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October 31, 2011

Does your business issue gift cards or sell gift cards on behalf of another retailer or service provider? If so, a recent New Jersey case that has been appealed to the Third Circuit Court of Appeals may affect your business.

When you think of unclaimed property and escheatment, a bank or insurance company probably comes to mind as the type of business that would be concerned with tracking and reporting items of unclaimed property. However, although state unclaimed property laws were first established because of banks and insurance companies, they now have a much broader reach and are applicable to many types of businesses. As we discuss in this article, recent developments in the area of gift card escheatment and the information gathering and reporting requirements surrounding them have caused many in the retail industry to scratch their heads wondering, “What does this mean for my business?”

Background on Unclaimed Property

Unclaimed property (sometimes referred to as abandoned property) is property held by an entity such as a corporation, business association, financial institution or insurance company that is owned by another party and has not been claimed by the rightful owner within a certain period of time. Common types of unclaimed property include savings or checking accounts, uncashed payroll checks, uncashed vendor checks, stocks, traveler’s checks, refunds or credits, trust distributions, unredeemed money orders, insurance payments or refunds, life insurance policies, annuities, certificates of deposit, customer overpayments, utility security deposits, mineral royalty payments, contents of safe deposit boxes and gift certificates.

All 50 states (including D.C., Puerto Rico, the Virgin Islands and Guam) have unclaimed property laws. These laws require the company holding the unclaimed property to return the property (that is, “escheat” the property) to the state if a certain period of time has passed. The state holds the property until the rightful owner makes a claim. If this claim is never made, the property remains with the state. According to the National Association of Unclaimed Property Administrators, about $32.9 billion of unclaimed property is currently being held by state treasurers and other agencies for 117 million different owners.

The amount of time that must pass before the unclaimed property is required to be turned over to the state is referred to as the “dormancy period.” States all have different dormancy periods, and, even within a single state, different types of property will have different dormancy periods. Most dormancy periods range from 1 year to 15 years and begin on the date the item of unclaimed property first materializes. Already, you can see why keeping track of a company’s various items of unclaimed property and their dormancy periods, let alone managing the reporting and remittance of these items, is a painstaking process.

To complicate matters further, holders of unclaimed property are required to make an effort to locate the owner of an item of unclaimed property before remitting it to the state. This is referred to as the “due diligence” process. Most states require that a letter must be sent to the rightful owner as soon as the property becomes dormant but not less than a certain number of days (usually 60) prior to the filing of the unclaimed property report that would include the item. Some states are now allowing phone calls and emails in lieu of letters. Proper documentation of a company’s due diligence efforts must be maintained to avoid penalties in case an audit is performed.

Between identifying the items of unclaimed property, tracking the dormancy periods, undergoing the due diligence process and filing the report, the compliance efforts surrounding unclaimed property reporting, while fairly straightforward, are very time-consuming. What is not so straightforward is the determination of which state has proper claim to the property.

The rules governing which state has the right to claim a particular item of unclaimed property were established through a series of Supreme Court cases and have come to be known as the “escheat priority rules.” The first priority, called the “primary rule,” states that the property is escheated to the owner’s “last known address as shown by the debtor’s books and records.” If the owner’s address is unknown, or if the address is known but it is in a state that does not treat such property as escheatable, the second priority rule comes into play. The second priority rule, known as the “secondary rule,” requires that the property be turned over to the holder’s state of incorporation.

Gift Card Specifics

For many types of property, the application of the above rules is relatively straightforward. However, applying these rules to gift cards, or stored value cards, brings about a whole host of issues.

To begin with, the escheatment rules for gift cards are not consistent across the states. Some states escheat the full value of the gift card, some states escheat gift cards at less than 100 percent of the face value, some states qualify only certain types of gift cards as escheatable (e.g., preloaded bank cards, phone cards, etc.), and some states exempt gift cards from escheatment altogether. The dormancy period varies from state to state as well. However, as mentioned above, the real complexities lie in the area of which state escheats the unclaimed gift cards under the escheat priority rules. The primary rule requires escheatment to the state of the owner’s last known address. With gift cards, historically issued as gift certificates, many companies did not track this information. Thus, the secondary rule came into play, and if the holder was in a state that did not require escheatment of gift cards, the company was able to retain the funds.

Over the last few years, gift certificates have been replaced by gift cards, many of which are purchased with a credit card and/or sold online and shipped to the purchaser. Additionally, more and more companies are using a third-party company to manufacture the actual cards, deliver them to the purchaser and track the balances. In light of this, can holders continue to take the position that they don’t know the owners’ addresses? Further, do the states have the right to require that holders track this information, which would make the secondary rule entirely inapplicable?

