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Weekly State Tax Report: News Archive
2012
Perspective
Unclaimed Property
Unclaimed property accounts or items held by one party belonging to another
who has not exercised control over the property for an extended period of time
can include inactive bank accounts, life insurance proceeds, uncashed dividend
checks, and even unredeemed gift cards and refunds. All states claim the right to
consider property abandoned after it has lain dormant for a stated period of time
and to seize abandoned property for the purpose of holding it in a custodial
capacity for the benefit of the owner. In this interview, Ethan D. Millar, of Alston &
Bird LLP, discusses recent trends in these escheat laws.
Practitioner Questions the Expanded Sweep of Unclaimed
Property Audits and the States' Focus on Generating Revenues
Ethan D. Millar, interviewed by Priya Nair and Steven Roll
Ethan D. Millar is a partner at Alston & Bird LLP in Los Angeles. His practice focuses on unclaimed
property and state tax matters, including audits, litigation and planning. He can be reached at
*****.******@******.***. Steven Roll is assistant managing editor and Priya Nair, tax law editor, for
state tax with Bloomberg BNA.
BLOOMBERG BNA:
Why do you think that the area of unclaimed property has recently come to the forefront in state
taxation?
MILLAR:
One reason is that a number of states have become very aggressive in auditing holders of unclaimed
property, typically through the use of contract auditors who are compensated on a contingent fee
basis. Unclaimed property laws originally had a very simple and useful purpose to return missing
property to its rightful owner. Over the years, though, many states have expanded these laws to try
to capture property that may not even be owed by the holder or that can never be returned to the
owner. Thus, for many states, unclaimed property laws have turned into a revenue generator, at the
expense of holders. The community of unclaimed property holders has become much more aware of
state overreaching in unclaimed property audits, and so holders are now looking to better understand
their rights and obligations in this area so they can be in a better position to prepare for and defend
against these audits.
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BLOOMBERG BNA:
With respect to states aggressively pursuing unclaimed property, can you give some examples of what
you consider to be the most aggressive actions by states?
MILLAR:
For starters, many states use an unreasonably high standard of proof for determining whether a
purported liability of a holder is still outstanding and therefore may constitute unclaimed property. For
example, some states treat a purported liability as unclaimed property unless the holder can prove
beyond a reasonable doubt that the liability is no longer owed. However, it is important to remember
that the state, rather than the holder, bears the burden of proving the existence and amount of
unclaimed property. Moreover, even if, as many states argue, the state can shift its burden to the
holder where the holder's records indicate the existence of a liability, the holder should still be able to
satisfy that burden based on a preponderance of the evidence. Use of a higher standard of proof will
artificially overstate unclaimed property liability by sweeping in liabilities that have very likely been
satisfied, but for which the holder's records (which are often imperfect, particularly for earlier years)
cannot substantiate at the higher level of proof. Basic unclaimed property principles would require that
the state use the same standard of proof that a creditor must satisfy in order to prove the existence of
a debt. Clearly, a criminal burden of proof exceeds this standard and should be resisted by holders.
Another common practice by states is to seek unclaimed property based on an estimate of the amount
owed by the holder. However, it is still not even clear that states have the right to estimate unclaimed
property at all. To the contrary, there is case law, including the U.S. Supreme Court's decision in
Delaware v. New York, 507 U.S. 490 (1993), that suggests that states may only escheat property
when the holder has a fixed and liquidated liability to the owner, which would never be true for an
estimation. Indeed, in Allstate Insurance Co. v. Eagerton, No. CV-79-468-P (Ala. Cir. Ct. (Montgomery
County)), rev'd on other grounds, 403 So.2d 172 (Ala. 1981), the court held that Alabama could not
use statistical estimation to prove the existence of unclaimed property for this very reason.
But even if estimation may be permitted under
Many states use statistical estimates to certain circumstances, there is a still a significant
prove the existence of unclaimed property. issue regarding what constitutes a reasonable
estimation methodology. Any claim by a state
based on statistical estimation necessarily results in a true escheat of the property (rather than a
mere custodial escheat, where the state holds the property temporarily until the owner reclaims it)
because there is by definition no owner of estimated property and therefore no person who could
reclaim the property from the state. The law strongly disfavors true escheats of property. As the
New Jersey Supreme Court stated in State v. United States Steel Corp., 95 A.2d 734, 738 (N.J. 1953),
in a true escheat, any doubt as to whether property is subject to escheat is resolved against the
state. This suggests that true escheats should only be permitted in rare and unusual situations where
there is no doubt whatsoever as to the existence and amount of the liability. Applying this standard of
proof to statistical estimations would seem to support the proposition that, if estimation is permitted
at all, the estimation methodology should be sufficiently conservative such that there is very little
chance that the estimation will produce a liability greater than what is actually owed. States, of
course, use much less conservative methods that regularly overstate liability.
