California Trial Court Denies Summary Judgment On Securities Dormancy Trigger

Background

In October 2021, Investment Company Institute ("ICI") challenged the California Controller's interpretation of California Code of Civil Procedure § 1516 ("Section 1516"). Section 1516 relates to the presumption of abandonment for securities and provides that a security is presumed abandoned "if (1) the [security] is owned by a person who for more than three years has neither claimed a dividend [or similar payment]. . . nor corresponded in writing with the [holder] or otherwise indicated an interest as evidenced by a memorandum or other record on file with the [holder], and (2) the [holder] does not know the location of the owner at the end of the three-year period." Section 1516(b) (emphasis added). Separately, Section 1516(d) requires a holder to mail outreach notices (referred to as pre-escheat "due diligence") to owners six to twelve months before stock becomes escheatable to the state.

ICI challenged the California Controller's ruling letter (the "Ruling") which took the position that Section 1516(d) requires due diligence letters to be issued even where the holder had not received returned mail from the owner and further, that a lack of owner response to due diligence letters itself confirms that the holder did not "know the location of the owner" as that phrase is used in Section 1516(b) to trigger abandonment. In other words, under the Controller's Ruling, a failure to receive a returned due diligence letter satisfies prong (2) of Section 1516(b) such the securities need to be escheated.

ICI filed for summary judgment and on September 14, 2023, the Superior Court denied the motion. The court found that ICI's interpretation of Section 1516 was "incorrect and unsupported by the plain language of the statute." The court also rejected the Controller's motion for judgment on the pleadings on procedural grounds.

In response, ICI amended its complaint, seeking a declaration that Controller's interpretation of Section 1516, as set forth in the Ruling, was erroneous and for injunctive relief preventing the Controller from enforcing that interpretation. Thereafter, both parties filed cross-motions for summary judgment.

Summary of Arguments – Cross Motions for Summary Judgment

In its motion for summary judgment, ICI raised three main arguments supporting the position that the Controller's interpretation of Section 1516 is incorrect.

First, ICI argued that under the plain language of the statute, the Controller's interpretation incorrectly presumes abandonment of securities entirely based on a lack of owner activity. ICI suggested that the Controller's view effectively nullifies the second subsection of 1516(b), that the owner's location is unknown, as it requires due diligence even where there is no indication this prong has been triggered. It then uses the lack of a response to due diligence in order to satisfy that condition. ICI acknowledged that an owner's response to due diligence is confirmation that the owner's location is known; however, ICI refuted the idea that no response to due diligence establishes that the owner's location is no longer known.

Second, ICI argued that the Controller's interpretation is contrary to the legislative history of Section 1516. ICI argued that the Controller's interpretation of Section 1516(b) relies on the due diligence requirements in Section 1516(d). Since Section 1516(d) was adopted 24 years later than Section 1516(b), ICI suggested that it could not have been the intent of the legislature for the location of the owner requirement in subsection (2) of Section 1516(b) to be reliant on due diligence letters sent under Section 1516(d).

Third, ICI argued that the Controller's interpretation should be rejected under the canon of constitutional avoidance – the maxim that if there are two plausible interpretations of a statute, the one avoiding potential entanglement with constitutional principles is favored. Specifically, ICI argued that under the due process and takings clauses, the Controller's interpretation would run the risk of requiring escheatment of securities when there is no substantial ground for believing that an investor abandoned his securities. If there is no substantial ground present for the escheatment of the securities, then the Controller's interpretation could be found to be unconstitutional as violative of the owner's rights. In ICI's view, consistent with the canon of constitutional avoidance, these constitutional considerations must be taken into account in construing Section 1516.

