Surviving A State Unclaimed Property Audit

March 6, 2013

Presented byDiane Green-Kelly, Partner

Jennifer Waryjas, Associate

Agenda Unclaimed property: What is it?

Audit and assessment process

Defending an audit

Appealing the result

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What is Unclaimed Property? Typically defined as: “unclaimed or

abandoned property held or owing in the ordinary course of business which has not been claimed for a specific amount of time”

Key Terms: “Property” “Holder” “Owner” “Dormancy Period”

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Examples of Unclaimed Property Uncashed checks: Payroll Accounts payable Self-funded benefits Dividends

Customer credits in accounts receivable

Royalty suspense accounts

Unclaimed shares

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Priority Rules –Which State Gets What? 1st Priority Rule: Holder reports property to

the state of owner’s last known address, according to the holder’s books.

2nd Priority Rule: If owner’s address is unknown or if address state’s laws do not consider the property unclaimed, holder reports to state of holder’s incorporation. Texas v. New Jersey, 379 U.S. 674 (1965)

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Delaware As Mandate State In Audits

Use of contract auditors (Kelmar Associates) whose compensation is contingent upon outcome of the audit

Other states may participate

Delaware takes lead

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Period Under Audit 1981 to 2007 (or 2008) for Delaware

No statute of limitations (in Delaware) for reports filed prior to July 2002 3 year statute of limitations for reports filed

after July 2002, except 6 year statute of limitations if “materially”

under reported (i.e., 25% or more)

Other participating states: Only “base years”

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Delaware UP Audit Process Initial notice NDA with Kelmar Opening meeting Information / document requests Sample selections and Remediation Interim Status Report (ISR) Report of Examination (ROE) Statement of Findings and Request for Payment Negotiation / Appeal

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Delaware UP Audits (cont.)

Information / document requests

Factors affecting ability to respond Availability of researchable records Accounting systems changes State recently has required IT to restore

Corporate events / incorporation/ divestitures/ mergers

Audit trail

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Authorization of Estimates of Liability “Where the records of the holder available for the periods subject to [audit] 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 . . . 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. . .”

12 Del. C. § 1155

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Authorization of Estimates of Liability – Comment No guidance in statute for what estimation

method(s) can be used

No reasonableness standard in statute

Must state provide basis for assumptions?

What constitutes “adequate records”?

Holders can still challenge methodology and use

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Authorization of Estimates of Liability – Comment It is critical to preserve objections along the

way to protect your property interests!

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Side Bar Creating and Maintaining the Privilege

Coordinating Audit Defense

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Creating & Maintaining Privilege Audit defense requires contemporaneous

review of facts and application of the law.

In order to protect defense strategy from disclosure, must retain counsel.

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Creating & Maintaining Privilege What is attorney-client privilege? A privileged communication is one that is made in

confidence to an attorney by a client for purpose of obtaining legal advice.

What is covered? Reports of investigations, communications,

emails, letters, etc.

What is not covered? Business records, communications regarding

strictly business issues.

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Creating & Maintaining Privilege What is work product privilege? A party may not obtain discovery of

documents or other tangible things prepared in anticipation of litigation. Litigation need not have commenced, but there must be an identifiable specific claim or impending litigation when materials are prepared.

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Creating & Maintaining Privilege When is litigation anticipated? Objective and subjective Commencement of an audit, by itself, does

not create anticipation of litigation

Disseminate litigation hold at start of audit

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Creating & Maintaining Privilege What is covered by work product privilege? Compilations of facts where an attorney collates

or categorizes the facts, internal reports and attorney memoranda prepared in conjunction with internal investigations, compilations prepared in conjunction with internal investigations.

What is not covered by work product privilege? Facts, business records prepared in the regular

course of business, any old document sent to an attorney.

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Creating & Maintaining Privilege Why is privilege important in this audit? Delaware litigation, CA, Inc. v. Pfeiffer During discovery, Delaware obtained high-level

non-attorney consultant –generated assessments discussing CA’s potential liability and strategies to reduce its reported liability.

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Creating & Maintaining Privilege Just remember: The privilege can be

waived! So, don’t disseminate privileged information.

