Gift Cards and Bankruptcy

11/29/12

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. 

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