“Escheat” without the “Es”

Two hands and arms pulling at American $100 bill - let's talk about the fight between Delaware and two different companies unclaimed property audits and estimations
On the heels of AT&T’s lawsuit against Delaware comes three more cases, attacking Delaware’s unclaimed property audit and estimation practices.

The cases were filed in federal court in the District of Delaware.

As the cases have substantially the same fact pattern and legal issues, they are discussed here together. Notable differences are pointed out below.

Current Status of Eaton v. Geisenberger

Eaton filed its lawsuit against Delaware on December 12, 2019. The case is 19-cv-02269 and styled Eaton Corporation v. Geisenberger. Delaware used third-party auditor Kelmar Associates to audit Eaton.

Delaware then filed a motion to dismiss and Eaton filed a motion for a preliminary injunction. Delaware’s motion to dismiss was granted-in-part and denied-in-part and the holder’s motion was denied on September 15, 2020.

Current Status of Fruit of the Loom v. Geisenberger

One day after Eaton, Fruit of the Loom v Geisenberger was filed on December 13, 2019. The case is 19-cv-02273.

The Fruit of the Loom (“FOTL”) audit was conducted by a relative newcomer to the unclaimed property audit landscape, Innovative Advocates Group (IAG).

Similar to the Eaton case, Delaware filed a motion to dismiss and FOTL filed a motion for preliminary injunction. Delaware’s motion to dismiss was granted-in-part and denied-in-part and the holder’s motion was denied on September 15, 2020.

Current Status of Siemens v. Geisenberger

Adding a third case to the discussion after it was also consolidated in the post-complaint motions.

The Siemens audit was assigned to Kelmar Associates, LLC as the third-party contingent fee auditor.

In Siemens, it is important to note that they have a letter agreement with the state regarding its potential unclaimed property liabilities, wherein the company deposited, and the state accepted, a significant amount of money. If the eventual liability exceeds this amount, the company will be required to pay additional sums, while if the liability is less than this amount, they will be owed a refund.

Like the other cases, Delaware’s motion to dismiss was granted-in-part and denied-in-part and the holder’s motion was denied on September 15, 2020.

Termination from Delaware Expedited Audit Program

All three companies, Eaton, FOTL, and Siemens, entered into Delaware’s expedited audit program, in the wake of the 2017 Delaware statutory amendments.

In 2019, the companies were terminated from the program after the companies objected to overly burdensome requests and highly inflated preliminary estimates.

You may also be interested in AT&T v. Geisenberger, a similar lawsuit based on the termination of the Delaware Expedited Audit Program. In the recent motion to dismiss, Delaware released the contract with Kelmar, dated December 31, 2019.

During the pendency of the current litigation, Delaware sent letters to the companies stating their desire to resume the audits, on a non-expedited basis. (April 2020)

Holder Claims Against Delaware

Like many unclaimed property audits, these three audits began many moons ago, all before the Temple-Inland case was decided. If you will recall, Temple-Inland was the case that gave us the quote that Delaware’s estimation methodology “shocks the conscience” in violation of due process.

Following Temple-Inland, Delaware’s legislature amended the unclaimed property law and created an expedited audit path. The carrot to this program was that, similar to a VDA, there would be no interest or penalties assessed against a holder that completed the program in two years.

However, as holders soon found out, the process remained as burdensome as ever. In these three audits, all the companies were given burdensome requests for 15 years and the auditors requested that the companies remediate outstanding or voided checks, even those that Delaware is not entitled to claim under the priority rules, as established in Unclaimed Property Priority Rules Established in Texas v. New Jersey. Delaware could not claim these checks because they had names and addresses outside of Delaware, in a state that has similar unclaimed property laws.

As the companies refused to remediate these checks (to show that they were not in fact unclaimed property), Delaware terminated their participation in the expedited audit programs on December 11, 2019, five days after the statutory deadline for the State to issue a final examination report and demand payment.

The companies all filed lawsuits against Delaware, with similar allegations: federal preemption of the Delaware unclaimed property law, both facially and as applied, 14th Amendment substantive due process violations as applied to the companies, and Fourth Amendment violations.

