United States: Federal Court Decision Warns Delaware: Be Prepared To Defend Audit Practices In Court

The United States District Court for the District of Delaware dismissed a lawsuit against the Delaware State Escheator, Abandoned Property Audit Manager, and the Secretary of Finance, and Kelmar Associates, LLC, but it came with an implied warning. In its decision to dismiss Plains All American Pipeline's request for injunctive relief from an unclaimed property audit, the court held that the case was premature.1 The state had not engaged in any action that presented a threat of harm to Plains . . . yet. According to the opinion, to the extent the state decides to continue its audit against Plains, it will have to issue and enforce a subpoena, and Plains can defend against that subpoena in due course.2

Plaintiff Sued to Bar the Audit

Plains brought the action after its objections to the breadth and scope of Delaware's intended unclaimed property audit and document requests from the state's contract-auditor Kelmar were rejected by the state.3 The plaintiff alleged, among other things, that its constitutional rights were violated by being exposed to a costly audit conducted by multiple states by a contract auditor with a financial interest in the outcome, and neither the state nor Kelmar would agree to keep the audit confidential from other states; nor would they agree not to estimate liability for years for which records no longer were available. The estimation is particularly problematic, given the federal court's recent decision holding that the state's typical estimation practices "shocked the conscience."4 Further, the state's Audit Manager, Michelle Whitaker, had threatened in a letter to the company that the state would consider Plains' cooperation when determining whether to impose penalties on any liability. The plaintiff sued for an injunction barring the state and Kelmar from conducting the audit.

The Court Dismisses the Action as Not Yet Ripe

The situation is not unusual. Companies across the nation have been targeted by contract auditors and told to submit to multi-state, multi-year audits that can cost hundreds of thousands of dollars and years of internal and external resources, "or else."5 Document requests often are extensive, broadly drafted, and unlimited as to time period. But the court noted that Plains' challenge to the audit process, a claim Plains based on the Fourth Amendment, was not ripe for an injunction action.

Rather, it held, "If Plaintiff wishes to challenge the enforceability of a future subpoena, it should refuse to comply with the subpoena and await any enforcement action."6 With respect to a substantive claim involving estimation, the plaintiff would have to wait until the state seeks to apply estimation before it can obtain relief. The district court observed that "it is entirely speculative whether the Delaware Defendants will use estimation in this particular audit." It explained, "In short, nothing has happened. Whatever does eventually happen will not happen imminently. If and when it does happen, it is unknown how it will happen."7

The court also recognized that the state had threatened to impose penalties "in connection with any past-due unclaimed property that is identified as a result of the examination." But in interpreting the state's letter in this regard, Judge Andrews notes that "the letter refers to 'statutorily available actions . . . in connection with property which is 'identified,' rather than estimated." In discounting any risk of penalties on estimated property, the court makes a distinction that Delaware likely does not. That is, the Delaware Audit Manager likely meant the term "identified" to refer to any property, whether actually identified or estimated to have existed "as a result of the examination." The court's distinction opens to debate whether penalties imposed on estimated liability are legally viable.

What the Court's Decision Means

While the experience of the holder community confirms that Plains' fears concerning the audit were not mere speculation, the court dismissed Plains' complaint for lack of ripeness because Plains had not yet been subjected to the objectionable conduct. But Plains' loss resulted only because the claim was brought too early—not because the state was right as to its authority. The court did not compel compliance with the state's requests or order Plains to submit to the audit generally. Instead, it laid out a procedural road map for challenges to unclaimed property audits—holders not only can, but must wait for the state to take actual steps to enforce the audit, by, for example, issuing and seeking to enforce a subpoena. Whether the state has such authority, however, was not addressed by the court and remains questionable. That issue is currently being litigated both in the Delaware Court of Chancery and in federal district court.

In particular, the Delaware Department of Finance is now on notice that it has no power to force holders to comply with audits and indeed has admitted before a federal judge that compliance is purely voluntary. While it certainly can continue to initiate audits and request information, to the extent it seeks to compel the provision of such information, it must have statutory authority both to issue a subpoena duces tecum and to enforce it in court. Even if it has such authority or obtains it through new legislation, however, the Fourth Amendment requires that a government subpoena be within the agency's authority to enforce Delaware's unclaimed property statute, and be reasonably relevant to that authority. Thus, perhaps the state will take more care in defining the scope of audits and crafting their requests, knowing it could be forced to defend its actions in court. The Plains case and other recent lawsuits may cause the state to take a second look at its policies concerning confidentiality, and/or be more amenable to compromise on audit requests where holders push back. On the other hand, holders would be well-advised to consider what a reasonable alternative to objectionable requests might look like under the law, and make concessions or compromises in order to avoid public litigation.

It may be too early to tell how the decision will practically affect audits, and other lawsuits pending against the state will certainly provide additional guidance.

Footnotes

1. The case is Plains All American Pipeline, L.P., v. Cook, et al., Civ. Action No. 15-468-RGA (D. Del. August 17, 2016), and the decision can be accessed here: http://www.reedsmith.com/files/uploads/alert-attachments/2016/DelawareDistrictCourt.pdf

2. This assumes, of course, that the defendants have the statutory authority to issue a subpoena for the production of records and enforce such a subpoena, an issue currently being litigated in other lawsuits pending both in the Delaware Court of Chancery and the federal district court in Delaware.

3. The court dismissed the claims against Kelmar, finding that Kelmar had no authority to enforce the audit on behalf of the states. Id. at 7-8.

4. See Temple-Inland, Inc. v. Cook, 2016 WL 3536710 (D. Del. June 28, 2016).

5. Reed Smith recently detailed these concerns in a brief it filed on behalf of the Unclaimed Property Professionals Organization with the Supreme Court of the United States on August 1, 2016. That brief can be accessed here: http://www.reedsmith.com/files/uploads/alert-attachments/2016/22O145_OriginalUnclaimedPropertyProfessionalsOrganization.pdf

6. Plains All American, No. 15-468-RGA, at 11-12 (internal citations omitted).

7. Id. at 15.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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