Excerpt from SB 13

EY Commentary

Reviews, examinations and VDAs

SB 13 would adopt a new concept — the "verified report." If a holder does not file an annual unclaimed property report or the State Escheator believes that the holder may have filed an inaccurate, incomplete or false annual report, the State Escheator could ask the holder to verify its filing or non-filing by means of a "verified report." The "verified report" would "[d]escribe property not previously reported or about which [Delaware] has inquired or about which there is a dispute as to whether it is reportable under th[e Delaware unclaimed property law]." (see Section 1174(a))

SB 13 is silent on specifically defining how many days, months or years Delaware will have to request a verified report from a holder. Therefore, it is unknown whether Delaware intends to use this provision to request verified reports one year at a time, or multiple years all at once (which would seem like a pre-investigation to an audit).

SB 13 includes a new concept — the "compliance review." If the State Escheator believes that a holder filed a deficient annual unclaimed property report, including a verified report, he/she could authorize a "compliance review." A compliance review would be limited to the contents of the annual report or verified report "and all supporting documents related to such reports." Holders would be notified of deficiencies found during a compliance review within one year of commencing the review; and holders would have 90 days to pay such deficiency. Failure to pay could result in judicial action or referral to the VDA program. A compliance review would not be a prerequisite to an audit. Also, the filing of a verified report or participation in a compliance review would not preclude the holder from participating in the VDA program. (see Section 1174(b))

Unlike a full-blown audit, compliance reviews would not require notification that the holder may participate in the VDA program. Compliance reviews appear akin to a desk audit, in which an annual report or verified report could be reviewed in detail along with its supporting documents. This would be an abridged way for Delaware and its auditors to investigate a holder's compliance without initiating a formal exam.

SB 13 is silent in specifically defining how many days, months or years Delaware has to conduct a compliance review of a holder's annual report or verified report. Therefore, it is unknown whether Delaware intends to use this provision to conduct compliance reviews one year at a time, or multiple years all at once. It is also unclear how far Delaware will stretch the definition of "supporting documents" related to annual reports or verified reports. Possibly, a compliance review could quickly feel like a full-blown audit.

For any exam authorized on or before July 22, 2015 (except securities exams in which estimation is not required), the holder would be allowed to elect to convert the exam to a VDA. A holder wishing to convert its exam to a VDA would be required to notify the State Escheator and Secretary of State in writing by July 1, 2017. The look-back period under such a converted VDA would be 10 years, plus the applicable dormancy period for a particular type of unclaimed property, calculated from the calendar year in which the state originally gave notice of exam (not from 2017). (see Section 1176(b))

This is a huge shift in the Delaware law and gives holders who have been under audit for approximately two or more years the opportunity to complete the examination through self-review. For holders involved in a multi-state audit, in which third-party contract auditors could be auditing on behalf of 15-20 or more states, a holder should consider whether the audit will continue for the remaining states. A holder will want to consider whether conversion to a VDA only in Delaware will save time and resources given the particular stage of the audit. Additionally, a holder must weigh its opportunity to contest the final findings of an audit in the Delaware Chancery Court compared to providing the Secretary of State full and complete authority to determine and resolve claims under the VDA program.

For holders already under exam when SB 13 is signed into law, Delaware would offer an "expedited" exam opportunity. The request for an expedited exam would have to occur by July 1, 2017. "Expedited" would mean that the ongoing exam would be completed within two years from the request date. Interest and penalties would be waived. Further, all requests for information by the state or auditors would have to be issued within 18 months from the request date. (see Section 1176(c))

A potential issue with an expedited exam is the requirement that a holder respond to requests for information within the time frame and in the manner established by the State Escheator (and its auditors). Typically, requests for information have a 30-day deadline assigned by the auditors. Some requests cannot feasibly be completed in 30 days. This section does not contemplate holding the state or its auditors to reciprocal deadlines. Further, the State Escheator and the Secretary of Finance would have the sole discretion to determine if the holder has responded timely, and may terminate expediting the holder's exam if determined to be untimely. The concept of an expedited exam may be difficult to achieve in practice.

Various sections of SB 13 codify the use of extrapolation and statistical sampling in the absence of records. Delaware indicates it will promulgate (by July 1, 2017) regulations regarding estimation and sampling, including permissible base periods, items to be excluded from the estimation calculation, aging criteria for outstanding and voided checks, and the definition of what constitutes complete and researchable records. These regulations would apply to compliance reviews, examinations and VDAs. (see Sections 1176(e) and 1180)

These provisions, if enacted as currently drafted, appear to delay resolution of Delaware's estimation and sampling techniques, which the court found lacking in Temple-Inland. This is one of the major issues the holder and advocate community have anxiously awaited. Given the uncertainty until the regulations are promulgated, holders should consider whether settlement of any audits or VDAs with an extrapolation calculation similar to that of Temple-Inland remains a beneficial option.

