Gift Card Creditors

Last February, REDgroup in Australia entered into voluntary administration after finding it difficult to pay off debts. Owning the Borders and Angus & Robertson bookstore chains in Australia, the administrators demanded that gift cards issued by these stores only pay for half the cost of purchases; the remaining half would have to come out of the customer's pocket.

As customers are accustomed to gift cards' applying to the full cost of a purchase, this caused quite an uproar, with sales staff being abused despite no fault of their own. However, this gesture may well have been a generous one considering how liquidation works, for gift card holders are creditors to the issuing business.

Gift cards are debt
The Framework for the Preparation and Presentation of Financial Statements (AASB) concisely defines a liability as:

...a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

When a business issues a valid gift card, it incurs a liability because:

• It issued the gift card in exchange for payment
• It promised to redeem the value of the gift card as part of a purchase (subject to expiry dates and other conditions)
• Such a purchase results in the sale of inventory, of which the business uses up the economic benefit of generating revenue

As long as the gift card stays valid, the gift card holder can legally call themself a creditor to the issuing business, with which comes the benefit of a share in the business' assets (a feature of any debt instrument). As long as the business stays solvent (that is, it can pay off its debts as they fall due), the gift card holder can only claim assets as part of a purchase. However, once the business becomes insolvent, as in the case of Borders and most Angus & Robertson bookstores, where the money comes from ceases to matter.

The liquidation pecking order
If a company becomes insolvent, the creditors can exercise their right to take control of the business away from management and the shareholders. In the case of REDgroup and its Borders and Angus & Robertson stores, it is under voluntary administration, where administrators appointed by the creditors attempt to rescue the failing business. If gift card holders hold on to their debt and the business manages to recover, they are again entitled to the full discounting power of their gift cards.

Of course, there is the chance that the business is beyond saving, in which case it must be wound up and the assets liquidated. There then arises an order in which the creditors to the business are paid:

1. Liquidator for their services (otherwise they will refuse to conduct the liquidation!)
2. Court that ordered liquidation for their services, if any
3. Administrators for their services (otherwise they will refuse to administrate!)
4. Court that ordered winding up for their services, if any (the government has the power to, after all)
5. Employees for their services (otherwise they will refuse to work up until the liquidation!)
6. Secured creditors for their debt (who have rights to 'foreclose on' specific assets; if they claim their security before the process starts, they are first priority)
7. Other unsecured creditors for their goods/services/money (includes suppliers and gift card holders)
8. Shareholders (who ultimately claim any surplus assets, as they were entitled to surplus revenue (profits) during any period of solvency)

Given the risk that REDgroup can face liquidation, it becomes apparent that the rest of the creditors were being very generous to the gift card holders! Under the 50% discount scheme, gift card holders had (during voluntary administration) first claim to the assets, above employees, secured creditors and even the liquidator. However, should they refuse to take advantage of that scheme and REDgroup does in fact fall into liquidation, they fall very low in the pecking order.

A final dilemma arises: claim gift cards at 50% discount now, or hold on to them and bet on recovery? That decision would have been made by 3 April. Those doing the latter must now sit and wait...

Bibliography

• Australian Accounting Standards Board (2009), Framework for the Preparation and Presentation of Financial Statements, Australian Accounting Standards Board, Melbourne, Victoria, viewed 21 April 2011, <http://www.aasb.gov.au/admin/file/content105/c9/Framework_07-04_COMPdec07_01-09.pdf>.
• Corporations Act 2001 (Cth).
• Harris, Jason, Hargovan, Anil, Adams, Michael (2009), Australian Corporate Law, 2nd edn, LexisNexis Butterworths, Chatswood, NSW.
• Zappone, Chris (2011), 'Double trouble for holders of Borders' gift vouchers', The Sydney Morning Herald, 18 February, viewed 20 April 2011, <http://www.smh.com.au/business/double-trouble-for-holders-of-borders-gift-vouchers-20110218-1ayth.html>.

EDIT 02Jun11: Amended liquidation pecking order to clarify position of secured creditors.