United States: Delaware Court Denies Most Of Defendants' Motion To Dismiss Unclaimed Property Gift Card False Claims Action

Two years ago, a former employee of Card Fact, LLC (subsequently purchased by Card Compliant), a company providing gift card issuance and management services to retailers, filed a false claims action in Delaware alleging that his former company and its retailer clients concocted a scheme to avoid remitting unclaimed gift card funds to Delaware. Last week, the judge in the case issued a memorandum opinion on the defendants' Motion to DismissState of Delaware ex rel. French v. Card Compliant LLC, et al., C.A. No.: N13C-06-289 FSS [CCLD] (Del Sup. Ct. Nov. 23, 2015). While the opinion is likely disappointing to most of the defendants, it should not be read as a final victory for the state. There is still much to be decided in the case, as this was just a motion to dismiss and not a decision as to whether the plaintiffs will ultimately prevail.

The judge did however make several legal conclusions that are of import to Delaware companies. First, the judge determined that as to gift card liability that was initially incurred by the retailers but subsequently transferred to Card Fact (and its affiliates), the retailers remained the debtors with respect to the card owners, unless the customers consented to the delegation of debt. The judge found that the contractual agreements between the retailers and the Card Fact companies were not controlling. However, the judge did not specifically rule on gift card liabilities that were never transferred from the retailers to Card Fact, but instead were incurred directly by Card Fact after its relationship with the retailers began.

Second, the judge found that for defendants that were not C corporations, the second priority rule was to be applied based on the state of formation, not the principal place of business. This is contrary to most state laws and sets up a direct conflict between the states.

Finally, the judge found that because one of the retailers had previously been audited by Delaware (through Kelmar), it could not be a defendant in this false claims action. The judge dismissed this defendant entirely, even for claims that arose subsequent to the audit conclusion. The judge noted that "[i]f the auditor has given [the retailer] a bye, that is between the escheater and the auditor." This is very good news for any company that has previously been audited by the state regarding the risk of a false claims action.

Practice Notes

  1. For companies that have been audited by Delaware, the risk of a false claims action has likely been significantly reduced if not eliminated;
  2. Unincorporated entities should investigate the indemnification provisions between their state of formation and state of principal place of business to determine the risk of choosing which state to remit to;
  3. Companies using gift card entities or other liability allocation arrangements should review their disclosures and agreements with customers to verify appropriate consent and understanding regarding which entity holds the actual liability.

Delaware Court Denies Most Of Defendants' Motion To Dismiss Unclaimed Property Gift Card False Claims Action

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