CBA Publications >> CBA Regulatory Compliance Bulletin >> Vol 2001 No. 17, December 5, 2001

Vol 2001 No. 17, December 5, 2001

State Controller Clarifies Escheat Issues

This Bulletin was written for CBA by Ted Kitada, VP/Senior Counsel at Wells Fargo and the chair of the CBA Escheat Task Force. James Clark, VP of State Government Relations, was the liaison with the Controller's Office for the Task Force.

Two years ago, the California Bankers Association established the CBA Escheat Task Force to foster good will and understanding between the California Controller's Office and the banking industry about compliance with California's Unclaimed Property Law (the "UPL"). To further that objective, the Task Force submitted certain questions to the controller involving issues that were unclear under the UPL to the industry. The Task Force also submitted with those questions proposed answers that it believed to be correct. (See attachment for the Task Force's proposed questions and answers).

In response to these questions and answers, the controller provided a response through the State Controller's Legal Office. The purpose of this article is to evaluate those responses.

Question: If a financial institution decides to increase the monthly fees on an account and sends a change-in-terms notice to its customer, is the notice effective for escheat purposes if it is returned unopened by the Post Office?

Controller's response: We would agree that if the notice is undelivered due to an error by the financial institution, the notice is ineffective for escheat purposes. However, whether the notice is deemed effective when it is undelivered because of actions of the account owner or when other methods of notice are used would depend on whether the notice was given pursuant to a valid, enforceable contract or a statute other than the Unclaimed Property Act.

Analysis: The industry effects account fee increases and other changes in terms of the deposit agreement through notices sent to customers, normally by mail. From time to time these notices are returned to the bank due to an undeliverable customer's address. The controller previously has taken the position that fee increases against, or other changes in terms to, inactive accounts may not be effected if notices are returned undeliverable, even if the customer has failed to advise the bank of a change in mailing address (and the customer is obligated to do so under the deposit agreement). The controller's response appears to suggest that an undelivered notice is effective so long as the customer has a contractual obligation to advise the bank of a change in mailing address.

Question: If a depositor asks the institution to hold all statements and notices at his or her branch of account, and agrees to be bound by those notices whether or not (s)he picks them up, are the notices effective?

Controller's response: We concur with the proposed answer from the Bankers Association that it would depend on whether the depositor's agreement is a valid, enforceable contract under state law.

Analysis: The bank may be directed by the customer to hold statements and notices at the branch of account. The controller's response would suggest that notices held at the branch are effective even if the customer fails to pick them up, so long as they are provided under the deposit agreement.

Questions: If an account is pledged as collateral to the depository institution as security for a loan by the institution, who is considered the "owner" of the account for purposes of Code of Civil Procedure §1513?

What if the account is pledged to a third party? May the institution consider the circumstances of the pledge in determining whether the account is active?

Controller's response: We disagree with the Bankers Association's response to both of these questions. In both cases, the depositor is the owner of the funds unless (s)he fails to perform under the contract. The interests of the institution or third party are contingent and arise, if at all, only upon the failure of the depositor to perform in accordance with the agreement. The institution or third party would not appear to be an owner within the meaning of CCP 1518 unless it could be established that the depositor did not perform pursuant to the agreement.

The funds deposited are used as security for the performance of the depositor under the contract. Implicit in such an agreement is the understanding that once the depositor has performed his or her obligations, the deposit will be released. Pursuant to the expressed language of CCP 1518, the dormancy period begins to run on the date the funds become distributable or payable. Thus, the accounts pledged as collateral and held by the financial institutions become payable and distributable when the depositor has paid the loan or performed under the contract with the third party.

Analysis: The Task Force takes the position that when a customer pledges an account in its favor as borrower or guarantor, the bank obtains a perfected security interest in the account. So long as the bank maintains its security interest in the account, the account is considered active. In addition to the customer, the bank is the owner of the account. In the case of a third party having a security interest in the account under a control agreement, in addition to the customer, that third party is the owner for purposes of the UPL. So long as the customer or third party maintains a continuous relationship with the bank, the pledged account remains active.

The controller's response to the Task Force's position is troubling in the case where the lender is the customer's bank. In that case, the controller takes the position that the customer is solely the owner of the account. Thus, in the event the bank is unable to contact the borrower or guarantor customer, the bank must nevertheless escheat an inactive pledged account, even if the loan or guaranty obligation remains outstanding. The customer may claim the account from the controller under CCP §1540 free and clear of the lien of the bank (because the bank no longer has possession of the account). While the loan or guaranty obligation remains outstanding, that obligation is now unsecured.

