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Delaware’s Unclaimed Property Audit Program Dealt Blow

The judge in a case challenging Delaware’s use of sampling and extrapolation to determine unclaimed property liability denied the state’s motion to dismiss and in doing so, seriously questioned the State’s approach.  Temple-Inland v. Cook, U.S. Dist. Ct. (DE), Civ. No. 14-654-SLR (3/11/2015).  Temple-Inland brought a suit against the State following an unclaimed property audit of its accounts payable balances and before the audit of other property types was completed.  Delaware found Temple-Inland liable for unclaimed property going back to 1986 based on the use of sampling and extrapolation.  On March 11, 2015, Judge Robinson ruled on the Temple-Inland’s summary judgment motion and the State’s motion to dismiss for failure to state a claim.  While the State won one issue, Temple-Inland certainly came out ahead overall.

Let’s start with the bad news first: the one dark spot in the opinion for holders is that the judge decided that the U.S. Supreme Court’s priority rule cases (Texas v. Delaware and its progeny) only applied to disputes over custody between states, not between a private holder and a state.  This decision seems to conflict with a precedential Third Circuit case, Retail Merchants Ass’n v. Sidamon-Eristoff, 669 F.3d 375 (3rd Cir. 2012).  The judge also did not seem to take to heart the role of the U.S. Supreme Court.  The judge oddly stated that “finding that the Supreme Court’s holding in Delaware preempts the State’s valid exercise of regulatory power . . . would be contrary to the well-established principle that federal courts may not ordinarily displace state law.”  That is exactly what the U.S. Supreme Court is supposed to do (in fact, last week the Court ruled federal courts have just such authority in Direct Marketing Association v. Brohl).

With the bad news out of the way, the good news is that not only does the judge agree to move forward with all of Temple-Inland’s other claims, but expresses significant doubt as to the validity of the State’s position regarding the authority to use estimation prior to a 2010 statutory change.  The judge appears to be ready to move forward on hearing factual support for the following claims asserted by the plaintiff:  substantive due process, Ex Post Facto Clause, Takings Clause, Commerce Clause and Full Faith and Credit Clause.

The really good news for holders is that the judge seems to have backed the State into a corner.  In analyzing the due process and ex post facto claims, the judge noted that “[the] defendants are faced with a dilemma:  “If §1155 [the 2010 provision authorizing estimation] is not a penalty provision, it likely violates plaintiff’s rights to substantive due process.  If, on the other hand, § 1155 is a penalty provision, its retroactive application likely violates the Ex Post Facto Clause.  The court is unprepared, at this juncture to determine which scenario is most likely.”  With this opinion, Delaware may finally be feeling the walls closing in and a giant alien cephalopod reaching up [...]

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You Do the Math: Unclaimed Property Lawsuit Filed Against Kelmar

Mark McQuillen, president of Kelmar Associates, LLC, was misinformed when he was quoted as saying “I’ve never been sued” on May 26—less than one week after suit was filed against Kelmar and three Delaware state officials in a Delaware Federal District Court. See 72 State Tax Notes 455 (May 26, 2014). While the timing of this statement was an unfortunate – but likely  honest – mistake, the lawsuit filed by Temple-Inland Inc. asserts the conduct of Kelmar in conducting an unclaimed property audit on behalf of the state of Delaware was anything but.

According to the complaint, Temple-Inland was initially asked to pay over $2 million to the state based on the “fatally flawed” extrapolation methodology used by Kelmar to calculate Temple-Inland’s liability (and Kelmar’s paycheck from Delaware). While the demand was reduced to $1.38 million after the plaintiff initiated administrative review, the result and details of how they got there remains alarming. Of note, Kelmar estimated that nearly $1 million was due to Delaware for the seven-year period of 1986 through 2003 after identifying a single unreported check for $147.30 during a subsequent six-year period (Complaint ¶ 84). The complaint contains countless examples of voided and reissued checks (even checks that escheated to other states) that were used in Kelmar’s extrapolation formula. Ultimately the result for Temple-Inland was a demand from Delaware alone of over $100,000 escheatable for prior year’s accounts payable, despite having only around $15,000 escheatable to all other states on these accounts for a five year period actually reviewed.

Based on these practices, Temple-Inland asserts that Kelmar and the state auditing officials have unconstitutionally applied the amendment to Delaware Escheat Law allowing for estimations of unclaimed property liability to years prior to its enactment in violation of the Ex Post Facto Clause. Along those same lines, the state penalized Temple-Inland for failing to maintain records for periods prior to 2010, when a substantive document retention requirement was imposed in the state (see S.B. 272 § 4). Nonetheless, Temple-Inland asserts that the methodology used by Kelmar violates federal common law, the Full Faith and Credit Clause, Commerce Clause and Takings Clause of the U.S. Constitution.

The opening brief filed on behalf of Temple-Inland is available here

Practice Note: While Delaware has settled every suit raising these questions and has an economic incentive to keep them from reaching what would likely be an adverse decision to the state’s (and Kelmar’s) financial interest, the discussion should not end there. Temple-Inland Inc. had a long history of solid compliance with the unclaimed property laws across several states, yet still was the target of a flawed and likely unconstitutional audit by Kelmar on behalf of the state of Delaware. The company was forced to hire counsel and litigate against Kelmar’s questionable practices. While two new Delaware bills have been introduced in an effort to eliminate unclaimed property contingent fee auditing practices (S.B. 215 and S.B. 228), holders should stand firm in opposition to Kelmar’s aggressive extrapolation methods and keep [...]

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