Another aggressive practice is requiring holders to remit cash to the state where the holder has no
obligation to pay cash to the owner of the property. The most common example of this is the
escheatment of unredeemed balances on gift cards, which are normally redeemable only for
merchandise and services and not for cash. Despite the fact that the owner of a gift card cannot
demand cash from the card issuer, many states including Delaware and New York require all or a
portion of the unredeemed balance to be remitted to the state in cash. By requiring a holder to
escheat cash for unredeemed gift card balances, the state changes the basic nature of the holder's
obligation to the owner by converting the holder's agreement to provide merchandise or services into
an obligation to pay cash. This is contrary to one of the most basic principles underlying state
unclaimed property laws, which is that the state derives its right to take custody of unclaimed
property from the owner and therefore should have no greater right to claim the property than the
owner. This principle has been recognized by the Supreme Court in Delaware v. New York, 507 U.S.
490, 503 (1993), where the Court stated that the holder's legal obligations define[ ] the
escheatable property at issue.
BLOOMBERG BNA:
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The Third Circuit in New Jersey Retail Merchants Assoc. v. Sidamon-Eristoff, 669 F.3d 374 (2012),
upheld a preliminary injunction against retroactive application of 2010 amendments to New Jersey's
unclaimed property statute (codified at N.J. Rev. Stat. 46:30B) for the escheat of stored value cards
redeemable only for merchandise or services. Prospective enforcement of escheat based on place of
purchase when the purchaser's address is unknown was also enjoined. What do you think is the
bottom line take away from this case for states? For the holders of unclaimed property?
MILLAR:
There are probably three primary take-aways from this decision for both states and holders. The first
is that, at least for now, New Jersey may not claim unredeemed stored value cards issued before July
1, 2010, the effective date of the act, unless the cards are redeemable for cash.
The second big take away is that New Jersey may not escheat stored value cards under either the
third priority rule or the place of purchase presumption. The third-priority rule purported to give New
Jersey the right to claim unredeemed cards if the cards are sold in New Jersey and neither the first-
nor the second-priority rule applies i.e., because the holder does not have a record of the
cardholder's address and the holder is domiciled in a state that does not provide for escheat of stored
value cards. The place-of-purchase presumption went even further, by providing that if the holder has
no record of the cardholder's actual address, then the address is deemed to be in New Jersey if the
card is sold in the state. This rule was designed to allow New Jersey to circumvent the second-priority
rule entirely, by substituting the state in which the card is sold for the holder's state of domicile. The
court found that both the third-priority rule and the place-of-purchase presumption conflicted with the
two priority rules created by the U.S. Supreme Court, and thus were preempted. As a result, New
Jersey may only escheat stored value cards under the first priority rule, which applies if the holder
has a record of the cardholder's address and the address is in New Jersey, and the second priority
rule, which applies if the holder's state of domicile is New Jersey.
The third major take away I would mention is that
New Jersey's right to require record- the Third Circuit upheld New Jersey's right to
keeping is upheld. require issuers of stored value cards to collect the
name and address of the purchaser or owner of
the card and, at a minimum, maintain a record of the owner or purchaser's zip code. However, New
Jersey has previously relaxed this rule to only require the collection of the purchaser's zip code and
not the full address in most cases. New Jersey contends that a zip code is an address sufficient to
trigger the first-priority rule, and thus is hoping to generate some revenue through this zip code
collection requirement.
However, New Jersey's own regulation, the 2010 Act itself, as well as other authorities, suggest that a
zip code is not a sufficient address for this purpose. Both Delaware and New York have also indicated
that they do not consider a zip code, without more, as sufficient to support a state's claim to escheat
under the first priority rule, and they would expect companies domiciled in their states to report
unredeemed gift card balances to them as the state of domicile under the second priority rule if the
only record the issuer has of owner address is a zip code. This means that companies domiciled in
those states, and perhaps others, may well face conflicting claims for the same unredeemed card
balances.
Regardless of the escheat issue, though, the forced collection of zip codes does create substantial
technical hurdles for many holders, who will need to implement significant and costly changes to
their point-of-sale systems and business processes to comply with this new rule. Some holders,
particularly those that sell cards through third party distribution networks, will be unable to comply
with the zip code collection requirement at all, and will be forced to stop selling cards in New Jersey.