In the case of a third party having a security interest in the account, the controller's response is also troubling. Her analysis would mean that a communication from the secured party would not constitute a contact for purposes of the UPL. If the customer (the owner in the controller's view) fails to maintain contact with the bank for a three-year period, the account becomes subject to escheat. Presumably, the UPL trumps the control agreement (governing the account) among the customer, the secured party, and the bank. In the event of demand for the account by the secured party subsequent to escheat, the bank would refer the party to the controller to recover the account, unless the customer has claimed it first! Indeed, in the event the secured party presses a claim against the bank, the bank can tender the claim to Attorney General for defense.

Question: Do blocked accounts escheat to the Controller if the owner fails to perform any of the activities described in CCP §1513 (i.e., conduct a transaction, correspond in writing, or otherwise indicate an interest in the account)?

Controller's response: We concur with the proposed answers from the Bankers Association. The funds in a blocked account under a court order are assets held in trust for the potential beneficiaries of an estate. Once an order of the court is issued distributing the assets of the estate, the funds become payable and distributable within the meaning of CCP 1518 and the court would no longer retain jurisdiction over the blocked account. Therefore, the dormancy period would begin to run. However, if the dormancy period has expired prior to the funds being put into the blocked account, then a court order is required for the funds to escheat to the State.

Analysis: The controller has agreed with the Task Force. The three-year escheat period commences from the date that the funds in a blocked account become payable or distributable. For example, if a bank maintains a blocked account for the benefit of a minor until that minor reaches the age of majority, the three-year period commences to run when the minor reaches 18 years of age. This analysis is especially helpful because some court orders expressly prohibit the bank from escheating blocked accounts.

Question: How should a bank treat funds that must be held in an account pursuant to state or federal law (e.g., funds deposited for the benefit of the state, in lieu of a bond to secure the depositor's performance)? In many cases, the depositor is not allowed to withdraw the funds, and a government agency is listed as the accountholder or the payee.

Controller's response: We disagree with the Bankers Association's response. The funds deposited are held in trust to secure the performance of the depositor. Implicit is the understanding that once the depositor has performed his or her obligations, the deposit will be released. Pursuant to the expressed language of CCP 1518, the dormancy period begins to run on the date the funds become distributable or payable. With respect to the accounts held in trust, an account is not distributable or payable until the governmental agency no longer has an interest in the account.

Analysis: The controller takes the position that the three-year escheat period commences to run when the state agency, e.g., the State Board of Equalization, no longer has an interest in the account. Contending that in-lieu accounts are fiduciary or trust accounts, the controller concludes that the three-year period commences to run after the account becomes payable or distributable. The account becomes payable or distributable when the government agency ceases to have an interest in the account. The controller's analysis would appear to be inconsistent with her analysis of pledged accounts. While the controller maintains that the owner of pledged accounts continues to be the customer, she seems to suggest that the owner of in-lieu accounts is the government agency, because it is the government agency's conduct that determines the running of the three-year escheat period. Further, her analysis would require the bank to monitor carefully the status of the customer's obligation under the account. If the bank inadvertently escheats an in-lieu account due to inactivity, the bank may have liability to the government agency if the customer's obligation to the agency has not been discharged. In addition, upon escheat, the customer could claim the account from the controller and leave the bank with the liability to the government agency under the previously escheated account.

Question: If a banking or financial organization issues a cashier's check, regardless of its purpose, does the cashier's check escheat to the State as provided in CCP §1513(d)?

Controller's response: We concur with the proposed answer from the Bankers Association.

Analysis: This response is an important change in the controller's policy. In many instances, notwithstanding the five-year escheat period prescribed under CCP §1513(d), the controller had taken the position that the purpose or source of a cashier's check issued by a bank determines the applicable escheat period. For example, if a bank issued a cashier's check to pay interest on an interest-bearing account, according to the controller, the applicable escheat period would be three years, not five years. Since the source of the funds was an account, the escheat period applicable to accounts would govern. With her response, the controller now subjects all cashier's checks to a five-year escheat period regardless of the checks' purpose.

Question: May a banking or financial organization assess an early withdrawal penalty to a time deposit withdrawn prior to maturity due to the funds escheating to the State of California?

Controller's response: We disagree with the proposed answer. It has been the position of this office for some time that when time deposits are forced to be withdrawn before
their maturity date because the funds escheated to the State, the deposits are not subject to early withdrawal penalties.

