By: Gary Joseph and Cornel Lupu
The inherent unclaimed property exposure risk associated with mergers and acquisitions (“M&A”) is nothing to ignore. Many companies have found themselves the unfortunate inheritors of past due unclaimed property obligations that were not accounted for throughout purchase negotiations.
The main M&A transactions are stock or asset acquisition. The acquired company may live on or merge into the acquiring entity. Each M&A transaction has its own manner in which unclaimed property liabilities can be inherited.
When companies acquire an entity in its entirety, the acquired entity’s assets and liabilities are wholly absorbed. With the absorption of the acquired entity comes inheritance of the entity’s historic obligations to payees – many of which may be unclaimed property. As the date of acquisition does not restart the dormancy period, the dormancy clock continues forward until the property is ultimately reported to the correct jurisdiction. Many companies unknowingly inherit unclaimed property exposure that they weren’t aware of due to the acquired entity’s practices.
Asset acquisitions occur more frequently than other M&A transaction types and impact is limited to a component or variable of an entity rather than an entire business. The terms of sale may provide for the transfer of historic liabilities between the entities. The acquiring entity may be liable for any unclaimed accounts receivable overpayments, unpaid royalties, unapplied deferrals or other liabilities owed.
Identifying and Mitigating the Risks
Pre-acquisition due diligence can help identify unclaimed property compliance risks. One of the items on the due-diligence checklist should include an evaluation of how unclaimed property compliance is governed by the company to be acquired. If you’ve already signed the purchase agreement and the deal is closed, it may not be too late.
Why is this so important?
- There may be hidden/unknown past due liabilities that are not evident by just reviewing the balance sheet. Liabilities may have been written off in prior years and may resurface during an unclaimed property audit.
- There could be an inventory of old outstanding checks and credits due to customers. Old liabilities could result in interest and penalties due to various states.
So how can you identify these potential risks?
- Review the unclaimed property reporting history of the entity you are acquiring. If there is no history or if it’s limited to one state or property type, there’s a strong chance of unclaimed property risks.
- Determine if there have been any prior unclaimed property audits. Past audits could indicate stronger compliance.
- Were any voluntary disclosure agreements filed and completed with any states? Past voluntary disclosures could also indicate stronger compliance efforts.
- Determine what unclaimed property policies and procedures were in place prior to and up to the time of acquisition.
- Review current outstanding checks and void check registers to identify checks outstanding greater than one year and patterns for voiding checks aged after a certain period outstanding.
- Review accounts receivable aged trial balances to see how credit balances are handled.
In order to effectively perform all of the above, it is crucial that these due diligence efforts be completed by individuals with knowledge of unclaimed property compliance. This way, accommodations can be proactively included within M&A agreements to protect the acquiring company and address potential unclaimed property risks before they become material issues.