Restrict email usage and commentary

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Coordinating Audit Defense Delaware typically expects parent

corporation to be point of contact

Avoids conflicting legal or factual positions that may compromise a defense strategy

Permits sharing of advice

Easier to negotiate as a unit

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But Parent Is Not Necessarily Liable For Subsidiaries Delaware v. Sourcegas, 2012 WL 1721783

(Del. Super. May 15, 2012)

Whistleblower lawsuit against subsidiary

Parent/sister companies dismissed because no allegations of piercing corporate veil

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Delaware UP Audit Process Notice from state

NDA with Kelmar Limit to participating states Pros/cons of signing quickly

Opening conference and first information request

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Delaware UP Audit Process - Scoping

Which entities are included?

Which trial balance accounts are tested?

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Delaware UP Audit Process-Sample Selection Disbursements Checks outstanding > 90 days Checks voided/stopped > 30 days

Credits Customers in net credit position from

aging Write-offs of credits

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Delaware UP Audit Process-Remediation Remediation: Prove property is not

abandoned

Standard of “proof” Periods with records Periods without records

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Delaware UP Audits (cont.)

Example of effect of failure to remediate: Uncashed rent check to sublessor for

$10,000 Evidence: Legal department notations Check voided within 60 days No copy of sublease Nonrecurring

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Delaware UP Audits (cont.)

Example of affect of failure to remediate Impact on liability: $10,000 Look back period to 1981 Amount due for 1981-2008 = 27 years X $10k Additional exposure = $270,000

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Delaware UP Audits (cont.)

If estimated liability of $50,000 per year, additional exposure is $1,350,000: 1981-2008 = 27 years 27 X $50,000 = $1,350,000

Interest can add an additional 50%

Penalties can add an additional 25% Can become $2,362,500 liability

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Delaware UP Audits (cont.)

“ISR” – Interim Status Report

“ROE” – Report of Examination from Kelmar Minimum 30 days to remediate

Assessment from Delaware 60-day clock starts to tick

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Delaware UP Audits (cont.)

Negotiation State Escheator Legal issues Dollars

Challenge to assessment Administrative review Litigation

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Internal Review Procedure Must file protest within 60 days after mailing

of Statement of Findings and Request for Payment (“State’s Demand”)

Amount in State’s Demand is final, including penalties and interest, except for amounts that the holder challenges in written protest.

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Internal Review Procedure Must pay amounts not contested with

protest.

May pay full amount of State Demand with right of refund, without interest, if prevail

Interest runs on unpaid liability

Payment and interest may reduce State’s urgency in resolving quickly

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First Stage of Internal Review –Written Protest To Audit Manager Must submit protest to the Audit Manager –

the person who issued the demand in the first place!

Effectively permits Audit Manager to reconsider the State’s Demand

Holder must state “specific grounds upon which the protest is based”

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Scope of Review by Audit Manager Audit Manager shall reconsider only those

property types, amounts and issues that are set out in the holder’s written protest

So, holder must have complete case ready and in writing within 60 days of Demand?

May submit additional information in support of protest within 30 additional days after protest is filed

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Review by Audit Manager Analyzed No provision allowing discovery of contract auditor

or the state

Holder must present all legal and factual issues in the protest

Holder must present all Constitutional issues

What are the Audit Manager’s qualifications for deciding legal and Constitutional issues?

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Comment 60-day deadline means that holder must be

diligent about building its case throughoutthe audit

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Protest to Audit Manager Audit Manager “shall” within 60 days of

receipt of protest or additional information make a written determination on the protest setting forth “basis for determination that is adverse, in whole or in part, to the holder” Extension of time for “good cause” Maximum extension of 540 days from

receipt of protest (1.5 years)

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Protest to Audit Manager (cont.)

30 days after mailing, Audit Manager determination is final and State Escheator may enforce in Chancery Court, unless holder first appeals to the Secretary of Finance (the Audit Manager’s boss?).

Appeal to Secretary must state “the matters in which the holder asserts that the Audit Manager erred”

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Independent Reviewer No later than 90 days after receipt of notice

of appeal, Sec’y of Finance appoints “Independent Reviewer” to consider the appeal

Independent Reviewer makes a written report to the Secretary of Finance, not the holder

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Independent Reviewer (cont.)

