice to bring in some money for your company?

You should search in your state of incorporation, as well as all states that you do business in. For large companies, this will involve a comprehensive search in all reporting jurisdictions.

Don’t forget to search for variations of your company name. For example, if you are ABC Corporation, then try ABC Corp and A B C Corp, and Corp ABC. You should also search as both businesses and individuals, since some times corporate names are parsed as individuals. Some state databases are more sophisticated that others but some will only return exact matches.

Once properties are identified in a state database, then a claim must be initiated. In most cases, the claiming employee will need a power of attorney from corporate officers to be able to complete the claims process.

I typically recommend that companies wait until after they have begun annual compliance reporting to reduce the risk that claiming property triggers an audit. Think of this money as your reward for a job well done.


Unclaimed Property Organizations

The main organization for holders is the Unclaimed Property Professionals Organization (UPPO). UPPO provides training to corporate stakeholders, advocacy for holders to state administrators and legislators, legislation and litigation tracking, and litigation assistance or amicus curiae briefs on behalf of the holder community.

Meanwhile, the states have their own organization, the National Association of Unclaimed Property Administrators (NAUPA). While once a stand-alone organization, they have recently become part of the National Association of State Treasurers (NAST).

The Uniform Law Commission (ULC) drafts model acts so that state laws may have uniformity between the various jurisdictions. The ULC model acts are not acts of law, at least until passed by the various state legislatures. Unfortunately for unclaimed property practitioners, there has been very little uniform adoption of the ULC model acts.


Beyond the Introduction to Unclaimed Property

Are you ready to go beyond the introduction to unclaimed property and dive deep into the issues?

Then check out these other resources from DeCarrera Law:

Unclaimed Property Litigation in-depth looks at the cases that have shaped unclaimed property laws and current cases that have the potential to re-shape the unclaimed property landscape.

UP Alerts are updates on unclaimed property, which can include statutory updates, litigation alerts, and miscellaneous commentary.

Don’t forget to sign-up for the DeCarrera Law newsletter to get the latest updates on unclaimed property delivered to your inbox!