According to the UK Gift Card & Voucher Association, in 2014 the gift card and voucher market was worth £5.4 billion in the UK and $124 billion in the US.
Gift cards can confer numerous benefits on the retailer, including promotion, working capital and additional profit from up-spend, and are popular with consumers as a method of paying for goods and services in advance of receiving them.
However, if a retailer who has accepted a pre-payment by way of gift card becomes insolvent in the US or the UK, consumers are at risk of losing their money, because insolvency legislation offers limited protection to this class of creditors.
While the purchaser or holder of a gift card does not always lose out entirely in a retailer insolvency situation, a number of highprofile retail insolvencies over the last few years have put the treatment of gift card holders under the spotlight.
UK: No preferential status for gift card holders
If a retailer becomes insolvent in the UK, consumers risk losing their right against the company to use their gift card or get their money back. Often, the formal insolvency will employ a process known as Administration, during which the business and assets of the company fall under the control of the Administrator. The consumer becomes an unsecured creditor in the administration of the company, ranking behind the retailer’s secured and preferential creditors in the statutory hierarchy. It is not uncommon for unsecured creditors to receive no distribution at all.
Consumers are not entirely unprotected
However, in insolvency situations, gift card holders are not entirely unprotected. They may benefit from one of the following:
Administrator decision to honour the gift card
When the administrators decide to trade the business of the retailer in administration, there is an opportunity for them to agree to honour gift cards issued by the retailer (in whole, or part, or subject to conditions) if they feel this would achieve one of the statutory objectives of administration and a better result for the company’s creditors as a whole.
There is, however, no obligation on the administrators to do so, and any such decision needs to consider a commercial review of the retailer’s position. The administrators need to balance competing factors, such as:
- The effect of any negative PR on the retailer’s goodwill and brand value (and therefore ultimately the value of the business) in not honouring the gift card
- The cost to the retailer (and therefore its creditors) in honouring the gift card (particularly where there are numerous cards and insufficient assets)
Purchaser decision to honour the gift card
A purchaser of the business and assets of the retailer is under no obligation to honour gift cards, but may choose to do so to maintain consumer goodwill and brand value.
Gift card monies held on trust
The retailer may have voluntarily set up a trust account prior to its insolvency in relation to the prepayment received from the consumer, ring-fencing the monies from the company’s assets and holding them on trust for the consumer. In an insolvency, so long as the trust complies with the necessary legal formalities, the monies which are the subject of the trust will belong to the gift card holders and will neither form part of the company’s assets nor be available for distribution to the company’s creditors. If there are sufficient funds in the trust, the gift card holder will receive its money back. If, however, the trust lacks the correct legal formalities and the administrators suspect the trust is invalid, they will be obligated to challenge the trust in order to maximise return for the creditors as a whole.
Consumer credit protection
In certain circumstances, consumers who have purchased a gift card using a credit or debit card (but not the recipient of the gift card) may be able to get a refund from the card issuer:
- Credit card payment protection - Pursuant to section 75 of the Consumer Credit Act 1974, the credit card provider is jointly and severally liable with the retailer for any breach of contract or misrepresentation claim which could have been made against the retailer, provided that the value of the item is more than £100 and less than £30,000.
- Chargeback protection - A card issuer’s chargeback scheme (set out in the relevant card scheme rules) may permit a purchaser to obtain a refund of the amount paid where a gift card has been purchased using a debit or credit card. There is no limit on the amount that can be claimed, but the claim must usually be raised within certain timeframes.
Dividend as an unsecured creditor
The consumer may receive a dividend as an unsecured creditor of the insolvent retailer, once the claims of secured and preferential creditors have been paid; however such a payment is not guaranteed and is likely to be negligible in any event.
Proposals for reform in the UK
In September 2014, the Department for Business, Innovation and Skills asked the Law Commission to examine the protections available in respect of consumer prepayments and to consider whether or not such protections could be strengthened.
