In a decision addressing issues of first impression concerning Delaware’s use of subpoenas to enforce unclaimed property laws, the Delaware Court of Chancery has quashed the state’s subpoena in its entirety, holding that enforcement of the subpoena would constitute an abuse of process.
The decision comes in the case of State of Delaware, Department of Finance v. AT&T Inc., No. 2019-0985-JTL (Del. Ct. Chancery) — an enforcement action related to Delaware’s long-running audit of AT&T, which separately has sparked federal constitutional litigation. While the decision itself is narrow, the case may have significant implications for Delaware-domiciled holders under audit, not only in terms of information that can and cannot be compelled, but also in terms of property that can and cannot be claimed by the state.
Background
In January 2012, the Delaware Department of Finance (“Department”) authorized the contingency-fee audit firm Kelmar Associates LLC to conduct an examination of AT&T and its affiliates. AT&T, which has filed annual reports in Delaware on behalf of itself and 33 affiliates since 1999, produced volumes of records in response to Kelmar’s requests.
While the audit was pending, the U.S. District Court for the District of Delaware decided Temple-Inland v. Cook, 192 F. Supp. 3d 527 (D. Del. 2016) — a watershed case in which certain of Delaware’s unclaimed property enforcement practices were found to shock the conscience and violate due process. In response, Delaware amended its unclaimed property laws in 2017. Among other things, the 2017 amendments authorized holders then under examination to convert to an expedited audit, and articulated a new statute of limitations.
AT&T converted to the expedited audit on Dec. 7, 2017. However, AT&T reserved its rights to challenge the audit process and to request modifications to the parties’ agreed work plan as the audit progressed. Consistent with that reservation of rights, AT&T declined to produce records in response to Kelmar’s rebates request and disbursements request. The rebates request sought an identification of all general ledger accounts used to track rebate accrual and expense activity, the period of time each account was so used and each third-party administrator used to issue such rebates. The disbursements request sought information on every check AT&T had issued from 27 accounts. Both requests sought records back to 1992. Citing AT&T’s failure to produce records in response to the rebates and disbursements requests, the state ultimately terminated AT&T from the expedited examination and issued an administrative subpoena for the requested records.
On Dec. 6, 2019, AT&T filed suit in federal court alleging that the state’s enforcement of unclaimed property laws violated the Fourth Amendment, due process, the ex post facto clause, the takings clause, and equal protection, and was void for vagueness and preempted by federal common law. See AT&T Capital Services, Inc., et al. v. Geisenberger, et al., C.A. No. 19-02238-MN (D. Del. Dec. 6, 2019). Three days later, the Department filed suit in the Delaware Court of Chancery to enforce the subpoena. AT&T responded with a motion to stay in favor of the federal court action, or in the alternative, to quash or modify the subpoena.
Delaware Court of Chancery Decision
As a threshold issue, the Chancery Court denied AT&T’s motion to stay in favor of the federal case. The court looked heavily to Univar, Inc. v. Geisenberger, 409 F. Supp. 3d 273, 281–82 (D. Del. 2019), in which several federal claims were dismissed as unripe because no decision had been rendered on the enforceability of the Department’s subpoena. Because enforceability of the subpoena could affect the constitutional issues raised in the federal litigation and AT&T had preserved its ability to litigate federal claims in federal court, the Chancery Court held that the issue of enforceability should be answered first.
The Chancery Court also rejected AT&T’s argument that AT&T affiliates needed to be joined for the action to proceed. The court reasoned, among other things, that AT&T could cause its affiliates to comply, the Delaware unclaimed property statutes (“Escheat Law”) authorized the examination of records in the possession of subsidiaries and affiliates of persons under examination, and AT&T had acted on behalf of itself and its affiliates by filing consolidated reports for 20 years and participating in the examination for nearly eight years.
On the procedural front, the Chancery Court outlined general “procedures that will lead to an expeditious resolution” of actions to enforce subpoenas under the Escheat Law. In this case, the Department had filed a complaint for enforcement, AT&T responded with a motion to quash, and the Department then insisted on a “final, appealable order.” The Chancery Court suggested that instead, a complaint should be followed by an answer and an accelerated case track that may include limited discovery and directives for the Department to provide justification for certain requests. However, because the Department here “eschewed the opportunity” to provide additional justifications or explanations, the Chancery Court considered the Department’s application for enforcement based solely on the allegations in the complaint. Similarly, the Chancery Court made it clear that it would not give AT&T an opportunity to raise additional fact-based objections, such as undue burden, and instead would consider only the “pleading-stage challenges” that AT&T advanced.
Turning to the merits, the Chancery Court first emphasized the Department’s broad power to issue subpoenas. So long as the Department has authority to issue the subpoena, then the scope of judicial review is limited to whether enforcement would constitute “an abuse of the court’s process.” As part of that evaluation, the Chancery Court found that Delaware law contemplates an inquiry into reasonableness, “albeit one that is deferential to the State Escheator.”
