Law & Regulation
By Jill M. Miller and Andrew T. Hayner
No, it’s not the CFPB’s proposed prepaid rules, at least not yet. Instead, issuers are increasingly grappling with a much older concern: state and federal escheat law.
Recent headlines related to gift cards, gift certificates, promotional cards, stored-value cards, and prepaid cards (collectively, “cards”) have been largely dominated by the recommended guidelines published Nov. 13 by the Consumer Financial Protection Bureau. While card-industry stakeholders certainly should pay attention to these new changes and their effect on cards, card issuers should not take their eyes off an older issue that only grows more pressing every day.
It’s the unclaimed-property laws and the laws governing expiration dates and fees. You may have thought nothing new could be said about this matter, but on a regular basis our office receives calls regarding the laws that govern card programs. With each new call comes a new set of unique characteristics.
Cards are a great way for both emerging and established businesses to build brand awareness and expand their customer base. But businesses wishing to issue cards should proceed with caution. Whether you have a single location or multiple locations or sell exclusively online, there are numerous legal issues that must be addressed both at the inception of the card program and while it’s in operation.
If you plan on issuing cards or currently issue cards, arguably the most important legal issue is, “Who gets to keep the unused balance on the card?” Typically, our response is, “It depends.”
According to various studies, the amount held in unused gift cards is in the billions of dollars. Issuers often implement dormancy periods and fees as a way of reducing the balance on cards. However, such dormancy periods and fees are often limited or banned entirely.
This issue is more salient now than it ever has been as cash-strapped state governments view escheat laws as a way to maintain funds in their coffers. As a result, state governments are actively enforcing their escheat laws.
Penalties for non-compliance can cost unsuspecting businesses hundreds of thousands of dollars. As if that weren’t bad enough, each state has its own escheat laws and some states’ laws contradict not only other states’ laws but also federal law.
This article seeks to educate business leaders on the escheat laws’ order of priority, which governs the treatment of unclaimed funds remaining on a card, so that businesses can maintain compliance with the appropriate laws as well as retain any balances that they are entitled to under the respective laws.
The Supreme Court of the United States has articulated a bright-line rule of priority for unclaimed intangible property (including the balances on cards). See Texas v. New Jersey (Texas), 379 U.S. 674 (1965); Pennsylvania v. New York, 407 U.S. 206 (1972); and Delaware v. New York, 507 U.S. 490 (1993).
In Texas, the Court introduced the bright-line rule, which says that the state in which the last-known address of the owner of the property is located has the primary right to take the property. However, if the issuer of the card has no record of the owner’s last-known address, or if the state in which the address is located does not provide for the escheat of the intangible property, then the state in which the card issuer is incorporated, organized, or formed may take the property.
To summarize, the primary rule is if an issuer of a card has in its records an address for the owner of a card, then that state’s escheat laws apply. The secondary rules are (1) if the issuer does not have an address for the owner of a card, then the applicable escheat law is that of the state in which the card-issuing entity is incorporated, organized, or formed, or (2) if the address used in the primary rule is in a state that does not require the balance on the cards to escheat to the state, then the applicable escheat law is that of the state in which the card-issuing entity is incorporated, organized, or formed, just like in (1).
Although the priority rules issued by the Supreme Court are federal common law and, as such, take precedence over state law, there are approximately 40 states that have instituted a tertiary rule of priority.
Under the tertiary rule, if the primary rule does not apply and the state in which the issuing entity is incorporated, organized, or formed does not require that such intangible property escheat to the state, then the intangible property would be governed by the escheat laws of the state in which the transaction took place.
It is unclear whether or not this tertiary rule is permissible, as it is likely pre-empted by the federal common law set forth by the Court in Texas. In Texas and its progeny, the overarching message from the Court was that it was enacting such rules to make the determination of which state escheat law to apply as simple as possible. It did not want a business that makes a good-faith effort to get into trouble for failing to comply with the appropriate state’s escheat law.
The tertiary rule complicates the priority rules (as demonstrated above) and defeats the Court’s overarching reasons for crafting the priority rules as it did.
As further support that the tertiary rules are pre-empted, the United States Court of Appeals, Third Circuit, stated in a case examining the priority rules, but not directly the tertiary rule, that “[t]he ability to escheat necessarily entails the ability not to escheat … [B]ecause companies might find the absence of state custodial escheat attractive, states may want to incentivize companies to incorporate in their jurisdiction by choosing not to escheat abandoned property.” 1
In other words, the advantages of an entity incorporating, organizing, or forming in a state that does not have escheat laws pertaining to its specific product would be nonexistent if the escheat laws of the state in which the transaction took place could essentially trump the decision of the state of incorporation, organization, or formation not to have the particular product escheat to the state.
Although there are strong reasons to believe that the tertiary rules are preempted by Texas and its progeny, the fact remains that laws are on the books for approximately 40 states that incorporate the tertiary rules. Before developing a card program, as well as during its duration, it is essential to review the state and federal laws to determine how the unused value on the cards will be managed. Ultimately, it is up to the card-issuing entity to determine its risk tolerance and how to proceed.
Awareness of this legal issue can help guide strategy and decision making for your successful implementation of a card program. By taking the time to understand these issues, discussing concerns with knowledgeable legal counsel, and designing the right approach and risk tolerance for your business, your business may be able to use cards to build brand awareness and expand your customer base.
These recommendations are general suggestions. They are not a substitute for specific legal advice. For specific information, consult experienced legal counsel.
Jill M. Miller is a partner, and Andrew T. Hayner is an associate, at Jaffe, Raitt, Heuer & Weiss, PC, Detroit. Reach Jill at 248-727-1623 or email@example.com and Andrew at 248-727-1633 or firstname.lastname@example.org.