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Analysis Regarding Gift Cards and Bankruptcy and Gift Cards as Loans vs.

Tangible
Property in California, and Including Analysis of Federal Preemption of State Gift Card
Laws

1. Gift Cards, Chapter 11 Bankruptcy and Federal Preemption

In the most recent case of a bankruptcy where the company had outstanding gift cards, In
re TSIC, Inc. f/k/a Sharper Image Corporation, --- B.R. ----, 2008 WL 3845378 (Bkrtcy. D.Del.
2008) (“the Sharper Image bankruptcy case”), the method by which gift card holders had any
right of recovery was outlined.

The Bankruptcy Code creates a hierarchy of claims enforced by adherence to what is


referred to as the “absolute priority rule,” and codified as part of the “fair and equitable”
requirement of 11 U.S.C § 1129. The priority scheme applies to both chapter 7 and chapter 11
cases. See 11 U.S.C. §§ 507 (describing Code priorities), 726 (explaining distribution hierarchy
in chapter 7), and 1129(a)(9) (detailing how priority claims are handled under a chapter 11). In a
chapter 11 plan, unless the senior creditors agree otherwise, priority claims must be satisfied in
full before junior claims are entitled to any distribution from the debtor's estate. 11 U.S.C. §
1129(b)(2)(B).

In general priority claims are those from secured creditors. See supra. However, “gift
card” holders, although not explicitly addressed by the bankruptcy court, are unsecured creditors,
because “gift card” holders hold no security interest as a part of “gift card” ownership. See
supra.

Thus, among the list of the company’s creditors, gift card holders are unsecured creditors
and according to the way the bankruptcy process works, unsecured creditors are very low in
priority when it comes to the order by which creditors are paid and recovery of any gift card
interest is very unlikely. Id.

However, in general, the bankrupt company has a duty to issue instructions to gift card
and certificate holders, as creditors, to file a claim against the company’s bankruptcy estate. Id.

One interesting and confusing fact is that some states (such as California with Cal. Civil
Code § 1749.5) have laws that require gift card issuers to continue to accept gift cards that were
issued before the bankruptcy was filed. But it appears that with both The Bombay Company and
the Sharper Image bankruptcies, federal law took precedence over state law and therefore any
California law or other state law that a gift card was still valid after a bankruptcy is preempted by
federal bankruptcy law and null and void. Id.

That is, although California has a law that require gift card issuers to accept gift cards
that were issued before the bankruptcy was filed (the Cal. Civil Code § 1749.5 provision that gift
cards cannot have expiration dates), Cal. Civil Code § 1749.5 was preempted and rendered
meaningless by action of federal bankruptcy law in the Sharper Image Bankruptcy Case, as one
example. See supra. This is because when a conflict exists between state and federal law,
federal law always preempts state law. Id.

2. Gift Cards v. Merchandise Cards in California

The California legislature has explicitly addressed and defined “gift cards” in Cal.Civ.Code §
1749.5 that statute provides:

§ 1749.5. Prohibited transactions; redemption or replacement; expiration dates; application of


section; full refund.

