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Gift Cards and Bankruptcy

posted by Adam Levitin

There's a linguistic irony that "gift" is the German word for poison. What, then, should we make of the "gift card"?  

Senator Richard Blumenthal's introduced new legislation, the Gift Card Consumer Protection Act (S.3636) that aims to close up the loopholes in existing gift card regulation and to protect consumers with gift cards when the retailer goes bankrupt. The legislation has a few moving parts:

  • It expands the definition of gift card to include loyalty, award, and promotional gift cards.
  • It would make the prohibition on dormancy, inactivity, and service fees absolute. Currently, the Electronic Funds Transfer Act permits inactivity, dormancy, and service fees for cards that have been inactive for a year, provided disclosure requirements have been met.  
  • It makes the ban on expiration dates on gift cards absolute.  Currently, the EFTA allows cards to expire after 5 years if the expiration date is properly disclosed. 
  • It makes it illegal for bankrupt firms to sell gift cards and for anyone to resell gift cards issued by firms that have been in bankruptcy for more than a week. 
  • The bill creates an automatic stay exception for presentation of gift cards and requires the trustee/debtor in possession to honor gift cards at full value the same as cash. 

It'll be interesting to see what the opposition ends up being to the bill. The bill is dealing with two separate, but related problems.  

Expiration dates and service/dormancy fees are an issue vis-a-vis solvent retailers. I would expect pushback from both retailers and prepaid card firms (e.g., Green Dot). Abolishing expiration dates may complicate already uncertain gift card accounting. It's annoying to have a deferred revenue liability outstanding potentially forever just because someone lost or threw away a gift card. That said, I don't think this is a huge burden for retailers who already have these deferred revenue liabilities outstanding for at least up to five years, and it does prevent some forfeitures.

Eliminating dormancy/service fees will clearly reduce gift card profitability--but by how much? I don't know of any good statistics on it.  The more major it is, however, the more problematic the gift card business model becomes. I think this puts gift card issuers in a tough spot. If they complain too loudly about lost revenue, it suggests that they really have a business model that depends on forfeiture.  And if it doesn't, then is this really a big deal?

Still, I can imagine that there are some minor ministerial costs associated with maintaining dormant gift cards. The Blumenthal bill would force retailers to either accept lower profit margins or recapture those costs either through higher upfront costs on gift cards or higher merchandise prices. I'm not particularly concerned by any of those outcomes (including the cross-subsidization they involve), primarily becuase I think the impact will be rather small. 

The second problem is a bankruptcy problem. The retailers and card issuers probably won't have a dog in this hunt. they should though because of the impact that bankruptcy treatment of gift cards will have on pre-bankruptcy consumer behavior.  Once the retailer/issuer is bankrupt, the question is whether the gift card cash pot is going to go to consumers or to other creditors.  In other words, will a retailer's bankruptcy result in a transfer of wealth from consumers to secured lenders? The legislation is trying to ensure that banks do not profit at the expense of consumers in business bankruptcies.

Protecting consumers' gift cards in bankruptcy should make gift cards more attractive to consumers and encourage their use. Who wouldn't want to give or to receive a bankruptcy remote asset for Christmas? Now you too can celebrate the New Year like a derivative trader! You're no longer subject to the stay! I don't think that better bankruptcy protection is likely to have a major impact on consumer behavior, but think of this as a type of deposit insurance, financed (like the FDIC's mutual insurance fund), by the banks. This should help retailers' promote their gift cards (I can even imagine this in the advertising!) and particularly help foundering stores sell gift cards.

That said, there is a bit of a consumer lulling concern here. Being able to redeem a gift card at full value from a bankrupt firm is great, but only if there's merchandise to redeem. If consumers think they are protected, they might not rush to redeem before a bankruptcy filing or immediately afer the filing. Thus, by the time they go to redeem, there might not be any merchandise left in the estate, so all the consumers will have are general unsecured claims--what they had before. Indeed, if there's lots of gift card liability outstanding, that could even place pressure on speeding up asset sales. 

I would expect the financial services industry to fighting this part of the bill, not least to make sure there are no leaks in the BAPCPA dike, even though it's an issue that's likely to come up in a rather limited class of retail bankruptcies. Maybe they make common cause with the retailers who won't like the non-bankruptcy components. But the retailers should be supporting at least the bankruptcy components of the bill.  It'll be interesting to see how the politics play out in the wake of the Durbin Amendment. 

