The Examiners: Don’t Disrupt Bankruptcy’s Level Playing Field

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

Customers have become more vocal about their losses in retail bankruptcy cases and have been more willing to take legal action to have their claims heard. The Federal Trade Commission and state attorneys general have also intervened on behalf of consumers either to protect the privacy of customer data or to collect the value of unredeemed gift cards—notably, in the ongoing RadioShack bankruptcy. Customer consternation when a retailer files for bankruptcy is understandable, but the potential losses customers may bear doesn’t justify giving such creditors additional safeguards in the bankruptcy process. The march to protect special interests could disrupt the level playing field the bankruptcy code seeks to establish.

Shoppers are already sufficiently protected in retail cases. Although the automatic stay prevents debtors from accepting gift cards issued prepetition without court approval, bankruptcy courts have allowed debtors to continue to honor customer loyalty programs, including the redemption of gift cards. Accepting gift cards is generally beneficial to a debtor, particularly those attempting to reorganize. Debtors hoping to emerge as a going concern depend on customer goodwill and loyalty. Similarly, attracting customers to stores can help liquidating debtors maximize the value of the estate assets.

However, if gift cards go unredeemed, either because customers don’t use them or because the debtor is unable or unwilling to honor them, the bankruptcy code provides gift-card holders with a mechanism for filing a claim as an unsecured creditor. Gift-card holders may also be entitled to priority claim. While courts are split on the issue and have seldom been called on to resolve it, the FTC and the attorney general currently suing RadioShack on customers’ behalf support priority status for gift-card claims. Some retailers have also acknowledged the possibility that gift-card claims would have priority in bankruptcy, including Sharper Image in 2008 and Borders in 2011. Even if gift-card claims are unsecured (and, as such, creditors may only receive a fraction of their gift cards’ value), a de minimis recovery is unfortunately a risk that many unsecured creditors face. While regrettable, that loss is a function of our bankruptcy system and consumers shouldn’t occupy an even more privileged place in the creditor body.

Customer-loyalty concerns also drive how data privacy issues are handled in retail bankruptcies. The sale of customer data in bankruptcy is not a new practice, but it has become increasingly salient in recent years as the amount of information collected and the ease of storing it has increased. Large-scale data breaches and identity theft have made consumers especially sensitive to how their data is used. However, there are safeguards in place to monitor these sales. A consumer privacy ombudsman is appointed where a sale may violate a debtor’s existing privacy policy, and the FTC has a long history of intervening in customer data sales. Importantly, this intervention has meant that buyers must generally be in the same line of business as the debtor and must abide by the debtor’s (or a similarly rigorous) privacy policy. Data sales are also typically limited to recent customers, and the type of data is often limited to contact information and buying habits, as opposed to social security numbers or financial information. Fundamentally, buyers have an equally strong interest in cultivating customer goodwill and loyalty as reorganizing debtors and, therefore, are incentivized to communicate their privacy policies and provide consumers with ways of opting out of communications.

Some (including the FTC) have proposed opt-in conditions that require either the debtor or the seller to obtain affirmative consent before information can be sold. However, opt-in requirements, particular those with long durations, prevent the buyer from immediately capitalizing on the purchased information and accordingly diminish its value. Buyers are unwilling to spend as much, or anything at all, if the data includes such limits, making it more difficult for debtors to maximize the value of such assets—an integral goal of the bankruptcy process.

Ultimately, a consumer bears some risk in his transactions with a retailer, regardless of whether a company later files for bankruptcy. Gift cards are lost or stolen, and personal and financial information can be illegally hacked from businesses. While retailers and regulators should shape their policies to facilitate transparency in consumer data use and encourage customers to exchange their gift cards for merchandise, customers—like any parties to a commercial transaction—should be aware of the risk of loss at the outset of the transaction. Caveat emptor has been a byword for centuries, and it applies in and outside of a bankruptcy.

Shaunna D. Jones is a partner at Willkie Farr & Gallagher’s business reorganization and restructuring practice. She is based in New York.