Jessica Masulli Reyes

The News Journal

A federal judge sharply criticized the way Delaware collects abandoned property – marking the latest challenge to a practice that helps balance the state budget with about half a billion dollars annually.

U.S. District Court Judge Gregory Sleet in a 39-page ruling said that Delaware's abandoned property practices violate due process and exploit loopholes in the statute of limitations for collection.

"To put the matter gently, defendants have engaged in a game of 'gotcha' that shocks the conscience," Sleet wrote.

The ruling issued Tuesday stems from a lawsuit in which packaging company Temple-Inland said Delaware violated the U.S. Constitution by demanding nearly $1.4 million in abandoned property payments based almost exclusively on estimates of what the company owed dating to 1986.

State Secretary of Finance Thomas Cook, a defendant in the suit, said that while the state is "disappointed" with the court's ruling, he would not comment on the litigation.

"We are reviewing the opinion with our attorneys and will make a decision as to next steps in due course," Cook said in a statement.

Usually, abandoned property is money in the form of unclaimed saving accounts, stocks, payroll checks, traveler's checks, or unredeemed money orders and gift certificates. That money flows to Delaware as the legal home of companies holding the unclaimed property left by vendors, former employees and customers.

It accounts for about 15 percent of Delaware's annual income, making it the third largest source of revenue for the state.

This practice known as escheat, has become a frequent source of friction between state officials and the businesses that incorporate in Delaware. Legal challenges have also arisen from other states claiming the funds should go to them.

Richard Heffron, the state Chamber of Commerce president, said Wednesday that while the ruling is good for businesses, it will have a major impact on the state budget in coming years.

“The chamber has raised these issues to the state over the years in an attempt to help address what companies under an abandoned property audit went through to calculate what they may owe," he said. "It has been an unfair practice to look back 30-plus years when no company keeps records going back that long.”

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The U.S. Supreme Court previously said states must abide by a two-tier system for abandoned property. First, abandoned property is reported to the state of the owner's last known address. Then, if no address is found, the property is reported to the state in which the owner is incorporated.

As the legal home to many of the nation's corporations, Delaware receives a large share of all abandoned property in which the owner or address is unknown.

However, Sleet called the way the state enforces this rule "troubling." Specifically he pointed to the state targeting large companies, and in this case, waiting 22 years to conduct an audit with no notice that the company should retain its records for that long.

"The court cannot help but wonder at Delaware’s sense of cadence," he wrote.

Sleet went on to criticize the way the state estimated the payment when no records could be located and prolonged the retroactive period for no obvious purpose other than to raise revenue.

"It is true that unclaimed property should not become a windfall for holders [or companies]," he said. "But, at the same time, unclaimed property laws were never intended to be a tax mechanism whereby states can raise revenue as needed for the general welfare."

Cook said the governor and General Assembly have taken a number of steps regarding abandoned property. He pointed to a law in 2010 which created a review process whereby audited companies could appeal to an independent reviewer.

Two years later, the state again passed a law permitting companies who had not been filing required reports with the state or who were not already in the resolution process to enter into a program to resolve their past-due filings in exchange for the state significantly shortening the look back period.

The state also passed a number of recommendations in 2014 from a task force created to look at unclaimed property. These included shortening the length of time an audit can reach back, providing further incentives for businesses to enter the voluntary disclosure program, and adding a requirement that the state issue notice to entities reminding them of their obligation to file abandoned property records.

Despite these steps, 21 states announced in June that they are suing Delaware in U.S. Supreme Court over unclaimed money orders. They claim the money should be returned to the state where the transaction occurred, not where the company is incorporated.

Similar suits were brought by Pennsylvania in February and Wisconsin in April.

Ed Ratledge, a public policy professor at the University of Delaware, said Delaware's procedures for collecting unclaimed property are actually "reasonable." He pointed out that people can – and do – claim abandoned property from Delaware. A searchable online database has even made it easy to do so.

"The Supreme Court is very, very clear that it doesn't belong to the holder," he said.

But, with mounting legal challenges, some say the state needs to look at other revenue streams in case the abandoned property money is not always available.

"What would you replace it with?" Ratledge asked. "New property taxes, higher income tax, etcetera."

Sleet's opinion said that while the practice is a violation of due process, he will defer his decision on a remedy until another day.

Contact Jessica Masulli Reyes at 302-324-2777, jmreyes@delawareonline.com or Twitter @jessicamasulli.