Monday, April 14, 2014

Danger on the Horizon: Gift Card Companies and Unclaimed Property Laws

There are approximately twenty states that require issuers and holders of gift cards to pay to their state treasury the balances of any unredeemed gift cards, which is otherwise known as “breakage.” (For purposes of this article, I refer to gift cards in the broad sense, including gift certificates, gift cards, and stored value cards). The larger states—New York, New Jersey, Massachusetts, and Delaware—provide, however, for the escheat of gift cards. (Technically the required payment of unredeemed gift card balances is based on unclaimed property or abandoned property laws rather than escheat, but the underlying principles of the state taking funds on behalf of its citizens are the same). A majority of state unclaimed property laws do not escheat unredeemed gift card balances.

For legitimate business reasons with the result of reducing payment of breakage, many retailers with gift card programs have entered into agreements with third parties such as Card Compliant in which the third party forms a special purpose gift card entity to issue the gift cards. Other retailers, without use of a third party, have set up their own gift card subsidiaries to issue their gift cards. The gift card companies are formed in states such as Ohio or Florida, which do not require the payment of breakage to the states. Under the priority rules established by a line of U.S. Supreme Court decisions and embodied in the various state unclaimed property statutes, if the records of the holder (i.e. issuer) of the gift card do not identify the last known address of the owner of the gift card, then the state for payment of the unredeemed gift card balances is the state of incorporation of the holder. Thus, since the gift card company is incorporated in a state with favorable laws regarding gift cards, and because the gift card companies do not maintain the addresses of the owners of the gift cards, the gift card company (and the retailer, which is not the holder) are not liable for payment of breakage. In other words, the theory is that the states with laws that require the escheat of gift cards—even if it is the state of incorporation of the retailer— cannot enforce its laws to require payment of the breakage against either the retailer or the gift card company.

The theory has now run up against the reality of a qui tam suit brought by a noted plaintiff’s securities fraud law firm on behalf of the State of Delaware and a relator (the individual who sues on behalf of the state in a qui tam suit) against Card Compliant, its special purpose gift card entities, and various retailers that caused their gift cards to be issued by these Card Compliant entities. In a 112 page complaint filed by Relator French, a former executive of Card Compliant, the plaintiffs describe in detail the formation of the gift card companies by Card Compliant and more than 20 retailers incorporated in Delaware. The complaint describes in detail the contractual arrangements between each retailer and the Card Compliant subsidiary and alleges that these arrangements and the creation of the Card Compliant entities are a sham and a scheme “to deprive the State of Delaware of hundreds of millions of dollars due to the State under the Abandoned Property Law.” The suit alleges that the Card Compliant entities are mere shell companies. Plaintiffs seek treble damages, forfeitures, and civil penalties as well as the law firm’s attorneys’ fees and costs, under the Delaware False Claims and Reporting Act. 6 Del. C. Sections 1201, et seq. The Relator seeks the payment of a bounty, termed the “relator’s share” of the award.

The suit was filed under seal in Delaware Superior Court in New Castle County on June 28, 2013. The Complaint was made public on March 26, 2014. None of the Defendants have yet to file answers. It is thus too early to determine the strength of the Relator’s claims. The suit should, however, raise alarm bells for any retailer that causes its gift cards to be issued through a special purpose entity. To my knowledge, this is the first proceeding by or on behalf of any state to challenge the gift card company structure.

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