“Independent Reviewer” is appointed by the Secretary of Finance, the boss of the Audit Manager who made the determination!

“Independent Reviewer” submits a report to the Secretary of Finance (not the holder?)

Secretary of Finance can reject Independent Reviewer’s findings and conclusions, in whole or part

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Independent Reviewer (cont.) Independent Reviewer must Not be “currently employed” by the Department of

Finance, and Shall be a former member of the Delaware

judiciary, or An individual who has been previously appointed

and served as a master of any Delaware court, or An attorney licensed in the State of Delaware who

is qualified by experience or training to serve

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Independent Reviewer – Comment Is the “Independent Reviewer” independent? Could be a retired or former government

lawyer Could be same one for all appeals, or just

one appeal? Could be a “friend” of the department

and/or the state?

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Independent Reviewer No provision allowing holder to object to

choice of IR because of: Bias Conflict of interest Qualifications

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Independent Reviewer (cont.) Appeal to IR is de novo on the record Record on appeal “shall be based solely upon

documents submitted during the course of the examination to the Audit Manager . . .

AND . . .

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Independent Reviewer – Comment “other non-privileged materials” and expert reports

that were prepared by or on Audit Manger’s behalf during his/her consideration of the protest These are materials prepared after holder has

submitted complete case No opportunity for holder to submit evidence or

expert report to refute Audit Manager’s additional materials and expert reports

Regulations permit holder to file motions, but no indication that motions to submit additional evidence are permitted

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Independent Reviewer (cont.)

IR “shall” hold an oral hearing on the appeal within 90 days after appointment

Holder and Audit Manager shall submit briefs with argument and citations to documentation from the record or explain why documentation is not available 5 days before hearing Does “documentation” include affidavits?

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Independent Reviewer (cont.)

IR shall issue a written decision with findings of fact and conclusions of law within 90 days after oral hearing or the completion of post-hearing briefing requested by the IR

IR to assess costs, including IR’s fees, in his/her discretion

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Independent Reviewer – Comment No guidance on fees to IR

Could IR decide to assess total costs to holder?

Will risk of paying all costs deter holders from appealing?

Will IR assess any costs to Secretary of Finance and risk no future appointments?

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Independent Reviewer – Comment To whom is the IR beholden?

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Independent Reviewer (cont.)

Secretary of Finance “may adopt or reject” the IR’s determination in whole or in part!

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Independent Reviewer (cont.)

Secretary of Finance “shall” issue a written decision setting forth basis for rejection or modification of the IR’s determination

IR’s decision and Secretary of Finance’s revisions are sent to holder by certified or registered mail within 60 days of IR’s decision Holder must wait for Sec’y’s decision to get

IR’s report?

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Independent Reviewer (cont.)

Secretary of Finance’s determination is final and amounts are due and owing

State Escheator may enforce in Chancery

Holder may appeal to the Court of Chancery within 30 days

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Appeal to Chancery Court review is limited to whether

Secretary’s determination was supported by substantial evidence on the record

Court shall remand “to the agency” for further proceedings on the record if the record is insufficient for its review

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Time Line of Review Process (13 months – 3 years to get to court)Day1: AM mails Stmt of Findings to Holder

60: AM determination finalHolder submits protest and pays

90: Optional addt’l submissions by holder120-600: AM makes written determination150-630: AM determination final

Holder appeals to Sec’y of Finance240-720: Sec’y appoints IR230-810: IR holds hearing320-900: IR issues findings to Sec’y (could be later)380-960: Sec’y report & IR findings sent to holder410-990: Deadline for holder to appeal to Chancery???: Chancery can remand to agency for further findings

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Protecting You Interests Build a factual record from day 1

Build legal arguments as the audit progresses

Assert legal objections as they arise

Assert factual objections as they arise

Time is of the Essence!!!

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What Can You Do To Protect Your Interests? Retain legal counsel to assist you in building

a record

Retain accounting consultants to assist in building a factual record

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Conclusion Unclaimed property audit can be taxing

But you can take steps to limit exposure

Build your record

Build your record

Build your record

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