Prior to the State Escheator commencing an examination, the holder would have to be notified in writing of its opportunity to participate in the VDA program. An exam would also be commenced if a holder failed to comply with the requirements of a VDA to which it agreed. (see Section 1176(a))

This language in SB 13 is carried over from previous amendments effective as of July 1, 2015 and maintained.

Notice of the opportunity to participate in the state's VDA program would not be required if Delaware were joining an examination initiated by another state. ( see Section 1176(d))

This language would clarify and codify prior administrative policy.

The state's VDA program continues to waive penalties and interest, and the right of the state to seek enforcement in court. Holders would have two years to complete a VDA unless extended by the Secretary of State. VDAs that cannot be settled between the holder and Secretary of State may be referred to the State Escheator for audit.

The State Escheator would be allowed to: 1) examine the records of a holder; 2) take testimony of individuals employed by the holder; 3) issue an administrative subpoena; and 4) seek enforcement of the administrative subpoena in the Court of Chancery. ( see Section 1175)

Delaware has issued subpoenas in the past which led to litigation.⁷ Section 1175 would codify the state's right to do so.

Record retention, statute of limitations and look-back periods

Delaware would add a record retention requirement, which would be 10 years after the date the report was filed. Records retained would have to support all details of the unclaimed property report. (see Section 1145)

A main criticism by the court in Temple-Inland was that Delaware historically had no record retention statute, one of the few states left in the country without one, yet it looked back sometimes 20-30 years during an audit. Delaware would remedy this deficiency through enactment of SB 13.

The statute of limitations for unclaimed property would be increased to 10 years and would be tolled by the delivery of an examination notice to a holder, or if the State Escheator concludes the holder filed a fraudulent or willfully misrepresented report. (see Section 1157(b))

A 10-year limitations period means that the state has 10 years after a report is filed to sue a holder for collection and payment of property that has been determined to be underreported. Ten years aligns with the new record retention requirement. Further, tolling the statute of limitations period with an examination notice ensures that years do not "fall off" once an exam has commenced and limits any benefit from delaying an audit.

Delaware would amend its look back under exam to 10 years, plus the applicable dormancy period for a particular type of unclaimed property calculated from the calendar year in which the exam commences (except for fraudulent reports or willful misrepresentation). (see Section 1176(h)).

The VDA program look-back period would likewise be restricted to not more than 10 years, plus the applicable dormancy period calculated from the calendar year that the VDA was accepted by the Secretary of State. (see Section 1177(c))

Delaware's record retention requirement would now align with both its statute of limitations and the look-back period under both its audit procedures and VDA program.

This change would end one of the main benefits associated with initiating a VDA versus awaiting an audit notification.

Definitions and unclaimed property basics

"Domicile" would be defined as the state of incorporation for a corporation; or for a business association other than a corporation, the state of its filing of formation or organization documents. (see Section 1130)

This definition clarifies that Delaware's unclaimed property law applies to LLCs and LLPs organized under Delaware law as well. This definition is consistent with RUUPA.

"Loyalty card" would be defined as a record given without direct monetary consideration under a loyalty or rewards program to be redeemed only for goods or services or a discount on goods or services and is specifically excluded from the definition of unclaimed property. (see Section 1130)

This exclusion should put to rest any of Delaware's outstanding document requests to holders in the hotel and retail industries surrounding loyalty points (e.g., hotel stay points, credit card points, frequent diner points), which has long been a point of contention under audit. This exclusion is consistent with RUUPA.

"Virtual currency" would be defined as a digital representation of value used as a medium of exchange, which does not have legal tender status recognized by the US, and is specifically included in the definition of property. (see Section 1130)

Virtual currency is common in the online gaming and gambling industries and at physical arcade/sporting locations. Bitcoin, Litecoin, Darkcoin, Peercoin, and Dogecoin are all considered virtual currency. "Game-related digital content" is specifically excluded from the definition of unclaimed property per RUUPA, but Delaware did not define nor even make mention of game-related digital content. It will be interesting to see if this omission is purposeful.

Gift cards and stored-value cards continue to be specifically included in the definition of property. Holders would still be allowed to reduce the amount of unredeemed gift cards escheated to the state by "the maximum cost to the issuer." (see Section 1133)

In practice, "maximum cost to the issuer" is roughly equivalent to costs of goods sold, and annual gross margin from a holder's tax return preparation is generally used for this calculation.

Delaware would continue not to have a business- to-business or current customer exemption. ( see Section 1133)

Delaware would define "knowledge of death" as triggering the five-year dormancy period for life insurance policies to become unclaimed, and would further define "knowledge of death" to include a Social Security Death Master File match validated by the life insurer. (see Section 1133)

This update to Delaware's unclaimed property law responds to recent activity and exposure in the life insurance industry, and is consistent with changes many other states made to their applicable unclaimed property and insurance laws, as well as RUUPA.

