The Examiners: Responsibility Lies With Consumers

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

Many sectors go through cycles of restructurings and bankruptcies, but retail has consistently been a troubled sector that draws the watchful eye of lenders, trade creditors and restructuring professionals. The ever-changing tastes of consumers, technology and macroeconomic factors that drag on consumer spending and confidence are among the factors that put retailers at higher risk for operational and financial distress. Consumers’ emotions tend to run high when they see their favorite store in a distressed situation, especially if they have a gift card or are part of a loyalty program.

The 2005 amendment to the bankruptcy code gave certain counterparties, specifically trade vendors and landlords, significant leverage and extra protection. These changes shifted the dynamic in retail cases as debtors have potentially more administrative claims and less time to reject leases. However, consumer programs—which include gift cards, return policies and other loyalty programs—have generally fallen under the protection of state attorneys general.

The impact of a retailer bankruptcy or restructuring on consumer programs varies depending on the nature of the case. For example, in a reorganization or sale of a company, it is common for a buyer to assume the full amount of the consumer program liabilities in order to protect the brand and maintain their customers’ loyalty.

It is the instance of a liquidation in which things get a little tricky. Generally, in a liquidation, a third party is brought in to manage the process under an equity or fee arrangement. Through a process that includes competitive bidding, the liquidation firm will guarantee a recovery of the retailer’s inventory, e.g. 107% of the cost value of the inventory. Included in that guarantee will be a provision for customer programs. Generally, pre-petition customer programs are honored for a truncated time during the liquidation, due to economics. If the consumer programs were to be honored for the entire liquidation, the guaranteed recovery would be less, making an impact on the estate. Under this scenario, state attorneys general have become active and have taken positions to better protect consumers by requiring the lengthier honoring of pre-petition customer programs.

In the end, it’s up to consumers to be cognizant of the potential they’ll be affected. They need to understand what asset they have—whether it’s a gift card or benefits of a loyalty program—and exercise it in an adequate amount of time. Consumers holding a gift card or store credit are unsecured creditors and under the bankruptcy code should be treated accordingly.

Perry Mandarino is the U.S. Business Recovery Services leader for PricewaterhouseCoopers, based in New York. Follow him on Twitter @Perrymandarino