March 16, 2017

Delaware Bankruptcy Court: Unredeemed Gift Cards Are Not Entitled to Priority Status

Zachary I. Shapiro – March 16, 2017

Prior to its bankruptcy filing in In re City Sports, Inc., No. 15-12054 (KG) (Bankr. D. Del. Aug. 4, 2016), City Sports, Inc., a Boston-based sporting goods retailer, sold prepaid gift cards for use at its retail locations. As of the petition date, gift cards with unredeemed balances totaled about $1.4 million. Pursuant to relief granted by the bankruptcy court, gift cards were honored at City Sports’ retail locations for the first 30 days of the bankruptcy case but not thereafter. At the time City Sports stopped honoring gift cards, unredeemed gift cards totaled about $1.1 million. The Commonwealth of Massachusetts timely filed a claim of up to $1,182,668 on account of unredeemed gift cards, seeking priority status under Bankruptcy Code section 507(a)(7) for that amount. City Sports objected to the claim, arguing that the entirety of the claim should be treated as a nonpriority, general unsecured claim. The bankruptcy court’s decision in City Sports addressed the merits of the objection.

Gift Cards Are Not “Deposits”
The bankruptcy court began its analysis by examining the plain language of the statute and, specifically, the meaning of the term “deposit.” Bankruptcy Code section 507(a)(7) affords priority status to

allowed unsecured claims of individuals, to the extent of $2,850 for each such individual, arising from the deposit, before the commencement of the case, of money in connection with the purchase, lease, or rental of property, or the purchase of services, for the personal, family, or household use of such individuals, that were not delivered or provided.

The bankruptcy court noted that the Bankruptcy Code does not define the term “deposit.” For that reason, to discern its meaning, the court looked to the ordinary meaning of the word and, after doing so, concluded that in order for a payment to be a deposit, there must be a temporal relationship between when payment for the goods was made and the right to use or possess the goods is vested in the individual who made the payment. The court further reasoned that, by using this analysis, one can discern a distinction between consideration tendered as a “true” deposit (i.e., an incomplete transaction in which the consumer is not provided with the goods and is not entitled to use or possess the goods) and a mere payment for goods. According to the court, a gift card transaction is complete upon payment because the benefit of the consumer’s bargain is immediately conferred upon the receipt of a gift card. In other words, when a consumer purchases a gift card, the transaction is complete as soon as the gift card is issued; thus the payment made to acquire a gift card is not a “deposit” within the meaning of Bankruptcy Code section 507(a)(7) and therefore not entitled to priority treatment under that section.

It is important to note that the bankruptcy court in City Sports disagreed with the bankruptcy court’s reasoning in In re WW Warehouse, Inc., No. 03-13655 (JBR) (Aug. 5, 2004), which held that gift cards satisfied the necessary temporal relationship to be a “deposit” because the purchase of a gift card requires the performance of an additional step (i.e., the use of the card to purchase merchandise). On this point, in deciding In re City Sports, Judge Gross disagreed with Judge Rosenthal (who wrote the opinion in WW Warehouse while acting as a visiting bankruptcy judge in the District of Delaware) because, in his view, the focus should be limited to the transaction in which the gift card was purchased and not the ultimate purchase of merchandise using the gift card, which would potentially result in an unlimited temporal extension.

Support in the Legislative History
After concluding that the purchase of a gift card is not a “deposit” within the meaning of Bankruptcy Code section 507(a)(7), Judge Gross examined the legislative history of the section to determine whether it supported this conclusion. The court’s analysis found support in the legislative history for the conclusion because, in its view, “Congress considered the plight of gift card holders in the context of retailer bankruptcy and decided not to afford such consumers priority status under 507(a)(7).”

Significance of the Decision
At the time City Sports filed its objection to the claim—while there were several conflicting decisions in other jurisdictions, including decisions addressing the priority status of money orders, store credits, and a deposit made toward the purchase of a swimming pool—WW Warehouse was the only written opinion in the District of Delaware on the issue of whether gifts cards were entitled to priority treatment under Bankruptcy Code section 507(a)(7), although Delaware Bankruptcy Judge Shannon had stated at a hearing in another case that he believed that gift cards were not entitled to priority status. See Transcript of July 22, 2015, Hearing at 29, In re RadioShack, No. 15-01097 (BLS). In fact, when City Sports filed its objection to the claim, it cited this hearing transcript as a basis to reclassify the claim. As a result of Judge Gross’s decision in City Sports, at least two of the six bankruptcy judges in the District of Delaware are of the view that unredeemed gift cards are not entitled to priority status under Bankruptcy Code section 507(a)(7), with the balance of the judges not having expressed a view on the topic to date.                                                                                      

The implications of this decision should be considered by retailers considering filing for bankruptcy and creditors holding claims against retailers that are in bankruptcy or financial distress. For a retailer with significant gift card liabilities that is considering liquidating its assets in Chapter 11, this decision may allow that retailer to more easily confirm a Chapter 11 plan because any gift card liabilities will be treated as general unsecured claims rather than priority claims, which must be paid in full (up to the statutory cap) pursuant to the Bankruptcy Code. For any retailers that are considering reorganizing their business in Chapter 11, this decision may have little impact because it is likely that they will seek (and obtain) authorization to honor and pay any gift card liabilities to ensure that they maintain valuable customer loyalty.

Zachary I. Shapiro – March 16, 2017