Federal regulations provide that time deposits may be paid before maturity without imposing early withdrawal penalties. For example, early withdrawal of time deposits is not subject to withdrawal penalties upon the death of the owner or when the owner is declared legally incompetent. In addition, a time deposit is not subject early withdrawal penalties when the time deposit is withdrawn within ten days after a specified maturity date, even though the deposit contract provided for automatic renewal at the maturity date.

It would appear that penalties for early withdrawal are applicable only when the owner closes the time deposit account prior to maturity. When the depositor no longer controls the funds, as is the case when a depositor dies or is declared legally incompetent, the early withdrawal penalties do not apply. Similarly, when the owner abandons the property, it may be presumed that the owner no longer exercises control over the funds on deposit. Thus, when abandoned time deposits escheat to the State of California for safekeeping for the rightful owner, the funds would not be subject to early withdrawal penalties.

Analysis: Contrary to the position of the Task Force, the controller takes the position that a bank may not assess an early withdrawal penalty prior to escheating the time deposit.

Question: Under what terms and conditions, if any, may a banking or financial organization cease the payment of interest to an inactive savings account?

Controller's response: We concur with the introductory section of the proposed answer from the Bankers Association.
We also concur with subsection (a) of the association's proposed answer. Under a valid, enforceable contract with its depositors, a bank or financial institution could credit interest to savings accounts only at the close of a quarter and, upon closing of an account prior to the end of a quarter, does not credit interest for a portion of the quarter. Therefore, upon closing of an account prior to the end of a quarter, the institution or bank would not under the Unclaimed Property Law be obligated to report interest for a portion of the quarter. The SCO would have the same rights as the depositor. If the depositor would not receive interest for this period upon closing the account, then SC0 would have no greater rights to demand payment of interest.

We disagree with subsection (b) of the proposed answer. CCP 1513 requires any savings accounts "together with any interest" to escheat to the State when the account is inactive for more than three years. It is clear that the legislative intent was not only for an item to escheat, but also any interest that accrued to that item. Furthermore, this section states that no banking or financial organizations may "discontinue any interest or dividends" on any savings deposits, on any funds paid toward purchase of shares or other interest, or on any deposits, because of the inactivity contemplated by that section.

The interest is paid and payable by the holder because (s)he has possession and use of the funds. That was the parties' intent and purpose and it is not changed by the fact that the funds are reported to the State. If the owner claims the funds from the bank after they are reported to the State, but prior to their delivery to the State, the bank or financial institution would undoubtedly pay interest to the date of remittance to the owner. In like fashion, the bank should pay interest to the date of remittance to the SCO. Finally, since the State has a statutory right to collect interest that has escheated, the release or surrender of such a right without adequate consideration would constitute a gift of public funds in violation of Article XVI 6 of the California Constitution.

Analysis: The Task Force took the following positions:
A. Under Deposit Agreement.

Under the deposit agreement, as to savings accounts, when interest is paid calendar monthly, or quarterly, some banks do not pay accrued but unpaid interest if that account is closed prior to the end of a calendar month or quarter. The Task Force contends that if the delivery or remittance of a savings account to the controller under the UPL is prior to the ending of a calendar month or quarter, the bank is not required to pay interest to the ending of such calendar month or quarter, if the delivery or remittance is prior to such period. The controller agrees with that conclusion.

Under CCP §§1530 and 1532, funds are to be delivered or remitted to the controller contemporaneously with the report of unclaimed property submitted by the bank. The report is filed by November 1 annually. Generally, banks report as to escheatable property as of December 31 of the preceding year. The Task Force suggested that banks may cease payment of interest for a reasonable period of time between December 31 and November 1, provided that period did not exceed 30 days. The controller requires the payment of interest to the date of the delivery or remittance of funds.

In conclusion, while the controller's response may have surfaced more issues and questions than it answered, the Task Force is nevertheless pleased with what has been accomplished. Some key issues were surfaced and satisfactorily addressed in favor of the banking industry. For example, the controller appears to have yielded on the issue surrounding cashier's checks. She also appears to have resolved the issue with regard to the treatment of blocked accounts under the UPL. The Task Force anticipates having further discussions with the controller with regard to many of the issues raised above, and introducing new questions and answers shortly. If members of the CBA have specific questions or issues requiring exploration, you may contact Ted Kitada at 415/396-5461.

The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.