Comments

The bankruptcy aspects of this are particularly interesting, because there are already two strands of precedent in Code jurisprudence.

First, and better-known, is the priority of layaway creditors in Section 507(a)(7). This priority is capped.

Second is the critical vendor order, which Blumenthal's legislation seems to model. Consumers are frequent beneficiaries of critical vendor orders, although the usual rationale is that of goodwill for a reorganizing firm, rather than consumer protection. Casino chips are reasonably similar to gift cards, and they have received critical vendor order protection. In re TCI 2 Holdings LLC, 428 B.R. 117, 180 (Bkrtcy. D.N.J. 2010).

Finally, I don't see the accounting problems with perpetual gift cards. Like any other untraceable liability, they should escheat within about five years, and get off the balance sheet of the issuer.

It's a relief that Prof. Levitin doesn't think this is a huge burden for retailers. I was worried for a second that this bill might exacerbate the economic recession coming in 2013 by adding additional compliance and financial burdens on already stressed companies, but now I am reassured.

In the same vein as Sen. Richard ("I served in Vietnam") Blumenthal's proposal, I hereby call for the banning of expiration dates on coupons to further protect consumers. I have a free oil change coupon from 1987 that I just found in my closet, and it burns me up to know those fat cats at Joe's Corner Garage were laughing all the way to the bank when the expiration date rolled around on Jan. 1, 1988 and the coupon hadn't been redeemed.

Also, I find it annoying that I can't use my coupons for Costco-brand cat food at Wal-mart, because Wal-mart is closer to my house, so Sen. Blumenthal's bill should be amended to provide for the universal acceptance of competitor coupons, with a noncompliance penalty of imprisonment for all the responsible corporate officers of any company not accepting competitor coupons.

Senator Warren, the people are crying out for the righting of these wrongs!

I like Oyez's snark. I think the coupon analogy is interesting, but misleading. A coupon is a contractual offer. The offeror gets to control the terms, including duration the offer will be held open. If I send out a 10% off coupon, there are really good business reasons why I might want that to be good only through this Christmas, say. I might be willing to lower prices now, but not commit myself to doing so in the future.

This logic doesn't hold with a gift card, as it doesn't commit the retailer to a sale at any particular price or even particular discount in the future. A gift card is more like a bailment of currency (sort of like a bank deposit) than a contractual offer. Seen this way, the bailment is returned to the cardholder at the moment of purchase and then transferred back to the merchant with the purchase.

If you think of a gift card as a bailment, then Blumenthal's bill's anti-expiry provision makes a lot of sense. If I entrust $50 to you today, I should be able to get back my $50 in a week, a month, a year, or a decade, etc., just as if I had entrusted my car to you--I'm entitled to get the same car back. Frankly, I should be able to get the $50 back with interest, since you've gotten to use it, just as I would be able to recover in trover for the diminution in value of the car if you'd done a Ferris Bueller's Day Off Maneuver and gone on a joy ride with it. (Pace Abraham Lincoln in Johnson v. Weedman ). For bank accounts or safety deposit boxes, abandonded property doesn't become the bank's. It is escheat to the state.

So think of the gift card as equivalent to a bank deposit with a 0% APY. The retailer gets an interest free loan because it gets to use the funds until they are redeemed; the funds aren't being held in a segregated trust account. That's huge value. To complain about then not being able to benefit from a forfeiture is, well, just greedy. If a retailer doesn't want to be a bailee because it isn't profitable absent forfeiture, then it shouldn't be in the bailment business.

As far as the "it's not a good time to regulate" argument, it looks suspiciously like an argument of convenience. I don't think Oyez's beef is when to regulate, but whether to regulate at all. That's fair, but don't hide behind the "might exacerbate the economic recession coming in 2013" argument, especially with gift cards for goodness sake.

> There's a linguistic irony that "gift" is the German word for poison. What, then, should we make of the "gift card"?

No irony here, both the German and the English word stem from the same root which referred to something that was given, so "gift" used to mean the same in German than in English. However in German the word developed the secondary euphemistic meaning of "a (deadly) gift", analogue to the way greek "dosis" (a giving) came to mean "a portion described" (http://www.etymonline.com/index.php?term=dose). Later on the secondary meaning became the main meaning and the traditional usage disappeared with the old meaning being still conserved in some cases such as German "Mitgift" (dowry).

Regarding poisons and euphemisms: Poison has the same root like potion which merely meant something to drink before later on it came to mean something deadly to drink.

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