Escheat Due Diligence: The Value Of Staying Connected

By John Carney, Unclaimed Property Recovery and Reporting, Inc.

Recent developments have underscored the value of “staying connected” to shareholders in an attempt to prevent escheatment or preserve the immunity granted by states when a corporation or its transfer agent escheats securities to a state as unclaimed property.

Case law and state unclaimed property official mandates indicate businesses must not only insure that due diligence is performed but may have to take additional measures to perfect that process. The time and expense required to take these measures may cause businesses to consider alternate approaches.

THE DUE DILIGENCE REQUIREMENT

Most state unclaimed property laws include a requirement that the business holding unclaimed property (called the “holder”) make a last ditch attempt to contact the owner. Commonly, the requirement is that the holder send a letter to the “owner” at the last known address in the holder’s records. Usually the law requires that the letter include specific information, including how to contact the owner, and that the letter be sent within a specific period of time prior to the state’s reporting deadline. A few state laws require holders in certain industries to advertise the unclaimed items in a newspaper in an effort to contact the owner.

During the past few years, states have taken steps to insure that the due diligence requirements have been met and/or to insulate the state from liability to the owner if it is not. The result has been more burden and potential liability for holders. This heightened attention to due diligence was sparked by a lawsuit called, Taylor v. Westly, filed in a California federal district court.1 On

June 1, 2007, the District Court issued a preliminary injunction that prohibited the California Controller from accepting any unclaimed property (i.e., cash and securities) until such time that the Controller could devise a regulatory scheme that would afford owners adequate notice prior to the state taking their property. The District Court, echoing the Ninth Circuit stated, “It is clear……..under the presently existing scheme, California does not give constitutionally adequate notice before accepting or taking title to property, or selling, converting to cash, or destroying property under the UPL.” The plaintiffs had argued that their rights under the Due Process Clause of the US Constitution had been violated. 2

The preliminary injunction was dismissed on October 18, 2007 by the District Court after it reviewed information from the California Controller. The Controller detailed the changes made in state law in August (Senate Bill 86 - 2007) and the additional appropriations that now permit the Controller to make reasonable attempts to notify owners prior to property being reported and remitted. The main case is pending before the District Court.

In October, 2007 an official of the California Controller’s office testified before the California Senate Government Organization Committee indicating that there was a need to make businesses more compliant with the California Unclaimed Property Law (CUPL).3 Specifically, the official noted that the CUPL includes a provision that relieves the holder of liability upon the payment or delivery of the property to the Controller and that the Controller would like to change this provision so that only holders that have complied with the CUPL, particularly the due diligence provisions, would be relieved of liability with respect to the property.

On October 11, 2009, California Assembly Bill 1291 was signed into law by the California Governor. The operative language in the enacted legislation states:

“Any person who pays or delivers escheated to the Controller, under this chapter and who prior to escheat, if the person’s records contain an address for the apparent owner, which the holder’s records do not disclose to be inaccurate, has made reasonable efforts to notify the owner by mail or, if the owner has consented to electronic notice, electronically, in substantial compliance with Sections 1513.5, 1514, 1516 and 1520, that the owner’s property…… will escheat to the state, is relieved of all liability to the extent of the value of the property so paid or delivered…..” 4 (emphasis added).

(Note: Most state unclaimed property laws contain a “release of liability” provision similar to the California provision prior to the enactment of California Assembly Bill 1291.)

The revised California “release of liability” provision is somewhat consistent with a July 16, 2009 California Supreme Court decision, Azure v. I-Flow5. In that decision, the California court upheld an appellate court ruling that if a holder fails to perform the statutorily required due diligence on property that it has reported and remitted, the statutory release of liability provision does not apply to the holder.

In this case the plaintiff, Azure Limited, had purchased about 95,000 shares of IFlow Corporation stock in 1990. In 1993, Azure learned in 2003 that I-Flow had transferred its shares to the California Controller’s office as escheated property. Azure attempted to claim the stock from the state of California in October, 2003. At that time, State officials informed Azure that it might not be able to receive the stock but instead might receive the proceeds of the sale of the stock.

In November, 2004, Azure discovered that the state had sold the stock in June 2003 for $4.62 per share. Shares of Azure stock were selling for $17.72 per share at that time. Azure then sued IFlow claiming breach of fiduciary duty and noted I-Flow’s failure to follow the Califor nia due diligence requirement. The tr ial cour t ruled in favor of I-Flow’s claim that it had immunity from suit. IFlow’s claim was based upon a provision in the California statute that says that a business that deliver s securities to the Controller “shall be relieved from all liability of every kind to any per son… for any losses or damages resulting to that person by the issuance and delivery to the Controller ”6.

In its opinion, the California Supreme Court stated:

“Although section 1532, subdivision (d), does not specifically refer to the notice requirement of section 1516, subdivision (d), the UPL, as a whole, makes clear that the corporation must not actually deliver stock to the Controller without first complying with the notice requirements.

This means the stock is not actually escheatable until the notice requirements are satisfied. Indeed, the notice provision would be meaningless if corporations could ignore it and still receive immunity for their actions.” 7

I-Flow’s failure to perform the statutorily- required due diligence was key in the Court’s determination.

The California Supreme Court decision in Azure was issued after the California appellate court decision in a case called Vondjidis v. Hewlett Packard, 85 Cal.

