These two cases, Marathon and Office Depot, have very similar fact patterns during an overlapping period, with the same outcome.
Thus, it is helpful to discuss both cases in tandem.
Both cases were the result of Delaware audits that sought to examine the books and records of special purpose entities established to hold gift cards. The Third Circuit determined that the Texas v. New Jersey trilogy of cases applied to dispute between a private individual and a State, instead of only disputes between States.
Background on the Marathon Petroleum Unclaimed Property Audit
Marathon Petroleum and Speedway (collectively “Marathon”) are Delaware incorporated entities. Within the corporate organizational structure, it has special purpose subsidiaries, organized in Ohio, for holding gift cards. Ohio exempts the reporting of gift cards as unclaimed property, assuming certain conditions are met.
Delaware began auditing Marathon in May 2007 and assigned the audit to Kelmar Associates. During the audit, Kelmar and Delaware requested “voluminous detailed financial records” covering 35 years.
Kelmar prepared an estimate for 1986 through 2000 for gift certificates, although gift certificates were only issued from 1987 to 1999.
Marathon protested to the Delaware unclaimed property audit manager Michelle Whitaker, stating that no estimation was warranted or authorized. In response, Delaware expanded the audit to gift cards.
In response to additional document requests, Marathon produced evidence to show that the gift card entities were Ohio limited liability companies. However, Marathon did not produce the balance of the documents requested. Kelmar threatened enforcement action and possible referral to the Attorney General’s office.
During this time period, Delaware was also pursuing a qui tam action against eighty-six defendants for failing to report “unredeemed gift cards issued by third-party special purpose entities organized in other states.”
On February 11, 2016, Marathon filed a lawsuit against Delaware, nine years into the unclaimed property audit! Marathon was living up to the new because that’s one long marathon of an unclaimed property audit.
Background on the Office Depot Unclaimed Property Audit
Meanwhile, Office Depot established a special purpose entity to hold and manage its gift card program in 2002. This special purpose entity was established in Virginia, another state that exempts gift cards under its unclaimed property laws.
In 2013, Delaware and Kelmar began an audit of Office Depot. During the course of the audit, Kelmar requested documents from the Virginia special purpose entity. Kelmar requested “voluminous detailed financial records” to 1995 an all unclaimed property reports for the entire audit period.
Office Depot refused most of the detailed requests, partially on the grounds that the requests predated the statute of limitations. Kelmar referred the case to the Delaware attorney general for enforcement action.
On July 18, 2016, Office Depot filed suit against Delaware, seeking that the state violates the Fourth Amendment and federal common law. Specifically, Office Depot claimed that Delaware is using unreasonable searches and seizure and violates the priority rules in the Texas trilogy.
District Court Dismisses Complaints
Marathon at the District Court
On September 23, 2016, the District Court dismissed the Marathon complaint against Delaware.
The District Court recognized that the “aggressive and persistent nature of Defendants’ audit together with the threatening referral to the attorney general’s office was real harm. The Court recognized that the audit itself presented detrimental effects and that the harm caused by the “ongoing, and possibly unconstitutional, audit process.”
If Delaware was attempting to audit a company where the end result was preempted, the District Court questioned whether the process leading to that result, the audit, was also preempted?
However, the District Court found that while the case was ripe for a decision, the Plaintiffs had no standing to enforce the Texas trilogy of cases. The court relied on an earlier decision in Temple-Inland that said the trilogy “apply to disputes among States, not to disputes between private parties and States.”
The District Court further dismissed Fourth Amendment claims of unreasonable search and seizure because the holder was not required to comply or cooperate with the audit, that it was a voluntary action, as the state did not have authority to issue a summons or take other actions to compel documents or requests for information.
Marathon appealed to the Third Circuit Court of Appeals.
Office Depot at the District Court
In March 2017, the District Court dismissed Office Depot’s complaint against Delaware.
The District Court found that the Office Depot dispute was ripe for judicial intervention, as the company would suffer actual or imminent injury if the requested declaratory judgment was not granted. Referring the case to the attorney general and the “expressly threatened penalties,” not to mention the continued disruption of the company’s business, were sufficient.
