Retailers Should Examine Gift Card Practices in Light of a Recent Unclaimed Property False Claims Action

By on May 14, 2014

A complaint in the Superior Court of Delaware alleges that numerous retailers “schemed to deprive the State of Delaware of hundreds of millions of dollars due to the State under the Abandoned Property Law” (emphasis added).  Delaware v. Card Compliant et al., Del. Sup. Ct (New Castle County), Case No. N13C-06-289 FS (6/2013).  The complaint asserts that the retailers were all incorporated in Delaware and, under the second priority rule, unclaimed gift card funds should have been remitted to Delaware after five years of inactivity.  According to the complaint, the defendants attempted to avoid this rule by setting up and using companies incorporated in states that exclude gift cards from the definition of unclaimed property for purposes of gift card issuance and management; however, the arrangements “are without substance as the value of all unredeemed gift cards remains within the possession, custody and control of the Delaware Defendants.”

The financial risk is considerable.  A qui tam lawsuit such as this one allows for triple damages plus a per violation civil penalty of $5,500 to $11,000. The defendants included 15 retailers, primarily restaurants, a third party gift card company and its affiliates, and a trade association that allegedly promoted the gift card company business.  As the action is under Delaware’s qui tam statute, it was filed under seal in June of 2013 and only recently became public.  The defendants are only now becoming aware of the suit.

The complaint is definitely worth reading for anyone involved in gift card unclaimed property issues.  There are several interesting points to note:

  • The original plaintiff bringing the suit (the relator) acted as controller and then vice president of client relations for the original gift card company offering the services to the defendants.  The business was operated out of the relator’s basement.  After the original gift card business was purchased by another company, the relator was a sales and support representative for the business.  The relator appears to have kept records of the company’s business arrangements with the retail defendants and now uses those records to bring a law suit against his former employer’s clients.
  • One of the law firms representing the relator is a well-known political powerhouse in Delaware.
  • The relator has asked for jury trial of this case.

Important take-away issues:   Any company involved in the use of gift cards should take a serious look at this complaint and initiate a review of gift card procedures.  This review should include consideration of the following:

  • If using a gift card company, verify that there is economic substance to the structure.  This applies both to the use of third party providers and captive gift card companies.  While there are certainly legal arguments regarding the level of economic substance necessary, it is better safe than sorry.  Furthermore, for any company relying on a captive gift card company, the risk of a piercing the corporate veil argument (or its equivalent) should be a consideration in how the relationship is structured.
  • Review and strengthen confidentiality and indemnification agreements regarding the use of gift card companies.  This should include both employee confidentiality agreements as well as agreements included in a contract with a third party servicer.  Consider whether any third-party servicer has the ability to make good on any indemnification agreement.
  • Work on legislation to exclude unclaimed property from state qui tam and false claims acts.
Diann Smith
Diann Smith focuses her practice on state and local taxation and unclaimed property advocacy. Diann advises clients at any stage of an issue, including planning, compliance, controversy, financial statement issues and legislative activity. Her goal is to find the most effective method to achieve a client's objective regardless of when or how an issue arises. Diann emphasizes the importance of defining a client's objective - whether it is finality of a frequently audited issue, quick resolution of a stand-alone tax liability, or avoiding competitive disadvantages in the application of a tax. The defined objective then governs the choice of the path to a solution. Read Diann Smith's full bio.




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