TEI Chicago Chapter Unclaimed Property Seminar March 3, 2016

Unclaimed Property Fundamentals

What Is Unclaimed Property or Escheat It is not a tax Nexus Standards - - are not applicable With few exceptions, there is generally no statute of limtiation (very extensive reach back periods) It is rooted in the concept of Derivative Rights No traditional administrative remedies (most states) 3March 3, 2016

Key Terms Escheat Holder Owner Custodian Aggregate Due diligence Dormancy periods 4 March 3, 2016

What Is Unclaimed Property? Unclaimed property is defined in the various uniform unclaimed property acts as intangible property owed to another that remains unclaimed by the owner after a specified period (i.e., the statutory dormancy period) Concept of outstanding obligation –“Fixed and certain” (as opposed to contingent or conditional) obligations to pay money to another –“Owner” = Creditor/person entitled to payment – “Holder” = Debtor/obligor 5March 3, 2016

What Is a “Holder”? “Holder”: States variously define the holder to be: –In possession of property belonging to another –Indebted to another on an obligation –A trustee –Obligated to hold for the account of, or deliver or pay property to the owner –Any person having possession, custody or control of the property of another… and every other legal entity incorporated or created under the laws of this State or doing business in this State (DE) 6 March 3, 2016

Types of UP Property types subject to state unclaimed property laws include: –Uncashed checks (A/P vendor checks, payroll, miscellaneous disbursements) –A/R credit balances, merchandise credits –Bank accounts and time deposits –Life insurance proceeds –Utility deposits and refunds –Uncashed dividend checks and other distributions of business associations –Property held by state courts and public officers and agencies (e.g. tax refunds; amounts interpleaded into custody of court) –“Other Miscellaneous Property Held for Another” 7March 3, 2016

Newer Categories of Property Rebates IRAs Self-insured plans Retirement benefits Third party administered plans Life insurance proceeds (death index) Gift cards/stored value cards (open and closed loop cards) Virtual Currency: Daily Deals, Bitcoins, Fantacy Sports? 8March 3, 2016

State UP Laws All states have an Unclaimed Property Act (“UP Act”). Such laws: –Establish time periods after an obligation becomes “due and payable” when it is “presumed abandoned” by owner if not paid –Require “holders” to perform “due diligence” to attempt to locate “owners” of property that is “presumed abandoned” –Require reporting and payment to the state of obligations that are presumed abandoned and owner cannot be located –Require State to maintain custody of property and pay it to owners who subsequently come forward to claim the property 9March 3, 2016

Common Terms Due Diligence Due Diligence, Reporting and Payment Requirements: A holder’s obligation to make one final (or first) attempt to contact owner and return property to same, before paying over to a state; annual reporting and payment obligations (zero return is required by some states) 10March 3, 2016

Common Terms Abandonment Presumption of Abandonment: statutory dormancy periods; shortening of same over time (states’ revenue grabs) –Trigger for dormancy period? Vesting of property right; and every contact by owner with regard to the item of property refreshes the dormancy trigger –Dormancy periods: 1 yr for payroll; 3 yrs for most property types under 1995 act; 5 years in NY, DE, and other states with 1981 act provisions; travelers’ checks were historically the longest (now, 15 years in many states, though recently shortened by several) 11March 3, 2016

Common Terms Dormancy Dormancy v. Owner Activity: So when do UP laws become relevant? With respect to an individual item of property, when the property is presumed-abandoned, or deemed-abandoned. That does not occur under the laws until a statutory “dormancy period” has run. However, if an owner actively manages its property, or communicates with the holder thereof, the item will never be presumed abandoned. –Examples of owner activity/communications: cash the check; redeem the gift card; apply the credit on your account –Does this constitute owner activity? Owner has several brokerage accounts with one bank; owner buys stock in one account, but leaves balance running and engages in no activity in IRA account. IT DEPENDS. 12March 3, 2016