Indeed, InComm, Blackhawk Network and American Express have already announced their intention
to withdraw gift cards from New Jersey for this very reason.
BLOOMBERG BNA:
How do you think that this decision will impact other states?
MILLAR:
The most immediate impact will be that other states will now need to think twice about attempting to
escheat cards or other property under the third-priority rule, or any transaction-based custody rule.
Thirty-six states, plus the District of Columbia, have adopted the third-priority rule in their unclaimed
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property statutes, and thus it is a significant win for holders that a federal appellate court has now
upheld a preliminary injunction against this rule on the basis that it is likely unconstitutional.
There is, of course, also a significant concern that other states may follow New Jersey's lead and
attempt to impose a similar zip code or address collection requirement at the time of sale of a gift
card. This is certainly possible, especially if New Jersey is successful ultimately in garnering
widespread industry compliance in collecting the zip code information and reporting and remitting
unredeemed card balances with New Jersey zip codes to New Jersey. However, the good news is that
most of the major states, including California, Texas, Illinois, Florida and Pennsylvania, generally
exempt gift cards from escheat. Also, as mentioned earlier, other significant states, like New York,
take the position that a zip code is not an address sufficient for purposes of the first-priority rule and
thus would have no reason to implement such a requirement.
But it is possible that New York or another state could seek to impose a requirement to collect the
purchaser's full address, which would clearly trigger the first-priority rule, assuming such a
requirement could withstand the numerous challenges that would certainly be brought against it. Such
a requirement would raise extremely difficult technical problems for issuers and sellers of stored value
cards, not to mention very serious constitutional issues (under the Commerce Clause, for example)
and privacy concerns and potential liability for obtaining and maintaining personally identifiable
information of consumers securely in a fast-moving retail environment. Such a requirement also may
well mobilize holders to mount further attacks against the bigger issue of whether a state can require
a holder to escheat cash with respect to unredeemed gift cards that are redeemable only for
merchandise or services. There are still significant constitutional arguments that can be made against
this type of escheat, which have not yet been specifically addressed by any court.
BLOOMBERG BNA:
The Third Circuit affirmed a preliminary injunction against the state of New Jersey. What do you think
New Jersey's next steps will be?
MILLAR:
First, we will need to see if any of the parties files a petition for writ of certiorari with the U.S.
Supreme Court. My understanding is that the plaintiffs will likely file such a petition by the end of May.
If the petition is denied, though, the case will go back to the district court to decide whether the
preliminary injunction will become permanent. Based on the reasoning in both the district court and
Third Circuit opinions on the substantive issues, I would expect the injunction to become permanent.
New Jersey's next step should be to issue guidance regarding the zip code collection requirement. First
and foremost, New Jersey will need to inform issuers when the requirement will become effective, if
indeed it is to become effective at all. We are in direct discussions with the New Jersey Treasurer and
Attorney General's Office regarding the zip code requirement, and the Treasurer and other officials
with whom we have met appear sincere in their willingness to listen to industry's concerns regarding
the burdens that this requirement imposes on card issuers and possible actions that could be taken to
alleviate or eliminate these burdens. Consequently, we believe there is still at least some chance that
a resolution will be reached that eliminates or substantially limits the zip code collection requirement,
though some comments made by Gov. Christie yesterday on this issue were quite discouraging. In the
event the zip code requirement does become effective, New Jersey has given us assurances that it will
provide card issuers at least some reasonable notice before the requirement takes effect.
If the requirement does become effective, New
New Jersey will need to explain how it will Jersey will also need to clarify a number of issues
apply penalties for failure to comply with regarding the scope of the requirement, including
its record-keeping requirements. whether the requirement will apply to sales of
stored value cards that have to be registered
before use, reloads of value onto previously sold cards, and cards sold online or by telephone. The
penalties for failing to comply with the zip code collection requirement are also uncertain, and New
Jersey will need to explain how it will attempt to apply statutory penalties for failure to comply with
requirements of the law, as well as whether it will agree to waive penalties for holders that voluntarily
escheat cards that are sold in New Jersey and that are not subject to escheat by any other state under
the first- or second-priority rules.
We hope to have further insight into New Jersey's likely course of action soon.
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BLOOMBERG BNA:
Daily deals, such as Groupon, have become very popular. What do you think the impact of unclaimed
property laws will be on these types of promotions?
