Gift cards may leave recipients unfulfilled

On Wall Street, lawmakers are talking about how "toxic debt" threatens banks and lending. Out on Main Street, shoppers better start thinking about "toxic" gift cards from companies that could go bankrupt. They won't be worth the plastic they are printed on.

There's a new realization that holding a gift card from a troubled retailer is like having a bank account without FDIC insurance.

It's not an idle worry.

Shoppers spent an estimated $26.3 billion on gift cards at retailers last Christmas season, compared with $24.8 billion in 2006 and $18.5 billion in 2005, according to the National Retail Federation.

"I am very wary of gift cards this year and do not plan to use any of them at all during the holiday season. I simply do not trust the companies unless they put on a label saying that they are fully returnable at face value," said Dr. Richard Glassock of Laguna Niguel, Calif.

Already some big retailers, including Sharper Image and Bombay Co., have filed for bankruptcy protection, leaving gift-card holders with millions of dollars of what the Bankruptcy Court considers unsecured debt. Both stores have since closed.

Circuit City, the consumer-electronics chain that filed this year's biggest retail bankruptcy on Monday, said its stores will honor its gift cards and warranty programs through its reorganization.

Consumers Union said that when Sharper Image filed for bankruptcy protection this year, it left an estimated $20 million on unused gift cards and maybe as much as $40 million when merchandise certificates and related promotional cards were included. At first Sharper Image said it would not honor the credits. Later it successfully petitioned the court to allow it to accept gift cards if consumers spent twice the value of the gift card on a single transaction.

"That wasn't such a good deal, and who knows if anybody used their cards that way," said Anthony Giorgianni, associate editor of Consumer Reports, which is published by Consumers Union.

In August, home-furnishing retailer Bombay Co., which closed 388 stores, won approval from a U.S. bankruptcy judge to pay off gift-card holders 25 cents on the dollar.

Gift-card holders could lose more than $75 million just from store and restaurant closings in 2008, said Brian Riley, senior analyst at Tower Group, a consulting company.

"The only way that number will change is up," Riley said.

Consumer groups are worried about how little shoppers are protected when spending all that money. In September, a coalition of organizations asked the Federal Trade Commission to protect shoppers from losing money on gift cards when retailers file for bankruptcy protection.

It said retailers should be required to place money from gift-card sales in a trust account that would be used to honor the cards if the merchants continued operations under the protection of the Bankruptcy Court. Consumers Union, Consumers Federation of America, National Consumer Law Center and the advocacy group U.S. PIRG are all behind the proposal.

FTC spokesman Mitchell Katz said the agency had received the petition "and we are determining what our response will be."

Unless the federal government steps in and regulates the industry, shoppers will lose the value of their gift cards when a merchant files for bankruptcy. The company can petition the court to allow it to continue to accept its gift cards, but the bankruptcy judge has the option to reject such a petition, which would leave the cards worthless, Giorgianni said. In those instances the only recourse for shoppers is to file a claim along with other creditors.

In cases in which a company is reorganized or sold and remains a continuing business, most owners will receive court authority to honor the cards as a way to maintain goodwill with consumers and drive customer traffic, said Marty Zohn, a bankruptcy attorney with Proskauer Rose in Los Angeles.

But in outright liquidations, in which the stores are closed, shoppers will be out of luck in most cases, he said.

State laws have proved ineffective in protecting gift-card holders in bankruptcies, said Giorgianni of Consumer Reports.

That's why Consumers Union is recommending that people avoid giving gift cards this Christmas season.

"If you don't know what gift to buy, just give cash," he said. "It's something that never expires."

Information about Circuit City provided by Bloomberg News.