As summarized in the memorandum opinion to dismiss, the companies wanted the Court to declare that:

  • Federal common law, i.e., the United States Supreme Court’s “Texas Trilogy” line of cases, bars Delaware from estimating the amount of unclaimed property it can claim from Plaintiffs;
  • Federal common law, i.e. the “Texas Trilogy” line of cases, preempts sections of the UPL and accompanying regulations that authorize the State Escheator to employ estimation and ignore owner addresses to estimate abandoned property escheatable to Delaware;
  • Federal common law conflicts with and preempts aspects of Defendants’ audits, including their continuing audit of property with customer addresses in other states that Delaware cannot claim under the “Texas Trilogy”; and
  • Retroactive enforcement of the same UPL sections and accompanying regulations violates Plaintiffs’ rights to substantive due process;
  • Defendants’ use of contingent-fee auditors to conduct the unclaimed property audits and determine liability violates Plaintiffs’ rights to procedural due process;
  • The UPL violates due process and the Fourth Amendment of the United States Constitution because it does not provide for pre-enforcement review of Defendants’ termination of Plaintiffs’ expedited audit election.

Delaware’s Motion to Dismiss

Delaware argued, and the court agreed, that the case was not yet ripe for the court to take action.

Even though Delaware had sought an action to terminate the expedited audit, they had not compelled the companies to participate in the audit through a Chancery Court enforced subpoena, nor had they made any final determinations or demands for payment. Basically, until one or both of these actions occur, there is no adversity between the parties requiring the court to take action to decide the dispute.

The court distinguished the Marathon Petroleum case, where the holders challenged the right of Delaware to audit special purpose (gift card) out-of-state entities. However, ultimately in Marathon the court said that the audits were not ripe, just like in Univar and Plains All-American.

“Thus, for the same reasons such claims were deemed insufficient in Marathon, Plains, and Univar, Plaintiffs’ preemption and substantive due process claims are insufficient here — i.e., Plaintiffs’ challenges remain contingent upon future events that may not occur as anticipated or may not occur at all. Defendants have not issued an administrative subpoena seeking compliance by Plaintiffs related to their audits, never mind sought enforcement of such a subpoena in the Court of Chancery. Thus, Plaintiffs are “not yet compelled to comply with the . . . unclaimed property audit[s] and thus not yet subjected to [them].” Additionally, although Defendants have issued preliminary reports, they have made no escheatment demands of Plaintiffs to date, so any constitutional injury arising from the estimation methodology employed — even that set out in statute — “remains . . . contingent upon it being used against Plaintiff[s] to form the basis of an escheatment demand.” “Such a situation remains contingent upon future events, and thus [Plaintiffs’] case[s] [are] not distinguishable from Plains” or Univar. Furthermore, although it may later be found that retroactive application of the UPL’s new estimation, records retention, and foreign escheatment provisions and the corresponding regulations are unconstitutional, the reality remains that those provisions have not yet been enforced against Plaintiffs. Thus, Plaintiffs remain “in the same stature” as those in Plains, Marathon, and Univar, “where [they are] free to `simply refuse to cooperate.'” ” (citations omitted)

The Court did find that the procedural due process claims regarding the early termination of the expedited audit program were ripe for a decision. The harm had already occurred, and furthermore “a ruling on the merits would be useful to the parties and others given Delaware’s apparent widespread early termination of expedited audits without pre-enforcement review.” (My emphasis added)

With the only remaining claims being a challenge to the early termination of the expedited audit program, Delaware challenged that it could not be sued in federal court under the basis of sovereign immunity. Delaware argued, and the court once again agreed, that the termination process was a matter of state law and was subject to review in state court, not federal court.

Those Third-Party Contingent Fee Unclaimed Property Auditors

Holders have been arguing for years (decades) that the use of a contingent fee third-party auditor is manifestly unfair as it creates a self-interest for the auditor to artificially inflate the estimation of unclaimed property liability. The State Escheator’s duties and responsibilities have been abdicated, leaving the Escheator as little more than a rubber stamp for the decisions the unelected and unaccountable auditors.