(a) It is unlawful for any person or entity to sell a gift certificate to a purchaser that contains any
of the following:
(1) An expiration date.
(2) A service fee, including, but not limited to, a service fee for dormancy, except as provided in
subdivision (e).
(b)(1) Any gift certificate sold after January 1, 1997, is redeemable in cash for its cash value, or
subject to replacement with a new gift certificate at no cost to the purchaser or holder.
(2) Notwithstanding paragraph (1), any gift certificate with a cash value of less than ten dollars
($10) is redeemable in cash for its cash value.
(c) A gift certificate sold without an expiration date is valid until redeemed or replaced.
(d) This section does not apply to any of the following gift certificates issued on or after January
1, 1998, provided the expiration date appears in capital letters in at least 10-point font on the
front of the gift certificate:
(1) Gift certificates that are distributed by the issuer to a consumer pursuant to an awards,
loyalty, or promotional program without any money or other thing of value being given in
exchange for the gift certificate by the consumer.
(2) Gift certificates that are donated or sold below face value at a volume discount to employers
or to nonprofit and charitable organizations for fundraising purposes if the expiration date on
those gift certificates is not more than 30 days after the date of sale.
(3) Gift certificates that are issued for perishable food products.
(e) Paragraph (2) of subdivision (a) does not apply to a dormancy fee on a gift card that meets all
of the following criteria:
(1) The remaining value of the gift card is five dollars ($5) or less each time the fee is assessed.
(2) The fee does not exceed one dollar ($1) per month.
(3) There has been no activity on the gift card for 24 consecutive months, including, but not
limited to, purchases, the adding of value, or balance inquiries.
(4) The holder may reload or add value to the gift card.
(5) A statement is printed on the gift card in at least 10-point font stating the amount of the fee,
how often the fee will occur, that the fee is triggered by inactivity of the gift card, and at what
point the fee will be charged. The statement may appear on the front or back of the gift card, but
shall appear in a location where it is visible to any purchaser prior to the purchase thereof.
(f) An issuer of gift certificates may accept funds from one or more contributors toward the
purchase of a gift certificate intended to be a gift for a recipient, provided that each contributor is
provided with a full refund of the amount that he or she paid toward the purchase of the gift
certificate upon the occurrence of all of the following:
(1) The funds are contributed for the purpose of being redeemed by the recipient by purchasing a
gift certificate.
(2) The time in which the recipient may redeem the funds by purchasing a gift certificate is
clearly disclosed in writing to the contributors and the recipient.
(3) The recipient does not redeem the funds within the time described in paragraph (2).
(g) The changes made to this section by the act adding this subdivision shall apply only to gift
certificates issued on or after January 1, 2004.
(h) For purposes of this section, “cash” includes, but is not limited to, currency or check. If
accepted by both parties, an electronic funds transfer or an application of the balance to a
subscriber's wireless telecommunications account is permissible.

Cal.Civ.Code § 1749.5.

a. Food products

A gift certificate for a restaurant meal does not constitute a food product, accordingly, the
exemption for “food products” under Civil Code § 1749.5, does not apply and gift certificates
sold by restaurants may not contain an expiration date. Op.Atty.Gen. No. 00-701 (Oct. 23, 2000),
2000 WL 1606571.

b. Expiration date
In one case, a store's policy of charging, against the outstanding balance of store's
shopping cards, a monthly service fee of one dollar if the card was not used within 24 months did
not constitute an “expiration date,” within meaning of the statute making it unlawful to sell a gift
certificate with an expiration date. In interpreting Cal. Civil Code § 1749.5 to the situation, the
court reasoned there was no predetermined expiration date, and even if there was a zero balance
because of deductions for service fees, cardholders could add money to balance and continue
using the card, if the card account had not been canceled. Freeman v. Wal-Mart Stores, Inc., 3
Cal.Rptr.3d 860, 111 Cal.App.4th 660 (Cal. App. 2003), review denied.

3. Legislative Purpose for Enacting Cal. Civil Code § 1749.5

Civil Code section 1749.5 was enacted to address a specific problem: the practice of
refusing to honor gift certificates that had expired. This practice had been the subject of a class
action suit brought against 18 large retailers. That suit settled out of court in 1995, with the result
that the retailers agreed to add language to their gift certificates stating that the certificates would
be honored after any expiration. Jan Goldsmith, a member of the Assembly, then introduced
legislation, in the form of Assembly Bill No. 2466 (1995-1996 Reg. Sess.), seeking to apply a
unified law to all who issued gift certificates whether or not the issuer was subject to the
settlement agreement. (Assem. Com. on Banking and Finance, Analysis of Assem. Bill No. 2466
(1995-1996 Reg. Sess.) Apr. 22, 1996.) The argument made in favor of the bill was that “[g]ift-
givers do not expect their gifts to expire. The retailer has already received payment for the value
of the certificate. Thus, expired gift certificates dash the expectation of gift-givers and constitute
an unfair windfall to retailers.” Sen. Jud. Com., Analysis of Assem. Bill No. 2466, comment, p.
4.

As the Legislature also recognized, it was not quite accurate to claim that retailers
received a windfall as a result of expired gift certificates, as under Code of Civil Procedure
section 1520 as it existed then, the value of unclaimed gift certificates was to be paid to the State
Controller after three years. Sen. Jud. Com., Analysis of Assem. Bill No. 2466, comment, pp. 4-
5; Assem. Com. on Banking and Finance, Analysis of Assem. Bill No. 2466 (1995-1996 Reg.
Sess.) Apr. 22, 1996.

