Lawmakers and courts alike have proclaimed that unclaimed property laws are primarily designed to protect the owners of property. In theory the state serves as the "custodian" of unclaimed property and steps into the shoes of the owner until the owner comes forward and claims the property. Under a modern unclaimed property statute, the owner should never lose rights to the owner's property.1 Unfortunately, aggressive state unclaimed property laws and the quest for additional revenue sources often lead to a different result. One area in which unclaimed property policy and reality are colliding is the extent to which a state can limit the scope of recovery by an owner of the full value of the property without running afoul of federal or state takings clause provisions.2
A common issue that generates controversy is whether interest earned on unclaimed property belongs to the owner or the state. State courts have reached inconsistent and irreconcilable conclusions as to whether those earnings must be paid to an owner once the owner steps forward and claims the underlying property. This article discusses Sogg v. Zurz,3 which is a recent Ohio Supreme Court decision on that issue. We also analyze the logic of this recent decision, the cases that came before it, and the policy surrounding the issue.
Background: State Treatment of Income
Earned on Unclaimed Property
In Canel v. Topinka,4 the Illinois Supreme Court ruled that Illinois's practice of not returning dividends attributable to unsold shares of stock held by the state was improper.5 The court held that the dividends were private property and that under the Illinois Constitution's takings clause those dividends could not be kept by the state without just compensation to the owner.6
Similarly, in Suever v. Connell,7 a federal district court ruled that California could not keep interest accrued on unclaimed property when the property was under custodial possession by California. The court held that because California does not take title to unclaimed property, the state cannot use that property (or the interest generated) for its own benefit, without compensation to the owner.8 The court said:
While purporting to take property only as a custodian, the state appropriated to itself the use and value of that property. It is as if California claimed to be holding a tree in custody for its owner but insisted on pruning back and keeping all branches that grew in the interim. Because the principle itself at all times remained the property of private individuals and not the state, so too did the interest.9
Unfortunately, other courts have not limited states' ability to retain income earned on unclaimed property. In Smyth v. Carter,10 the Indiana Court of Appeals held that Indiana was not required to return accrued interest to owners. The court reasoned that Indiana's retention of the interest earned on property while in the state's possession was not an unconstitutional taking of property under the Indiana or U.S. constitutions. In so holding, the court focused on the "owner's failure to act," which the court apparently concluded was the real cause of any deprivation of property.11 Thus, the state was justified in keeping the interest because it was the owner's (in)action, not the state's, that resulted in any loss to the owner.
In Smolow v. Hafer,12 the Pennsylvania Supreme Court held that under Pennsylvania's unclaimed property law, an owner was not entitled to any interest that accrued while the owner's property was in the "custody of the state." In holding against the owner, the court reasoned that when property is transferred under unclaimed property law, the delivery of the property to the state treasurer does not constitute an unlawful governmental taking that mandates compensation, nor is the state liable for interest in the absence of a contract or statute.
Model Unclaimed Property Laws
The uniform acts are not silent on this issue. The 1981 Uniform Disposition of Unclaimed Property Act (1981 Act) provides that an owner is entitled to any amounts that accrue regarding the underlying property, which may include interest or issued dividends. Although some states follow the 1981 Act's treatment of income earned on unclaimed property, many states do not. In those states that do not permit owners to recover accrued interest or dividends, the amount is placed into the general fund or allocated toward some specific state program, never to be reunited with the true owner.13
Sogg v. Zurz — An Important, Recent Win for Owners
In Sogg v. Zurz,14 a class action lawsuit, the Ohio Supreme Court held that the state of Ohio was not entitled to retain interest generated from unclaimed funds in the state's custody. This Ohio decision is a significant holding in unclaimed property cases addressing whether a state has the right to keep interest and other earnings that accrue during custodial possession of unclaimed property.
