United States: Major Changes To The Delaware Unclaimed Property Audit And Voluntary Disclosure Regime That Delaware-Formed Entities Should Consider

Delaware Senate Bill 141, signed by Governor Mardell on July 22, 2015, makes significant changes to Delaware's procedures relating to unclaimed property audits and voluntary disclosures. Overall, these procedural changes should offer some benefit (or relief) to business entities formed in Delaware. But at least for now, while pending cases challenge Delaware's right to estimate property without evidence of its existence, Delaware continues to demand estimation of unclaimed property liability for historic years if records are deemed insufficient.

The new law governing Delaware voluntary disclosures and certain unclaimed property audit and reporting procedures:

• Became effective immediately upon signing by the Governor;
• Prohibits the State Escheator from initiating an audit unless the Secretary of State has notified the business entity that it may enter into the voluntary disclosure process with the Secretary of State (as long as the business entity is eligible, as discussed below);
• Shortens the applicable look-back period for audits conducted by the State Escheator;
• Removes the sunset date for the Secretary of State voluntary disclosure process that was enacted in 2012, in effect implementing that process with the Secretary of State as an ongoing part of Delaware's unclaimed property procedures;
• Changes the applicable look-back periods for voluntary disclosure agreements concluded with the Secretary of State; and
• Provides for assessment of interest for late-filed unclaimed property with a cap on total interest that may be assessed. (Note: penalties and interest are not assessed on amounts paid under voluntary disclosure agreements with the Secretary of State.)

The Unclaimed Property Landscape in Delaware

Prior to 2012, the Delaware State Escheator was charged with the responsibility and authority to initiate unclaimed property audits and enter into voluntary disclosure agreements for payment of unreported, past-due unclaimed property. Once a business received notice of an audit, the voluntary disclosure process was no longer an option. Delaware retained contingent fee auditors to conduct the audits (a practice that still continues today and is unaffected by S.B. 141), and the auditors regularly asserted unclaimed property liability back to accounting periods beginning in 1981.

Under U.S. Supreme Court rulings, the state of the unclaimed property owner's last-known address has the first priority right to escheat the property. Where there is no last-known address, property may be subject to escheat by the state of corporate domicile, where the business is incorporated.¹ In both audits and the voluntary disclosure process, Delaware regularly asserts the right to escheat estimated unclaimed property from entities formed in Delaware for years where an entity's records are insufficient to prove that all unclaimed property has been reported. Under Delaware's estimation technique, for historic years for which the business has limited records, Delaware asserted liability is estimated as a projection from amounts of unclaimed property reportable to other states in more recent years, even when no business was conducted in Delaware. Unclaimed property audits in Delaware often take three to five years to complete and are extremely time-consuming and expensive for the entity under audit.

In 2012 legislation, Delaware implemented a new voluntary disclosure program through which a holder could enter into a voluntary disclosure process administered by the Secretary of State in which shorter look-back periods would apply and penalties as well as interest would be waived. This program was to sunset on July 1, 2016, after which time the Secretary of State would have had no responsibility or authority with respect to the Delaware unclaimed property procedures.

Changes to Delaware's Unclaimed Property Procedures Under the New Law

Limit on State Escheator's Authority to Conduct Audits. Under the new procedures, the State Escheator "shall not initiate" an audit of a person or entity (the unclaimed property "holder") unless the holder has first been notified in writing by the Secretary of State that the holder may enter into the voluntary disclosure process with the Secretary of State. The requirement of notice from the Secretary of State does not apply, however, to holders who previously enrolled in the Secretary of State voluntary disclosure program that was enacted in 2012 and (i) formally withdrew from that program, or (ii) were removed from the program for failure to work in good faith to complete a voluntary disclosure agreement. As to holders in those two categories, the State Escheator has authority to initiate an audit without prior notice and without the opportunity for the holder to enter the voluntary disclosure process with the Secretary of State.

Holders who do receive a notice from the Secretary of State have 60 days from the date the notice was mailed to deliver to the Secretary of State the appropriate form indicating the holder's intent to enter into the voluntary disclosure process. If the Secretary of State does not receive the form within 60 days after the date of mailing, the holder "will be referred" to the State Escheator for an audit.

Shorter Look-Back Periods for State Escheator Audits. The new law shortens the look-back period for audits by the State Escheator as follows

• For audits that were pending as of the date of S.B. 141's enactment, the applicable look-back period commences on January 1, 1986, rather than 1981 as Delaware has regularly asserted in the past;
• Any new audits initiated after S.B. 141's enactment (July 22, 2015) through December 31, 2016 will apply a look-back period that commences on January 1, 1991, and in such audit, the State Escheator will not seek payment with respect to any transaction prior to January 1, 1991; and
• Any audits initiated on or after January 1, 2017 will apply a look-back period no longer than 22 years prior to the report year for which the State Escheator provides written notice of the audit; in such audit, the State Escheator will not seek payment with respect to any transaction more than 22 years prior to the calendar year in which the State Escheator provides written notice of the audit.

Thus, effective January 1, 2017, a rolling 22-year look-back period will be applied for unclaimed property audits in Delaware.