Custodial v. True “Escheat” State as Custodian (Distinguishing Escheat Laws): –As ULC comment makes clear, the laws of states originally mirrored common law escheat laws of the UK – those laws vested title to property that had been abandoned in the King (bona vacantia is the Latin phrase; the gist, to paraphrase Mel Brooks, History of the World: Part I, is “It’s good to be the King”). –However, modern laws are custodial in effect, albeit many states hold cash payments in their general funds, and/or allocate a percentage of such funds to the general fund for operational use. 13March 3, 2016

State Jurisdiction over UP Jurisdictional rules had to be developed by the U.S. Supreme Court to prevent situations in which two states claimed an item of property based upon some contact with the property, the owner, or the holder of same. –Jurisdiction over the holder of property for audit or enforcement of UP laws is not based on “nexus” of the holder, but rather on a principle derived from intestacy law: mobilia sequuntur personam, i.e., the property is deemed to have situs in the state of residence of its owner. »The Supreme Court has clarified that the Commerce Clause and Due Process nexus standards do not apply where that holder lacks physical presence or even minimum contacts –However, the owner and/or its address is not always known; then what? 14March 3, 2016

Jurisdictional Priority Rules The Supreme Court, in 1965, first set forth the two-pronged jurisdictional priority scheme that controls UP in Texas v. New Jersey (379 U.S. 674 (1965)) –Factual background drove Court’s consideration of four distinct theories of jurisdiction –Court recognized that its ruling was driven by considerations of convenience and uniformity (i.e., pragmatism), as much as theory 15March 3, 2016

Texas v. New Jersey - Background Sun Oil Co. (incorporated in NJ, principal place of business in PA) had unclaimed property on its books and records TX, NJ, PA, and FL claimed the UP under various theories: –TX: the unclaimed property/funds are paid to the state with the most significant contacts with the debt (oil wells) –NJ: the funds are paid to the state of the debtor company's (i.e., holder's) incorporation –PA: the funds are paid to the state in which the holder has its principal place of business –FL: the funds are paid to the state of the creditor's (i.e., owner's) last known address, as shown by the debtor's/holder's books and records 16March 3, 2016

Texas v. New Jersey, cont’d Article III original jurisdiction Federal common law Two-pronged priority scheme was articulated by the Supreme Court, although the Court entertained additional jurisdictional grounds that amici proposed to the Court. Once property that is being held by a Holder is “presumed abandoned,” and the owner cannot be located, the Holder must report and remit it to: 1.State of last known address of the owner, based on Holder’s books and records 2.State of Holder’s incorporation, if the property owner is unknown or Holder has no record of an address for the property owner, or if first priority state “does not provide for” escheat of the property 17March 3, 2016

Public Policy Concepts Underlying UP Laws The public policies that inform the structure and operation of the states’ unclaimed property laws are each important, but they are may operate in ways that are inconsistent. 18March 3, 2016

Consumer Protection The UP laws function as consumer protection laws, by 1.Enforcing the rights of owners to intangible property, in the absence of affirmative owner contact with the holder 2.Attempting to reunite owners with their property 3.Preventing unfair enrichment to holders 19March 3, 2016

Per this principle, a state as custodian may only exercise jurisdiction over property: (1) to which the owner’s right is fixed and certain, and (2) only to the extent of the owner’s rights therein. –“The State's right is purely derivative; it takes only the interest of the unknown or absentee owner.” State v. Standard Oil Co., 74 A.2d 565, 573 (1950), aff’d, 341 U.S. 428 (1951). –Delaware v. New York, 507 U.S. 490 (1993): Supreme Court holds that the first step to determine if a state has UP jurisdiction is to “determine the precise debtor-creditor relationship that as defined by the law that creates the property right at issue” -- “the holder’s legal obligations… define[] the escheatable property at issue.” Derivative Rights Doctrine 20March 3, 2016

