Legal Matters

Escheat. The very word sounds sinister, and for good reason — direct marketers beware! But how do state escheat laws, which are often known as “abandoned property laws,” work? And what risk do they pose to multichannel merchants?

Defining ‘Unclaimed Property’
Let’s start with unclaimed property. This is a liability that a company owes to an individual or other business that has remained outstanding beyond a specified period of time. Every year, billions of dollars of economic entitlements go unclaimed, including obligations of retailers to their customers and suppliers. Depending on the particular state, these include:

• unredeemed gift certificates and gift cards;
• uncashed refund and rebate checks;
• uncashed checks payable to vendors or employees;
• stored value cards with remaining balances; and
• buyer rewards programs.

With gift card sales becoming increasingly attractive to both multichannel merchants and consumers, the economic implications of escheat laws are growing. Moreover, with heightened financial scrutiny resulting from the Sarbanes-Oxley Act, many accounting firms now require their clients to account for unclaimed property liability on financial statements.

The theory behind state escheat laws is this: Companies that owe money to their customers or suppliers don’t have the right to continue holding such funds, even if those sums go unclaimed by the parties that have a rightful claim to them. State governments maintain that they have two specific interests in such unclaimed property.

First, state abandoned property offices argue they’re in the best position to reunite unclaimed property with its rightful owner; we’re all familiar with the long lists periodically published in newspapers identifying people whose names are associated with property being held by the state treasurer or similar government official.

Second, government officials argue that if property belonging to members of the public remains unclaimed, the state is an appropriate proxy for the individual. Therefore, the state should be the beneficiary of any property rights that have been abandoned by its citizens.

Why States Care
In reality, state governments view unclaimed property as a major source of new revenue, enabling states to raise revenue without raising taxes. Consequently, what was once a seldom-enforced area of the law has spawned aggressive audits of catalog companies and electronic merchants.

And as the nation’s economy slides into recession and state coffers run dry, strict enforcement of escheat laws will be an increasingly attractive way for states to deal with their burgeoning budget deficits.

Moreover, to haul in as much money as possible, states hire private audit firms on a commission basis to identify and audit target companies. Typically receiving 10 percent to 15 percent of the amounts they collect, these bounty hunters frequently conduct audits on behalf of several states at the same time. The bill to direct marketers can be enormous, especially when interest and penalties are piled on.

How to Comply
Compliance with escheat laws isn’t easy. State laws vary considerably regarding the types of property that must be reported and the time period before retailers must turn unclaimed property over to state treasuries. The period of time that must pass before property is considered abandoned (the so-called “dormancy period”) ranges from one year to 10 years, depending on the state and type of property.

Pay attention to how state laws deal with issues such as gift card expiration dates. Many marketers mistakenly believe they can retain the unredeemed value of gift cards, sometimes referred to as “slippage” or “breakage.”

While some states exempt gift cards from their unclaimed property laws, these exemptions often aren’t available if expiration dates or service charges are imposed by merchants. Careful planning is required to minimize your exposure to unclaimed property liability with these programs.

Compliance is further complicated because it’s sometimes difficult to determine which state is entitled to the unclaimed property. It’s not uncommon for states to compete with each other for these unclaimed funds.

The U.S. Supreme Court tried to referee the battle among competing — did someone say greedy? — states more than 40 years ago, establishing the basic principles controlling which jurisdiction has priority over unclaimed property. In the case of Texas v. New Jersey, the Supreme Court ruled that first priority goes to the state of the rightful owner’s (e.g., customer’s) last known address as evidenced by the holder’s business records.

If a merchant issued a rebate check to a customer in California, for example, the value of the uncashed check would need to be reported to California.

If the rightful owner’s address is unknown, however, then the property belongs to the state where the company holding the property is incorporated. This may be Delaware, a state in which many companies choose to incorporate due to its liberal corporation laws.

Belated (But Safe) Disclosure
If your company’s not in compliance with escheat laws, most states have voluntary disclosure programs allowing merchants that haven’t made abandoned property reports to fully disclose amounts owed with a waiver of interest and penalties. These can be very substantial.

Voluntary disclosure agreements, however, are only available to companies that haven’t been audited or received a notice of audit. So if your business has unreported abandoned property, you’re at risk of being targeted for a state unclaimed property audit. You should get advice from a professional who can help quantify the risk. If the situation warrants action, that professional can help you negotiate voluntary disclosure agreements before states start sending you audit notices. «

George S. Isaacson is a senior partner with Brann & Isaacson. He represents multichannel merchants on tax matters and is tax counsel to the Direct Marketing Association (DMA). Reach him at gisaacson@brannlaw.com.