The Secretary of State Voluntary Disclosure Program is Retained without Sunset and with Revised Look-Back Periods. The new law deleted the sunset date of July 1, 2016 for the Secretary of State voluntary disclosure program, making that program a regular, ongoing part of Delaware's unclaimed property procedures. The legislation also revises the look-back periods applicable to voluntary disclosure agreements with the Secretary of State, as follows:

• For holders who submitted the "intent to enter" form and were accepted for voluntary disclosure by the Secretary of State on or before September 30, 2014, and who complete a voluntary disclosure agreement and make payment (or enter a payment plan) by June 30, 2016, the look-back period commences on January 1, 1996 (under the prior procedures, the look-back period for these holders was three years longer, commencing on January 1, 1993);
• For holders who submitted (or hereafter submit) the "intent to enter" form and were or are accepted by the Secretary of State after September 30, 2014 but before December 31, 2016, and who complete a voluntary disclosure agreement and make payment (or enter a payment plan) within two years after the Secretary of State's acceptance, the look-back period commences on January 1, 1996; and
• For holders who submit the "intent to enter" form and are accepted by the Secretary of State on or after January 1, 2017, and who complete a voluntary disclosure agreement and make payment (or enter a payment plan) within two years after the Secretary of State's acceptance, the look-back period commences on January 1 of the year that is 19 years prior to the year that the Secretary of State accepted the holder for voluntary disclosure.

Thus, the new procedures implement a 19-year rolling look-back period for holders accepted for voluntary disclosure on or after January 1, 2017, a look-back period three years shorter than that for audits initiated on or after that date. The law also provides the Secretary of State discretion to amend the due date for the holder to enter a voluntary disclosure agreement and make payment or enter a payment plan. Holders who were or are accepted for voluntary disclosure by the Secretary of State after September 30, 2014 but who do not complete a voluntary disclosure agreement and make payment or enter a payment plan within 30 days of the end of the two-year period, or the period as amended by the Secretary of State—or who are unable to resolve the asserted liability by agreement with the Secretary of State—may be "deemed to be referred" to the State Escheator for audit.

Reinstated Interest on Late-Filed Unclaimed Property. The new law provides for interest at 0.5 percent per month on outstanding, unpaid amounts for any late-filed unclaimed property reported and remitted on or after March 1, 2016, unless the holder shows that the failure to report and remit timely is "due to reasonable cause and not willful neglect as determined by the State Escheator." Interest is capped at 25 percent "of the amount required to be paid," presumably meaning the amount of the outstanding, unpaid amounts for the late-file property. Essentially, the law reinstates interest provisions that had been eliminated in 2014 legislation, with a 25 percent cap instead of the prior 50 percent cap.

No interest or penalties are assessed, however, on late-filed property remitted pursuant to a voluntary disclosure agreement with the Secretary of State.

Notice of Filing Obligation and Business Designation of Contact Person. The new law adds notice obligations for both the State Escheator and holders. The State Escheator is required to send a notice no later than 120 days prior to the March 1 filing deadline to holders who have made filings in the past five years, notifying them of their apparent obligation to file a report. While some might argue that entities formed in Delaware that have not been filing are the entities that need to be notified of unclaimed property filing obligations, this provision may be intended to give notice to companies that may not qualify for notice of the opportunity to enter into a voluntary disclosure process before an audit.

Holders of unclaimed property have notification obligations as well. The new law requires holders of unclaimed property to file an annual report that will be verified and will designate an individual employed by the holder who will serve as the contact for all correspondence with Delaware related to unclaimed property. Holders are obligated to notify the state of any change of the designated individual or any change of contact information provided.

What Should Business Entities Do in Light of the New Law?

Business entities formed in, or that conduct a material volume of business in, Delaware that have not yet taken steps to evaluate their potential liability under unclaimed property laws should evaluate their alternatives in light of the enactment of Senate Bill 141. While most entities should receive a notice from the Secretary of State regarding the option of voluntary disclosure before a Delaware audit, the entity will have only 60 days from the date the notice was mailed. Advance consideration and evaluation of the entity's unclaimed property compliance and any potential exposure for past-due property will afford time for a more careful and well-considered evaluation.

Multistate businesses formed in Delaware that do not have written policies and procedures for adequately monitoring and reporting unclaimed property on a multistate basis should consider a careful update of such policies and procedures to limit exposure from potential multistate unclaimed property audits. Unclaimed property audits of Delaware entities are performed by contingent-fee auditors who often represent several states. These audits typically last more than three years, and most result in estimated liability beyond any amount expected by management.

Particularly for Delaware-formed businesses that have not reported (or substantially under-reported) unclaimed property to Delaware in the past five years, it is hard to imagine a situation where a self-audit would not provide some benefit. But a Delaware voluntary disclosure agreement is not necessarily good for all businesses. Before completing a voluntary disclosure agreement, businesses would be well-advised to consider their alternatives, including evaluating the legal implications of any applicable statute of limitations and the magnitude of likely required payments due to estimation of nonexistent property.

Practical Advice for Delaware-Formed Entities. Delaware-formed entities that have not already undertaken a Delaware voluntary disclosure or received a release from Delaware after an unclaimed property audit would be well-advised to inform company representatives not to simply ignore notices related to the Delaware unclaimed property voluntary disclosure program. Even just that much advance planning could save a lot of audit expense!

Footnotes

1.See Texas v. New Jersey, 379 U.S. 674 (1965).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.