A recent New Jersey case addresses these questions. During 2010, the state of New Jersey enacted legislation that has become controversial because of the enormous data gathering and reporting requirements it imposes on gift card issuers. L. 2010, c.25, also known as “Chapter 25,” is an amendment to N.J.’s unclaimed property law. This amendment was enacted on June 30, 2010, with an initial effective date of July 1, 2010. It broadened the definition of “property” for purposes of N.J.’s unclaimed property law to include stored value cards. It creates a two-year dormancy period for stored value cards and was written to apply retroactively. The value of the card, on the date it is presumed abandoned, is reportable to N.J.

In addition to the reporting requirements for gift cards, Chapter 25 imposes some burdensome data gathering and record retention requirements on the stored value card issuers. Under Chapter 25, issuers are required to collect the name and address of the purchaser and, at a minimum, a record of the purchaser’s zip code must be maintained.

Chapter 25 also contains what has come to be known as a “place of purchase” presumption:

If the issuer of a stored value card does not have the name and address of the purchaser or owner of the stored value card, the address of the owner or purchaser of the stored value card shall assume the address of the place where the stored value card was purchased or issued and shall be reported to New Jersey if the place of business where the stored value card was sold or issued is located in New Jersey.

American Express Prepaid Card Management Corporation, American Express Travel Related Services Company, the New Jersey Retail Merchants Association (NJRMA), and the New Jersey Food Council filed lawsuits in United States District Court challenging Chapter 25. The plaintiffs claimed that Chapter 25 violates certain provisions of the Constitution and is preempted by the federal Credit Card Accountability, Responsibility and Disclosure (CARD) Act (which requires that issuers honor gift cards for at least five years) and the priority rules established by the Supreme Court.

On November 13, 2010, the U.S. District Court of N.J. issued a preliminary injunction that enjoined N.J. from enforcing certain provisions of Chapter 25. Specifically, the Court enjoined the state from enforcing the “place of purchase” presumption and applying Chapter 25 retroactively against issuers of stored value cards with existing contracts that require the issuers to redeem the cards solely for merchandise or services, as opposed to cash.

In a Treasury announcement dated November 24, 2010, the state of N.J. acknowledged the preliminary injunction of the two items mentioned above and summarized the Chapter 25 address collection requirements that were not enjoined:

  • If in the normal course of its business, the issuer obtains the name and address of the purchaser or owner of any stored value card issued or sold in New Jersey, then the issuer shall continue to maintain that information.
  • If the issuer of a stored value card requires the registration of the card by the purchaser or owner before initial use, the name and address must be obtained at that time and maintained by the issuer.
  • Except as provided above, all other issuers are immediately required to, at a minimum, obtain and maintain the purchaser’s zip code provided an existing system/process is in place that has this capability. Any issuer of stored value cards who does not have a system/process capable of recording and maintaining the purchaser’s zip code will have until January 3, 2011 to install and implement a system that meets this requirement.

On December 7, 2010, the state filed an appeal with the Third Circuit Court of Appeals of the District Court’s preliminary injunction of the place of purchase presumption and the retroactive application of Chapter 25. Upon request, the District Court judge clarified that the zip code collection requirement was not enjoined as part of the Court’s decision to enjoin the place of purchase presumption. The plaintiffs appealed the District Court’s denial for preliminary injunction of the zip code collection requirement to the Third Circuit Court of Appeals. In addition, the plaintiffs asked the Third Circuit Court of Appeals to issue a preliminary injunction of the zip code requirement. The Third Circuit complied and, on February 8, 2011, issued an injunction preventing the enforcement of the zip code collection requirement until the appeals by both parties are heard. Prior to the Third Circuit’s injunction, the zip code collection requirement effective date had been extended to February 1, 2011.

Oral arguments were heard by the Third Circuit Court of Appeals on September 12, 2011. As of the date of this article, no decision has been issued.

Alvarez & Marsal Taxand Says:

What does all of this mean for companies that issue gift cards? If the zip code collection requirement of Chapter 25 is eventually upheld, the secondary rule and the place of purchase presumption become moot, since the primary rule will always come into play. However, what is the practical interpretation and application of Chapter 25?

It is a N.J. law. It has no effect in other states. Therefore, companies can choose to track only the name and address of N.J. purchasers and continue reporting under the secondary rule for all other gift card sales to the extent they do not have the address of the purchaser/owner. However, many are asking what ability, what right, does a state have to require a business to implement a data collection system? These issues will likely be addressed as the case moves forward. One thing is sure: there is little doubt that if the provisions of Chapter 25 are upheld by the courts, other states will soon follow with similar provisions. Retailers beware!

Author

Kelly Peele
Senior Director, Seattle
503-442-3625

Christy Vernor, Senior Director, contributed to this article.

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