Judge Martin Glenn of the Bankruptcy Court for the Southern District of New York recently ruled that Borders gift card holders did not qualify as “known creditors.” The Court concluded that the gift card holders were entitled only to publication notice rather than actual notice of the bar date for filing bankruptcy claims in Borders’ chapter 11 case. Because potential gift card claims often constitute a significant portion of the unsecured claims in retail bankruptcy cases, the treatment of gift cards and the type of notice to which their holders are entitled can significantly impact the recoveries of other unsecured creditors including bondholders. In re BGI, Inc., f/k/a Borders Group, Inc., No. 11-10614, 2012 Bankr. LEXIS 3724 (Bankr. S.D.N.Y. Aug.14, 2012).
On February 16, 2011, book retailer Borders Group, Inc. filed a voluntary petition for chapter 11 bankruptcy relief in the Bankruptcy Court for the Southern District of New York. On April 8, 2011, the Court entered a bar date order establishing the deadline for creditors to file proofs of claim and providing for two different forms of notice to creditors depending on whether or not they were “known” creditors. The order provided that known creditors were entitled to service of notice by first class mail at least thirty-five days prior to the general bar date. For the benefit of unknown creditors, the order provided that Borders also needed to publish a notice in the national edition of The New York Times at least twenty-eight days prior to the general bar date. The different types of notice provided to known and unknown creditors were in keeping with well-established case law establishing that, as a matter of due process, known creditors are entitled to actual notice of a bankruptcy bar date while constructive notice by publication is sufficient for unknown creditors.
Borders ultimately proved unable to sell its business as a going concern and thus sought approval of a full-chain liquidation. On September 27, 2011, the Court authorized the sale of Borders’ intellectual property to Barnes & Noble, and on the same date Borders stopped honoring its gift cards. On December 21, 2011, the Court confirmed a chapter 11 plan of liquidation that created a liquidation trust charged with distributing the estate’s assets to its creditors.
On January 4, 2012, a handful of individual gift card holders filed a motion seeking authorization to file untimely proofs of claim. The holders, through class action attorneys, argued that the publication in The New York Times had not provided them with adequate notice of the general bar date because they were “known” creditors and should have received actual notice. Accordingly, the gift card holders argued that their failure to file timely proofs of claim constituted excusable neglect. A few days later, the gift card holders’ attorneys filed a second motion seeking to certify a class of all holders of prepetition Borders gift cards. The class action motion also asked that gift card claimants be accorded priority unsecured creditor status pursuant to section 507(a)(7) of the Bankruptcy Code, which grants a priority higher than general unsecured claim status to claims arising from a pre-petition deposit of money in connection with a purchase of property intended for personal use. The Borders liquidating trust objected to both of the gift card holders’ motions.
Generally speaking, “known” creditors include both those whose identity is actually known to the debtor and those whose identity is reasonably ascertainable. The gift card holders based their argument that they should have qualified as “known” creditors on the premise that Borders’ databases contained enough information about the holders of its gift cards to allow Borders to identify these holders and provide them with personal notice. Based on the evidence before it, however, the Court concluded that the gift card holders’ status as possible creditors had not been known to or reasonably ascertainable by Borders. The court noted that gift cards, as their name implies, are not intended to be used by the purchaser, but are instead meant to be passed along as gifts to others. Accordingly, even if Borders had had a means of identifying the purchasers of its gift cards, Borders would still have had no way of tracing their ultimate recipients. Significantly, the gift card holders who had brought the motion to file late claims had, in fact, received their gift cards as gifts, a circumstance that the Court cited in support of its reasoning.
In any case, an uncontested declaration by a former Borders general counsel established that Borders had never maintained a list of gift card purchasers containing the purchasers’ contact information. Although Borders had contact information for some of the gift card holders based on the fact that these holders had also been members of Borders’ customer rewards program or had used the Borders website, Borders did not have any way of easily connecting this contact information with the fact that these customers also held gift cards. Because the identity of the gift card holders was not readily ascertainable, the Court ruled that the gift card holders were unknown creditors and that the notice published in The New York Times had been constitutionally adequate to inform them of the need to file a proof of claim.
In light of the adequacy of the notice they had received, the Court found that the gift card holders’ failure to file timely proofs of claim did not constitute “excusable neglect” under the four-factor test articulated in Pioneer Inv. Servs. Co. v. Brunswick Assocs. Ltd. P’ship., 507 U.S. 380, 388 (1993). Under Pioneer, the four factors a court must consider in determining whether a late filing is excusable are (1) whether the delay will prejudice the debtor; (2) the length of the delay and its impact on efficient court administration; (3) whether the delay was beyond the reasonable control of the person whose duty it was to perform; and (4) whether the creditor acted in good faith. In all, the Court found that three of the four Pioneer factors weighed against a finding of excusable neglect, but the Court’s analysis particularly emphasized the first Pioneer factor, namely prejudice to the debtor’s estate. In this case, the Court found that certifying a class of gift card holders and allowing them to file late claims would have a “disastrous” effect on the remainder of the Borders estate. Notably, Borders’ books and records indicated the existence of approximately 17.7 million outstanding gift cards with unredeemed balances amounting to approximately $210.5 million. The Borders liquidation trust, meanwhile, was expected to have only $90 million available to pay all unsecured claims. Given these numbers, if the gift card claims had been allowed and granted section 507(a)(7) priority, as the gift card holders requested, then the gift card claims would have entirely wiped out the recoveries of all general unsecured creditors.
Indeed, the Court found that allowance of the gift card claims would so drastically change the estimated recoveries for unsecured creditors that it would necessitate a modification of the plan and a re-solicitation of votes. Under section 1127(b) of the Bankruptcy Code, however, a plan cannot be modified after it has been “substantially consummated.” The Court found that the Borders liquidation plan had been substantially consummated, because all of Borders’ assets had already been transferred to the liquidation trust and were in the process of being distributed to creditors. Section 1127(b) thus created an additional barrier to the allowance of the gift card holders’ claims.
The Borders decision illustrates the way in which gift cards can function as potential “wild cards” in the retail bankruptcy context. As in the Borders case, potential gift card claims often constitute a significant portion of the total unsecured claims against a retail debtor, and yet the dispersed nature of gift card holders and the difficulty of identifying them creates uncertainty as to whether their potentially game-changing claims will ever be effectively asserted.
To some extent, the Borders decision mitigates the uncertainty surrounding gift cards by establishing that gift card creditors are not entitled to actual notice of a bankruptcy bar date. As a practical matter, this means that most gift card holders in future retail bankruptcy cases will likely remain unaware of the need to file proofs of claim and thus will effectively be excluded from participation in the case.
There is also a possibility, however, that class action attorneys may learn to organize quickly enough to file timely proofs of claim on behalf of large numbers of gift card holders in future retail bankruptcies. If so, the result may be to diminish recoveries for other unsecured creditors, including any unsecured bondholders. In some cases, this risk that gift card claims could significantly dilute recoveries by other unsecured creditors may suppress investor demand for distressed retailers’ unsecured debt. This same risk could also create interesting investment opportunities, however, for example by allowing a hedge fund or other investor to bet against gift card claims being asserted by investing in a retail debtor’s unsecured debt at depressed prices. In any event, the consequences of this decision are worth monitoring in future retail bankruptcies.