US District Court declines to dismiss unclaimed property suit
Constitutional claims against Delaware’s estimation methods may proceed
TAX ALERT |
On March 11, 2015, the U.S. District Court for the District of Delaware issued a decision in Temple-Inland, Inc. v. Thomas Cook et. al, denying the state of Delaware's motion to dismiss an unclaimed property holder's suit alleging that the state's unclaimed property estimation methods violate the United States Constitution, but, likewise, denying the unclaimed property holder's motion for summary judgment.
Facts and procedural history
On Dec. 22, 2008, the Delaware State Escheator initiated an unclaimed property audit against Temple-Inland, Inc. (Temple-Inland), a corporation organized under the laws of Delaware with its principal place of business in Tennessee. The State Escheator notified Temple-Inland that the examination period included periods back to 1981, and that Temple-Inland was required to make available all past and present records related to unclaimed property. Temple-Inland provided reports showing that it had "[…] escheated a cumulative total of $1,338,116.70 of unclaimed accounts payable and payroll checks to various states during the audit period, including Delaware.” In particular, Temple-Inland provided documentation showing that it had no additional Delaware escheat responsibility in relation to its payable disbursement accounts for periods starting in 2004, and an additional $147.30 Delaware escheat responsibility in relation to its payroll disbursement account, which Temple-Inland remitted to the state on May 22, 2013.
Because Temple-Inland was unable to produce adequate records for other years under audit, the State Escheator applied an estimation method as allowed under 12 Del. C. §1155, which, for the periods in question provided no guidance regarding estimation, but which was amended in 2010 to provide, "Where the records of the holder available for the periods subject to this chapter are insufficient to permit the preparation of a report, the State Escheator may require the holder to report and pay to the State the amount of abandoned or unclaimed property that should have been but was not reported that the State Escheator reasonably estimates to be due and owing on the basis of any available records of the holder or by any other reasonable method of estimation." The State Escheator then issued a deficiency report, showing an underpayment of approximately $2.1 million. This amount was subsequently reduced to approximately $2 million, and then to $1,388,573.98.
On May 21, 2014, Temple-Inland filed a complaint in the United States District Court for the District of Delaware, alleging that the State Escheator's estimation methods were pre-empted by federal common law and violated substantive due process, the Ex Post Facto Clause, the Takings Clause, the Commerce Clause, and the Full Faith and Credit Clause of the United States Constitution. In its complaint, Temple-Inland sought relief from the assessment and immediately filed a motion for a preliminary injunction against the state in relation to the $1,388,573.98 assessment and any further audit of its records for unclaimed property purposes. On July 22, 2014, the state agreed to halt its audit and assessment efforts pending entry of a final judgment by the district court, and Temple-Inland withdrew its motion for a preliminary injunction. Subsequently, the state filed a motion to dismiss for lack of jurisdiction over the subject matter and failure to state a claim, and Temple-Inland filed a motion for summary judgment.
District court's decision
In its March 11 decision, the U.S. District Court for the District of Delaware made short shrift of the state's motion to dismiss for lack of jurisdiction over the subject matter, stating:
The court has federal question jurisdiction pursuant to 28 U.S.C. § 1331, as plaintiff asserts five counts for federal preemption and violations of the United States Constitution. Requests seeking injunctive relief, such as those asserted by plaintiff, have been held to form the basis for federal question jurisdiction. See Shaw v. Delta Air Lines, Inc., 463 U.S. 85, 96 n.14 (1983) ("A plaintiff who seeks injunctive relief from state regulation, on the ground that such regulation is pre-empted by a federal statute [over] which, by virtue of the Supremacy Clause of the Constitution, must prevail, thus presents a federal question which the federal courts have jurisdiction under 28 U.S.C. § 1331 to resolve.").
Having resolved the issue of its ability to proceed, the court turned to the question of whether Temple-Inland had properly stated a claim. The court addressed each alleged violation in turn.