Wilton Sogg filed a claim with the Ohio Division of Unclaimed Funds for the return of an insurance policy -- and dividends paid on that policy -- before the policy's deemed abandonment date. Sogg received a check from the division for $320.71, representing the total of the policy and the policy dividends. However, the $320.71 did not include interest earned after July 26, 1991. Ohio had amended Ohio Revised Code section 169.08(D) to provide that "interest is not payable to claimants of unclaimed funds held by the state.15
Sogg sued Ohio, claiming he was owed interest earned on his insurance policy. He successfully sought class certification as the representative for all classes of people who filed with or will file claims with the division. In his lawsuit, Sogg alleged that Ohio's law regarding the nonpayment of interest to owners was "unconstitutional and void because it denies the protection of the property owner's private property rights" afforded by the Ohio and U.S. constitutions.16
The trial court granted the plaintiff class's motion for summary judgment on the constitutional issue.17 The court of appeals reversed, holding the unclaimed property at issue was "abandoned property" and therefore the state's retention of the interest generated during the custodial possession of the property did not constitute a constitutional taking.18
The legal issue on appeal at the Ohio Supreme Court was whether section 169.08(D), which limited an owner's right to the accrued interest, violated the takings clause of the Ohio Constitution.19 In a necessary two-step analysis, the Ohio Supreme Court held that it did. First, the court determined that under the Ohio Unclaimed Funds Act (UFA) unclaimed property is not "abandoned." Second, the court determined that because the property was not abandoned, the retention of the interest earned on unclaimed property by the state violated the Ohio Constitution.
In a sharply worded decision, the court observed, as related to property rights generally, that section 169.08(D) was "breathtakingly bold and strikes at the core concept of private property because . . . the General Assembly severed the link between the owner of an asset and the income produced by the asset."20 The court noted that no provision of the UFA provided for the state's ownership of interest. Second, the court noted that in failing to return accrued interest, the state was unable to use any common law right to appropriate abandoned property because there was nothing in the UFA that treated unclaimed funds as abandoned, escheated, or forfeited.21
In overturning the court of appeals, the Ohio Supreme Court distinguished the UFA from the underlying law in other state court decisions that reached different conclusions.22 In those cases, the state court determined the particular state unclaimed property law at issue provided for a presumption of abandonment that resulted in an actual change in ownership in the unclaimed property, generally after a passage of time.23 The UFA did not contain such a provision. Therefore, the Ohio Supreme Court concluded that the General Assembly had not legislated that unclaimed funds are or can be "deemed abandoned property." Rather, as the parties stipulated, the unclaimed funds are "held in perpetuity for the benefit of the owners of the unclaimed property." Because the property never becomes property of the state, but rather is held by the state for the original owner, Ohio's use of and failure to return the interest is simply the use of private property of another.24
After concluding that the unclaimed property was not abandoned, but rather was "custodially" held for the benefit of the owners of the unclaimed property, the court had to decide whether the interest generated by those funds could be constitutionally retained by the state. The court cited the takings clause of the state constitution which provides:
Private property shall ever be held inviolate, but subservient to the public welfare. When taken in time of war or other public exigency, imperatively requiring its immediate seizure or for the purpose of making or repairing roads, which shall be open to the public, without charge, a compensation shall be made to the owner, in money, and in all other cases, where private property shall be taken for public use, a compensation therefore shall first be made in money, or first secured by a deposit of money; and such compensation shall be assessed by a jury, without deduction for benefits to any property of the owner.
Section 19, Article I, Ohio Constitution.
The court held that section 169.08(D) violated this section of the constitution. In balancing the importance of private property with the notion that it is subservient to the public good, the court concluded that although property is to be "subservient to the public good" in accordance with the constitution, "it shall never be held inviolate and shall not be taken for the public use without compensation." Ohio's use of and claim of ownership over interest earned on unclaimed property violated that fundamental premise.
Sogg Got It Right — Income Earned on Unclaimed Property
Belongs to Owners, Not States
The decision in Sogg, while based on an interpretation of a specific Ohio constitutional provision and a specific set of unclaimed property laws, is still an important decision.