However, the District Court ruled that the Texas trilogy of cases that determine the priority rules for unclaimed property only applies to disputes between two states, not a dispute between a private company and a state.
Office Depot and Delaware agreed that the Fourth Amendment claim would be moot upon the 2017 Delaware unclaimed property law amendments (Senate Bill 13).
Office Depot appealed the federal preemption claims to the Third Circuit Court of Appeals.
Third Circuit Applies Texas Trilogy to Private Disputes
Marathon at the Third Circuit
On December 4, 2017, the Third Circuit said that private parties have standing to challenge a state’s authority to conduct an audit and escheat abandoned property.
The Court also applied New Jersey Retail Merchants Association v. Sidamon-Eristoff, where the Third Circuit said that if the states in the first two priorities, the state of the creditor’s last known address and the state of the debtor’s incorporation, were unwilling or unable to escheat the property, a third state may not attempt to escheat the same property. In other words, the first two priority rules are exclusive, despite the potential for a windfall.
Moreover, since “a state’s power to escheat is derived from the principle of sovereignty,” a state is also entitled to choose not to escheat property. . . Efforts by a state outside of the established rules of priority to escheat would be disrespectful to “the principle of sovereignty” and would effectively be an attempt to “force a state to escheat against its will.”
In analyzing whether the Texas trilogy should apply, the Third Circuit found that the reasoning behind the cases directly applied to disputes between a private individual and a state. The priority rules were established by the Supreme Court to avoid individual’s risk of double liability that would violate the Due Process Clause, protecting not just the states but also individuals.
It also would not make sense that individuals (holders) would have to wait to be sued by states to assert its rights. If the holder can assert the right as a defendant, they should also be allowed to sue for enforcement of those same rights. Moreover, allowing a private cause of action permits holders to aid states that have chosen not to escheat property to defend their state sovereignty.
Marathon’s Claims are Not Ripe
However, the Court also found that the case was not ripe – that the Texas trilogy did not foreclose the possibility of an audit of an out-of-state entity and the state had taken no formal steps to compel compliance with the audit.
That standing does not prevent Delaware from initiating an inquiry into the true holder of the unclaimed property. Remember, the first step in the unclaimed property framework, as described in Delaware v. New York is to determine the precise debtor-creditor relationship; Marathon says that Delaware may seek information to assist it in making that determination.
In particular, Delaware was looking at the Marathon gift card entities to see if the Ohio or Delaware entities were the true holder of the property; the Court said that Delaware did not need to take the company at its word that the gift cards were held by the out-of-state entity. Rather the State could look into the books and records of the companies to determine the precise debtor-creditor relationship.
Was the special purpose entity merely a shell company or were the corporate formalities actually followed? That is, the Court determined, a proper inquiry for an unclaimed property audit, particularly in light of the Card Compliant case.
The Court noted that an audit process could become so abusive such that a legitimate inquiry turns into a case that would be ripe and could be preempted. However, the record in this case was not developed such that the Court could determine that this audit should be preempted, at least at this time. (Editorial commentary: Although a nine year audit does seem to suggest that such an audit has become so abusive as to require preemption.)
The Search for State Revenue
As a side note, at the beginning of the discussion into the Marathon case, the Third Circuit recognized that unclaimed property was “Delaware’s power to search for revenue by auditing companies and escheating abandoned property.”
This has long been a concern for holders of unclaimed property in Delaware. The states claim that unclaimed property is custodial in nature and that as a matter of public policy, they are in a better position to hold the money for the true owner.
But in some states, particularly in Delaware which uses an aggressive look-back period and estimation methodology with a relatively low percentage of claims returned to owners, it looks more like a money grab to fill the public coffers than it does helping people be reunited with lost money.
Unclaimed property has long been the second or third source of revenue for Delaware. The state even uses unclaimed property to balance the budget and provide core government services.
Applying Marathon to Office Depot
The Third Circuit says that its decision in Marathon squarely applies in the Office Depot case and the same outcome is warranted in this case.
It is important to note here, and not to blame the District Court, that the result is due to the timing on the cases. The District Court issued its decision in this case on March 3, 2017, prior to the Third Circuit decision in the Marathon case, on December 4, 2017.
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