The Story of the Staples Unclaimed Property Audit and Litigation

Staples Inc settled a lawsuit against Delaware after an unclaimed property audit following a Delaware voluntary disclosure agreement

Staples originally filed suit against Delaware in 2010 based on an unclaimed property audit that began five years prior, after the company’s Voluntary Disclosure Agreement was ignored.

In that audit, Delaware assessed Staples’ liability for abandoned property consisting of unclaimed accounts payable and paychecks from 1995 to 2003. Delaware claimed Staples owed it amounts attributable to unclaimed customer rebates, despite the UCC statute of limitation.

VDAs, Private Auditors, and Contingency Fees: The Context

After the 2008 recession hit, states struggled to fill the growing gaps in their budgets that resulted from the mayhem in the financial markets.

Many state officials viewed unclaimed property as a key source to achieve that goal, and Delaware was no different. After all, unclaimed property is not a tax so states could raise revenue without increasing taxes. With minimal efforts to return property to owners, states could count on the bulk of collections for their general fund and to balance budgets.

Several states began to adopt a more aggressive posture to collect from corporations under unclaimed property programs. Being the home state of incorporation for a large number of businesses, Delaware soon saw unclaimed property proceeds become its third-largest source of revenue, behind only corporate franchise taxes and personal income taxes.

Just a few years later, in 2010, the annual amount Delaware collected from its corporations reached $500,000,000.

Corporate Concerns Over the Delaware Model: Overreach and Conflict of Interest

Many holders and their attorneys raised concerns about this aggressive posture, pointing out that these programs weren’t intended to serve as a permanent source of revenue for the states. After all, state officials were supposed to turn all those proceeds over to the real owners of the underlying property.

In addition, Delaware’s use of Kelmar as a private contract auditor that worked on contingency concerned corporate holders who saw the arrangement as incentivizing a larger dollar amount “finding” in the audit. The more property that Kelmar identified (or “identified”), the more money it would in turn make from Delaware.

Yes, the use of quotes is intentional – while large assessments were common, they were all based on estimations from periods when a company lacked complete records; this property could never be returned to an owner and was strictly a penalty against companies for failing to realize that at some point in the future, a state would require that they have 30 years or more of records.

Delaware’s Rebuttal: File a VDA and We Won’t (Usually) Audit

In response to the concerns about its private auditor and the contingency basis of the contract with Kelmar, Delaware pointed out that the auditors were limited to a 12% cap on their contingency fee.

In addition, the state argued, not every corporation would be audited. All the holder had to do was submit a voluntary disclosure agreement (VDA) to the State Escheator’s office. If the company had complied with the state’s annual filing requirements and the state accepted the corporation’s VDA as “reasonable,” there would be no audit. The company would also avoid the imposition of penalties and interest.

According to this Boston.com story, about 348 VDAs were filed between 2001 and 2010, with 23 or 7% of the companies filing those VDAs being audited subsequently.

However, for companies who were audited, the audit seemed to work in the state’s favor. Initial amounts claimed by those companies totaled $7.2 million, while the amount ultimately assessed and collected was more than 10x greater ($75 million).

Staples VDA Turns Into An Audit and Litigation

In 2000, Staples filed a VDA with Delaware, paying $137,412 for accounts payable. Under the then applicable statute, Delaware had three years to complete a review of the VDA.

Delaware initiated an audit in 2005, with a look-back period to 1995 which included portions of the VDA period.

Five years after starting the audit, Delaware presented a Demand for Payment of $3,155,541 for accounts payable and payroll, plus $807,208 in interest. The state demanded payment of that full amount within thirty days for the accounts payable and payroll property types while keeping all other property types open and subject to the ongoing audit.

Rather than comply with the Demand, Staples filed a complaint in the Delaware Court of Chancery.

Staples argued that among other things, Delaware put the company “in a compromising position because if Staples assert[ed] any good faith challenge to Delaware’s demand for payment, Delaware [was] in a position to retaliate against Staples by exercising its discretion in its audit of other property types in a manner that is even more adverse to Staples than the accounts payable and payroll audit.”

Staples also argued that the estimation was incorrectly calculated because it used owners outside of Delaware to calculate the amount owed and that it was prejudiced by the delay in auditing because it destroyed records, under a standard record retention policy, that would have otherwise been used to defend itself in the audit.

The Debate Over Rebates

Among other forms of relief, Staples sought a declaratory judgment that the state could not properly escheat unclaimed customer rebates. These rebates were for large corporate buyers that would receive a reduction in price when certain thresholds of purchasing were attained each year. The reduction would then be applied retroactively to the prior purchases, resulting in a “rebate” which could be either a refund check or a credit for future purchases.

These “rebates” are distinct from the typical consumer rebates where a consumer purchases an item and then completes paperwork for a rebate check.

