The Examiners: Buyer Beware

Do shoppers suffer too much in bankruptcy, or should they be expected to share the pain?

As the saying goes, “buyer beware.” But is it reasonable to expect the average customer to consider the creditworthiness of a retailer when buying an item or purchasing a gift card? In most cases, the customer can return the item or use the gift card, but in the case of a bankruptcy—particularly a liquidation—all bets are off.

In a bankruptcy, the relationship between a retailer and its customers can fundamentally change. If a retailer is going to be restructured and continue in business, the debtor often asks the bankruptcy court to protect its customers by allowing the retailer to honor its previous obligations with them. To preserve the value of the business, it’s in the retailer’s best interest to maintain customer loyalty and thus future sales.

However, in the case in which a retailer permanently closes up shop, customers may find that they can no longer rely on the retailer to stand by its previous practices. They may find their gift cards are worthless, their deposits for merchandise are not returned, ordered merchandise is not delivered, service and warranty programs may not be honored and purchases may not be returnable. In a liquidation, the customer becomes a creditor and may be left with claims against the bankrupt company that are often paid at only cents on the dollar.

In these situations, shoppers find themselves at the bottom of the creditor stack along with trade vendors. (However, customer deposits up to $2,775 are given priority claim status under the bankruptcy code.) A case can be made that a shopper shouldn’t be treated as an equal with trade creditors because the shopper is unlikely to have considered the retailer’s financial condition and its ability to meet its obligations in the same way that a trade creditor would. Additionally, figuring out how to appropriately file a valid claim can be difficult for customers because often, they don’t receive notice that the bankruptcy has been filed and that they need to file a claim by the bar date. One could argue that the customer should be granted a preferred status in a retail bankruptcy, although this is unlikely to happen.

Another more recent but important consideration in retail bankruptcies relates to the treatment of a shopper’s personal information. Customer data can represent significant value to a company, and that data increasingly is viewed by lenders as a realizable asset, the ownership of which can be a contentious matter. Here, great care is needed to ensure customer data is strictly protected; otherwise, it may be compromised through a sale to unintended parties. However, the topic of protecting personal data might be better solved through data privacy laws rather than in the bankruptcy courts.

In an effort to better represent customers’ interests, certain state attorneys general have attempted to file claims and contest other matters on behalf of customers when a retailer goes bankrupt. Although this may prove impractical, it does signal an increasing awareness of the plight of the customer in retail bankruptcies and the potential need for laws to further protect the customer’s personal information.

Lisa Donahue is global leader of the turnaround and restructuring services group at business-advisory firm AlixPartners LLP, and is based in New York.  Follow her on Twitter at @LisaJDonahue