Against that standard, the Chancery Court found that although the six arguments advanced by AT&T fell short individually, they collectively “established that the Department issued an overly broad and unreasonable subpoena such that to enforce it would abuse the court’s process.” First, the Chancery Court rejected as semantics AT&T’s argument that the Department sought records for the improper purpose of identifying unclaimed property, as opposed to the proper purpose of determining AT&T’s compliance with the Escheat Law: “The process of examining a party’s compliance with the Escheat Law necessarily involves determining whether that party has unclaimed property in its custody that should be escheated to the State of Delaware.” That the Department’s enforcement complaint did not contain an allegation of relevance was not fatal to enforcement. However, where the Department serves “a wide-ranging request” and “valid concerns” are raised in response, then “some form of explanation or justification may be warranted.”
Second, the Chancery Court found that “[t]he statute of limitations thus does not operate as a bright-line rule that leads to a finding that a subpoena is unauthorized if the agency seeks records that are outside the limitations period,” but recognized that “[t]he extent to which an information request goes beyond the statute of limitations thus becomes part of the inquiry into whether it would represent an abuse of the court’s process to enforce a subpoena ….” In this case, the statute of limitations in place when the Department initiated its examination was tied to the filing of annual reports. If the holder had filed a report, then the state could recover property only if the state issued a notice of deficiency within three years after filing, or six years in certain circumstances. If no report was filed or if a report was filed fraudulently, then no statute of limitations applied. Under the 2017 amendments, the statute of limitations is 10 years after the duty to report arose, provided, however, that a notice of examination tolls the limitations period.
Because AT&T had filed annual reports in Delaware since 1999 and Delaware never issued a notice of deficiency, AT&T argued that the statute of limitations had run for its reports filed through 2013. Thus, because checks are subject to a five-year dormancy period, AT&T argued that the state could not recover for checks issued before 2008. The Department, which sought records back to 1992, responded only that the new statute of limitations should apply. The Chancery Court disagreed with the state’s assertion that the new statute of limitations applied retroactively. “It thus appears correct that there are reports covering years for which the Old Statute of Limitations would bar the State Escheator from seeking to recover escheatable property. But AT&T’s bright-line argument that the statute of limitations bars the Department from investigating those years runs contrary to precedent.”
Third, the Chancery Court agreed with AT&T that Delaware cannot recover for checks issued to persons with last-known addresses in other states with applicable unclaimed property laws. The court found that this was “a defense to an enforcement action, not an investigation.” However, the court agreed that “the State Escheator acts at the outer limit of its auditing authority when it requests records involving that type of property.”
Similarly, the Chancery Court found that the Department’s request for “all checks issued,” regardless of whether those checks were voided, reissued and cashed, was expansive, but within the authority granted to the State Escheator. Notably, the Chancery Court made it clear that “AT&T only has the burden to produce records,” and “[t]he State Escheator has the burden to show that a check was improperly voided because it was unclaimed.”
Fifth, the Chancery Court found that the Department’s demand for AT&T to complete a Kelmar-created Excel chart detailing the years, accounts, and administrators of each of its rebate programs did not require AT&T to create new documents. The court viewed the request as essentially requiring AT&T to query a database to extract the requested information. Notably, the Chancery Court remarked that the state could have deposed AT&T to obtain the same information, and that AT&T had not raised any burden objections.
Lastly, the Chancery Court found that a combination of factors supported finding that enforcing the subpoena would constitute an abuse of the court’s process. Most significantly, the court found that the subpoena was expansive as to time period and subject matter, covering more than 16 years preceding the expiration of the statute of limitations, and seeking detailed information on checks that “are almost certainly non-escheatable.”
For these reasons, and noting recent concerns about the Escheat Law being used primarily as a source of revenue instead of as a vehicle for reuniting owners with property, the court quashed the subpoena in its entirety.
The Chancery Court noted that the Department could pursue an appeal or issue a new subpoena. The Department recently chose a third option and requested rehearing. AT&T lodged the Chancery Court decision in the federal action on July 23, and the federal court has set a teleconference for July 28, 2020.
Implications
While the Chancery Court’s decision is narrow on its face, the implications for holders may be significant. From a procedural standpoint, the decision reinforces that a holder who files first in federal court to preclude enforcement may be required to first litigate those issues in the less-holder-friendly state courts. In addition, the case outlines the process contemplated by the Chancery Court in an action to enforce an administrative subpoena, and highlights the importance of raising all objections — both fact-based and legal — in any motion to quash. Interestingly, the opinion several times remarked that the Department could seek information via deposition — a device not typically pursued in connection with the Escheat Law.
On substance, the case confirms that holders under audit before the 2017 amendments that historically filed Delaware reports can and should rely on the pre-2017 statute of limitations to cut off applicable periods of potential recovery and unreasonable requests for historical records. Similarly, the court further solidifies that requests for information concerning transactions tied to persons with known addresses outside Delaware may be objectionable, and that Delaware assessments based on such data likely are improper. Finally, the court made it clear that the state bears the burden of proving that voided checks are unclaimed and recoverable in audit. While the court arguably misunderstood the nature of the voided check inquiry — the state historically has sought to discern whether checks are unclaimed because they were improperly voided, as opposed to determining whether checks were improperly voided because they were unclaimed — the ultimate point on burden provides a welcome basis for objection by holders who face unreasonable requests to prove through line-item research that checks properly were voided or otherwise no longer are owed.
In short, while the Chancery Court no doubt remains deferential to the State Escheator, the decision provides ample basis for continued challenges, both at the investigation and concluding stages, by holders confronting unreasonable Delaware audit demands.