Plains and Univar made clear that this relationship was an issue. The contingent fee auditors in an unclaimed property audit are not merely prosecutors. These auditors are involved in the process from the “selection of targets through determination of ultimate liability” and are compensated by their assessments. Delaware also argued that Kelmar’s new contract (as disclosed in AT&T made the issue moot, but the court rejected this saying “there is no indication that the constitutionality of contingent fee auditors in Delaware unclaimed property audits is moot.” The defendant unilaterally changing its behavior after a lawsuit has been file will not moot a case unless it is clear that they can return to the objectionable behavior.

The court actually had some harsh language for Delaware and Kelmar: “Moreover, the character of Defendants’ past violations and current actions leaves the Court with doubts as to Defendants’ commitment to ending the practice.

First, Kelmar’s fee structure is set by contract, not law, and Defendants admit that the UPL and applicable regulations still allow for contingent-fee arrangements. Thus, the contract could presumably be altered in the future if the parties so wish. Second, there is no indication that Defendants intend to remove contingent fee arrangements from all third-party auditor contracts. This is highlighted by the facts that, by law, Kelmar’s contract only applies to — at most — half of all unclaimed property audits in Delaware, 12 Del. C. § 1178(a), and that there has been no argument from Defendants that IAG is subject to a similar payment structure. Third, Defendants continue to defend the practice of contingent fee arrangements for unclaimed property audits. Finally, the timing of the new Kelmar contract, coming just a few weeks after these and one other suit challenging Delaware’s contingent fee practice were filed and only a little more than a month before the instant motions to dismiss were submitted, “strongly suggests that the impending litigation was the cause of the [change] and, given the continued defense of the [practice] in question,” never mind the state of the law, “there [is] no assurance that [Defendants] w[ill] not enter into a [relationship] similar to [that being challenged] in the future.” Thus, to the extent Defendants argue that Kelmar’s new fee arrangement obviates Eaton and Siemens’ procedural due process claims based on the State’s enlistment of contingent-fee auditors, the Court disagrees.

For the above reasons, the Court is satisfied that Plaintiffs’ contentions and supporting claims are sufficient to state procedural due process claims that Plaintiffs must submit to non-neutral adjudicators for their unclaimed property audits. (internal citations omitted)

However, the court did not enjoin Delaware, nor the auditors, from enforcing the audits because the companies did not establish irreparable harm. A preliminary injunction is one of the most powerful tools that a court has in its arsenal. Thus, they try to wield this weapon with great caution. A purely economic injury, unless so great to threaten the existence of the business, will not satisfy the burden of irreparable harm since the plaintiff can be compensated with money.

Escheat Without the Es

Wondering where the new title for this litigation summary came from? It is a direct line from Judge Maryellen Noreika, District Judge hearing these consolidated cases.

See, escheat comes from feudal times, when land reverted back to the sovereignty. Since then, every state, plus a handful of other American jurisdictions, have passed escheat laws, allowing for the states’ collection from holders of abandoned property to provide for the safekeeping of the property until the owner can claim it.

Meanwhile, state escheat laws have come “under assault for being exploited to raise revenue” by the states, rather than as a mechanism to protect the property for the owners. Delaware specifically has managed to make this safekeeping property its third largest source of revenue, with the use of the highly exaggerated estimations of unclaimed property under its fortunate position as the state of incorporation for so many holders.

Here’s the money quote from the case:

“In other words, it appears that many observers — not to mention targeted parties — have come to think “escheat” should be written without the initial “es.””

What’s Next In Delaware Unclaimed Property Litigation

The major outstanding federal issue is the use of the contingent fee auditors and what the harm is to the companies. This will proceed in federal court.

In April 2020, Delaware indicated its intent to resume the audits. Delaware can resume the audits and the companies can decide whether to comply. Or wait for Delaware to take enforcement action. Of course, all pending the decision of whether to appeal and the outcome of any appeal.

And while the current decision decided the cases were not ripe or that they were suffering irreparable harm, that could always change and the companies could seek future injunctive relief if the need arises.

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