Financial Advisors: Beware the Pitfalls of Gift Cards

With retailer bankruptcies on the rise, financial advisors need to be aware of the complications and pitfalls associated with gift cards. This article brings to light some of the issues faced when a retailer with a significant amount in outstanding gift cards files for bankruptcy proceedings. Like many problems faced in bankruptcy, gift card challenges can be tackled with solid information, clear communication and planning. To meet these challenges, a financial advisor must understand the liabilities associated with outstanding gift cards.

Gift cards are big business. Gift card sales by private-label retailers and financial institutions totaled $97 billion in 2007, according to TowerGroup research. That's a lot of money for the promise of future goods or services, and a small percentage are never redeemed. A gift card shows up on the balance sheet as a liability, and when a retailer files for bankruptcy proceedings, the court views the cardholder as an unsecured creditor.

Retailers sell gift cards directly to consumers and through distributors to general retailers such as grocery stores, gas stations, pharmacies or office supply stores, which then sell to consumers. Gift card sales usually spike before gift-giving holidays such as Christmas and Valentine's Day because they are convenient. However, during the 2008 Christmas season, sales of individual store gift cards went down, according to the National Retail Federation. This is due in part to a growing concern among consumers that retailers might "go bankrupt" before gift cards can be redeemed. Media reports have further fueled this fear and may cause this trend to continue. Financial advisors need to be prepared for this possibility as they create cash forecasts for retailers.

Many media reports throughout this Christmas season warned of gift card troubles such as the ones consumers experienced when The Sharper Image filed for bankruptcy protection in 2008. Sharper Image initially suspended $20 million worth of gift cards, causing an intense public relations uproar. Sharper Image subsequently offered a deal to gift cardholders: They could use gift cards if they spent at least twice the value in a single transaction. Instead of solving the problem, this solution caused more confusion and heightened negative perceptions of the company.

Financial advisors need to be aware of gift card issues like these and decide how to address them early in the bankruptcy planning process. During a bankruptcy proceeding, financial advisors often consider rejecting gift cards as the easiest and most practical financial solution. However, there are several drawbacks to consider. Not honoring gift cards can:

• alienate customers needed for future revenues (and future store owners, if stores are intended to be sold in the bankruptcy);
• create an operating nightmare for franchisees, if the retailer's business model is based on franchisee operations;
• incite a public relations explosion of bad press;
• attract the attention of state agencies that rectify consumer-harm situations;
• trigger challenges for the retailer's employees, who will have to deal with angry customers because their gift cards no longer have value;
• complicate operations: The IT systems that manage the redemption, sale and tracking of gift cards are complex and often are outsourced with detailed contractual agreements that are difficult to modify quickly; and
• cause financial delays: The banking systems needed to move gift card revenue between store bank accounts cannot be changed quickly

An In-depth Study in Gift Card Challenges
Bennigan's, one of the largest chapter 7 filings last year, provides a detailed illustration of outstanding gift card complications. When the parent company of Bennigan's Grill & Tavern and Steak & Ale restaurants filed for bankruptcy, it immediately closed more than 300 corporate-owned restaurants, trapping $15 million in outstanding gift cards in the filing. This posed a complex problem for the 132 franchisee-owned restaurants still in business.

The franchisees were inundated with customers trying to pay with gift cards. Some customers, fearful that the franchisees might also go out of business, ordered additional or more expensive meals to try to use up gift cards. Unfortunately, the IT systems used to determine gift card value and validity were shut down after the filing and gift cards could not be redeemed without them. It took months to restart the IT systems, reprogram bank account information and revise vendor contracts. Bennigan's franchisees and its advisors worked hard to accommodate and update customers on the situation, but competing restaurant chains complicated their efforts. The restaurants offered to redeem Bennigan's gift cards for a free entrée and received significant media coverage for the offer. This muffled the franchisees' marketing message that they remained open for business and hampered customer relations.

The franchisor, which was not in bankruptcy, offered franchisees a special arrangement that enabled them to accept gift cards that had been sold in franchised Bennigan's stores, crediting the amount against future royalties. The franchisor worked with the companies operating the IT systems to modify the program, which allowed franchisees to know where gift cards were purchased. The franchisees then pledged to redeem gift cards among themselves.

While these decisions and commitments enabled customers holding nearly $3 million in gift cards to obtain value, it left $12 million in corporate-issued cards, which were nonredeemable by the franchisees. This caused further customer and public relations issues. Especially difficult was the major credit card company that purchased gift cards to use as customer rewards just 60 days before the filing. The company was left holding a total of over $4 million in useless Bennigan's gift cards in its inventory.

Some customers were luckier. They were able to return gift cards to the retailer they purchased from such as grocery stores, office supply stores and convenience stores. These retailers often gave refunds in the spirit of customer service. Reimbursements were made at the store manager's discretion.

Lessons for Financial Advisors
Financial advisors must act quickly on behalf of retailers filing for bankruptcy, and involve the company's redemption and financial transaction managers in the process because they can provide access to bank accounts that are frozen by bankruptcy proceedings. Gift card liabilities also need to be determined and action plans put into place early in the bankruptcy planning process. This may help alleviate confusion for employees and customers, as well as maintain franchisee relations. It may also minimize negative press because it allows the retailer to develop press releases to deliver its message.

Without a solid action plan to address gift card liabilities, retailers risk alienating customers, damaging relationships with franchisees, losing valuable employees and incurring financial delays that could make a significant difference in the retailer's ability to emerge from bankruptcy and regain profitability.