The areas of consultation include:
- Increasing the information available to consumers about chargeback in credit and debit card transactions.
- Exploring ways to make it easier for traders to protect prepayments on a voluntary basis, in light of the difficulties involved in protecting consumer prepayments though trusts, bonding and insurance.
- Sector-specific regulation of prepayments.
- Giving preferential status to a small, limited category of consumer claims, namely those arising out of the situation where businesses take significant sums of new money from consumers shortly before entering insolvency and no other protections are in place.
Of particular interest will be the Law Commission’s recommendations on its proposal to confer preferential status on (inter alia) gift card holders so that they are paid ahead of floating chargeholders (such as lenders) and unsecured creditors in circumstances where the gift card is not redeemed on insolvency.
If the category of preferential creditors expands, it is likely to have a considerable impact on the amount to be returned to lenders in a retail insolvency, particularly where numerous gift cards are in circulation. This could in turn lead to an increase in the cost of loans to retailers and a reluctance on the part of lenders to advance credit in an already uncertain lending market.
In addition, the likelihood of a distribution to unsecured creditors (who already invariably receive a negligible dividend (if any)) on insolvency will be further reduced if the category of preferential creditors expands.
Any such protection will also need to be considered from a public policy perspective as increasing the category of preferential creditors will reduce the money available to employees who are essentially, at present, the only category of creditor with preferential status under insolvency legislation.
The Law Commission intends to publish its recommendations in the Autumn of 2016.
US: Priority status for some gift card holders
In many retail bankruptcy cases in the US, the debtor will either liquidate or sell the business as a going concern. In both instances, gift card holders are at risk of not being able to redeem unused gift cards or be fully paid on their claim for the unused amount of the gift card. Generally in a liquidation scenario, a gift card holder only has a brief period of time to use the gift cards before the company closes its doors. In a going concern transaction, the purchaser may not want to continue to honor gift cards issues by the debtor prior to the bankruptcy.
In the highly publicized RadioShack bankruptcy case, RadioShack sold its assets as a going concern and the buyer, General Wireless, ultimately agreed to honour gift cards previously issued by RadioShack, but only for 50 percent of the purchase price of merchandise. For instance, if a customer purchased $20 of merchandise, only $10 of the gift card could be redeemed. Gift card holders could either redeem their gift cards at the buyer’s store or submit a claim in the RadioShack bankruptcy case. However, if a gift card holder elected to submit a claim instead of redeeming the gift card at a store, it was not guaranteed that the gift card holder would receive the full claim amount.
A significant issue raised in the RadioShack case was whether claims for unredeemed gift cards are entitled to what is referred to as 'priority' status. Under the United States Bankruptcy Code, unsecured claims are subject to a priority scheme. For instance, administrative expenses, employee wages and taxes are entitled to priority and thus are paid prior to the claims of general unsecured creditors.
Furthermore, the Bankruptcy Code provides that an unsecured claim arising from the deposit, purchase, lease or rental of property, or the purchase of services, for the personal family, or household use that were not delivered or provided is entitled to priority status. It is based on this provision that certain parties in the RadioShack bankruptcy case asserted that all claims for unredeemed gift cards were entitled to priority status.
After extensive briefing and oral argument, the bankruptcy court approved a settlement whereby only certain types of gift cards would be entitled to priority status, such as gift cards purchased by customers. Other types of gift cards, such as those issued in connection with the return of merchandise and promotional giveaways, were not entitled to priority status.
The issues raised in the RadioShack bankruptcy case with respect to gift cards and the treatment of claims for unredeemed gift cards will certainly be revisited, given the rise of retail bankruptcy cases in the US and the significant liability that a retail debtor will face if holders of unredeemed gift cards are entitled to priority status.
In both the US and the UK, the position of gift card holders on insolvency certainly warrants further review and consideration. As retail insolvencies appear to be on the rise, providing gift card holders with more rights will inevitably have knock-on effects for other parties affected by a retailer’s insolvency.