Customers of retailers facing bankruptcy often left holding gift cards

RadioShack shoppers with unused gift cards will face the same fate as customers of other recently bankrupt chains that closed down before some consumers could redeem the vouchers.

Just ask La'Keya Keo, a Body Central Corp. customer in York, Pennsylvania, who was holding a $50 card when the apparel chain shuttered in January. By the time she took it in, the store was gone and headquarters wasn't answering the phone.

"I didn't find out until we went there that the store was closed," said Keo, 33, a nurse. "They were still sending out the emails about discounts."

With Body Central, Delia's, Deb Shops and several other retailers announcing plans to close their doors in recent months, gift-card holders are learning they have to move fast. In the pecking order of who gets paid when a retailer goes belly up, customers are considered unsecured creditors. That means if they don't use their cards while stores are still open, consumers have less protection in a bankruptcy than, say, a bank lender.

Cardholders' claims for payment can't be satisfied until after those of secured creditors are fulfilled. In the meantime, the stores may have liquidated their inventory and left customers with nowhere to spend their card balance.

While retailers often file for Chapter 11 with the intention of re-emerging later, the move is increasingly the first step toward liquidation. That's because companies frequently wait to file until they're loaded up with debt. In that state, retailers have less chance of reorganizing and fewer assets left to pay the people they owe money - including gift- card holders.

Lawrence Gottlieb, a partner at Cooley LLP in New York, said his law firm is seeing fewer retailers bounce back from bankruptcy.

"Our typical Chapter 11 these days, unfortunately, is a liquidation of all or most of the stores," he said.

Since the end of last year, retailers representing thousands of stores have declared bankruptcy and begun winding down their businesses. RadioShack, the almost-century-old electronics chain, joined the list when it filed on Feb. 5. The company got court approval to honor gift cards for 30 days after that date, meaning customers have to act by the end of the week if they want to use the cards. Deb Shops, a women's clothing retailer that's also going out of business, is accepting its gift cards until March 8.

The mass closings have followed a boom in the use of gift cards. Sales of retailer-branded cards have jumped 37 percent in the past five years, climbing to $41 billion in 2014 from $30 billion in 2009, according to Brian Riley, senior research director at Arlington, Virginia-based CEB. He predicts that the market will reach $48 billion in 2017. For shoppers, they're viewed as being good as cash.

But when there's a bankruptcy, things get complicated.

After a company files, it can ask a judge to approve the honoring of gift cards during going-out-of-business sales. Judges typically agree because they don't want to anger customers or state attorneys general, who have been known to press the issue, Gottlieb said. He said he's not aware of any judges rejecting a request to redeem gift cards.

The liquidation firms that run going-out-of-business sales say honoring the cards creates goodwill that will bring people into the stores and boost their return.

"We want them as part of the sale," said Michael McGrail, chief operating officer at Tiger Group, a Boston-based company that conducts such events. "It's good publicity for the sale."

The sales typically last a few weeks and then the stores close for good. After that, it gets trickier. While retailers are required to notify customers that they can fill out a claim form for the value of the card, most gift cards aren't held by the people who bought them, said Michael Klein, another Cooley lawyer who covers corporate restructuring and bankruptcy.

"They may wake up and find out that they didn't do what they had to do to protect their rights," he said.

Some lawyers have tried to organize class-action lawsuits on behalf of cardholders, arguing that the customers should be near the top of the unsecured creditors' list. But such efforts have had little success, Klein said. He points to a case brought on behalf of Borders Group gift-card holders that was dismissed twice.

Competitors sometimes step in to honor gift cards of defunct retailers to try to win new customers, said Greg Segall, chairman and chief executive officer of Versa Capital Management in Philadelphia. There's no guarantee of that, though.

With more retailers waiting until their assets have dwindled before they file for bankruptcy, there's less money to go around in general, Klein said.

"There's nothing left in the estate to pay any creditor who has a claim out there, and that includes people who hold unredeemed gift cards," he said. "It's a real problem in retail bankruptcies."