- Attempt to Block Unclaimed Property Gift-Card Audit Again Rejected by Delaware Federal Court
- March 7, 2017 | Authors: Brendan Ballard; Wilson G. Barmeyer; Kristine M. Ellison; Amy F. Nogid; Holly H. Smith; Phillip E. Stano; Steuart H. Thomsen; Mary Jane Wilson-Bilik; John Allen Zumpetta
- Law Firms: Eversheds Sutherland (US) LLP - Washington Office; Eversheds Sutherland (US) LLP - New York Office; Eversheds Sutherland (US) LLP - Washington Office; Eversheds Sutherland (US) LLP - New York Office
- Marking its second decision on the issue, the Delaware federal district court has held that the U.S. Supreme Court’s priority rules governing the distribution of unclaimed property among competing states do not apply to disputes between private holders and a state, in a decision March 3, 2017, in Office Depot v. Cook, C.A. No. 16-609-LPS. An earlier similar decision in Marathon Petroleum Corp. v. Cook, No. 16-80-LPS (D. Del. Sept. 23, 2016), has been appealed to the U.S. Court of Appeals for the Third Circuit.
The current controversy with the State of Delaware arose when Delaware’s auditor Kelmar expanded the scope of an ongoing audit and turned its attention to unredeemed gift cards. Like Marathon Petroleum Corp. (Marathon), Office Depot sued to enjoin the state’s audit, arguing that the gift cards were issued by an out-of-state subsidiary and were hence unreachable by Delaware’s audit. In response, Delaware filed a motion to dismiss, arguing both that Office Depot’s suit was not ripe and that Delaware was entitled to audit anonymous gift cards issued by a non-Delaware subsidiary.
Similar to the earlier decision in Marathon Petroleum, the district court ruled first that Office Depot did not file suit prematurely and that the case was “ripe” for decision. Relying on the recent decision in Temple-Inland, Inc. v. Cook, 2016 WL 3536710 (D. Del. June 28, 2016), the court highlighted the audit’s harmful effects, and held that the holders need not wait until the audit’s conclusion to sue if they can demonstrate a sufficient threat of injury and present a conclusive legal issue.
On the merits, however, the district court sided with Delaware and ruled that the audit could proceed. The central issue was whether the priority rules articulated in Texas v. New Jersey, 379 U.S. 647 (1965), would prevent Delaware from escheating gift cards issued by Office Depot’s Virginia-incorporated subsidiary. Consistent with its ruling in Marathon Petroleum, the court held that Office Depot could not use the priority rules as a defense against Delaware, reasoning that the rules apply only to competing claims between states, not to a dispute between private holders and a state.
In finding a lack of federal preemption, the district court again applied a questionable rationale for distinguishing the Third Circuit’s decision in New Jersey Retail Merchants Association v. Sidamon-Eristoff, 699 F.3d 374 (3d Cir. 2012). The district court stated that, unlike in New Jersey Retail Merchants, Delaware is alleging that fraud occurred through the setting up of out-of-state subsidiaries for the purpose of avoiding escheat to Delaware. However, as the holder has argued on appeal in Marathon Petroleum, if a holder’s alleged fraud is the basis for distinguishing New Jersey Retail Merchants, then the court is suggesting that Delaware may be able to assert second priority under federal law by proving fraud and disregarding the corporate form. That approach would be inconsistent with the court’s broader statements that Delaware can disregard federal law entirely.
Despite legal challenges, Delaware is continuing to push forward with unclaimed property audits of gift cards. Holders are not, however, backing down without a fight. Marathon is continuing in its appeal to the Third Circuit, and any appellate decision in that case or the Office Depot case may be very important to whether and how companies can use federal law to defend themselves against aggressive state audit tactics on unclaimed property. Eversheds Sutherland will continue to monitor and report developments in this and other unclaimed property matters.