Now You See It, Now You Don’t: The Vanishing Value of Gift Cards in Bankruptcy

The holiday season is fast approaching and it would not surprise me if many of you reading this article receive a gift card at some point during the next couple of months. As you look at that gift card, however, you may find your heart sinking as you recall the numerous retail stores that recently filed for bankruptcy. American Apparel, RadioShack, The Wet Seal, Brookstone, Quicksilver, Ashley Stewart and Delia’s – just to name a few! One issue that all retailers face when filing for bankruptcy is how to deal with claims that arise from outstanding gift cards.

In an effort to preserve the goodwill of its customers, a retailer that files bankruptcy for the purpose of reorganizing its business will often want to ensure that gift cards are honored at the store’s retail locations. To accomplish that retailers may file a motion, sometimes as part of their “first day” motions, for authority from the bankruptcy court to continue honoring prepetition obligations to customers and to continue customer programs in the ordinary course of business, including their gift card programs. This type of motion is often granted by bankruptcy courts if no objections to the motion are filed.

Issues can arise, however, in liquidating cases when a bankruptcy retailer determines that it will stop honoring outstanding gift cards. In those situations, it must determine whether claims relating to outstanding gift cards will be treated as general unsecured claims or claims entitled to priority under § 507(a)(7) of the Bankruptcy Code. Section 507(a)(7) provides for priority payments of “allowed unsecured claims of individuals, to the extent of $2,775 for each such individual, arising from the deposit, before the commencement of the case, of money in connection with the purchase, lease, or rental of property, or the purchase of services, for the personal, family, or household use of such individuals, that were not delivered or provided.”

It seems logical that retail customers who purchased gift cards prior to that retailer’s bankruptcy filing did so as a deposit in the expectation that all or some of the face value of the gift card would later be applied to a future purchase. Courts have disagreed, however, on whether claims arising from gift cards constitute priority claims under § 507(a)(7). Some bankruptcy courts have held that money paid for gift cards are “deposits” within the meaning of § 507(a)(7). Others, however, find that the term “deposit” refers only to partial payments of future purchases, while gift cards represent transactions that are paid in full and are therefore not within the meaning of the Bankruptcy Code.[1]

This issue arose in the RadioShack bankruptcy cases[2] in connection with an adversary proceeding commenced by the Texas Attorney General.[3] The suit was brought in response to RadioShack’s proposed plan of liquidation, which provided that gift card holder claims over $10 would be classified as general unsecured claims.[4] The Texas Attorney General argued that, among other things, gift card claims should be entitled to priority as customer deposits pursuant to § 507(a)(7) of the Bankruptcy Code.

RadioShack and the Texas Attorney General were ultimately able to settle the dispute.[5] As part of the settlement RadioShack agreed to modify the plan of liquidation to provide that claims by certain gift card holders, such as those that were purchased by customers, would be given priority status and receive payment in full. Other gift card holders, such as those who received cards through promotions, would continue to be treated as general unsecured claims. To accomplish this RadioShack, with the assistance of its financial advisor and gift card vendor, will identify the type of gift card held by a holder based on the card’s number.

The issue of whether gift card claims fall under the § 507(a)(7) priority scheme also arose in Sharper Image Corporation’s bankruptcy cases.[6] In February 2008, Sharper Image filed for bankruptcy protection. In May of that year it stopped accepting gift cards. During the case an order was entered authorizing the certification of the holders of Sharper Image gift cards as a class.[7] The class representative then filed a motion for summary judgment seeking resolution as to whether the gift card class was entitled to priority treatment for their gift card claims under § 507(a)(7).[8]

In support of its motion, the class representative relied on In re WW Warehouse, Inc.[9] In that case, the bankruptcy court found that money paid by customers for gift certificates issued by the debtor prepetition constituted “deposits” within the meaning of § 507(a)(7). The bankruptcy court held that “[t]o relegate gift certificate holders to the status of general unsecured creditors perpetuates the very problem Congress sought to remedy…[c]onsumers do not purchase gift certificates, whether they be in the form of paper or a plastic card similar to a credit card, as the ultimate purchase. Consumers expect merchants to apply some or all of the face value of the gift certificate toward the ultimate purchase.”[10]

The summary judgment motion in Sharper Image case was ultimately settled by the entry of an order establishing procedures for Sharper Image’s settling of claims of gift card holders.[11] The procedures enabled Sharper Image to determine which members of the gift card class were entitled to priority treatment and to satisfy those claims in whole or in part. In short, gift card holders that could provide a photocopy of the gift card with the card’s serial number were treated as priority claimants. Holders who could not provide a photocopy of their gift card were treated as unsecured claimants. As a result, the bankruptcy court did not need to rule on the issue of whether the holders of outstanding gift cards were entitled to priority treatment for their gift card claims under § 507(a)(7), leaving the issue open for future debate.

If nothing else, these cases provide a helpful reminder for consumers – use it or lose it. Don’t wait to redeem that new gift card that you receive during the holidays or you may find yourself holding nothing more than a pretty piece of plastic.