Judge refuses to dismiss challenge to Delaware abandoned property system, key revenue source

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DOVER, Delaware — A federal judge on Wednesday refused to dismiss a lawsuit challenging Delaware's abandoned property collection system, raising questions about the constitutional validity of one of the state's largest revenue sources.

Wednesday's ruling by U.S. District Judge Sue Robinson involves a lawsuit filed last year by packaging company Temple-Inland Inc., a subsidiary of Memphis-based International Paper that is incorporated in Delaware

The company challenged Delaware's claim to almost $1.4 million in purported uncashed accounts payable and payroll checks.

Temple argues among other things that Delaware's practice of estimating unclaimed property liability for years in which actual records are not available amounts to an unlawful taking of property and violates constitutional provisions regarding due process.

State officials began an unclaimed property audit of Temple-Inland in 2008, telling the company that the audit period would begin in 1981. But because the company was unable to produce records prior to 2003, officials used an estimation method to extrapolate that the state was owed $2.1 million. The figure was subsequently reduced to the amount still in dispute.

"Today's ruling by Judge Robinson is a big victory for businesses suffering from Delaware's abuses of its unclaimed property laws," said Matthew Mock, a Chicago attorney who specializes in state and local tax litigation and has been following the Delaware case. "For years now, the state has successfully extorted money from companies merely because they are incorporated in Delaware."

An attorney for Temple-Inland declined comment, citing the ongoing litigation. Delaware finance secretary Tom Cook said state officials were pleased that the judge dismissed one of the company's claims regarding federal common law and looked forward to addressing the remaining issues in the case.

The Temple-Inland complaint is the latest in a series of lawsuits challenging Delaware's abandoned property, or escheat, system, which has become a source of tension between the business world and a state that is the legal or corporate home to more than 1 million business entities, including more than 60 percent of Fortune 500 companies.

Abandoned property can include stocks and bonds, uncashed checks, unclaimed dividends, wages, refunds, and utility deposits. Partly because of Delaware's status as a hub of incorporation, abandoned property has become the state's third-largest revenue source, with collections this fiscal year expected to top $550 million.

Before collecting the money, the state is supposed to try to find the owner.

In her ruling, Robinson denied Temple-Inland's motion for summary judgment in its favor and agreed with the defendants that Delaware's practice of estimating liability is not pre-empted by federal common law.

But she said questions remain about due process and whether a 2010 law in which the General Assembly clarified that state officials could estimate liability amounted to a retroactive penalty for inadequate record-keeping. Robinson said that if the section of law in question is not a penalty provision, it likely violates a company's due process rights. On the other hand, if it is a penalty provision, it likely violates a constitutional prohibition against retroactive application of a law, she said.

"The court is unprepared, at this juncture, to determine which scenario is most likely," Robinson wrote.

Robinson said Delaware's escheat system also touches on constitutional limits regarding government taking of private property. She noted that Temple-Inland has sufficiently argued that it has a legitimate property interest because the estimated debt may not be traceable to bona fide creditors.

"It follows that, if Delaware does not have the authority to escheat the property in question, then the seizure of such property without just compensation would be a violation of the Takings Clause," she wrote.

Finally, Robinson said Temple-Inland may have a valid argument that Delaware's method of seizing abandoned property interferes with interstate commerce in other states, including those that exempt property from escheat.

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