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False Claims Act Risk for Unclaimed Property Holders

In what has become an unfortunate trend, unclaimed property holders continue to be subject to lawsuits under state false claims acts (FCA – also called a qui tam or whistleblower action) for alleged underreporting and remittance of unclaimed property obligations. More than 30 states have a false claims act with whistleblower provisions and nearly all are applicable to unclaimed property. While an honest mistake should not create liability under an FCA, a holder could be liable if its failure to report not only was done knowingly, but also if such failure to comply was done with deliberate ignorance or with reckless disregard. Actual fraud is not a necessary precursor to being subject to false claims act liability.

Potential liability under state FCA laws is far in excess of any liability under an unclaimed property audit. FCA laws impose treble damages (3x the value of the underreported property), penalties, interest and attorney’s fees. Successful claims under these laws are not just extremely punitive to the holder but also lucrative for the person bringing the lawsuit who can earn up to 30% of the ultimate recovery to the state. Liability under a FCA can turn a holder’s failure to be appropriately diligent in determining its unclaimed property compliance obligations into a multi-million dollar legal battle with long-term public relations implications. The fact that a holder has already been audited or that the State may have historically agreed with the holder’s position may not prevent a FCA case progressing.

A holder’s FCA unclaimed property horror begins with an investigation, which can be prompted by either claims by private parties (called relators) or the state attorney general’s office. A relator may be a disgruntled employee or any clever person with good research skills. The holder may not even know the claim has been filed and the investigation has been going on for years. These investigations may open closed periods and, once the holder is informed, are very interrogation-like, with the holder often knowing very little about the underlying claims until the case is unsealed. Eventually, these investigations may turn into a public court battle with a sometimes politically motivated state attorney general on the other side. Even if the state AG’s office declines to proceed with the case, the private party initiating the case may nevertheless proceed.

While frequently FCA cases are settled before becoming public, several recent cases provide some background for holders looking for FCA examples. In a series of Delaware qui tam cases, more than 25 retailers and restaurants were sued by a former disgruntled employee of a gift card issuance and management company alleging unclaimed property compliance violations. All but one settled or was dismissed by the court. In New York, a court recently dismissed claims by an audit firm against nearly a dozen life insurers in response to allegations under the false claims act that the companies failed to report life insurance policy funds – alleging more than $14.5 billion in damages. Regardless of industry, these lawsuits are a [...]

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New York Legislation Proposes to Retroactively Remove FCA Culpability Standard for Tax Law Claims

With Halloween just a few weeks away, a scary proposal is brewing in the New York State Legislature that should give taxpayers chills. Companion bills Assembly Bill 11066 and Senate Bill 8872 were recently introduced by committee chairs (Assembly Ways and Means Chairwoman Helene Weinstein and Senate Committee on Judiciary Chairman Brad Hoylman). This legislation would substantially expand the scope of the New York False Claims Act (FCA) for claims under the New York State Tax Law by retroactively creating a new tax-specific cause of action that would award single (as opposed to treble) damages, including consequential damages when the taxpayer makes a false statement or record material to their obligation to pay money to state or local governments under the tax law by mistake or mere negligence.

Specifically, the bill would not modify the existing “knowing” causes of action in NY State Fin. Law § 189(1) that, if proven, result in civil penalties, treble damages and consequential damages. Instead, the bill would create a new tax-specific cause of action with strict liability—i.e., no intent requirement that the violation be shown to have been committed “knowingly” (with actual knowledge or deliberate ignorance or reckless disregard for the truth). As a result, inadvertent non-reckless tax mistakes, misunderstandings or mere negligence of the law would result in the taxpayer being subject to a viable claim under the FCA—something that is currently expressly prohibited by law. (See NY State Fin. Law § 188(3)(b) (“acts occurring by mistake or as a result of mere negligence are not covered by this article”).)

To make matters worse, the companion bills (as introduced) would “apply to all false claims, records, statements and obligations concealed, avoided or decreased on, prior to, or after such effective date.” (§ 4; emphasis added.) Thus, if enacted, the bill would open the door to 10 years of backward-looking scrutiny of tax law violations in court by private relators and the New York Attorney General—including years of tax periods that are currently closed under the New York Tax Law or were settled with the New York Department of Taxation and Finance. (See NY State Fin. Law § 192(1) (“[a] civil action under this article shall be commenced no later than ten years after the date on which the violation of this article is committed”).) As a reminder, the FCA would continue to only apply to tax law violations with pleaded damages in excess of $350,000 by persons with net income or sales of more than $1 million in at least one tax year at issue.

Practice Note

As if managing tax audits and potential compliance mistakes administratively was not enough, the introduced New York companion bills would allow a separate parallel path for litigious private parties and the New York Attorney General to enforce the tax law as they see fit in court—creating a framework that is ripe to drag well-intentioned taxpayers through the mud and force them to either defend themselves through costly litigation [...]