Rptr. 3rd 806, (6th App. Dist., Nov. 25, 2008) in which the California appellate court stated that:

“The immunity provided to corporations by section 1532, subdivision (d) does not extend to a corporation that transfers property to the State even though it knows the location of the property owner.”8

In Vondjidis, the shareholder was an employee of Hewlett Packard (HP) that was on assignment in HP’s Athens, Greece office. Mr. Vondjidis purchased HP shares through the employee stock purchase plan and provided his Athen’s home address. It was HP’s policy to send dividend checks to office addresses for employees on overseas assignment and therefore, sent Vondjidis dividend checks to that address. In 1978, Vonjidis left HP employment leaving no new address upon termination even though HP policy stated that it was the employee’s responsibility to do so upon termination. Twice, HP sent a change of address form to him but the forms were never returned. Vondjidis’ dividend checks continued to be sent to the HP Athens office. For four years, he received the checks through this office but the checks were never cashed. Later, that office closed and Vondjidis had no more communication with HP and received no more dividend checks. In 1993, the dividends and shares were reported and remitted to the state of California. In 2001, Vondjidis became aware of the escheatment of his shares and sued Hewlett Packard in 2003, contending that HP knew his whereabouts and failed to perform due diligence. HP claimed that it was immune from suit under the California Unclaimed Property Law’s immunity provisions.

The question of immunity also was analyzed in a recent Delaware Supreme Court (DESC) case. The United States District Court (USDC) for the Southern District of New York requested that the DESC answer four questions relating to the Delaware Escheat Statute. The questions arose in a pending lawsuit in the Southern District of New York, called A.W. Financial Services v. Empire Resources, American Stock Transfer Company and Affiliated Computer Services, Inc.9 In this case, the plaintiff alleges that its shares were escheated to Delaware in violation of the Escheat Statute, breach of fiduciary duty, breach of contract and negligence.

One of the questions that the DESC was asked to answer is which immunity section of the DESC applies to the escheatment of securities; Section 1203 (a) or 1203 (b). On September 15, 2009, the DESC answered that only Section 1203 (b) applies to securities escheatment and that a defendant must assert this immunity as an affirmative defense and prove that it acted “in good faith” in delivering the securities to the state. The main case is pending before the USDC.

ANALYSIS

The cases mentioned above trend toward strict compliance with state due diligence requirements and emphasize a holder’s responsibility to maintain a connection with shareholders in order to avoid exposure.

Further evidence of the states’ renewed emphasis on due diligence is the new language on some states’ report cover sheets. The new language requires the business to attest that it has complied with the due diligence requirements of the pertinent state statute.

At least 12 states now include language like this on their report cover sheets. The Virgin Islands goes so far as to require the holder to file an affidavit stating that the holder has complied with the due diligence requirements of the law.10

The implication for issuers and transfer agents is that implementing or enhancing procedures designed to prevent escheatment may be the best answer for avoiding exposure due to alleged wrongful escheatment.

One such procedure would be quick follow-up contact with shareholders after one mailed item (i.e., dividend check, proxy statement, etc.) or one emailed item is returned as undeliverable. In some instances this follow-up may include database searches for a better address and a subsequent mailing, phone call or email. Following up soon after one returned item will most likely cause a greater number of “reconnections” with shareholders as the tracking trail will be shorter.

Waiting until the shareholder must be tracked due the SEC’s lost security holder 17Ad-17 regulation may make locating and reconnecting with the shareholder more difficult and less successful. Further, database searches for better addresses and/or the sharing of employee-shareholder address information between issuers and transfer agents may forestall situations like that of the Vondjidis case.

CONCLUSION

Staying connected with shareholders has a distinct value to issuers and transfer agents.

First, most state unclaimed property laws require due diligence for items that are not claimed or cashed and therefore, some attempt to reach out to “disconnected” shareholders must be performed to be compliant. Second, preventing shareholders from becoming “disconnected” saves time and money in annual unclaimed property reporting and “reconnection” may forestall exposure due to shareholder lawsuit.

Finally, providing evidence of enhanced attempts to stay connected may squelch liability by permitting the issuer/transfer agent to effectively assert immunity in a shareholder lawsuit.

Disclaimer: The information herein is provided for educational purposes only. UPRR is not liable for any penalties, damages or costs that are incurred by any individual or organization that relies upon the information provided. Readers are urged to contact their legal counsel to determine the complete details of statutory or regulatory requirements and/or the impact or applicability of court decision to them or their organization.

NOTES:

1. Taylor v. Westly, No. Civ. S-01-2407 WBS GCH (U.S.Dist. Ct. E. D. Cal. June 1, 2007). This decision was based on a decision and remand by the United States Court of Appeals for the Ninth Circuit.
2. Taylor v. Westly, No. Civ. S-01-2407 WBS GCH (U.S.Dist. Ct. E. D. Cal. June 1, 2007) at pg 7.
3. California Code of Civil Procedure, Section 1560 (a)
4. Ibid., in pertinent part and as amended by enacted California Assembly Bill 1291 (10/11/09).
5. Azure Limited v. I-Flow Corporation, California Supreme Court , Slip Opinion No. 164884 (July 16, 2009)
6. California Unclaimed Property Law, Section 1532 (d) in pertinent part.
7. Azure v. I-Flow at p. 9
8. Vonjidis v. Hewlett Packard at p. 11
9. A.W. Fin. Serv., S.A. V. Empire Res., Inc., 07 Civ. 8491 (SHS) (S.D.N.Y. 2008).
10. Virgin Islands Code, Title 28, Chapter 29, Section 658 paragraphs (e)(3) and (g), respectively.

Unclaimed Property Recovery, Inc. (UPRR) Shareholder Location:

For information about innovative, comprehensive services designed to locate and “reconnect” with shareholders, contact John Carney or Bob Irvine of Unclaimed Property Recovery and Reporting, Inc. at 212-971-3333, ext. 11 or 12

email: jcarney@uprrinc.com or birvine@uprrinc.com