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Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

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The State Taketh: The Story of Leftover Escrow Money

Comments (7)

My partner and co-conspirator at AsktheVC (Jason Mendelson) guest blogs tonight.

Unfortunately, I (Jason) get stuck being the shareholder representative in our merger deals where we can’t find someone else to do the job. (Someone should start a company – hmmm.) We had a deal that over a year ago distributed the escrow, but the escrow agent wasn’t able to find a dozen or so shareholders and today, we still have $500,000 or so in the account.

Every month, I get a statement from U.S. Bank saying “Hi, you have $500,000 in your account.” And every month, I ask myself “what can I do to bring this to a close?” I’ve done the obvious. I’ve gotten the shareholder list, tried some Internet searching, asked former company executives if they know any contact information, etc. Nothing. (As an aside, I don’t really have a duty to do this, but I figured it’s all good karma to try.)

So today, I ask our friends at U.S. Bank “what happens” if these folks are never located. Simple, she says: the state gets the money. (In this case, the state being California.)

Huh?

It seems that money left in escrows defaults to the state after some period of time. Here is a little source of revenue for the state that I was previously unaware of. I began to ask myself is there a way that lawyers can better draft a merger agreement; i.e. all money left over in the account is distributed pro-ratably to shareholders who are locatable. Answer: no.

CA state law says that you must treat all shareholders equally. If you give one set of shareholders the consideration earmarked for other shareholders, you breach this covenant. Even is Delaware if the choice of law, or the companies involved are located outside of CA, it still may be possible for CA to go after you if the shareholder who doesn’t get paid is a resident of CA. You can, however remit the cash or stock back to the acquiring company if you so choose to do so. Um, yeah, thanks.

So, the bottom line is that the state has found a hidden revenue source and is using corporate law as a shield to support its position. I love it.

This example is relevant for California.  We haven’t done an exhaustive analysis of other states, but we will just for our perverse curiosity.

  • Dan G

    Why don’t you put a list of names here so that if anyone here knows them or if they Google themselves, you’ll find them…

  • http://residualist.com/ John

    I am guessing you will find that it is similar in most if not all states. I know that most states undergo their own process of trying to locate the rightful owner of the money before committing it permanently to their coffers, but that process is pretty weak. I think in most cases the information about the “unclaimed funds” goes into a database where people can look it up (now on the internet in most states) and if no one looks it up and finds their money after some amount of time, then it reverts to the state.

    For example, here is the site for my home state, Virginia:

    http://www.trs.virginia.gov/ucp/ucp.asp

  • Toffer

    In point of fact, all 50 states have “escheat” laws. This is actually more relevant than one might think because it can effect marketing promotions where prizes of monetary value are paid. The issue is no two states have identical language which makes it a challenge when organizing a campaign.

    For example large car manfuacturers sometimes provide cash incentives to dealer sales representatives to push one model or another based on inventory, sales numbers, etc. Given the high turnover rate in dealership sales employees the person has moved on by the time an award is paid. The manufacturer may have to commit to locating these people and to do so, incur the cost of taking out ads in newspapers to get the word out. Other states may be more specific about how it has to be done, others more lax.

    This is also a common issue with respect to gift cards (retail-specific or Visa/MasterCard/Amex), gift certificates, etc. Spitzer was on a war path against gift cards because to get around having to escheat money (and because sections of language were written for gift certificates – a paper-based payment process) card providers were charging fees to fee down the accounts. It was construed as bilking consumers out of their unclaimed cash. For a long time companies came up with their own rules about what to do with the money because nobody was policing this.

  • http://www.petertdavis.net Peter Davis

    Can the agreement be drafted that all money left over goes to a charity before the state gets their paws on it?

  • http://www.feld.com Brad Feld

    From a friendThe

  • http://BoldlyGoing.com James D Kirk

    Couldn’t there be some sort of provision in place that created a separate payout account that these sort of funds would go to for the investor. I’m sure there’s a better name and description, but I keep seeing “Direct Deposit” flash in front of my eyes. When the investor signs up they enter their Pay Pal account, bank account, trust fund account number, whatever. When these payments “have” to be made out, there’s already signed language that allows the immediate electronic payment to be made, and thus everyone gets funds now, not never, and they don’t go for the “good of all the people”. Who the heck are “all the people” anyways? What have they done for me lately? ;)

  • http://blog.triggit.com Zach Coelius

    Sounds like a company just waiting to be started. The only question is who pays since the value is in the information.

    Keep up the good work. I especially like the book posts

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