U.S. District Court Finds Delaware Unclaimed Property Audit Procedures Unconstitutional

On June 28, 2016, the United States District Court for the District of Delaware determined that Delaware's unclaimed property audit procedures violated substantive due process.1 Specifically, the Court found that the technique used by Delaware to estimate a holder's Delaware unclaimed property liability subjected the taxpayer to liability imposed by multiple jurisdictions.

Background

The taxpayer, Temple-Inland, is a Delaware corporation principally engaged in manufacturing corrugated packaging with its primary place of business in Texas and additional operations in Indiana. In 2008, Delaware began an unclaimed property audit of Temple-Inland through the use of a contract auditor, which audited both accounts payable and payroll transactions. The audit period spanned 22 years, from January 1986 to December 2007. However, pursuant to its document retention policy, Temple-Inland could only produce complete books and records for its accounts payable and payroll beginning in 2003 and 2004, respectively. Temple-Inland also produced copies of its Delaware unclaimed property reports for its 1998 through 2008 tax years, as well as a couple of reports from pre-1998 years. Further, Temple-Inland produced two Texas unclaimed property audit reports relating to its 1985-2005 tax years.

For those years for which Temple-Inland did not have complete records, Delaware estimated its unclaimed property liability.2 To compute the estimate, the auditor based its calculations on the base years for which Temple-Inland had complete accounting records.3 Also, the auditor selected 217 of the highest value checks (purportedly on a random basis) and asked Temple-Inland to research these checks to determine if they were remediated or unclaimed property. Temple-Inland was able to remediate all but four checks from accounts payable totalling $4,508.73 and three checks from payroll totalling $805.90. Only one of these checks was associated with a Delaware address. Nevertheless, all of the checks were included in the calculation to estimate the total unclaimed property amount for the audit period. Specifically, the estimate was based on the total amount of the unclaimed checks divided by the adjusted sales amount in each of the base years. This amount was further adjusted by excluding sales for which payments were made by ACH rather than by check.4 Based on this estimate, Temple-Inland's liability was determined to be $2,128,834. The minimal amount of unclaimed property that Temple-Inland had previously reported to Delaware in its timely filed reports, $1,357, was deducted from the estimated liability in computing the amount assessed.

In response to the assessment, Temple-Inland filed an administrative appeal to the Audit Manager, who concluded that Delaware was forced to estimate a liability because Temple- Inland "failed to maintain records sufficient to permit the preparation of a report."5 The Audit Manager reduced the liability by $95,435 for two double-counted checks and increased the sales amount used in the denominator relating to the ACH payments, finding that the original adjustment was unreasonable. In April 2014, the Secretary of Finance adopted the adjustments and declared that Temple-Inland owed $1,388,573.97. Although the Delaware statute stated that Temple-Inland was to appeal to the Court of Chancery,6 Temple-Inland instead sued Delaware in federal district court, claiming that Delaware's audit procedures and use of estimation violated substantive due process, the takings clause and the ex post facto clause of the U.S. Constitution. The District Court took jurisdiction because of the constitutional claims.7

Delaware and Unclaimed Property

In consideration of the issues, the Court cited three historic factors contributing to the reason for this dispute: (i) Delaware's dependence on unclaimed property revenue; (ii) the United States' Supreme Court rules for escheating unclaimed property; and (iii) Delaware's historically lax enforcement of its unclaimed property laws. Notably, unclaimed property is Delaware's third largest revenue source, making it a "vital element" in the state's operating budget.8 Although the money still belongs to its owners...