Derivative Rights Doctrine, cont’d The Derivative Rights Doctrine underlies all custodial unclaimed property laws. The rights of the state in the property are derived from the rights of the owner and state has no greater rights in the property than the owner. The state may take custody of the property and act on the owner’s behalf. –Example: gift certificates redeemable solely for merchandise or services. The State “stands in the shoes of the owner.” States’ rights are derived from the rights of the owners of the property, and are subject to any defenses the holder could assert if the owner were claiming the property directly (with certain important statutory exceptions discussed later). 21March 3, 2016

ARE THERE ANY LIMITATIONS TO THE DERIVATIVE RIGHTS DOCTRINE? Connecticut Mutual Life Ins v. Moore (US 1948): NY law required escheat of insurance policy proceeds even if State could not produce documentary proof of death and surrender the policy (i.e., contractual requirements) –HELD, because “State is acting as a conservator, not as a party to a contract,” it cannot be forced to satisfy formalistic conditions of the contract – such as presentment of the policy and proof of insured’s death. Hence, Contracts Clause is not violated by this law. –However, the Supreme Court upheld the NY Court of Appeals’ determination that a holder may assert all defenses to escheat, including substantive contractual conditions of ownership. –States tend to cite this case for proposition that UP laws trump all contractual restrictions on an owner’s property rights. 22March 3, 2016 Derivative Rights Doctrine, cont’d (Consider Deleting)

Corollary application: The holder has not received consideration for its promise to pay or deliver property to the owner. »If the owner’s rights in the property have not vested or the property is not payable and distributable, it is inappropriate for the state to escheat such property. »If the owner had not paid consideration, as the holder is under no obligation to the owner, it also has no obligation to the state standing in the shoes of the owner. Corollary application: The holder has no obligation to pay cash to the owner of the property. »If a state receives cash from the holder it would circumvent the contract if the owner possessed no right to cash. »e.g., a contract for services 23March 3, 2016 Derivative Rights Doctrine, cont’d (Consider Deleting)

Statutory exceptions to the DRD: –State laws that require the escheatment of the cash value of unredeemed gift cards that are redeemable solely for goods – i.e., monetization of intangible property with respect to which an owner has NO RIGHT TO CASH –Anti-limitations provisions: Laws that disregard contractual limitations on an owner’s right to claim property (e.g., expiration dates) for purposes of state UP laws. –Both types of law effectively revive or expand an owner’s property rights – the owner may claim the property after it has been remitted to the state 24March 3, 2016 Derivative Rights Doctrine, cont’d

Anti-Windfall Policy As between the holder entity, and the state of last known residence of an owner (in the alternative, state of domicile/incorporation of the holder), the UP laws prefer any windfall obligations that remain unsatisfied to accrue to the states as opposed to private holder entities 1.Avoid “windfalls” to holders of property belonging to others to which the holder has no rightful claim 2.Allow unclaimed property to be used for benefit of public until owner comes forward to claim it 25March 3, 2016

Legal Concepts Underlying the UP Laws Consider Deleting Slide Intangible Property Represents an Obligation from a Holder to an Owner: The term “Holder” is defined in the 1981 Act by reference to three distinct tests: (1) is entity in possession of property belonging to another? (2) does holder bear an obligation to another? or (3) is holder a trustee? In any of these fact patterns, the obligation is key. 26March 3, 2016

Legal Concepts Underlying the UP Laws “Fixed and Certain” Obligation: And, the obligation must be vested, not inchoate – i.e., “fixed and certain,” or put another way, the property must be “payable or distributable” to an owner, before the UP laws even come into play. No vested property right on the part of an owner, no UP obligations on the part of the putative holder. Hence, conditions precedent to the vesting of a property right (e.g., owner must register and set up an account to receive a credit; owner must generate at least $10 in commission to be entitled to payment; etc.) are critical defenses to the creation of an obligation that the UP laws would govern. 27March 3, 2016