When considering dormancy triggers, SB 13 would provide an outline of specific examples of what might indicate an owner's interest in property. One example of note is: an "oral communication by the owner to the holder" if the holder "contemporaneously makes and preserves a record of the fact of the owner's communication." (see Section 1136(b))

This illustrates the importance for holders to keep detailed notes in their accounts payable and accounts receivable systems when investigating and resolving uncashed checks and customer credits for unclaimed property purposes. This section is consistent with RUUPA.

SB 13 would define the "last known address of an owner" as "a description, code, or other indication of the location of the owner on the holder's books and records which identified the state of the last-known address of the owner." [emphasis added] (see Section 1139)

This is significant as Delaware's previous administrative policy was to require a full address sufficient for mailing via the US postal service. The revised definition of last-known address only requires that the state be identified. This has the result of likely classifying more property as due outside of Delaware's jurisdiction.

SB 13 would make clear that Delaware may take custody of unclaimed property if the last-known address of the owner is in a foreign country and the holder is incorporated in or formed in Delaware.

This section clearly states Delaware's intent to continue to take custody of foreign property if it is the holder's state of incorporation.

Beginning March 1, 2018, SB 13 would require all unclaimed property reports to be web-based. (see Section 1142(a))

SB 13 provides that "a holder may not assign or otherwise transfer its obligation to hold for or pay or deliver property or to comply with the duties of this chapter, other than to a parent, subsidiary, or affiliate of the holder." (see Section 1147(a))

This section appears to assert that unclaimed property is the obligation and responsibility of the holder only and cannot be transferred to a third party, such as a payroll or benefits administrator.

SB 13 indicates that any successor in a merger, consolidation or acquisition (whether a capital stock or asset transaction) would be responsible for fulfilling the holder's unclaimed property obligation, unless the parties in the transaction agree otherwise. (see Section 1147(b))

This highlights for organizations the importance of considering unclaimed property liability when entering into a purchase and sale agreement and clearly defining in that agreement which party is intended to be the obligor of historical unclaimed property liabilities.

SB 13 would add a due diligence mailing requirement. Holders would be required to mail due diligence letters by first-class US mail 60-120 days prior to filing an annual report for property valued at $50 or more (but for securities). There would be no minimum threshold for due diligence mailings for securities. (see Section 1148)

Currently, Delaware is the only state that does not have a due diligence mailing requirement for general ledger-type property.

Provisions of SB 13 would require the State Escheator to send written notice to an owner of a security (valued at greater than $50) prior to liquidation and provides that "the State Escheator and the State of Delaware are not liable to the owner of a security … for an amount that exceeds that which was actually received upon the liquidation of the security." Further, for securities delivered to Delaware after July 1, 2017, the State Escheator shall, after sending written notice to an owner, liquidate a security "as soon as the State Escheator deems practicable after the delivery." (see Section 1150)

This specific section appears to have roots in a lawsuit brought by Belgian investors who have demanded compensation from Delaware for an alleged $12M change in value of their stock that was liquidated by Delaware.⁸ RUUPA suggests a three-year holding period after delivery of a security to a state before the security may be liquidated, which Delaware did not adopt.

Property would not be subject to custody of the State Escheator if the property were specifically exempt from custodial taking under Delaware law or the state of the last-known address of the owner. (see Section 1141(b))

This section is of interest because one of the prime complaints in Temple-Inland is that Delaware utilizes property owed to other states in its base for estimation. For example, an outstanding check due to a business in Arizona (which has a B2B exemption), may be included in Delaware's base for estimation under audit. Del. Code tit. 11, Section 1141(b) indicates that the Arizona check would not be subject to the custody of Delaware. It remains to be seen if this section will be applied to estimation techniques when the estimation regulations are promulgated by July 1, 2017.

Interest and Penalties

Interest would be calculated at 0.5% per month from the date the property was due until paid, not to exceed 50% of the property amount. (see Section 1187)

Interest and penalty amounts have changed in Delaware's statute several times over the past few years. SB 13 places both interest and penalty back on the table in regards to both audit findings and late-filed property. Interest and penalty amounts are waived under an expedited exam and the VDA program.

Penalty would be 5% per month for each month the holder fails to file by the due date, not to exceed 50% of the property amount (or a civil penalty not to exceed $5,000).

Penalty would be 0.5% per month for each month the holder fails to pay by the due date, not to exceed 25% of the property amount. (see Section 1187)

The State Escheator would be allowed, for good cause, to waive penalties in whole or in part; and to waive interest by 50%. (see Section 1189)

Historically, interest and penalties were rarely assessed by Delaware. SB 13 mandates that interest is assessed, and Del. Code tit. 11, section 1189 gives the state the right to only waive interest by 50%. It will be interesting to see how this applies in practice.