December 2, 2016
Solving the Gift Card Conundrum
Co-Authored by Gregory J. Flasser1
Retail debtors and consumers have long debated the appropriate treatment for claims on account of unredeemed gift cards. The facts giving rise to the debate, and the competing legal positions, are quite simple and easy to place into context. Consumer X purchases a gift card from Retail Debtor Y. However, before Consumer X (or his/her subsequent transferee) uses the gift card, Retail Debtor Y files for bankruptcy. Retail Debtor Y enters into a consulting agreement with a liquidation consortium, which promptly commences going-out-of-business (GOB) sales. Previously purchased gift cards are honored at the GOB sales, but many go unredeemed by the time the GOB sales have been concluded.
Having lost the ability to use the gift card, Consumer X submits a claim in the bankruptcy case to recover the lost value.2 The claim is submitted as a “deposit” priority pursuant to § 507 (a) (7) of the Bankruptcy Code, which affords priority treatment for claims of individuals (up to $2,775 per individual) “arising from a 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.”3 Retail Debtor Y objects to the claim on the basis that payment in return for a gift card is not a true “deposit” within the meaning of the statute and seeks to have Consumer X’s claim reclassified as general unsecured in nature. Consistent with the current trend, Retail Debtor Y’s bankruptcy proceeding is riddled with underwater secured creditors fighting to squeeze every dollar from their collateral, and priority claims are the only class of unsecured claims likely to receive a full recovery. Therefore, Consumer X’s ability to recover the value lost on account of the unredeemed gift card turns entirely on whose interpretation of the word “deposit” is correct.
On Aug. 4, 2016, Hon. Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware sided with Retail Debtor Y in In re City Sports Inc.4 The court’s opinion is at odds with prior decisions in Delaware and elsewhere, and while consistent with certain decisions in other districts, it will undoubtedly impact future bankruptcies filed in Delaware and beyond. This article provides a summary of the competing legal positions, certain prior case law and the bankruptcy court’s decision in City Sports.
Founded in 1983, City Sports Inc. was a Boston-based athletics retailer that sold its products through retail stores in Massachusetts, Rhode Island, New York, Pennsylvania, Maryland, New Jersey and Vermont.5 Facing an increasingly challenging retail environment, City Sports commenced a chapter 11 proceeding on Oct. 5, 2015, pursuant to which it closed all of its stores and liquidated all assets.6 Prior to filing for bankruptcy, City Sports sold pre-paid gift cards to consumers.7 At the conclusion of its GOB sales, City Sports estimated that gift cards totaling approximately $1.18 million remained unredeemed.
The Commonwealth of Massachusetts submitted a claim on behalf of Massachusetts residents for the full amount of City Sports’ unredeemed gift cards.8 Like Consumer X in the hypothetical, the Commonwealth sought priority status for its claim under § 507 (a) (7). In support of its argument, it cited In re WW Warehouse Inc.,9 wherein, under similar circumstances, the court found unredeemed gift certificates to be true “deposits” that must be paid on a priority basis pursuant to § 507 (a) (7).
City Sports, with the support of the unsecured creditors’ committee, objected to the Commonwealth’s claim and predictabl
Retail debtors and consumers have long debated the appropriate treatment for claims on account of unredeemed gift cards. The facts giving rise to the debate, and the competing legal positions, are quite simple and easy to place into context. Consumer X purchases a gift card from Retail Debtor Y. However, before Consumer X (or his/her subsequent transferee) uses the gift card, Retail Debtor Y files for bankruptcy. Retail Debtor Y enters into a consulting agreement with a liquidation consortium, which promptly commences going-out-of-business (GOB) sales. Previously purchased gift cards are honored at the GOB sales, but many go unredeemed by the time the GOB sales have been concluded.
Having lost the ability to use the gift card, Consumer X submits a claim in the bankruptcy case to recover the lost value.2 The claim is submitted as a “deposit” priority pursuant to § 507 (a) (7) of the Bankruptcy Code, which affords priority treatment for claims of individuals (up to $2,775 per individual) “arising from a 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.”3 Retail Debtor Y objects to the claim on the basis that payment in return for a gift card is not a true “deposit” within the meaning of the statute and seeks to have Consumer X’s claim reclassified as general unsecured in nature. Consistent with the current trend, Retail Debtor Y’s bankruptcy proceeding is riddled with underwater secured creditors fighting to squeeze every dollar from their collateral, and priority claims are the only class of unsecured claims likely to receive a full recovery. Therefore, Consumer X’s ability to recover the value lost on account of the unredeemed gift card turns entirely on whose interpretation of the word “deposit” is correct.
On Aug. 4, 2016, Hon. Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware sided with Retail Debtor Y in In re City Sports Inc.4 The court’s opinion is at odds with prior decisions in Delaware and elsewhere, and while consistent with certain decisions in other districts, it will undoubtedly impact future bankruptcies filed in Delaware and beyond. This article provides a summary of the competing legal positions, certain prior case law and the bankruptcy court’s decision in City Sports.
The Parties’ Positions
Founded in 1983, City Sports Inc. was a Boston-based athletics retailer that sold its products through retail stores in Massachusetts, Rhode Island, New York, Pennsylvania, Maryland, New Jersey and Vermont.5 Facing an increasingly challenging retail environment, City Sports commenced a chapter 11 proceeding on Oct. 5, 2015, pursuant to which it closed all of its stores and liquidated all assets.6 Prior to filing for bankruptcy, City Sports sold pre-paid gift cards to consumers.7 At the conclusion of its GOB sales, City Sports estimated that gift cards totaling approximately $1.18 million remained unredeemed.
The Commonwealth of Massachusetts submitted a claim on behalf of Massachusetts residents for the full amount of City Sports’ unredeemed gift cards.8 Like Consumer X in the hypothetical, the Commonwealth sought priority status for its claim under § 507 (a) (7). In support of its argument, it cited In re WW Warehouse Inc.,9 wherein, under similar circumstances, the court found unredeemed gift certificates to be true “deposits” that must be paid on a priority basis pursuant to § 507 (a) (7).
City Sports, with the support of the unsecured creditors’ committee, objected to the Commonwealth’s claim and predictabl