Unclaimed Property: Days May Be Numbered for Abusive Estimation Techniques

Two recent lawsuits in federal court suggest companies are fighting back against the estimation techniques used by third-party contract auditors in unclaimed property audits. In Temple-Inland Inc. v. Cook, No. 1:14-CV-00654-SLR (D. Del. filed May 21, 2014), filed in federal district court last month, the holder of unclaimed property is challenging a contract auditor's (Kelmar Associates) $1.3 million estimated assessment based on federal common law and several constitutional provisions including the Due Process Clause, the Commerce Clause, the Full Faith and Credit Clause, and the Takings Clause. The district court could strike a major blow to Delaware if it holds that estimation methods are unconstitutional. Delaware relies on unclaimed property revenue for almost one third of its budget. Even if the court holds that estimation methods may only be used for periods after 2010 (the year Delaware enacted a statute authorizing auditors to use estimation techniques when adequate business records do not exist), or that Kelmar has a higher burden for applying estimation methods when holders offer up business records, refunds could be required and the entire complexion of unclaimed property audits in Delaware could change for the better going forward.

Earlier this year Select Medical Corp. settled a suit also dealing with Kelmar's estimation methods for undisclosed terms. Select Medical Corp. v. Cook, No. 1:13-cv-00694-UNA (D. Del. filed April 17, 2013). After participating in Delaware's voluntary disclosure program and remitting close to $18,000 in unclaimed property, Select Medical was notified by Delaware that Kelmar would be auditing the company for all years dating back to 1981. Kelmar estimated that Select Medical owed close to $300,000 in unreported unclaimed property even though Kelmar could not identify any specific unclaimed property. Select Medical had already paid over $300,000 in unclaimed property to other states based on the owners' last known addresses.

At the heart of both of these cases is a Delaware statute that allows audits to date back to 1981. However, the holders of unclaimed property are unlikely to have records dating back three decades. Consequently, contract auditors determine holders' liabilities for past years by extrapolating from samples of more recent years. These extrapolations are not valid if the recent years are not typical of earlier years and in such circumstances result in oversized assessments unsupported by facts. The situation is made worse because there is little guidance on whether business records are "adequate," the precursor to the use of extrapolation techniques.

If you have been contacted by Delaware or one of its contract auditors or have questions about your unclaimed property obligations, contact one of the authors of this alert.

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