For the second time in as many months, a federal appeals court has said federal law doesn’t pre-empt state government audits of unclaimed property issued by an out-of-state subsidiary of a Delaware corporation.
In a four-page non-precedential ruling, a three-judge panel of the U.S. Court of Appeals for the Third Circuit on Monday said state officials may assess whether stored-value card funds issued by Office Depot Inc.’s Virginia-based subsidiary belonged to the corporate parent and may be forfeited to Delaware’s state coffers.
The unanimous three-judge panel also held that Office Depot’s challenge to the scope of the audit was premature, because Delaware had not officially begun the enforcement process.
Office Depot had sued to shut down the audit, arguing it violated a trio of U.S. Supreme Court cases out of Texas, which established priority rules for disbursing abandoned or unclaimed property to competing states. Because the cards were held in Virginia, Delaware could have no escheatment claim to the funds, Office Depot said in court papers.
But Judge Cheryl Ann Krause of the U.S. Court of Appeals for the Third Circuit pointed to U.S. Supreme Court precedent that she said allowed the state to begin its review in order to determine which entity actually owned the abandoned property.
“The Supreme Court has observed that the first step in assessing a state’s right to escheat intangible personal property is ‘determin[ing] the precise debtor-creditor relationship as defined by the law that creates the property at issue,’ and Delaware may seek information that will assist it in making that determination,” she said.
While deeming the audit challenge premature, Krause did note that the company—and its Virginia-based subsidiary—would be able to restate its pre-emption claims should Delaware formally move to secure the property.
The result mimicked the Third Circuit’s precedential ruling last month in Marathon Petroleum v. Secretary of Finance for the State of Delaware, which reversed a lower court’s dismissal of that case based on escheatment priority and pre-emption rules.
In both cases, the Third Circuit clarified that Delaware’s ability to conduct an audit would not bar companies from filing suit once the state brings an enforcement action to recover the funds.
“An audit process that extends beyond a legitimate inquiry into whether a subsidiary company is bona fide may well trigger the priority rules,” Krause wrote on Monday. “Although no such argument is available where, as here, the state has not initiated an enforcement proceeding, it is possible that appellants will have a viable claim as to the scope of the audit at a future date.”
Delaware’s counsel, Steven S. Rosenthal of Loeb & Loeb in Washington, D.C., declined on Tuesday to comment on when Office Depot’s claims against the state could potentially mature, but he declared the ruling a clear win for his client.
“We got what we wanted,” Rosenthal said. “What we wanted all along was a dismissal of the complaint, and that’s what we got.”
Diane Green-Kelly, a partner with Reed Smith who represented Office Depot, said she was encouraged to see the Third Circuit affirm that private parties have standing to contest the state’s authority to conduct an audit and escheat abandoned property.
She added that the result “was expected, in light of the Marathon ruling,” and her clients’ claims would be ripe for another challenge once the state begins an official enforcement action or if it requests information beyond the narrow bounds of ts inquiry.
The case was captioned Office Depot v. Secretary of Finance for the State of Delaware.