MILLAR:
These daily deal programs can be structured in a variety of different ways, and the unclaimed property
consequences will depend substantially on what structure is chosen. However, in general, the daily
deal consists of a voucher that is purchased by a consumer at a discount from its face value. The
voucher is typically bifurcated into two components: a paid component that can be redeemed by the
consumer for the amount paid, and a promotional component that can be redeemed for some
additional value during a specified promotional period. The paid component is similar in many ways to
a gift certificate, and thus should be exempt from escheat in most states because it does not expire.
The promotional component is more analogous to a promotional certificate, and promotional
certificates also should not be subject to escheat in most states even if they have expiration dates.
On the other hand, some states are more aggressive and may attempt to escheat both the paid
component and the promotional component even though that may require the holder to escheat an
amount greater than the amount actually paid for the voucher by the consumer a result that would
go beyond even the most aggressive state statutes as previously applied.
In most daily deal programs, the holder of any unclaimed property will normally be the merchant
that issues the voucher rather than the marketing/distribution company (such as Groupon,
LivingSocial, Gilt City, etc.) that sells the voucher to the consumer. However, oftentimes, the
merchant will be a small mom-and-pop store that is completely unaware that it might have potential
liability for unredeemed vouchers under state unclaimed property laws. It is unlikely that states will
seek to go after such small businesses on audit, and therefore may instead target the larger deeper
pocket marketing/distribution companies. It may take some time (and possibly litigation) to educate
the states on how these programs work and why the marketing/distribution company is not the holder
for unclaimed property purposes.
Recent Delaware Developments
BLOOMBERG BNA:
Delaware recently issued proposed regulations on unclaimed property that impose new requirements
on holders. Do you see any inherent problems or issues with these proposed regulations?
MILLAR:
There are several issues raised by the proposed regulations, which can be found at 15 Del. Regs.
959 and 965 (Jan. 1, 2012). For instance, the proposed regulations impose a new due diligence
requirement on holders of unclaimed securities, dividends and similar property. However, there is no
statutory authorization for such a requirement, which would appear to be necessary given the
significant compliance burdens such a requirement would impose. The due diligence requirement also
purports to apply to securities property where prior mailings to the owner have been returned as
undeliverable. Given that the property has already been determined to be undeliverable, further due
diligence would seem to be unnecessary.
The proposed regulations also provide additional guidance on Delaware's new administrative appeals
process, which was adopted in July 2010. One issue raised by the regulations is that the holder must
be represented on appeal by an attorney admitted to practice before the Delaware Supreme Court or,
in the discretion of the independent reviewer, by an attorney that is admitted pro hac vice by a
member of the Delaware Bar who maintains a law office in the state. Holders need to have the right to
select the counsel of their choosing, and so it is clearly a problem that the independent reviewer, who
is appointed by the Delaware Secretary of Finance, has the discretion to bar non Delaware attorneys
from representing holders in the appeals process. The requirement that a non Delaware attorney be
admitted pro hac by a member of the Delaware bar who maintains an office in Delaware is also
problematic, as many law firms may have Delaware licensed attorneys but may not actually have a
physical office located within the state.
BLOOMBERG BNA:
What are some of the issues with using contingency fee auditors for unclaimed property assessments?
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MILLAR:
The use of contingent fee auditors in this area is a very controversial issue. Obviously, when an
auditor has a financial stake in the outcome of the audit, the auditor has an incentive to take
aggressive positions that may produce a larger assessment. In addition, there are a number of factors
that make the use of such auditors particularly problematic in the unclaimed property area. For
example, unclaimed property laws involve many gray areas where the law is simply unclear, and
which therefore may be exploited by auditors. Another factor is that few states have administrative
appeals processes for unclaimed property disputes, and thus a holder's only real recourse to deal with
an overstepping auditor may be litigation. However, contingent fee auditors also routinely audit on
behalf of multiple states simultaneously often as many as thirty or forty states at once. This makes it
much more difficult, and costly, for holders to appeal any assessment, either administratively or
through litigation. Finally, where a state does not maintain close control over the conduct of the audit,
and allows the contract audit firm with a contingent fee interest in the outcome to make decisions that
adversely affect the holder, that would also seem to raise significant due process concerns.
BLOOMBERG BNA:
What steps should companies take to make sure that they comply with their state's unclaimed
property laws?
