Gift cards are a big business. Which means that gift cards are also an attractive source of potential unclaimed property for states.
However, many companies have used careful planning to avoid unclaimed property liabilities related to unredeemed gift cards.
One whistleblower that worked for companies doing this planning, but then went to work for a top Delaware audit firm, says that what some companies went too far in their gift card planning.
Delaware Gift Cards
With a five year dormancy period, unknown names and addresses, and a minuscule chance of the owner ever claiming the unused balance of a gift card, this is a very lucrative property type for any state, but in particular Delaware.
Unlike many states, Delaware does not fully exempt gift cards from unclaimed property reporting. Instead, Delaware requires that the “amount representing the maximum cost to the issuer of the merchandise, goods, or services represented by the card” be reported as unclaimed property.
This requires that companies calculate their cost of goods sold to determine the profit portion of the gift card. This is the amount reported as unclaimed property, versus the entire unredeemed portion of the gift card.
Gift Card Planning
As noted above, many states, but not Delaware, exempt gift cards from the unclaimed property reporting requirements if certain conditions are met. Most commonly, these conditions require that the gift cards have no expiration dates and no dormancy fees that would “eat up” the unused balance of the card.
Overall, this is seen as a win-win for both the companies and consumers. Consumers never have to worry about the balance on their cards disappearing and the companies get to keep the cash until the card is used.
To take advantage of these exemptions, gift card issuers undergo careful planning to setup gift card companies (GiftCos) in states with favorable laws. The GiftCos are subsidiaries of the retailer and are created with the intention of using the more favorable laws to shield the company from the unclaimed property liability.
This tension between Delaware and other states sets the stage for the Card Compliant case.
Whistleblower Files Lawsuit Against Numerous Retailers
William Sean French filed a whistleblower lawsuit on August 7, 2017 under the Delaware False Claims and Reporting Act. The underlying premise against all the retailers was that the retailers “devised a contractual scheme to defraud the State of Delaware out of money from unredeemed gift cards issued by [the retailers] to which the State was lawfully entitled under Delaware’s Unclaimed Property Law.” (Quote from Delaware v. CVS Health Corporation, et al.)
CardFact was operated by French beginning in 2003 to 2009 and was then purchased by Card Compliant. French then continued operations under a new name, Vacation Properties United, Ltd.
At various times, each of the retailers entered into contracts with CardFact or Card Compliant to own and manage the gift cards under Ohio law. French alleges that the retailers issued and sold the gift cards, collected and retained the money, and never transferred the money to the CardFact or Card Compliant entities (except for the small service fee).
The differences between the new CardFact contracts and traditional GiftCo planning included that the agreement between CardFact and the retailer was between outside parties, not a parent-subsidiary relationship. French also alleged that the retailers did not transfer the value of the cards to CardFact like is traditionally required with GiftCo planning.
The retailers did not report the unredeemed cards to Delaware or any other state, despite the retailers or a related company being incorporated in Delaware. French says that this was a fraudulent scheme, intended to avoid reporting unredeemed balances to Delaware.
Dismissals Due to State Action
Many of the retailers presented arguments that they should not be subject to the whistleblower lawsuit because the State of Delaware had already reviewed and signed off on the gift card programs at issue in this case.
Notably, many of the retailers had been through an unclaimed property audit or voluntary disclosure program with Delaware.
Under 6 Del. C. § 1206(a), DFCRA (Delaware False Claims and Reporting Act) claims are barred if they are “based upon allegations or transactions which are the subject of a civil suit or an administrative proceeding in which the government is already a party.”
The Court found in favor of defendants like CVS and Ralph Lauren based on the fact that they had already or were currently under audit or VDAs that covered gift cards.
Also of interest: William Sean French worked with his brother-in-law Ted Zieglar who founded CardFact and then sold to Card Compliant in 2009. In 2011, French joined Kelmar Associates, the top auditor for Delaware unclaimed property. Then in 2013, this lawsuit happened where many of the retailers were dismissed because they were under audit by Kelmar. If the whistleblower lawsuit is successful, it would provide additional incentive to Kelmar for those that it currently had under audit. Treble damages plus a larger contingency fee on new cases!
Retailers Settle Case
In a whistleblower action, the risk of losing the case is pretty drastic. Not only is the underlying liability part of the damages, but to encourage whistleblowers, the law permits treble damages – with a portion going to the whistleblower. Thus, it would be very costly for a retailer to go to trial and lose.
As a result, if retailers did not have ongoing or prior administrative proceedings (audits or VDAs), most of them settled out of court.
All but one… Overstock.com.
Overstock.com Goes to Trial
Overstock.com is an online company incorporated in Delaware. Overstock sold gift cards, redeemable for merchandise on its site, under the same Card Compliant contract outlined above. Overstock did not report unredeemed gift cards to Delaware.
The Superior Court denied a pre-trial motion to dismiss brought by Overstock, wherein Overstock argued that it had not made a false record or statement per the DFCRA because it had not filed a report. The Court found that the company’s books and records were a false record and that the failure to file a report was equivalent to filing a false report.
At trial, the Court included similar information in the jury instructions.
Overstock lost at trial, with $22,000 in civil damages and $7,266,412.94 in treble damages being awarded for violations of the DFCRA.
Failure to File Not Making a False Statement
The Supreme Court of Delaware said that the trial court erred by instructing the jury that the knowing failure to file escheat reports is the same as actively making a false statement and reversed the judgment of the Superior Court.
Of special note to the analysis is that this is actually a reverse false claim case. In reverse false claim cases, an entity avoids the payment of money due to the government instead of receiving money from the government.
In order for liability to attach in a reverse false claim case, “one must, in some way, falsely asset entitlement to obtain or retain government money or property.” In fact, the “false statement or record forming the basis of a reverse false claim must, in some form, have actually been submitted directly or indirectly to the government in order for liability to attach.”
Or in other words:
In order for Overstock to be found liable for making a reverse false claim under the applicable 2009 statute, it must have submitted a false record or statement that gave the State the impression that Overstock either did not owe the State money or owed the State less money than Overstock was required to pay. The absence of a record or statement cannot form the basis of a revse false claim under 6 Del. C. § 1201(a)(7).
Overstock’s failure to file escheat reports is not a false record or statement as contemplated by the 2009 version of the Delaware False Claims Act.
False Claims Acts Going Forward in Delaware
Holder beware! The Court in overuling the Overstock decision made note that the new 2013 Delaware False Claims Act law broadens the scope of liability for a false claim.
The 2013 amendments include “or knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government.“
This could conceivably change the entire outcome of the analysis of the Delaware Supreme Court to make a failure to report a false claim.
Is the Card Compliant Contract A Way Forward for Gift Card Planning?
This is a very narrow win for Overstock and the holder community. While the judgment was reversed, that does not mean that the issue of contracting the liability is resolved.
Historically, the states have said that you cannot contract away your unclaimed property liability. However, proper planning prior to incurring the liability is generally permissible.
In most circumstances, it is not advisable for a company to try to contract the liability as was done by CardFact and Card Compliant. Take the extra steps with proper planning to make sure that gift card planning is done properly.
Also note that new requirements for negative reporting, record retention, and a new DFCRA could change the entire outcome of future gift card planning lawsuits.
For more on whistleblower cases:
How Do False Claims Act Laws Impact Unclaimed Property?
Return to Unclaimed Property Litigation