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Gift cards protected in bankruptcy

Sometimes, business bankruptcy may leave consumers out in the cold or end a businesses' ability to serve customers. Chapter 11 bankruptcy protects businesses from creditors during the liquidation of debts under a court-approved plan. But, how are gift cards handled in a Chapter 11 bankruptcy.

There are court opinions on the treatment of gift card claims after the filing for bankruptcy. In fact, the Bankruptcy Court recently ruled that business owners must segregate gift card proceeds received after the filing of the bankruptcy petition. This, according to the court, provides adequate protection to customers and does not constitute an excessive burden on the debtor.

In that case, the debtor operated two spas that provided beauty and spa treatments. Before filing for bankruptcy, it sold gift cards that were redeemable for services or products. The spa deposited all sale proceeds into its general operating account, and commingled with funds from other sales, regardless of when or if the cards were redeemed.

The spa asked the court for access to these proceeds and argued that 15 percent of gift cards are normally not redeemed. It claimed that it wanted to give another type of protection to card holders with a lien on its commercial real estate, instead of holding the funds in a separate account.

According to the court though, holders of this lien have lower priority or lower access to funds. The spa did not explain how its proposed substitution was equitable, justifiable or provided adequate protection to holders of unredeemed gift cards. Accordingly, the court rejected this plan.

The court ruled that purchasers of gift cards, after the filing of the petition, are debtor-in-possession lenders who provided an unsecured loan. In return, purchasers received the assurance that they will later receive goods or services equal to the gift card's value. The court ordered separation of all gift card sales into a separate account to assure possible claims of gift card purchases made after the filing of the Chapter 11 petition, if the cards could not be redeemed.

Debtors undergoing commercial bankruptcy face additional pressures by resolving their debt while trying to continue to serve their customers. Legal advice may help businesses and their owners seek the best plan to remain open.

Source: Bloomberg, "Gift cards sold in bankruptcy must have adequate protection," Diane Davis, Feb. 9, 2017

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