Unclaimed property reporting for LLCs under Texas v. New Jersey.

The rapid emergence of limited liability companies (LLCs) has indelibly changed the landscape of business organizations in the U.S. In 1991, only eight states had enacted LLC legislation. By 1996, all of the states and the District of Columbia had enacted such legislation. Due in large part to the allure of partnership or branch treatment for Federal income tax purposes, coupled with limited liability under state law, the number of LLCs in the U.S. has grown exponentially in the past several years. Moreover, LLCs are being put to increasingly diverse uses (e.g., joint ventures between corporations) in an expanding number of industries.

Coincident with the emergence of LLCs, unclaimed property (escheat) has risen to prominence in the field of state and local taxation. As state unclaimed property administrators continue to broaden their audit efforts to target more and more holders (or potential holders) of unclaimed property, LLCs and other noncorporate holders (such as limited partnerships) are beginning to discover that they are not immune from compliance requirements imposed by the escheat laws of 53 different jurisdictions (50 states, the District of Columbia, Guam and Puerto Rico).

While due process prevents more than one jurisdiction from escheating a given property item (Western Union Tel. Co. v. Pennsylvania, 368 US 71 (1961)), determining which jurisdiction should have the right to escheat is not a simple question when intangible property rights are involved. In Texas v. New Jersey, 379 US 674 (1965), the Supreme Court established two well-known priority rules for resolving conflicting state claims to unclaimed intangible property. Under the primary rule, property is subject to escheat by the state of the owner's last known address, as shown by the holder's books and records. Under the secondary rule, property for which there is no owner's last known address escheats to the holder's state of "corporate domicile" (state of incorporation). The secondary rule also applies when the state of the owner's last known address does not provide for escheat of the subject property.

In Pennsylvania v. New York, 407 US 206 (1972), and Delaware v. New York, 507 US 490 (1993), the Supreme Court reaffirmed Texas v. New Jersey's escheat priority rules in the face of vigorous state challenges. Delaware v. New York involved $360 million in unclaimed, owner-unknown securities distributions held by financial intermediaries incorporated mainly in Delaware, but with principal executive offices located primarily in New York. Delaware contended that it was entitled to escheat the unclaimed distributions under Texas v. New Jersey's secondary rule (i.e., the holders' state of incorporation). New York, in contrast, asserted that it was entitled to escheat the distributions as the state of the holders' principal executive offices. The Supreme Court agreed with Delaware, noting that "[t]he mere introduction of any factual controversy over the location of a debtor's principal executive orifices needlessly complicates an inquiry made irreducibly simple by Texas' adoption of a test based on the State of incorporation."

Although Texas v. New Jersey and its Supreme Court progeny involved corporate holders of unclaimed property, the secondary rule is often formulated more broadly to encompass all unclaimed property holders--corporate and noncorporate. For instance, the leading treatise on unclaimed property law states that, under the secondary rule, "the state of domicile of the holder is entitled to claim the property" (Unclaimed Property Law and Reporting Forms, [sections] 2.0514][a][i] (1999)). It is not at all dear, however, that Texas v. New Jersey was intended to establish such a broad rule applicable to all holders.

The Supreme Court's Texas v. New Jersey opinion uses the term "corporate domicile" solely in reference to the holder's state of incorporation, a choice of terminology some commentators have criticized as confusing and unnecessary:

When a domicil[e] is assigned to a corporation, it is always in the state of incorporation. No useful purpose ... is served by assigning a domicil[e] to a corporation. Most of the uses which the concept of domicil[e] serves for individuals ... are inapplicable to corporations, which do not, for example, vote, marry, become divorced, beget or bear children, or bequeath property ... Attribution of a domicil[e] to a corporation may lead to complications and confusion and should be avoided (Restatement, Second, Conflict of Laws (1988 Revision) [sections] 11, comment (1)).

Had the Supreme Court in Texas v. New Jersey eschewed the "corporate domicile" terminology in favor of "state of incorporation" (as it later did in Delaware v. New York), the opinion could scarcely be used to support a broad formulation of the secondary rule that encompasses any holder's state of "domicile" Indeed, to the extent the secondary rule of Texas v. New Jersey is extended to noncorporate holders (such as LLCs and limited partnerships) it seems the better approach would award the secondary right to escheat to the state of the holder's organization--without regard to any concept of "domicile." Such an approach would certainly be consistent with Texas v. New Jersey's overriding policy of ease of administration. Determining the state of organization of an LLC or a limited partnership is just as "irreducibly simple" as determining a corporation's state of incorporation.

Nonetheless, both the Uniform Unclaimed Property Act of 1981 (1981 Uniform Act) and the Uniform Unclaimed Property Act of 1995 (1995 Uniform Act) purport to follow Texas v. New Jersey by awarding the secondary right to escheat to the state in which the holder is a "domiciliary..... Domicile" is defined in both acts as the state of incorporation of a corporation and the state of the "principal place of business" of a holder that is not a corporation (e.g., an LLC or a limited partnership) (1981 Uniform Act, [sections] 1(6), and 1995 Uniform Act [sections] 1(4)).Thus, both Uniform Acts give rise to potential factual controversy as to the location of a noncorporate holder's principal place of business--the very sort of controversy the Supreme Court sought to avoid in Texas v. New Jersey.

The potential for such controversy exists in over 30 jurisdictions that have modeled their unclaimed property statutes (in whole or in part) on either the 1981 or 1995 Uniform Act. Further, even in the absence of a dispute as to the location of a noncorporate holder's principal place of business, there is also the potential for conflict with the remaining jurisdictions (which generally follow the Uniform Disposition of Unclaimed Property Act of 1954 or its 1966 revision or have enacted their own unique form of unclaimed property legislation). For instance, Delaware's Custodial Abandonment Law provides:

"Holder" means any person having possession, custody or control of the property of another person and includes ... every other legal entity incorporated or created under the laws of this State or doing business in this State (Del. Code tit. 12, [sections] 1198(6)).

Delaware's broad definition of "holder" would encompass, for example, an LLC organized ("created") in Delaware but with a principal place of business located in Montana, a state that follows the 1995 Uniform Act. If such an LLC holds an item of unclaimed property for which it does not have the owner's last known address, both Montana and Delaware could ostensibly claim the right to escheat the property under Texas v. New Jersey's secondary rule. Montana's claim would be based on its statutory provisions taken from the 1995 Uniform Act, while Delaware could claim the right to escheat the property under at least two theories. One theory would be that the LLC is domicried in Delaware (Texas v. New Jersey did not define the domicile of a noncorporate holder); the other theory would be that Texas v. New Jersey awards secondary right to escheat to the holder's state of organization without regard to any concept of domicile.

As indicated, this latter theory certainly seems more consistent with Texas v. New Jersey's policy of simplicity and ease of administration in resolving escheat disputes between the states; however, until the Supreme Court exercises its original jurisdiction to resolve a dispute involving an LLC or another noncorporate holder, such holders and their advisers will continue to face considerable uncertainty in interpreting and applying the secondary rule.

Karen J. Boucher, CPA 

Arthur Andersen LLP Milwaukee, WI

Robert A. Garvey, J.D. Christian M. Winther, J.D., LL.M.

Arthur Andersen LLP San Diego, CA