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Business Victorious in Unclaimed Gift Card False Claims Case

The Delaware Supreme Court gave Overstock.com a win in a False Claims Act (FCA) suit alleging the retailer failed to remit unclaimed gift card funds to the state. Overstock.com Inc. v. the State of Delaware and French, DE Sup. Ct., No. 327,2019 (June 25, 2020). A jury previously found Overstock liable for approximately $7.3 million. The Delaware Supreme Court, interpreting the FCA statute in effect for the years at issue, determined the trial court judge improperly instructed the jury that the knowing failure to file unclaimed property reports was the making of a false statement as required to succeed on an FCA claim. Contrary to the trial judge’s instructions, the Supreme Court determined that to meet the FCA standard in effect for the years at issue, some document incorporating the alleged false claim must have been provided to the government. Failure to file a report was by definition not a false record or statement because there was not record or statement.

Based on this interpretation of the FCA statute, the jury verdict was reversed because Overstock did not file any unclaimed property reports with Delaware. Absent a filed report, there was no false claim. The plaintiffs alleged other documents were sufficient to meet the submission of a “false record or statement” element of the relevant FCA: (a) Overstock’s books and records and (b) statements to the SEC. The Supreme Court rejected these arguments. Overstock’s books and records were not sufficient because these documents were not submitted to the State and the SEC filings were not submitted in order to avoid the alleged unclaimed property liability.

Delaware, like many states, adopts the same language as the federal FCA statute. The federal government made amendments in 2009 to include language imposing liability if someone “knowingly conceals or knowingly and improperly avoids or decreases an obligation.” Delaware amended its FCA statute in 2013 to include this language.

Practice Note:
This win does not provide any guidance on the substantive issue asserted by the plaintiffs at trial regarding whether and under what facts contracting with another entity to issue gift cards imposes unclaimed property obligations on the issuer rather than the retailer. This is a narrow victory as it applies to a prior version of Delaware’s FCA statute. However, companies confronted by FCA suits – for both unclaimed property and tax liability, should look at when or if the state at issue amended the FCA to adopt the modern version and whether they have a filing history. It is interesting that a company that did not file any report is potentially better off under the historic FCA language than one who did. While this a victory based on a narrow issue, a victory is a victory.




Illinois Appellate Court Blows the Whistle on Serial Relator

In a bombshell opinion, the Illinois Appellate Court held that a law firm serving both as client and attorney may not recover statutory attorneys’ fees under the Illinois False Claims Act (the Act). In People ex rel. Schad, Diamond & Shedden, P.C. v. My Pillow, Inc., 2017 IL App (1st) 152668 (June 15, 2017), the Illinois Appellate Court, First District, reversed the trial court’s award of attorney fees in excess of $600,000 for work performed by Diamond’s law firm on behalf of itself as the relator. McDermott represents My Pillow in this matter.

Much like its federal counterpart, the Act allows private citizens (referred to as relators) to file fraud claims on behalf of the state of Illinois. If successful, relators can collect up to 30 percent of the damages award plus attorneys’ fees. The Diamond firm is hardly a traditional “whistleblower” with “inside knowledge,” as it has filed approximately 1,000 different qui tam actions as the relator over the last 15 years. The firm initially focused its suits on out-of-state businesses for allegedly knowingly failing to collect Illinois use tax on merchandise delivered to Illinois customers, then expanded its dragnet to allege a knowing failure to collect tax on shipping and handling charges associated with merchandise shipped to Illinois. The firm then targeted out-of-state liquor retailers for alleged knowing nonpayment of certain taxes on the sale of alcoholic beverages to Illinois residents and, most recently, the firm filed over 80 lawsuits targeting tailors based in Hong Kong and London, making similar claims for not collecting Illinois use tax.

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Illinois Bills to Watch

Just days away from the May 31 close of its regular legislative session, the Illinois General Assembly has yet to enact the comprehensive series of tax and budget reforms that were first proposed by the Illinois Senate leadership late last year. Yesterday, the Senate passed a modified version of Senate Bill (SB) 9, the tax proposal we described in a previous post, without any Republican support. SB 9 now moves to the Democratically-controlled House for consideration. Even if approved by the House, it seems likely that Illinois’ Republican Governor will veto the legislation. (more…)




Illinois Appellate Court Delivers Another Blow to Relator in False Claims Act Litigation

On Monday, October 17, the Illinois Appellate Court issued another taxpayer-friendly opinion in an Illinois False Claims Act case alleging a failure to collect and remit sales tax on internet and catalog sales to customers in Illinois (People ex. rel. Beeler, Schad & Diamond, P.C. v. Relax the Back Corp., 2016 IL App. (1st) 151580)). The opinion, partially overturned a Circuit Court trial verdict in favor of the Relator, Beeler, Schad & Diamond, PC (currently named Stephen B. Diamond, PC).

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Cook County Circuit Court Dismisses 201 False Claims Act Lawsuits

At a hearing yesterday, Cook County Circuit Judge James Snyder granted the State of Illinois’ (State) Motion to Dismiss 201 Illinois False Claims Act (FCA) cases filed by the law firm of Stephen B. Diamond, PC (Relator) against out-of-state liquor retailers.  The lawsuits alleged that the defendants were obligated to collect and remit sales tax on their internet sales of alcohol shipped to Illinois customers.  The complaints admitted that the defendants lacked any physical presence in the state, and would not qualify for any Illinois liquor retail license, but nevertheless asserted a tax collection obligation for sales and a tax remission obligation for gallonage tax arising under the 21st Amendment of the US Constitution and the Supreme Court’s decision in Granholm v. Heald, 544 U.S. 460 (2005).

