Escheatment: The States’ Anticipated Cash Cow
The COVID-19 pandemic has caused significant economic loss around the world. The United States has seen a 32.9% drop in its GDP as of August 2020.1 In times of financial stress, state governments focus on finding additional revenue streams. Escheatment, the process by which a state takes custody of unclaimed property, is one way through which states can collect revenue and generate windfall income. With the anticipated deficits caused by the pandemic, including decreased state income taxes and increased spending, it is anticipated that states will step up their enforcement of the escheatment laws. In the wake of the 2007- 2009 recession, states aggressively exercised their escheatment rights — increasing the amount of their collective holding of unclaimed property from $32.8 billion in 2010 to over $43 billion in 2013.2 In 2018 alone, Delaware collected $506.2 million in unclaimed property, making up Delaware’s third largest source of revenue.3
What Is Escheatment?
“Escheat,” from the Latin ex-cadere meaning “to fall out”, refers to unclaimed property laws that date back to feudal England. It is a general principle of U.S. law that when title to property goes unclaimed, “it necessarily reverts or escheats to the people, as forming part of the common stock to which the whole community is entitled….” O'Hanlin v. Van Kleeck, 20 N.J.L. 31, 44 (1842) (emphasis added). Escheatment is the process through which the state takes custody of unclaimed property and provides a system for rightful owners to reclaim their property from the state – rather than from the previous holder of the property. Unclaimed property refers to property an owner has forgotten about or of which the owner is unaware. Unclaimed property is typically intangible in nature and is held within a financial institution or a company with whom the property owner has previously transacted business. After a state-specific statutorily determined period (referred to as the “dormancy period”) with no activity or contact with the property owner, the property becomes “unclaimed” and must be reported and turned over to the state in which the owner resides. If the property owner cannot be located, the priority rules set forth in the Supreme Court’s landmark decision in Texas v. New Jersey, 380 U.S. 518 (1965) apply, with the property holder’s state of incorporation being second in priority. The companies and financial institutions holding unclaimed property can be held liable for noncompliance with the escheatment reporting laws, which carry the potential imposition of hefty monetary penalties and interest. The escheatment laws impact is widespread across many industries, with unclaimed property taking on many forms, including:
Financial Institutions – certificates of deposit, checking and savings accounts, IRAs, safety deposit box holdings, unredeemed money orders, and brokerage accounts;
Insurance – insurance proceeds, including annuities and life insurance proceeds;
Retail – unredeemed gift cards, concert tickets, balances in PayPal/Venmo cash accounts, customer refunds/credits; Utilities/Oil, Gas and Mining – suspense account balances, mineral/mining royalties, customer credits/refunds/overpayments;
Health Care – patient overpayments, vendor credits, payor credits/overpayments, refunds and rebates, long term care trust accounts, prepaid medical and dental account balances;
Labor and Employment – unclaimed payroll, commission and dividend checks and retirement accounts (including IRAs, 401(k) and 403(b) accounts); and Corporate – stock, bonds, dividends and vendor credits.
Many states have Voluntary Disclosure Agreement (“VDA”) programs that enable companies and financial institutions who have either under-reported or not reported unclaimed property to become compliant for previous periods — while mitigating the imposition of penalties and interest. Participation in a VDA program has several advantages, including: Instead of responding to an audit, the holder of the unclaimed property can perform its own internal review/audit; VDA programs are generally more efficient and less expensive than audits; Reduced penalties assessed; and A potentially reduced look-back period for extrapolated liability.
Defense Against State Audits
State audits are time-consuming and invasive. States typically contract with third-party audit firms to conduct unclaimed property examinations on a contingency basis. This compensation structure creates the dynamic whereby the auditors take an aggressive approach and put the auditing party on the defensive. These third party firms have the financial incentive to maximize the state’s recovery – and their own – and oftentimes represent a grouping of states vis-à-vis an audit target. As such, it is important to define the scope of the audit from the onset, assess applicable statutes of limitations, as well as any applicable business-to-business exceptions and legal defenses.
Challenges to Extrapolation Method
Extrapolation methodologies often implicate constitutionality concerns. As the “look-back” period for an audit often exceeds typical record retention periods, many states use estimation techniques based on available records to calculate unclaimed property liability for years when a property holder is unable to provide actual records. This means that, even if a holder has a relatively insignificant amount of liability for the years tested by the auditors, the liability may be much more significant on an extrapolated basis.
Several states currently recognize a business-to-business exemption and do not require a company to remit unclaimed property when the owner of the property is a commercial entity and maintains an ongoing business relationship with the holder. As states continue to experience financial pressure during and after the COVID-19 pandemic, however, states may eliminate the business-to-business exemption and demand retroactive reporting of previously exempt property.4
False Claims Act Lawsuits
One of the specific areas where there is an emerging trend in escheatment law is the filing of lawsuits under both federal and state False Claims Act (FCA) laws by whistleblowers/qui tam relators who are making novel claims in order to use the FCA as a basis upon which to recover against property owners who have allegedly failed to report and refund unclaimed property. These lawsuits generally claim that a holder has knowingly and willfully underreported amounts owed to the state. As FCA claims sound in fraud and provide for treble damages, the potential consequences of FCA litigation based on unclaimed property compliance can be severe. See, e.g., Delaware ex rel. French v. Card Compliant et al. (Overstock.com), No. N13C-06-289-FSS (Del. Super. Ct. New Castle County, filed 2013) (jury returned a verdict against defendant with judgment entered for $7.2 million for violation of Delaware’s FCA by not reporting the balances of unredeemed gift cards as unclaimed property to the state).
Importance of Unclaimed Property Compliance Programs
Establishing a robust compliance program is essential for avoiding liability under the escheatment and related laws. In devising and implementing an organization’s unclaimed property compliance program, it is important to take an approach that:
(i) creates defined and comprehensive policies and procedures; and
(ii) ensures ongoing compliance assessment and adherence.
First, companies/financial institutions should develop and implement unclaimed property policies and procedures that encompass the following factors and goals:
Identify potentially escheatable property: The types of unclaimed property a holder may have exposure vary by state;
Determine when items are due to be reported to the states: Items are reportable to the state after the expiration of a dormancy period, which varies by state and by property type. The due dates for unclaimed property reporting differ by state; Perform due diligence in an attempt to locate and make contact with owners of unclaimed property: Holders of unclaimed property have an obligation to attempt contact with owners of unclaimed property before remitting property to the state; and
Annually report and remit eligible unclaimed property in accordance with all applicable laws: Each state has specific laws regarding the preparation and filing of unclaimed property reports.
Second, an important element of an effective compliance program is on-going internal risk assessment of past and present compliance efforts. This includes ongoing training, regular and systematic review of internal records and controls, and enlisting legal counsel to engage in the privileged assessment of potential remedial actions, including the potential benefits of an interested state’s VDA program. Although unclaimed property laws can have significant financial implications on all types of businesses, they are too often overlooked. In the wake of the COVID-19 pandemic and as state authorities gear up to recover unclaimed property through audits and litigation, it is important for businesses to evaluate their past and present compliance with the escheatment laws.