- Pre-emption by federal common law – Temple-Inland argued that the United States Supreme Court created a set of rules for determining which state has the priority claim for unclaimed property, and that an essential factor pointed to by the Court in applying these rules is that a debtor-creditor relationship must be found to have created the property at issue. Temple-Inland alleged that Delaware's estimation methods violated this principle because the state failed to point to specific debtors in making its assessment. The district court disagreed, finding that the priority rules could be used only to settle disputes between states and not disputes between a state and a holder, and that, therefore, a precise debtor-creditor relationship was not required under federal law. RESULT: Motion to dismiss granted.
- Violation of substantive due process – Pursuant to Amendment 14, § 1 of the United States Constitution, a state may not arbitrarily deprive a person of a protected property interest. Temple-Inland alleged that Delaware's estimation methods result in double- or multiple-escheat because some of the funds claimed were (1) uncashed checks escheated to other states, (2) checks that were voided, reissued and cashed by the payees, and (3) checks payable to payees with addresses in other states. The district court found, "If the allegations as claimed are true, the disputed money may indeed violate the Supreme Court's prohibition against 'more than one State ... escheating a given item of property.'" RESULT: Motion to dismiss denied.
- Violation of Ex Post Facto Clause – Pursuant to Article 1, § 10 of the United States Constitution, a state may not retroactively increase the penalty for a violation of the law. Temple-Inland alleged that 12 Del. C. § 1155 did not permit estimation during the years under examination, and that the state's estimation methodology was only permissible after the amendment of 12 Del. C. § 1155 in 2010. Therefore, according to Temple-Inland, the state's use of an estimation method to generate an assessment for years prior to 2010 was an impermissible retroactive application of the law because it created liability for Temple-Inland that would not have existed prior to the 2010 amendment. The state argued that the 2010 amendment to 12 Del. C. § 1155 was merely a clarification, and that estimation was allowable under the prior version of the statute. The district court found that, in this scenario, a violation of the Ex Post Facto Clause could exist. RESULT: Motion to dismiss denied.
- Violation of Takings Clause – Pursuant to Amendment 5 of the United States Constitution, a state may not take private property for public use without providing fair compensation in return. Temple-Inland alleged that, because the state's estimated unclaimed property amounts could not be traced to a bona fide creditor, it has a legitimate property interest in the estimated debt that Delaware could not take without providing just compensation. Acknowledging that no public taking could exist where property is escheated by the state from a holder to an owner, dismissal of Temple-Inland's Takings Clause argument was inappropriate because Temple-Inland had presented sufficient facts to support its argument. RESULT: Motion to dismiss denied.
- Violation of Commerce Clause and Full Faith and Credit Clause – Pursuant to the negative implications of Article 1, § 8, cl. 3 of the United States Constitution, a state may not unjustifiably discriminate against or burden interstate commerce, and a state law is unconstitutional if it results in "differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter." Further, Article 4, § 1 of the United States Constitution, requires states to respect the judgments of other states, which includes a prohibition against double-escheat. Temple-Inland alleged that Delaware's estimation methods violated these clauses because the resulting assessed amounts included unclaimed property more properly attributed to states other than Delaware under the priority rules established by the Supreme Court, and that, in some instances, these amounts were actually escheated to those other states. Finding that the alleged "Full Faith and Credit Clause violation is inexorably intertwined with the alleged violation of the Commerce Clause” and that Temple-Inland's arguments had merit, the district court declined to dismiss Temple-Inland's Commerce Clause and Full Faith and Credit Clause claims. RESULT: Motion to dismiss denied.
Lastly, the district court dismissed Temple-Inland's motion for summary judgment, deciding instead to defer a ruling on the merits of the case until after the factual record is more fully developed. Interestingly, even though it declined to issue a decision in Temple-Inland's favor, the district court did acknowledge:
[…] defendants are faced with a dilemma: If § 1155 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.
This tension, as well as concerns regarding the potential for multiple-escheat and unjust seizure, are likely to be significant considerations as this case progresses, and will likely pose substantial hurdles for the state in supporting its application of an estimation methodology.
While the district court's decision regarding the motions by Delaware and Temple-Inland is not a final decision on the merits and may be subject to appeal, the court's analysis points to the conclusion that an unclaimed property holder, in specific circumstances, can make a meritorious argument that Delaware's unclaimed property estimation methods violate one or more provisions of the United States Constitution. Holders under examination by Delaware should consider their facts and circumstances in relation to this analysis as part of the audit defense process.