In its motion to dismiss and at oral argument, the State relied upon the favorable standard for consideration of motions to dismiss False Claims Act cases filed by the State established by the Illinois Appellate Court in two prior cases:  State ex rel. Beeler, Schad & Diamond v. Burlington Coat Factory Warehouse Corp., 369 Ill. App. 3d 507 (1st Dist. 2006) and State ex rel. Schad, Diamond & Shedden, P.C. v. QVC, Inc., 2015 IL App (1st) 132999 (Apr. 21, 2015).  In both cases, the appellate court held that when the State moves to dismiss a qui tam action allegedly filed on its behalf, its motion should be granted absence evidence of “glaring bad faith” on the part of the State in moving to dismiss.  The State argued that it had concluded that the Relator’s claims were weak, based in part on the Relator’s admission that the defendants lacked nexus.  In response, the Relator argued that the State had acted in bad faith by relying on Quill Corp. v. North Dakota, 504 U.S. 298 (1992) and other commerce clauses nexus rulings and, according to the Relator, ignoring the 21st Amendment and Granholm, which the Relator alleged supplanted any nexus analysis (a point the State and the defendants vigorously disputed in briefing prior to argument).

After hearing argument, Judge Snyder ruled from the bench that the Diamond firm had failed to meet its burden of proving bad faith by the State in moving to dismiss the 201 lawsuits.

The Diamond firm will have 30 days from the date of entry of the Circuit Court’s dismissal orders to either seek reconsideration or appeal from the trial court’s ruling.




Illinois Appellate Court Affirms Dismissal of State Tax Qui Tam Lawsuit

On March 31, 2015, the Illinois Appellate Court issued an opinion affirming the dismissal of a qui tam lawsuit filed by a law firm acting as a whistleblower on behalf of the State of Illinois against QVC, Inc., under the Illinois False Claims Act.  The opinion affirmed an important precedent previously set by the court regarding the standard for dismissal of such claims when the State moves for dismissal, and established favorable precedent for retailers by holding that use tax voluntarily paid after the filing of a qui tam action does not qualify as “proceeds” of the action within the meaning of the Illinois False Claims Act.

Read the full article.




Illinois Law Firm Continues to Clog Court System with Tax-Related False Claims Act Allegations—but Proposed Legislation May Offer Relief

As many readers of this blog know, over the past 12 years the Circuit Court of Cook County, Illinois has been deluged with lawsuits filed by a Chicago law firm against internet retailers as a “whistleblower” under the Illinois False Claims Act.  The factual support for the lawsuits comes solely from internet-based investigations, including purchases made on retailer websites.  The lawsuits typically allege that the retailers have knowingly failed to collect and remit sales and use tax on some aspect of their internet sales shipped to Illinois.  See 740 ILCS 175/1 et seq.  Substantial damages are claimed, including up to three times the tax allegedly owed to the State, attorneys’ fees, and a penalty assessment for each tax filing that failed to disclose the tax due.

An initial wave of approximately 90 lawsuits was filed in 2003 and 2004 against retailers that did not collect Illinois tax on their internet sales.  In 2011, the whistleblower firm began to file a second round of lawsuits against retailers that collected tax on their internet sales of merchandise, but not on the shipping and handling charges associated with those sales.  To date, more than 200 of these “shipping and handling” tax lawsuits have been filed.  Most recently, the whistleblower firm has filed claims against defendants in the liquor industry, alleging a failure to collect sales and use tax and, in some instances, the failure to remit Illinois’ gallonage tax on sales of alcohol.

The validity of these lawsuits is hotly contested.  Many lawsuits have been dismissed, and at least two shipping and handling tax cases have resulted in trial rulings against the whistleblower firm and in favor of the retailer defendants.  It remains to be seen how the courts will determine the viability of Relator’s most recent claims, which appear on their face to be flawed.

Many other cases, including those that raise only nuisance value damages, have been settled to avoid the cost of litigation.  These settlements appear to have fueled the whistleblower firm’s continued voracious appetite for this type of litigation.

Although the State of Illinois has the right to intervene and lead the prosecution of these actions, for the past several years the Office of the Illinois Attorney General has generally declined to intervene in these actions.  Unfortunately, when this occurs, the Illinois False Claims Act permits a whistleblower claimant to proceed on its own with the litigation.  In almost all cases in which the State has declined to intervene, the whistleblower firm has elected to proceed on its own with its tax-related claims.

The continued activity in this area underscores the need for the Illinois General Assembly to address and pass House Bill 0074 – legislation carefully crafted, through negotiations with the Illinois Attorney General’s office, to modify the procedure for state tax-related False Claims Act litigation in Illinois.  The legislation would vastly improve the current False Claims Act situation by modifying the law as follows:

  1. Requiring whistleblowers with state tax-related claims to first disclose their claims [...]

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