The Delaware Department of State recently sent a new round of letters to companies they identified as likely not being in compliance with Delaware’s unclaimed property laws. The purpose of these letters is to invite the companies into the state’s unclaimed property voluntary disclosure program (“Program”). If the company decides to not enter the Program, there is risk of audit. Below is a high-level overview of the Program, as well as certain considerations that must be weighed in response to the invitation letter.
What is Unclaimed Property
Unclaimed property is any form of property (cash, contents of safe deposits, securities, etc.) that are held by a company, but are not owned by the company. Common examples include unredeemed gift cards, undelivered securities, and uncashed checks. States generally require that unclaimed property is given (escheated) to the state after a certain number of years of it remaining dormant (e.g., no activity by the property owner on the account). In theory, the state is charged with holding the property on behalf of the owner who can make a claim with the state to retrieve the property. In reality, much of this property is never returned to its owner, but instead, serves as a crutch for state coffers.
As one can imagine, this revenue source originally resulted in multiple states making claims to the same dormant property. From such claims, the federal common law priority rules were born. Under these federal common law rules, unclaimed property is generally escheatable to states using a cascading approach. First, if the company has a last-known address on file for the owner of the dormant property, the property is generally escheatable to that state. If the company does not have a last-known address for the owner, the property is generally escheatable to the state where the company is incorporated or domiciled. Enter Delaware.
Delaware’s Unclaimed Property Law
Delaware is the most aggressive state in the unclaimed property space, with some estimates ranking unclaimed property as the state’s third highest source of revenue. Delaware’s appetite in this space is partly a product of its far-reaching unclaimed property law, but also because the federal common law rules, as noted above, source a lot of unclaimed property to Delaware as a leader in company incorporations.
Delaware’s unclaimed property law is broadly written to include most forms of intangible property (e.g., interest, dividends, insurance proceeds, etc.). There is a general dormancy period of five years for most property types in Delaware, meaning if the property has sat unclaimed by the owner for five years, it is generally escheatable to the state.
On audit, the state is allowed to collect unclaimed property from as far back as ten years from the date the property became escheatable. For property with a five year dormancy period, this essentially results in a fifteen year lookback period. And for years where a company may not have adequate records, the state will use crude estimation methods. However, under current Delaware law, the state cannot initiate an unclaimed property audit without first inviting the company to participate in the Program. For additional information related to Delaware’s current unclaimed property law, please see here.
Delaware’s Unclaimed Property Voluntary Disclosure Program
Like traditional tax voluntary disclosure programs, the Program offers certain incentives for participation, such as the ability to control the process, waiver of interest and penalties, and finality. However, the Program lookback period is generally the same as the audit period: ten years from the date the property became escheatable.
Because the state cannot initiate an audit without first inviting the company into the Program, much of the activity in the Program results from these invitations. There is not complete clarity on how a company is selected for a Program invitation, but it is generally companies that are incorporated in Delaware and operate in a space that is likely to generate some unclaimed property, but have not filed unclaimed property reports in Delaware.
Considerations for a Voluntary Disclosure Invitation Letter
The first consideration upon receipt of a Program invitation letter is whether to participate. Since the letter is often signaling that the state has tapped a company for audit, not participating in the Program will likely result in an unclaimed property audit. In audit, the company loses a certain level of control over the process and will likely be forced to pay interest and/or penalties on any escheatable unclaimed property that is discovered. Other considerations on whether to participate in the Program include:
- Does the company have Delaware unclaimed property on its books. This requires a complete review of the books and records of the company to determine whether there is any dormant property with an owner with a last-known address in Delaware, or if the company is incorporated in Delaware, then also any dormant property with no last-known address.
- A review of M&A activity to determine whether Delaware unclaimed property was acquired in an acquisition.
- A review of potential preemption positions (e.g., ERISA-covered benefit plans).
If the company decides to enter the Program, it generally unfolds in four phases. The first phase is the scoping phase, where it is determined which entities and property types will be included in the disclosure. This is a critical step because Program coverage will only extend to the entities and property types in scope. The second phase is identifying the Delaware unclaimed property that will be escheated. The third phase includes submission of the disclosure materials, and the state’s review of the same. The fourth and final phase is execution of the closing agreement and payment.
The state generally recommends that an advocate be brought on to help facilitate these processes. An advocate is important in mapping the scope of the disclosure, identifying what constitutes Delaware unclaimed property, and recognizing certain preemption positions. Also, an advocate’s familiarity with the Program will help streamline the process and ensure important deadlines are not missed.
Finally, it is important to note that the invitation letters generally require a response within 60 days. Failure to respond during this time may trigger an audit, which may disqualify the company from seeking voluntary disclosure. If you have received a Program invitation letter, you should consult an advisor on the response as soon as possible.
Contact the Authors: Ted Bots and Trevor Mauck