Staples argued that these rebate amounts were not enumerated in the applicable statute, 12 Del. C. § 1198(11), because the statute of limitations for these rebates had already run (the UCC statute of limitations). That meant the rightful owners could not sue to claim the rebate amounts in court. Staples contended that this meant the state could not claim the right to escheat the property, because the owner’s claim was time-barred.

The State of Delaware counter-sued for a declaratory judgment that the amount assessed was proper and authorized by law, including the amount assessed as unclaimed customer rebates. Both parties made motions for partial judgment based on the pleadings in the case.

Applicable Law: The Escheat Statute, “Abandoned Property” and the Period of Dormancy

The single question at issue for this opinion is fairly straightforward: Are unclaimed rebate checks that Staples issued to its business customers properly considered as “property” (for “abandoned property” purposes) under one of the “specifically enumerated” categories in the Escheat Statute?

If the answer is yes, then Delaware was right to include them in the audit and the assessed amounts due from Staples. If the answer is no, they must be excluded, because property that isn’t contained in those enumerated categories but that is subject to a statute of limitations that runs before the dormancy period does cannot be subject to escheatment.

Under 12 Del. C. § 1155, Delaware officials may audit (and thus claim under escheatment) “abandoned property” as that term is defined by § 1198(1): “property against which [the] full period of dormancy has run” (or five years, during which time the rightful owner has made no claim to the property in question). In this case, both Staples and Delaware agreed that the period of dormancy had expired for the unclaimed rebates.

1198(11) of the Escheat Statute provides in part (added emphasis):

`Property’ means … personal property… of every kind or description, tangible or intangible, … [including], but not by way of limitation, (i) money; (ii) bills of exchange; … (iv) credits …; and (xiii) all other liquidated choses in action of whatsoever kind or character…. The word `property’ does not include … any property, except the items specifically enumerated above in paragraph (11) of this section …, the right to recover which in a proceeding brought by the owner would be barred by any statute of limitations ….

The court holds that the rebates fit either one of two enumerated categories: “bills of exchange” or “credits.” Thus, it grants the State’s motion for partial judgment on the pleadings and denies the Staples motion.

Bills of Exchange, Credits and Counsel’s Concession

Interestingly, the basis for the court’s decision came not from any specific part of the pleadings, but from a statement made by Staples’s lawyer at oral argument. Apparently, the parties’ pleadings were not clear as to how the rebates were earned, transmitted or cashed in, so this was a point of exploration at oral arguments held on the parties’ cross-motions.

Specifically, this following exchange was cited in the court’s opinion:

Q: The way this works is you send them — in my hypothetical, Chancery [meets the minimum volume requirement for a rebate], gets [a] $1,000 rebate eligibility. [Staples] send[s] me a check that I can then take to a bank and get $1,000 from.

A: Yes. Usually what happens is the salesperson takes a check … and if they’ve met their requirement, they’ll hand it to them.

Q: It’s a check.

A: But it’s a check. It can be a check or it can be an offset to amounts owed….

Q: An offset to amounts owed, that’s a credit.

A: [State’s counsel] It’s called a credit.

A: [Staples’s counsel] It can sometimes be a credit, it can sometimes be a check. It’s a rebate ….

If the rebate took the form of “an offset to amounts owed,” it would be a “credit” under the provisions of § 1198(11), quoted above.

However, as Staples’ lawyer conceded, rebates might also be issued as a check. In that case, the rebate was a negotiable instrument that the customer/owner could cash at their bank. If that’s the case, the rebate constitutes a “bill of exchange,” which is also within the § 1198(11) provisions.

Staples argued that the rebate itself was neither a check nor a credit, but only might be paid in one of those forms. In other words, it attempted to draw a distinction between the underlying property (the rebate) and the form in which the holder transferred that property to the customer.

The court rejected this as a question of “what versus why.” Specifically, the property is what is transferred. Why it is given is irrelevant. If the Delaware legislature had wanted to carve out specific forms of property from the enumerated list in § 1198(11), it could easily have done so. It would not have left it to the state’s judiciary to create those exclusions, then justify them on the basis of some proffered rationale, especially where, as here, the holder’s own explanations made it clear the property fell within the specifically enumerated categories in the statute.

Staples Settles Unclaimed Property Audit With Delaware

Following its loss on the issue of whether unclaimed customer rebates were abandoned property, Staples agreed to settle with Delaware. Both parties wanted those terms to be kept under wraps.

However, the Associated Press challenged that move, and the terms were finally released to the public in September 2012. The amount Staples agreed to pay Delaware under the terms of the settlement was $8.9 million.

Due to the settlement, many important issues remained unresolved: Delaware’s estimation methodology, how long it takes to audit and the length of the audit look-back period, and other aggressive methodology. Despite subsequent wins in Temple-Inland and other cases, these issues are still the subject of unclaimed property litigation.

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