Unused Gift Cards: A Ticking Time Bomb?

Gift cards are big business.  One 2012 report put the amount spent on gift cards in the United States at a whopping $110 billion that year, with an estimate that the market will exceed $130 billion by 2015.  To a merchant, the benefits are obvious: immediate cashflow and a compelling reason for the consumer (or, more likely, the consumer's giftee) to return to your store.  But because of unclaimed property laws throughout the country – known as escheat laws – unused gift cards can become a source of liability that can result in large penalties for the unsuspecting retailer.

Escheat laws are the laws governing unclaimed property.  At their core, these laws spell out when, how, and under what circumstance, a business must turn over – or escheat – unclaimed property to the state government.  There is no uniform system of law on escheat; every single one of the 50 states has a different set of escheat laws.  Even states that have started from the Uniform Unclaimed Property Act (the “Uniform Act”) have ended up with laws that differ as a result of legislative tinkering.  The various state laws differ on such fundamental topics as what kinds of property escheat to the state (e.g., whether gift cards escheat); how long property must go unclaimed or unused (two years to five years is the general range); the process for reporting unclaimed property; and the penalties for not timely reporting unclaimed property.

There are even differences among the various laws as to how one decides which state to potentially escheat property to and thus which state's law to follow.  The Supreme Court has laid out a priority scheme for escheatment.  If a business knows the last known address of the owner of the gift card (the buyer in this instance, not the person to whom the buyer gifted it), then the buyer's state's laws apply and that state is the proper state for escheatment.  If the address is not known, then the business's place of incorporation, or in some cases, principal place of business is used. 

But some states have enacted or attempted to enact yet another presumption, putting the place of the transaction before the other rules.  To complicate matters further, the Third Circuit Court of Appeals – whose decisions apply to New Jersey, Pennsylvania, Delaware and the Virgin Islands – has held that any such place-of-transaction presumption is invalid and that only the Supreme Court's priority scheme can be used.  But other courts may not follow the Third Circuit's lead on this, and thus disputes can exist as to which state's laws apply, even putting aside the differences between the various state laws themselves.

To illustrate the difficulty in figuring out which law applies, let's look at a retailer incorporated in New York.  New York has a five-year escheatment period and requires gift cards to escheat.  In other words, a gift card unused for five years must be “turned over” to the state of New York.  But what if the retailer collected the addresses of those people buying gift cards?  Then the retailer must follow the escheat rules of each and every state identified by that process, which could be all 50!  And some of those states, such as Ohio, do not require the escheatment of gift cards at all.  And yet in other states, some types of gift cards do not escheat, and others do.

What if you fail to escheat? The penalties and costs associated with a failure to properly escheat can be severe.  As state treasuries face ever mounting pressure to increase revenues, audits to find escheatable property can be an easy solution.  Most states have long look-back periods, sometimes measured in decades, giving them many years to locate and pursue unclaimed property. This means that the unused gift cards you've long forgotten about can be the surprising source of meaningful liability. 

There are penalties for willful failure to report, but there can also be costly interest provisions that make even a small gift card credit metastasize into a much larger liability that you now owe to the state.  On the other hand, sometimes unredeemed gift cards can inure to your benefit through so-called breakage, which is the taking into income of abandoned, expired gift cards by the retailer rather than the state.  As noted above, state laws differ on this subject and this requires a detailed analysis to determine what is escheatable versus what is not, and to whom the obligation may be owed.

The entire escheat landscape under state law must also be set against federal laws regarding gift cards, specifically the U.S. 2009 Credit CARD Act.  That law provides that gift cards cannot expire for a minimum of five years from the date of issuance, and some states, such as California, have enacted laws providing that gift cards never expire.  It is possible under the current system of federal and state overlapping regulations that a retailer may be required to escheat a gift card to the state, only to have the consumer return to the store and seek to redeem the card.  In such a situation, the current guidance seems to require the retailer to honor the card and then seek return of the property from the state government, which is not the most business-friendly solution.

As an example of escheat liability, in the ongoing case State of Delaware ex rel. French v. Card Compliant, LLC, et al., N13C-06-289, Delaware has alleged that a number of Delaware corporations have failed to properly escheat gift cards to the state, and have thus violated the Delaware False Claims and Reporting Act.  Defendants' liability could be significant – not only would they have to escheat the value of the gift cards, but the Delaware Unclaimed Property law allows penalties ranging from 25 percent to 75 percent of the amount due in addition to the required escheat.  In another case, though not involving gift cards, a company found itself with a $1.4 million escheat liability resulting from an audit going back to 1981.  Temple-Inland, Inc. v. Cook, No. CV 14-654-SLR, 2015 WL 1069274, at *2-3 (D. Del. Mar. 11, 2015). 

Escheat issues will remain endemic to any retailer that issues gift cards.  The varied laws applicable to this area can leave a retailer in danger of neglecting a (seemingly minor) responsibility, only to face substantial liability years or even decades after the fact. 

What you should do to protect yourself: 
  • Review your existing outstanding gift cards to see if you are properly identifying unclaimed property and also escheating to the relevant state or states.
  • Review your unclaimed property policy and be sure that relevant employees understand the need to comply with escheat laws.
  • If you think you may be facing escheat liability, conduct a detailed review of your unclaimed property to determine if any mitigation strategies may are available.
This is a troublesome issue facing a crazy quilt of many laws, including some that conflict.  Retailers should take care to avoid these difficult traps for the unwary. 

Steve Hecht is a partner and Rich Bodnar is an associate with Lowenstein Sandler's litigation practice.

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