In making its decision whether the Ohio law was unconstitutional, the Sogg court rightly chose to focus on the unclaimed property laws rather than on the action of the owner. The court was true to the text of the UFA, which was not drafted to punish an owner's inaction but rather to protect the owner from that inaction. When there is no transfer of title and ownership, there should not be any state claim of an ownership interest in the income from unclaimed property. When a state's possession is custodial, it is for the benefit of the owner. If the laws are for the benefit of the owner, there is no equity in, or sound policy for, denying the owner the right to accrued income.
In staying true to the text of the UFA and not being misled down the path whereby the inaction of the owners informed the decision, the Ohio court was able to not only come to the right result, but also provide a framework for future decisions. The court acknowledged a fundamental tenet of most states' unclaimed property law -- the custodial nature of the state's possession. The Sogg court was able to rely on the lack of any provision in the UFA referring to property as abandoned to conclude that ownership never passes to the state. However, any state that uses a custodial system, like that in Ohio, should arguably reach the same result as Sogg. Accrued interest and dividends belong to the true owner of the property regardless of who maintains the property in the owner's absence.
The cases holding that a state may keep income earned on unclaimed property while the state maintains custody improperly shift the focus from the purpose and principles of unclaimed property law to the acts or omissions of the owners. Those courts incorrectly adopted a notion of presumed negligence on the part of the owner to answer the prevailing constitutional question with swift brevity. By restricting the analysis to that limited and underdeveloped notion, those courts failed to consider a variety of factual situations in which negligence is not present or situations in which the income would have been earned on the property regardless of the custodial taking by the state.
A properly instituted policy through which unclaimed funds benefit the public is an appropriate state role. However, that policy must be carried out in accordance with the primary intent and purpose of the statutes and must remain aligned with the underlying principles in unclaimed property law. States do use and benefit from unclaimed property in ways that align with that policy -- namely use of funds that are truly never claimed. To expand the states' use and benefit to include property that is actually reclaimed by the true owners by using the very same laws designed to protect those owners calls into question the actual motivation for the states' "protective" unclaimed property laws.
Sogg raises several important questions. Will more courts recognize that some states' application of unclaimed property law is deviating from the laws' modern roots as a body of law aimed at protecting owners? Are courts sensing that unclaimed property laws are trending toward being implemented to raise revenue for cash-strapped states? Are owner-favorable decisions such as Sogg bound to proliferate if some states' increasingly aggressive stance toward unclaimed funds continues? Are all modern "custodial in nature" unclaimed property laws similarly susceptible to a state or federal takings clause challenge?
Whether states and state courts truly protect owners of unclaimed property has significant considerations beyond Sogg getting his interest. For example, to the extent that states have different laws and judicial precedent regarding an owner's right to receive the income from unclaimed funds accrued while in possession of the state, an owner rights will vary based on facts beyond the owner's control -- specifically, the state of incorporation of the holder. If a holder does not have a last known address for a lost owner, deemed abandoned property generally must be reported and paid to the holder's state of incorporation. Few, if any, owners know the state of incorporation of their banks, employers, or stores in which they shop, yet the owner's property interest could vary greatly based on just such an obscure fact. The issue also implicates state budgets. A judicial decision requiring a state to pay income earned on unclaimed property to the owner will likely be retroactive and will certainly upset the state budget and programs funded specifically by that income.
Finally, many holders have been suspicious for years now of some states' administration of unclaimed property laws -- viewing aggressive audit tactics and expansive interpretations of what constitutes unclaimed property as being merely a hidden tax on business and having only a tenuous relationship with the original intent of the statutes. If states insist on keeping the earnings from unclaimed property rather than return the earnings to the owner when the owner shows up, owners may become equally suspicious of the laws as well.
