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A look at Delaware’s statute recognizing first priority states’ exemptions under S.B. 13, part 1

Posted By Mark Watters, Thursday, June 22, 2017
Updated: Thursday, June 29, 2017

One of the key provisions of Delaware’s S.B. 13, 149th General Assembly (the 2017 revision of its unclaimed property act), is Del. Code Ann., tit. 11, §1141(b), honoring exemptions of all first priority jurisdictions.

 

Formerly, Delaware was known to take properties exempted by the first priority jurisdiction based upon its interpretation of the priority rules (discussed below). As a majority of business associations are incorporated or formed in Delaware, this was a significant frustration of purpose for many other jurisdictions’ exemptions and provided a sizable windfall to Delaware. 

 

The new Delaware statute now maintains the exemption of the state of first priority, a reversal of the former Delaware common law practice. All the same, is the new “broad brush” Delaware exemption as it appears, or will it be restricted in practice by the state escheator?

 

Priority Rules and Prior Delaware Application

Under Texas v. New Jersey, 379 U.S. 674 (1965), the U.S. Supreme Court settled competing claims to property, creating a set of priority rules between competing state claims to properties. Under those priorities, the state of the property owner’s last known address has first priority to take the property. The second priority, which applies if the state of first priority takes no claim to the property, fell to the state of the holder’s incorporation (and now, formation for unincorporated business associations). The third priority, which is less well defined and which is rarely applied, is essentially any state with an economic interest, such as the jurisdiction where the original obligation arose. 

 

Under these common law rules, Delaware has historically benefited by taking properties with no known owner and address, foreign properties (that had no “state” of last address) and properties that were not escheatable to the state of first priority for any reason.

 

Del. Code Ann., tit. 11, §1141(b) (S.B. 13, 149th General Assembly)

Under its new statute, it appears that this substantial source of Delaware’s historic unclaimed property has been proactively eliminated; properties, once exempt in the jurisdiction of first domicile but taken by Delaware, may no longer be escheatable in Delaware under Del. Code Ann., tit. 11, §1141(b):

 

(b) Property is not subject to custody of the State Escheator under subsection (a) of this section if the property is specifically exempt from custodial taking under the law of this State or the state of the last-known address of the owner.

 

Under previous application, other states’ exemptions were frustrated by requiring holders incorporated in Delaware to escheat properties under the second priority.

 

This new Delaware statute raises several complex issues of application and definition, which will be resolved over time through regulation, policy, and practical application:

  • What constitutes an “exemption”?
  • How should holders manage these exemptions?

This article seeks to create awareness of these questions for further discussion.

 

What constitutes an “exemption” under §1141(b)?

There is no statutory definition of “exemption” under S.B. 13, so initially state regulation, policy statements, and audit practice will provide parameters. Guidance is promptly needed, since many potential “exemptions” represent substantial and growing amounts on the records of holders and, thus, potential significant exposure.

 

The meaning of “exemption” should apply to any specifically-identified by that term in the law. Beyond the use in statutes and common law of that exact word, there are other statutory constructions that arguably act as exemptions, but are not so named or act as property value reductions only. These terms include:

  • Exceptions. Exceptions differ from exemptions primarily by how they arise. While an exemption recognizes that such properties would generally be escheatable, by affirmative statutory construction an exception is created by carving out that property type from the general statutory base. There are two types: Those created by definition restriction; and those created by statutes of application. The former will be found in statutes of definition, typically in that for “property”; the latter in statutes requiring general escheatment of a property type “except for” certain properties falling under a particular fact pattern or other condition. These differences are not important to our survey; each can be identified by the word “except” and its derivatives in the statutory or common laws proper;
  • Minimal value “exemptions.” Minimal value exemptions restrict the escheatment of properties exceeding a certain minimal value; 
  • Business sector exemptions. A few jurisdictions have exemptions based solely on the holder’s industrial sector, applicable to certain property types;
  • De facto exemption through superseding statutes. Federal and state laws, especially in the consumer protection, banking, insurance and commercial sectors, superseding unclaimed property law;
  • Deferral “exemptions,” where the holder need not report property until there is a clean break in overall relationship with the (typically business) owner; and
  • Reductions and deductions. These are reporting value adjustments recognizing and relieving duties and burdens imposed on holders. Typically, these are cost reimbursements, actual or computed, for the management of properties, particularly for performance of due diligence and preservation of properties and their maintenance on the books and records of the holder. These reductions and deductions may apply to both holders and state property administrators, the latter as compensation for property advertising and preservation. 

These are discussed in the context of Delaware’s statute below. 

 

Exceptions in state codes are clearly purposed to withdraw certain properties from escheatment in their jurisdictions just like exemptions. Unlike exemptions, these generally are not discretionary but mandatory. One would hope by application and intent exemptions and exceptions would receive equal treatment.

 

Partial exemptions. Several states provide a partial exemption, typically exempting minimal values of specific properties; higher property values are fully subject to escheatment. This issue is very hard to predict, as minimal values under the reporting threshold but having a single owner could be consolidated by Delaware to pass the threshold of such minimal values, and even if analyzed alone, might not rise to the level of “exemptions” under Delaware’s statute. 

 

Business sector exemptions. A few states create special exemptions for cooperatives, certain preferred business sectors, and similar holder groups. These exemptions are usually also limited to certain property types. By practical application these should be recognized as exemptions

 

De facto exemption through superseding statutes. There are many areas where federal and state laws supersede those for unclaimed property; many state laws are universal. These include life insurance, gift cards and certificates, commercial paper, and many others. Such statutory preemption should expect to be recognized. Common law (through litigation) recognizes other circumstances of preemption, such as U.S. savings bonds, although the case law may not be recognized until litigated in courts of local jurisdiction. 

 

Deferral “exemptions.” These are not true exemptions, but rather stay or delay escheatment until certain conditions are met, typically when the holder breaks connection with the owner. While these may be titled or described as “exemptions”, these are rightly deferrals, where the state of first priority delays (“defers”) reporting until after a break between the holder and owner. These properties may be subject to Delaware escheatment, especially considering the 10-year statute of limitations (Del. Code Ann. tit. 11, §1156(b)), and the closing door of opportunity; likewise, Delaware could honor the deferral and allow the jurisdiction of first priority to take when it is appropriate to do so.

 

Reductions and deductions. These are generally modest amounts to recompense the holder for costs associated with property management and reporting compliance. One might expect Delaware to honor such allowances of its sister states. However, there is no clear statutory requirement that it do so except through the statutory authority cited in this paper. This author is unaware of any instance where Delaware has historically pursued such allowances under the old law. 

 

Holders should be careful to recognize that any applied “exemption” does not extinguish its obligations to the property’s owner; rather, exemptions only relieve the holder from reporting and remitting the property to the appropriate jurisdiction. Obligations to the property’s owner are never relieved. 

 

The ultimate duty of all holders is to return property held to its rightful owner or report and remit it to the state. In addition, rolling such properties back into P&L may violate accounting standards that are beyond unclaimed property laws. Thus, other than the important consideration as to who should have the right to hold and have use of the property until redemption, there is no permanent value to its possession. 

 

Part 2

Part 2 of this article examines how holders should manage these exemptions.

 

About the Contributor

Mark Watters is technical director, unclaimed property, for DuCharme, McMillen & Associates Inc.

 

Disclaimer: Neither UPPO nor DMA, or any of their affiliated or related entities, by means of this summary, is rendering business, financial, legal, tax, reporting or compliance or other professional advice or services. This blog post is not a substitute for such professional advice.

Tags:  Compliance  Delaware  priority rules  unclaimed property 

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