|Business Credit Law and Regulations
Is your corporation setting itself up to an unwanted or unclaimed credit audit? State regulator are enforcing escheatment laws more than ever today to offset budget shortfalls brought on by tax cuts, diminished fee collections and additional expenses associated with combating terrorism. If your company is not aware of the states’ unclaimed property laws, or if they have largely ignored them hoping they would not get audited by the government - be aware as states are cracking down on enforcing escheatment laws today.
A corporation’s duty to remit abandoned property to appropriate state authority is governed by the abandoned and dormant property laws of each state. How does a state’s interest in abandoned property affect the credit professional? A credit professional often manages a portfolio of hundreds of commercial accounts, with credit extensions that can be in the millions of dollars. With an active trade relationship, it is not uncommon for the credit professional to have accounts with a surplus or credit balance. On occasion, the corporate customer may never claim the credit balance.
Are escheatment laws, or as commonly referred unclaimed property, a problem for the credit executive, especially where states are seeking untapped revenue sources to help offset budget deficits brought on by tax cuts and diminished fee collection? What is considered unclaimed property that may fall under the escheat laws? Does a credit balance qualify? What may be the consequence if the vendor declares the unclaimed property as income and applies it to the bottom line, as the vendor views it as a windfall to offset losses from unrelated delinquent accounts?
Why is escheatment appealing to the State?
Escheatment revenue is an appealing revenue source from the states’ view as it does not require raising taxes. States are looking for sources of revenue, and abandoned property, as the press reports, may be that untapped source for states. For example, states collected over $20 billion in 2005 in escheatable funds.
Escheatment includes all forms of property, both tangible and intangible, that becomes abandoned by its rightful owner. Common types of property are un-cashed checks, customer credit balances or refunds, security deposits, dividend check, corporate securities, insurance refunds or claims, and sometimes wages. Businesses and residents abandon over a billion dollars of tangible and intangible property annually. The purpose of escheatment laws is to reunite lost owners with property that is rightfully their. Escheatment laws also protect the holder of abandoned property from subsequent claims by the owner after the property is transferred to the state. They ensure that any economic windfall goes to the state and not to the holder of the property. Escheatment laws provide that the state becomes the legal owner of abandoned property, based on the concept of state sovereignty. Of interest to the state is those businesses that have failed to escheat or turnover abandoned property to the state.
Development of Escheatment Law
The origin of escheatment law dates back to British law. Escheatment was originally used to describe the permanent transfer of abandoned land to the King of England. In the United States, the concept has been adapted to apply to tangible and intangible personable assets; since we have no king the assets go to the state government.
Uniform Disposition of Unclaimed Property Act
With the growing popularity of state unclaimed property statutes as a new source of state revenue in the 1950's, uniformity of such laws became a necessity, as controversies between states over conflicting claims to property developed. For example, if a corporation abandons credits it has based on a trade relationship with a vendor, several states might attempt to claim custody. The credits could be covered under the law of the state where the company was incorp orated, or the state where the corporate headquarters was located. In addition, any state that was doing significant business with the corporation might claim the property.
In 1954, the Uniform Disposition of Unclaimed Property Act (the “Uniform Act”) was introduced to unify the state statutory scheme of escheatment. The Uniform Act was last amended in 1995. Under the Uniform Act of 1995, every company and banking institution must file annual unclaimed property report with the states and make a good-faith effort to find the owners of their dormant accounts. The Uniform Act attempts to prevent multiple state claims for property by designating the last known address of the owner as the basic test of jurisdiction. Thus, under the Uniform Act, if two states claim custody of the same property, the law of the state of the last known address of the owner governs. If property is abandoned, the state must establish its right to the property by proving that the property is located within its territorial limits.
In the case of real property, this is not difficult. However, because the states' escheat statutes also apply to intangible abandoned property, a state must establish that it has sufficient contacts with intangible property before escheat. Generally, if the property is considered to have a situs within the state, it is subject to escheat. The Uniform Act establishes a period for a presumption of abandonment for most types of property. For example, in California if the property is unclaimed for three years after it becomes payable or dispersible, the escheat laws apply. Presently, forty-two states (including California, New York, Texas, and Florida) and the District of Columbia have enacted some version of the Uniform Act.
Delaware receives a significant portion of escheated property, notwithstanding that its population is but 800,000. This is because a large percentage of corporations incorporate in Delaware and where the address of the owner can no longer be located under the escheat laws, a party forwards the abandoned property to the company’s state of incorporation.
Factors Causing the Recent Spike in Abandoned Property
The passage of Sarbanes-Oxley corporate reporting law, changes in the insurance business and other changes in corporate governance have dramatically increased the amount of “unclaimed property” money being collected by all 50 states, according to state treasurers.