* * * * *
UPwords is a new column about unclaimed property from Sutherland Asbill & Brennan LLP's State and Local Tax Practice. This installment is by Diann L. Smith and Matthew P. Hedstrom. Smith is counsel and Hedstrom is an associate with Sutherland's State and Local Tax Practice.
1 Older statutes -- true "escheat" laws -- did vest actual ownership in the state and raise different issues. Modern unclaimed property statutes are generally custodial in nature. Statutes that are custodial in nature have the common feature that title to unclaimed property never passes to the state but rather remains with the owner until it is claimed. The state simply steps into the shoes of the owner until the owner claims the property.
2 The U.S. Constitution's takings clause prevents the legislature (and other government actors) from depriving private persons of vested property rights except for a "public use" and upon payment of "just compensation." Similarly, the Ohio Constitution's takings clause provides that when private property is taken for public use, owners must be provided just compensation. In the unclaimed property context, the inquiry first must focus on whether the property is "private" property or whether title has been transferred to the state.
3 Sogg v. Zurz, 905 N.E.2d 187 (Ohio 2009).
4 Canel v. Topinka, 818 N.E.2d 311 (Ill. 2004).
5 The Illinois Supreme Court has, at times, allowed the state to retain interest earned on unclaimed property. Recently, the Illinois Supreme Court found the owner was not entitled to the interest earned by the state on unclaimed funds. See Cwik v. Topinka, 2009 Ill. App. LEXIS 116 (Ill. App. Ct. Mar. 9, 2009). The court did acknowledge that in some circumstances -- such as when the owner proves that the property had been in an interest-bearing account before being reported to the state -- recovery of interest during the state's custodial period may be constitutionally required. The Illinois court appears to premise its holdings on whether the owner would have earned income on the property in the absence of the state's intervention.
6 Canel v. Topinka, 818 N.E.2d at 333.
7 Suever v. Connell, 2007 U.S. Dist. LEXIS 79265 (N.D. Cal. Oct. 12, 2007).
9 Id. at 20.
10 Smyth v. Carter, 845 N.E.2d 219 (Ind. Ct. Ap. Apr. 12 2006).
11 Id. at 220.
12 Smolow v. Hafer, 959 A.2d 298 (Pa. 2008).
13 See, e.g., N.C. Gen Stat. section 116B-64. (If property other than money is delivered to the state treasurer, the owner is entitled to receive from the treasurer "any income or gain realized or accruing on the property at or before liquidation or conversion of the property into money. If the property is interest bearing or pays dividends, the interest or dividends shall be paid until the date on which the amount of the deposits, accounts, or funds, or the shares must be remitted or delivered to the Treasurer . . . otherwise, when property is delivered or paid to the Treasurer, the Treasurer shall hold the property without liability for income or gain."); see also, Minn. Stat. section 345.45 (2008). ("When property is paid or delivered to the commissioner . . . the owner is not entitled to receive income or other increments accruing thereafter.")
14 Sogg v. Zurz, 905 N.E.2d 187 (Ohio 2009).
15 Ohio Rev. Code section 169.08(D) (2009).
16 The Ohio Supreme Court held that the Ohio statute regarding the nonpayment of interest to owners was unconstitutional in violation of the Ohio Constitution's takings clause and did not address the U.S. Constitution's takings clause.
17 Sogg v. White, 860 N.E.2d 163 (Ohio Ct. Com. Pl. 2006).
18 Sogg v. Dir., Ohio Dept. of Commerce, 2007 Ohio App. LEXIS 2829 (Ohio Ct. App. June 21, 2007).
19 The decision was based on the Ohio Constitution's takings clause, but the state constitutional provision had been interpreted to be consistent with the U.S. Constitution's takings clause. Moreover, the decision raises important policy considerations that will likely have to be addressed by other courts.
20 Sogg v. Zurz, 905 N.E.2d at 190.
22 See Smyth and Smolow, supra notes 10 and 12.
24 Sogg v. Zurz, 905 N.E.2d at 191.
END OF FOOTNOTES
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