In its cross-motion, the Controller relied principally upon the plain language of the statute. The Controller argued that Section 1516(d) requires a holder to send pre-escheat notices to owners six to twelve months in advance of the end of the three-year abandonment period, which runs even without reference to Section 1516(b)(2). The Controller posits that the notice is intended to confirm contact with the owner and allows the owner to provide updated address or contact information. The Controller argued that under a common sense reading of the statute, no response from these pre-escheat notices indicates that the holder does not know the location of the owner even if the notice is not returned as undeliverable. The Controller went further and argued that ICI's interpretation of the statute would render Section 1516(d) superfluous by eliminating the method by which holders can confirm knowledge of an owner's location. Lastly, the Controller argued that ICI interprets the statute too narrowly by saying that a holder knows the owner's location unless and until the Postal Service returns a notice as undeliverable. According to the Controller, returned mail is one way to identify that the holder does not know the location of the owner, but not the exclusive way to do so.

The Superior Court's Decision

On September 12, 2024, the Superior Court heard oral argument and denied both parties' motions for summary judgment.

(a) ICI's Motion for Summary Judgment was Denied

The Court denied ICI's summary judgment motion and request for declaratory judgment on the grounds that their request was vague and overly broad. Specifically, the Court found that ICI did not establish how a determination that the Controller's interpretation would provide "meaningful guidance that will permit the parties to conform their future behavior." The Court went on to find that ICI's request was broader than their First Amended Complaint in that the request did not specifically identify why the Ruling as a whole was erroneous. ; The pleadings define the scope of the issues in a motion for summary judgment; therefore, the Court also denied the motion on the grounds that the request was too broad and suggested that ICI should amend its complaint.

Lastly, the Court found that ICI requested a declaratory judgment finding that the Controller's ruling letter was erroneous, but that ICI only addressed a small part of the ruling letter. In other words, the Court held that it could not find that the Controller's interpretations in the ruling letter were erroneous because ICI did not address every interpretation made in the letter. Overall, the Court appeared to provide little or conflicting guidance as to how any pleading might present sufficient grounds for declaratory relief.

(b) The Controller's Motion for Summary Judgment was Denied

To win her motion for summary judgment, the Controller needed to establish that ICI's sought-after declaration is legally incorrect or that the undisputed facts do not support ICI's position. Ultimately, the Court denied the Controller's motion for the following reasons. First, the Court found that the Controller did not "sufficiently or directly confront the broad relief actually sought" through ICI's amended complaint. Second, the Court held that the Controller failed to establish that her interpretation was proper, or at the least, not completely erroneous. In supporting this finding, the Court acknowledged that, contrary to the Controller's position, the statute "does not state anywhere that if the owner fails to respond to the due diligence notice, then the business is 'deemed to not know the location of the owner'". As a result, the Court held that the

Controller did not meet her burden of proving that the ruling letter is not erroneous in its entirety.

Third, the Court found that the Azure and Vanacore cases relied on by the Controller, which contain dicta about Section 1516, are inapplicable and do not support the Controller's position. Lastly, in completing its order, the Court held that the Controller's position is not supported by the legislative history and that as a whole the Controller has not met her burden for summary judgment.

Trial has been set in this matter for December 17, 2024.

What's Next?

• The Court has found that it cannot grant summary judgment to either party with the current pleadings and factual record. This means that ICI will likely need to amend its complaint—again—and that the parties will need to go through another round of summary judgment briefing. There is no guarantee that the Court will be able to grant summary judgment on the amended complaint and updated record, and even if the Court issues a final decision construing Section 1516, that decision would only be binding on the parties and the losing party will likely appeal. This means that it may take several years for holders to receive final, binding guidance on the construction of Section 1516.
• By denying summary judgment to both parties, the Court has left intact the uncertainty regarding when a holder must escheat securities, and possibly even deepened that uncertainty by asking new questions about the meaning of Section 1516. This poses a practical dilemma for holders, who must decide whether to comply with the Controller's guidance (which the Court has now suggested is not necessarily correct) and face the risk of wrongful escheat claims or to disobey the Controller's guidance and face the risk of interest and penalties.
• Holders should consider consulting with counsel for assistance in navigating this complex situation. Different holders may face different considerations in how to best minimize their risk.

In-depth 2024-197