Corporate Close-Up: Second Delaware Corporation Challenges Unclaimed Property Liability in Federal Court

Another Delaware corporation, Osram Sylvania, Inc., filed suit in federal court to stop the state from collecting an estimated unclaimed property liability of more than $2.2 million.  Osram is seeking a declaratory judgment and preliminary and permanent injunctions against Delaware, alleging that its unclaimed property policies violate federal common law, Osram’s substantive due process rights and the Takings Clause of the U.S. Constitution.  [Osram Sylvania Inc. v. Cook, No. 1:14-CV-01475 (D.Del. filed Dec. 11, 2014)]

Osram’s claims arise from Delaware’s demand that the corporation pay almost $2.24 million in unreported unclaimed property for the period running from 1991 through 2006, even though, Osram alleges, the state can identify only $21,833.92 of actual unclaimed property, which the company timely escheated to Delaware.  It did not pay the remaining amount because Delaware lacks the authority to claim it, according to Osram’s complaint.

In May 2014, Temple-Inland, Inc. filed a similar suit in federal court to overturn the first published decision from an administrative appeal under Delaware’s unclaimed property laws, which upheld the state’s assertion that Temple-Inland was liable for more than $1.3 million of estimated unclaimed property.  That lawsuit is still pending. [Temple-Inland Inc. v. Cook, No.1:14-CV-00654-SLR, (D. Del. filed May 21, 2014)]

Delaware conducted audits of both Osram and Temple-Inland using the services of a third-party contractor, Kelmar Associates, LLC.  Kelmar conducts approximately 90 percent of Delaware’s unclaimed property audits, and its compensation is “contingent upon and limited by the amount of unclaimed property liability companies pay as a result of the audits,” according to Osram’s complaint.  Osram argued that, because Kelmar’s compensation provides an incentive for the auditor to generate as large a liability as possible, Kelmar’s estimation methodology results in inflated unclaimed property liabilities.

The assessment against Osram stems primarily from an audit of the company’s accounts payable disbursements unclaimed by vendors and accounts receivable credits unclaimed by customers.  Kelmar calculated that Osram should pay to Delaware almost $260,000 in uncollected accounts payable and $1.98 million of unclaimed customer credits.  

The complaint stated a small percentage of the accounts payable obligation resulted from checks issued and voided or issued to payees with unknown or foreign addresses.  Approximately 85 percent of the liability, however, could not be traced to any obligation of Osram, but was “Kelmar’s estimate of what [Osram] might have failed to report to all states (not just Delaware) for the period 1991-2001.”  Similarly, Kelmar identified a small amount of credits unclaimed by one Delaware customer and a number of foreign customers, but 99 percent of the assessed liability for unclaimed credits was estimated.

Osram argues, therefore, that to require it to remit an estimated $2.2 million to Delaware would deprive the company of its property without due process and without just compensation.  Because the estimation was based on property already escheated to other states, Delaware’s methodology exposes Osram to liability in multiple states and includes property owned by foreign owners over which Delaware lacks jurisdiction.  In sum, Osram asserts “the estimated amount is a fictitious number;” it does not represent a precise obligation to any creditors, which must be determined under federal law before the amount is escheatable to a state.

Discussing the Temple-Inland case, Ethan D. Millar, partner with Alston & Bird LLP, Los Angeles, told Bloomberg BNA’s Weekly State Tax Report, June 27, 2014, there is a high likelihood the case will be settled because Delaware has too much to lose. “Temple-Inland has a number of very compelling legal arguments which, if successful, would eviscerate Delaware’s unclaimed property program,” Millar said.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn:  should states be required to identify property specifically before taking custody of it under their escheat laws, and should estimated unclaimed property not be subject to escheat?

For more information about this and other state tax and unclaimed property issues, sign up for a free trial of the Bloomberg BNA Premier State Tax Library today.  Additional information is available from PwC’s State and Local Tax Research and Insights.