The passage of Sarbanes-Oxley Act in 2002 forced companies to tighten their auditing processes. Section 302 of the Act requires CEO’s and CFO’s to certify the accuracy of the company’s financial statements filed with the SEC. The first step in improving financial reporting was Section 404 which requires that all companies perform an assessment of their internal controls. Adequate internal controls are a responsibility of company management. In addition, the company’s CPA must report on and attest to management’s assessment of the internal controls. Further, fines between $1 to $5 million and a prison sentence between 10 to 20 years are prescribed for non-compliance due to “sloppiness” or “willfulness” in Section 906 of the Act. Given the harsh punishment for noncompliance, more and more companies are tightening their auditing processes and starting to hand over more unclaimed money to the government.
Other factors are also contributing to the rise in the amount of money being collected by the government. According to Associated Press, Banks, for example, must transfer to state governments the money in any account whose owner has fallen out of touch with the institution for anywhere between three to five years, depending on the state.
A change in the insurance business is also a contributing factor. Today many mutual insurance companies have reorganized their structure and have become publicly traded companies. As a result, though many don’t realize it, policyholders have received billions of dollars in stock and cash from insurers’ initial public offerings.
In addition, some state treasurers express the fact that Americans are now more likely to mover from city to city resulting in them opening accounts but them forget them when they move.
How does a state enforce its escheatment law? Generally, through audits. Audits are usually handled by the state treasurer’s office or controller. The scope of the audit usually goes back several years. The auditors usually request the following: (1) chart of accounts; (2) general ledger/trial balance; (3) annual report; (4) journal entries; (5) bank reconciliations; and (6) accounting policies.
Business to Business Exception
Under the business-to-business exception, outstanding balances between vendors may be deemed a duplicate payment. Accordingly, under this exception there is no unclaimed property to turnover. Nine states recognize the exception: Illinois, Iowa, Kansas, Maryland, Massachusetts, North Carolina, Ohio, Virginia and Wisconsin. However, application of the exception has proven a problem. Under the ruling of Texas v. New Jersey, should one state not require unclaimed property be turned over, but another state does require turnover, the later state would control for turnover of the property. Thus, only those cases where both states do not require turnover is the credit professional free not to escheat.
Risks of Not Escheating
Most states require businesses to review their records to determine whether any property has been unclaimed for the dormancy period and to make an annual report. As an owner of unclaimed property a vendor has a legal responsibility to exercise appropriate due diligence to track abandoned property, take appropriate steps to locate its rightful owner and, assuming the owner cannot be located, report that property to the state in accordance with its reporting guidelines. The state escheat statutes have harsh provisions for parties that fail to timely report or turnover unclaimed property. In addition to interest that runs from period that the property should have been turned over, the state may assess fines, penalties and damages.
To avoid negative consequences of non-compliance, vendors need to maintain systems, controls, policies and procedures that adequately and effectively identify, age and separately account for escheatable and potentially escheatable property and report such property in a timely fashion.
Most businesses use spreadsheets to manage and track unclaimed property. This is not a bad method of management but it may become complicated down the line due to the countless items, processes and regulations that must be factored into the process of maintaining compliance with each state’s unclaimed property legislation. If a vendor does business in multiple states, the vendor may be required to file unclaimed property report and remit funds to more than one state. Unfortunately, each state has its own set of rules and unclaimed property legislation, making compliance even more challenging. California, for example, requires escheatment to the state after three years of abandonment.
As an alternative to keeping spreadsheets, there are numerous software products that are designed specially for managing unclaimed property. Many of these software products will automatically track dormancy periods and state reporting timeframes and will remind the user that a particular action is pending. Furthermore, businesses do not have to be concerned about changes in the legislation as these solutions are supported by organization that make considerable investment in remaining abreast of changing legislation and ensuring that those changes are incorporated into the next release of the software.
Note that if a business chooses to outsource escheatment related matters the business may still be fully responsible for the performance of the vendor complying with the law and responsible for avoiding conflicts of interest as well.
Steps to Protect Against Escheatment Claims
A credit executive should develop a game plan, and consider the following:
Step One: Determine the Situation
Has the company made any recent acquisitions that should be included?
Step Two: Determine Eligible Property
If this is an initial filing, what about years that may not be on the books?
Step Three: Perform the due diligence
Step Four: Prepare Reports and Remittances
Step Five: Filing Reports and Remittances
Step Six: Follow up…Reconcilement
Step Seven: Celebrate Credit professionals can also look to the following web sites for guidance:
Turning Over the Property
If the vendor decides to turnover the property to the state, most state statutes provide that the vendor should turn the property over to the State Controller. Most legislation requires the vendor to make reasonable efforts to notify the owner of the property by mail that the owner’s property will escheat to the state. The notice should be mailed generally not less than six months before the property is to be turned over to the State Controller.
Depending upon the nature, all unclaimed property should either be delivered to the State Treasurer or Controller. When the unclaimed property is cash, delivery is made to the State Treasury; all other types of personal property go to the Controller.
The party delivering the property is relieved and held harmless by the state from all claims regarding the property. No action or lawsuit may be maintained against the holder of the property.
Prior to delivery, the holder must furnish notice to the Controller.
At a minimum notice must include: The amount of cash, or nature or
description of other personal property; the name and last known address
of the person entitled to the property; and reference to a specific
statutory provision under which the property is being