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6 Common Mistakes Impacting Unclaimed Property in M&A

By: Cathleen A. Bucholtz Matthew B. Chenowth |

The Current Environment

As more and more companies look to grow and expand, we’ll continue to see an increase in merger and acquisition (M&A) activity.  With larger and inherently more complex transactions being completed (e.g. Amazon’s acquisition of Whole foods, aka internet giant acquires brick and mortar grocer), effective and thorough due diligence is now more important than ever.

A target’s historical compliance with unclaimed property laws is important, but is often overlooked or given only a cursory review during  due diligence efforts.  Unfortunately, the failure to comply with unclaimed property laws can create a multi-million dollar liability for a company, which can be inadvertently acquired by a purchaser during a transaction.

Common Mistakes

Even the most experienced buyers may underestimate potential unclaimed property risk during M&A transactions.  Among the most common reasons a company may mistakenly acquire unclaimed property liabilities during an acquisition include:

  1. Buyer does not know how to properly identify unclaimed property
    • Sometimes the problem is simply not being aware of unclaimed property or that it can be acquired during standard M&A transactions. Other times, limited due diligence is performed because the parties do not know how to identify potential unclaimed property liabilities, or have the belief that they are “immaterial”.
  2. Belief that asset purchases protect against unclaimed property successor liability
    • While it is true that the acquisition of potential unclaimed property liabilities may be avoided if the buyer is only purchasing the assets (rather than the stock) of a target, sometimes unclaimed property liabilities can be lurking in the assets. One of the most common areas where potential unclaimed property may be acquired during an asset acquisition is Accounts Receivable, where the buyer inadvertently acquires credit balances along with the receivables.
  3. Poor record retention or accessibility of records
    • Large M&A transactions tend to make the news and unclaimed property auditors notice! Once the deal is complete the acquirer may find that the target had an inadequate record retention policy to defend an unclaimed property examination.  Even if records “exist”, they may be inaccessible due to antiquated technology or a change in service providers.  For most unclaimed property audits, the “scope” period is 10 report years, plus the applicable dormancy period (3-5 years).  As a result, most unclaimed property audits cover 15 years or more – much further than the typical records needed to defend a tax audit.  Unfortunately, if the records are inadequate an auditor often estimates the past-due unclaimed property liability.
  4. Knowledge lost from personnel elimination
    • Once of the biggest challenges most companies face when defending an unclaimed property audit on a recently acquired entity is that there is no one at the target with “corporate history”. Along with the lack of records outlined above, this lack of history can further hinder a company’s ability to defend an unclaimed property audit of a target entity.
  5. Prior assumption of liability in earlier acquisitions
    • Companies often unknowingly acquire potential unclaimed property liabilities from target entities, and when those companies in turn get acquired, the company acquiring the parent company can acquire all of their inadvertently acquired unclaimed property as well.
  6. Ignorance of potential impact of unclaimed property on deal purchase price
    • Oftentimes a target’s potential unclaimed property liabilities may not meet certain materiality thresholds given the size of the transaction. However, depending on the target’s industry and practices, the potential unclaimed property exposure could still significantly impact the value of the target.

Who Is Responsible?

There is an old saying that “when everyone is responsible, no one is responsible”.  That is especially true with unclaimed property when everyone is convinced that some other person or department is “handling it”.  To confirm that a thorough due diligence process is followed to properly assess potential unclaimed property risk, the due diligence team should ensure that specific areas of responsibility are clearly defined including upper management, counsel, accounting and other  key internal departments.

Do You Have a Due Diligence Checklist for Unclaimed Property?

In order to conduct an effective unclaimed property due diligence, an acquirer must request appropriate materials from the target for review.  Many of the items typically requested during standard M&A due diligence, like tax returns and organizational charts, may be useful as part of an unclaimed property review.  However, others items that may help determine a target’s potential unclaimed property, like unclaimed property reporting history or detailed bank records, are often not part of a standard due diligence document request.  Obtaining the proper information is critical to accurately assess, and document, any potential unclaimed property liability that may be transferred between the parties during a corporate transaction.  Request a sample due diligence unclaimed property checklist.

Conclusion

Given the increased attention that unclaimed property has been receiving from state unclaimed property administrators and third-party auditors, it is important to avoid any unnecessary mistakes during an M&A transaction.  One of the best ways to protect your company is to include unclaimed property as part of your due diligence process.  Doing so enables the acquirer to determine what unclaimed property liabilities  a target may have that could be transferred to the buyer during an acquisition.  In addition, understanding the extent of such liabilities could make the acquirer more knowledgeable when valuing the target.  Ultimately, conducting a thorough due diligence before the acquisition is finalized can result in significant time and cost savings for the acquiring company.  Sellers too should be aware of their own potential unclaimed property liabilities.  Addressing potential unclaimed property issues before putting themselves on the market may make for a more attractive target to investors.