4. Cases Interpreting Cal. Civil Code § 1749.5


In Waul v. Circuit City Stores, Inc., Not Reported in Cal.Rptr.3d, 2004 WL 1535825
(Cal. App. 2004), the court stated, “Civil Code section 1749.5, accordingly, speaks to gift
certificates, including gift certificates in the form of gift cards. In light of the section's language,
and the problem addressed by the settlement leading to the enactment of the section, it is clear
that the section contemplates a “gift”; i.e., a certificate or card purchased or obtained by someone
for the purpose of giving it to someone else. Circuit City's merchandise cards, although similar to
gift cards in that they represent money that can be spent on items at Circuit City's stores, and at
least in theory vulnerable to some of the same abuses as gift cards, are not purchased or obtained
as gifts. They are provided by the store as a “bonus” to a qualifying customer, much in the way
that a seller could provide the customer with an additional “bonus product” with a qualifying
purchase. Although a particular customer might choose to give the product or the card as a gift to
someone else, the store does not provide the item or card for the purposes of gift-giving by the
customer.

The Waul court further stated, “We see no reason to assume that the Legislature intended
Civil Code section 1749.5 to extend to a merchandise card distributed by a retailer to a customer
as a kind of bonus offer for making a particular purchase merely because it might expire before
the customer acted on the offer. In short, while Circuit City's operations with respect to its
merchandise cards may or may not be an unfair business practice, those operations do not fall
within the purview of Civil Code section 1749.5.” Id.
Thus, merchandise cards received as a bonus offer for making a particular purchase are
not considered “gift cards” under Cal. Civil Code § 1749.5 and are not subject to that section’s
prohibition on expirations for “gift cards.” Id. As such, a legal analysis of “merchandise cards”
reveals that they are effectively an open contract with a condition precedent. Thus,
“merchandise cards” have no legal or property value until the “bonus offer” attached as the
condition precedent is activated by making the particular purchase and the merchandise card
thereby becomes a contractual interest to enforce the value of the “merchandise card.” See
supra.

However, interpreting Cal. Civil Code § 1749.5, the possession of a gift card is a tangible
property interest, without expiration, and not a loan. See Cal. Civil Code § 1749.5. The
language of the statute expressly creates a tangible property right, with a fixed value and without
expiration, in a “gift card.” Id.

5. Gift Cards and Federal Preemption

However, the debate regarding characterization of “gift cards” continues. In SPGGC,


LLC v. Ayotte, 443 F.Supp.2d 197 (D.N.H. 2006), a gift cards merchandiser brought a
preemptive action against the New Hampshire state Attorney General, seeking a declaratory
judgment from AG that the that cards did not violate state's regulatory requirements. The
banking entities that actually owned and issued the cards intervened and together, the plaintiffs
brought a motion for summary judgment. Id.

Again, federal preemption of a state consumer protection statute was at issue. Plaintiffs
sought a declaratory judgment that the gift cards did not violate New Hampshire’s Consumer
Protection Act. The court stated that, “[the][ National Bank Act preempted the limitations that
the New Hampshire Consumer Protection Act (CPA) would have imposed on a fee structure of
stored value gift cards which had been promoted and sold by agent for federally chartered bank,
because federal regulations authorized the bank to issue stored value cards, and implicit in that
grant of authority was incidental power, subject to applicable federal consumer protection laws,
to establish conditions under which those cards were issued and employed. The bank was thus
authorized to use third parties to carry on business of banking, and agent's involvement did not
alter substantial relationship between consumer and bank. 12 U.S.C.A. § 24; 12 C.F.R. §
7.5002(a)(3); RSA 358-A:1 et seq.” Id.

Thus, stored gift cards issued by banks, as banks are defined in the federal National Bank
Act, are allowed by the federal statute and any state law prohibiting such cards is preempted and
rendered null and void by the federal statute. Id.

The court further found that, “[the] Home Owners' Loan Act preempted limitations that
the New Hampshire Consumer Protection Act (CPA) would have imposed on the fee structure of
stored value gift cards which had been promoted and sold by agent for federal savings
association, since federal regulations authorized association to issue stored value cards, and
implicit in that grant of authority was incidental power, subject to applicable federal consumer
protection laws, to establish conditions under which those cards were issued and employed,
association was authorized to use third parties to carry on business of banking, and agent's
involvement did not alter substantial relationship between consumer and association. 12
U.S.C.A. § 1461 et seq; 12 C.F.R. § 555.200(a); RSA 358-A:1 et seq.” Id.