MILLAR:
The first step is generally to conduct an internal review of the company's entire business operations,
with the dual goals of quantifying the amount of unclaimed property liability that may be due, and
establishing policies and procedures to ensure that any unclaimed property is properly identified and
reported and remitted to the appropriate jurisdiction after any required due diligence is performed. If
a company identifies a significant outstanding unclaimed property liability that has not previously been
reported, the company may want to consider entering into a voluntary disclosure agreement (VDA)
with the appropriate states. Often, states will agree to waive interest and penalties for holders that
enter into these agreements. Some states also will agree to reduce the look-back period that would
otherwise apply if the holder had been audited by the state. For example, Delaware will normally look
back to 1981 in an audit, but will only go back to 1991 in a VDA. This reduced period can result in
significant savings for holders. VDAs also give holders much greater control over the process than
they would have in an audit, which can be quite valuable in and of itself.
Future Trends in 2012
BLOOMBERG BNA:
What trends do you see emerging in the area of unclaimed property laws in 2012?
MILLAR:
I would expect to see continued aggressive interpretation and enforcement of unclaimed property laws
by states. This may occur in a variety of different contexts. For instance, Delaware and many other
states are now focusing on equity property securities and dividends in audits, and have already
begun to issue significant assessments. The industry audits of life insurance companies suggest that
some auditors may be focusing on certain highly-regulated industries that may be perceived by the
auditors as more willing to settle dubious claims. Many financial institutions regularly over-report
unclaimed property for similar reasons. I would also anticipate that we will see some states continue
to try to expand the types of property that are subject to state unclaimed property laws, such as
promotional incentives and uninvoiced receivables.
On the other hand, holders now seem more willing to challenge state unclaimed property positions
than they have been in the past, and hopefully that will lead to some favorable court decisions that
will provide a much-needed check on state overreaching in this area.
BLOOMBERG BNA:
In terms of unclaimed property as a practice area, would you say that this is a growth area? Is the
need for legal advice on how to comply with unclaimed property laws likely to expand? How has the
demand for legal services grown since you've been practicing?
MILLAR:
Demand for legal services in this area is directly related to how expansively states interpret their
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unclaimed property laws and how aggressively the states seek to enforce these laws and
interpretations. With states becoming much more aggressive over the years, particularly as they
struggle to close budget gaps, we have seen demand for legal services rise as well. Moreover, since
there is little evidence that states will reverse this trend any time soon, I would expect demand for
unclaimed property legal services to continue to grow over at least the next few years. Indeed,
Delaware says that fewer than 10 percent of companies incorporated in Delaware are filing annual
unclaimed property reports with the state, and Delaware has only recently embarked on its securities
audit program that it says will eventually extend to all publicly traded companies incorporated in
Delaware. As a result, we expect the flow of audit-related work to continue for an extended period.
BLOOMBERG BNA:
Do you think it would make more sense for unclaimed property laws to be created and enforced at the
federal level?
MILLAR:
Federal regulation of unclaimed property would certainly address some of the significant problems
facing the holder community today. Most clearly, it would solve the non-uniformity problem, thus
making compliance much easier for holders. For instance, holders would only need to understand one
set of unclaimed property laws rather than fifty. Holders would also save significant costs in filing
annual reports, under a federal system, presumably only one report would be due once a year,
whereas under the current state-regulated system, up to fifty reports are due each year, and the
reports may have different deadlines and even different reporting years. A federal system would also
make it much easier to appeal adverse determinations, which would be a significant benefit to holders.
Moreover, I would anticipate that a federal system would be less likely to be influenced at least to
the same degree by budgetary concerns. At the federal level, unclaimed property would represent a
very tiny source of revenue, relatively speaking. By comparison, unclaimed property is currently the
third largest revenue source for the State of Delaware, bringing in roughly half a billion dollars
annually. Delaware is understandably quite protective of this revenue stream, often to the detriment
of holders.
Finally, a federal system for regulating unclaimed property would also presumably benefit owners by
making it easier for owners to find their missing property, as there would be only one place to look.
Unclaimed Property Webinar: Defending Against Aggressive State Audit,
Enforcement Tactics
Join us for an April 26 Bloomberg BNA Webinar (12:30-2pm ET) in which Ethan Millar,
with Alston & Bird LLP and Cathleen Bucholtz, with True Partners Consulting will analyze
recent developments and offer insights into how holders of unclaimed property can
develop an approach toward defending themselves against aggressive practices.
Attendees who fulfill certain requirements will be eligible to receive a CPE credit. Register
online. Or, call 1-800-***-**** and choose option 6, then option 1, and refer to the date
and title of the webinar. Lines are open Monday through Friday from 8:30 a.m. to 7:00
p.m. ET, excluding most federal holidays. Once you've registered, send your e-mail
questions to ***********@***.*** and they will be submitted to the presenter(s) for
consideration.
Contact us at http://www.bna.com/contact/index.html or call 1-800-***-****
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