Gift Cards Sold in Bankruptcy Must Have Adequate Protection

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By Diane Davis

A North Carolina spa owner may continue to sell gift cards in Chapter 11, but must place 85 percent of sale proceeds in a separate account until the cards are redeemed, the U.S. Bankruptcy Court for the Eastern District of North Carolina held Feb. 3 ( In re Skin Sense, Inc. , 2017 BL 33767, Bankr. E.D.N.C., No. 16-05626-5-JNC, 2/3/17 ).“The need for adequate protection in the form of a segregated bank account is the price required of the Debtor if it wishes to continue the sale of gift cards while in (C)hapter 11" to protect the value of the card holder’s interest in property used by the debtor, Judge Joseph N. Callaway wrote.

While case law on the treatment of post-petition gift card claims is lacking, segregation of post-petition gift card proceeds is an appropriate measure of adequate protection and doesn’t impose an “excessive burden” on the debtor, the court said. Post-petition gift card purchasers are “unknowingly post-petition debtor-in-possession lenders,” which amounts to an unsecured loan premised on a promise that the purchasers will one day receive goods or services for their cash spent now, the court said.

Debtor Skin Sense, Inc. provides beauty and spa treatments and services at two locations in North Carolina.

Before filing Chapter 11, Skin Sense sold gift cards that could be redeemed for services or beauty products. Upon the sale of a gift card pre-petition, the company would deposit all sale proceeds into its general operating account without regard to when or if the promised services would or could be performed, the court said. As a result, unearned funds would be commingled with money generated by all non-gift-card sales.

After filing Chapter 11, the court ordered segregation of all post-petition gift card proceeds into a separate debtor-in-possession account to secure the possible administrative claims of post-petition gift card purchasers, if services couldn’t be performed.

Later, Skin Sense asked the court if it could get immediate access to all of the card proceeds. The debtor testified that historically, 15 percent of gift cards are never redeemed—the breakage rate. Skin Sense wanted to give alternative adequate protection to post-petition gift card holders in the form of a lower priority lien on its commercial real estate rather than in the segregated debtor-in-possession account.

The debtor failed to explain how the proposed substitution was equitable or justifiable, and a junior lien to post-petition lenders with no notice and no representation fails to adequately protect the holders of unredeemed gift cards sold after the bankruptcy case filing date, the court said. Chapter 11 protects companies from creditors while they seek to reorganize their debt or liquidate under a plan that must be approved by the court. The Law Offices of Oliver & Cheek, PLLC, represented Skin Sense, Inc.

To contact the reporter on this story: Diane Davis in Washington at DDavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at JHorowitz@bna.com

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