The court thus found that both the federal National Bank Act and the federal Home
Owners’ Loan Act preempted the any New Hampshire consumer protection statute that would
limit the ability of banks to issue “gift cards.” Id.

In a similar case, with the same plaintiff but in Connecticut, the Second Circuit Court of
Appeals applied a different analysis, based on the relationship between the bank and the
company administering the gift cards at issue.

In SPGGC, LLC v. Blumenthal, 505 F.3d 183 (2007), the plaintiff, a seller of pre-paid
gift cards (and the same plaintiff in the New Hampshire case), sued to prevent the Connecticut
Attorney General from enforcing a state consumer protection law that regulates the terms and
conditions of gift cards provided by the plaintiff. Id. In this case, the plaintiff sold gift cards
issued by Bank of America, a national bank. Id. Although Bank of America was the issuer of
the Simon Giftcard (the Bank of America gift card offered by the plaintiff), the plaintiff bore the
costs of administering the program and also collected and retained maintenance and other fees
associated with the cards. Id.

The court noted that “[w]hile [Bank of America] had review and approval authority over
any terms and conditions the gift cards carried,” it was not clear whether it had the authority to
establish such terms in the conditions in the first instance, as that power belonged to SPGGC.”
Id.

As in New Hampshire, Connecticut had a statute that prohibited the sale of gift cards that
contained expiration dates or certain fees. Id. Because the plaintiff’s gift cards contained these
fees and expiration dates, the Connecticut Attorney General threatened to bring an enforcement
action against the plaintiff for violating the Connecticut Gift Card Law. Id. The plaintiff filed an
action in federal court seeking a declaratory judgment that the proposed enforcement action was
preempted by the federal National Bank Act. Id. The district court granted the Attorney
General's motion to dismiss. In so doing, the district court rejected any analogy between the
plaintiff and an operating subsidiary. Instead, the district court found that the plaintiff had a
close agency relationship with Bank of America but that the relationship was insufficient to
entitle the plaintiff to protection under the federal National Bank Act. Id.
On appeal, the Second Circuit affirmed in part and reversed in part the district court's
ruling. According to the Second Circuit Court of Appeals, it was “beyond genuine dispute that
national banks have the authority under federal law to develop and market gift cards.” Id. The
court also noted that the Connecticut Gift Card Law would be preempted if applied to a national
bank or the operating subsidiary of a national bank but that “[plaintiff] is neither a national bank
nor the operating subsidiary of a national bank.” Id. The court of appeals agreed with the
plaintiff and the Connecticut Office of Consumer Complaints on the issue that “the district
court's preemption analysis should have focused less on the identity of the plaintiff than on
whether and to what extent the Simon Giftcard represented an exercise of [Bank of America's]
powers as a national bank.” Id.
The court ultimately held that the plaintiff failed to state a valid preemption claim
regarding the Connecticut Gift Card Law's prohibition of gift card fees. Id. The court also held,
however, that the plaintiff stated a valid preemption claim insofar as the Connecticut Gift Card
Law prohibited expiration dates on gift cards. Id.
Thus, in summary, the Second Circuit found that the Connecticut Gift Card Law was
applicable and not preempted by federal National Bank Act regarding gift card fees but that the
Connecticut Gift Card Law was preempted by the federal National Bank Act regarding
expiration dates on gift cards.

Final Analysis

In states with similar statutes to California’s Civil Code § 1749.5 such as those in New
Hampshire and Connecticut discussed above, the statutes expressly state that gift cards cannot
contain an expiration date. This excludes the possibility that the gift cards could be a loan in
these states, because loans by definition contain expiration and/or due dates. See supra. Thus,
in these states with statutes stating that gift cards cannot have expiration dates, gift cards in these
states are not loans but are a tangible and fixed property interest in the amount of the gift card.

However, despite an extensive search of caselaw in other jurisdictions, no relevant cases


concerning gift cards could be found. In these states without gift card laws, the legal status of
the gift card would ostensibly be determined based on the terms of the gift card. They may be
considered a merchandise card attached to a “bonus offer” and thus essentially a contract with a
condition precedent, which contractual property right does not accrue unless the specific item
attached to the bonus offer is purchased. See supra. Where the gift cards are issued with
expiration dates, a case by case analysis can be applied such that in these cases where there is an
expiration date, the gift card interest is more akin to a loan than a tangible property interest.

Finally, whether a gift card regulated by statute, a merchandise card or gift card with an
expiration date in those jurisdictions that allow such gift cards, if the company that issued the gift
card goes bankrupt under Chapter 11, without plans to reorganize, the holder of the gift card is
relegated to an unsecured creditor. Although the bankrupt company is required to provide gift
card holder creditors with information on how to try to recover some amount in the bankruptcy,
gift card holders are unsecured creditors, and in a Chapter 11 bankruptcy situation, are very
unlikely to receive any kind of meaningful recovery from the gift card. See supra.

Additional pieces of the puzzle on the treatment of retail gift cards are discussed in these cites:
(future research can be tasked upon request).
° Lucas v. Kmart Corp. 234 F.R.D. 688 (D.Colo. 2006) Kmart will establish
a fund (the “Damages Sub-Class Fund”) in the amount of $13,000,000
(consisting of $8,000,000 in cash and $5,000,000 in gift cards redeemable
at face value) from which members of a Damages Sub-Class that plaintiffs
have requested the Court to preliminarily certify for settlement purposes
concurrently with the requested preliminary approval of this settlement are
eligible to recover (Agreement ¶ 15.1.1);

° In re LaBovick 355 B.R. 508 Bkrtcy.W.D.Pa.,2006For purposes of


presumption of nondischargeability applicable to certain consumer debts
for luxury goods or services or cash advances obtained within 60-day
prepetition period, $285.05 gold chain and $171.71 watch bought by
debtor with credit card during 60-day prepetition period would qualify as
luxury goods, as would debtor's purchases of six gift cards totaling
$3,500.00, but debtor's remaining purchases, for items such bed,
cookware, small electrical items, clothing, bedding, and rug, would not. 11
U.S.C.(2000 Ed.) § 523(a)(2)(C).

° In re Tripp 357 B.R. 544 (Bkrtcy.D.Ariz. 2006) Creditor seeking to except


debt from discharge as one for money obtained by debtor's “false
pretenses, false representation, or actual fraud” bears burden of proof on
all elements of such a nondischargeability claim under 11 U.S.C.A. §
523(a)(2)(A): Customer to whom Chapter 7 debtor had promised to
provide gift cards from major retailer at 20% off their face value of
$15,000, but to whom he failed to provide such cards after receipt of
customer's $12,000 payment, failed to satisfy burden of showing that
debtor's false representation was made with fraudulent intent.
° Young v. Polo Retail, LLC Slip Copy, 2007 WL 951821 (N.D.Cal. 2007)
Gift cards as part of a class action settlement figure.
° Muro v. Target Corp. 250 F.R.D. 350 (N.D.Ill. 2007) Class consisting of
major retailer’s gift card customers were sent unsolicited credit cards.
° In re Fortunoff Fine Jewelry and Silverware, LLC Slip Copy, 2008 WL
618986 (Bkrtcy.S.D.N.Y. 2008) Gift cards were listed as a category of
“assumed liability” upon a Debtor’s Motion for Entry of an Order
approving Bid Procedures for the Debtors' assets (the “Assets”),
authorizing Debtors to offer certain bid protections and scheduling a final
sale hearing and approving form and manner of notice.
Section 1.02. Assets and Liabilities.

(a) Acquired Assets

(b) Excluded Assets

(c) Assumed Liabilities

For purposes of this Agreement, “ Assumed Liabilities ”


means (i) all Liabilities of the Sellers that are required to be
performed, and that accrue, on or after the Closing Date
under the Assumed Contracts (but excluding any Liabilities
of the Sellers in respect of a breach by any Seller of, or
default by any Seller under, such Assumed Contracts prior
to the Closing Date), to the extent such Assumed Contracts,
and all rights of the Sellers thereunder, are effectively
assigned to Buyer at the Closing; (ii) all Cure Amounts in
respect of the Assumed Contracts; (iii) liabilities for gift
cards, merchandise credits and deposits set forth on the
Balance Sheet, or incurred in the ordinary course of
business after the date of the Balance Sheet, in each case to
the extent identified in Schedule 1.02(c), which schedule
shall be updated by the Sellers at Closing (“ Assumed Gift
Cards, Merchandise Credits and Deposits Liabilities ”),
provided that such liabilities incurred prior to January 1,
2003 shall not constitute Assumed Gift Cards, Merchandise
Credits or Deposit Liabilities; (iv) liabilities assumed by
Buyer pursuant to Section 5.10(c) and 5.10(f) or for which
Buyer is liable pursuant to Section 1.08.

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