By Breton Leone-Quick and Steve Ganis
What are you currently doing about unredeemed balances on your company’s gift cards? Are these amounts being tracked, reported and paid over to your state of incorporation? If the answer to these questions is no, you could be at risk for significant liability, depending on the outcome of a case currently pending in Delaware. Every company with a gift card program should be aware of this case, titled State of Delaware v. Card Compliant, et al., which could have broad and wide-ranging implications for how unredeemed balances on gift cards must be treated.
Every state has a series of statutes that are commonly referred to as abandoned property laws. These laws include a definition of what constitutes abandoned property, and they also create requirements for the reporting and payment of that property to the state.
In Delaware, and in numerous other states, the abandoned property laws specifically include balances on unredeemed gift cards within the definition of abandoned property. These balances are considered “abandoned property” after five years and the statute requires any person or company holding abandoned property to pay that property over to the State of Delaware.
But, in practice, most companies are not paying unredeemed gift card balances to their state of incorporation. This is because the general practice has been for companies to hire a third-party program manager to run their gift card program. The program manager is responsible for issuing the gift cards, tracking their sales and redemptions, and providing other administrative support. The third-party is also identified as the holder or owner of unredeemed gift card balances, and is typically incorporated in a state that does not include unredeemed gift card balances in its definition of abandoned property.
To date, the general understanding has been that the applicable abandoned property laws are those of the state of incorporation of the program manager, and because – as discussed above – those laws do not include unredeemed gift cards in their definition of abandoned property, there was no need to report or pay over unredeemed gift card balances to any state.
But the Card Compliant case challenges this basic assumption.
The Key Allegations from the Card Compliant Complaint
The central allegation in the Card Compliant case is that even though companies contract with a program manager, the program manager is not really the holder of unredeemed gift card balances. Rather, the sponsoring company itself is the actual holder. Under this theory, it is the abandoned property law of the sponsoring company’s state of incorporation – not that of the program managers’ state of incorporation – that controls how unredeemed gift cards must be treated.
The key allegations in support of this general theory are:
• Certain of the corporate defendants retained possession of the proceeds from gift card sales;
• Certain of the corporate defendants recorded unredeemed gift card balances as revenue after a few years;
• The consumer was never informed that the gift card manager was the obligor with respect to the card;
• The value of unredeemed balances came back to the corporate defendants in the form of trademark or licensing and handling fees; and
• The program managers assumed historic liability for all unredeemed gift card balances.
The complaint claims that the failure to report and pay unredeemed gift card balances to Delaware (their place of incorporation), violates not only Delaware’s abandoned property laws, but also its False Claims and Reporting Act.
Understanding the Practical Implications of the Card Compliant Case
The Card Compliant litigation is in its very early stages and an initial substantive decision on plaintiff’s legal theory is likely months away. But prior to a final decision on the merits of this theory, there are several practical implications this litigation raises that are ripe for consideration:
• This theory could be applicable to non-Delaware corporations. Even though the Card Compliant case is brought against Delaware corporations under Delaware state law, it could still impact companies incorporated in other states. This is because the abandoned property laws in numerous states other than Delaware include unredeemed gift card balances in their definition of abandoned property.
• Increased state audits. Most state abandoned property laws provide the state an opportunity to conduct audits of companies to determine if those companies are properly reporting and paying over abandoned property to the state. The Card Compliant litigation may prompt the State of Delaware to conduct specific audits of other companies that are not defendants in the Card Compliant suit.
• States have powerful incentives to conduct these audits. First, there is significant money at stake. One study cited in the Card Compliant complaint estimates that there is potentially up to $8 billion of “abandoned” unredeemed gift card balances that states could argue belong to them. Second, seeking recovery of unredeemed gift card balances administratively is cheaper for states than bringing actions under their false claims acts.
• The scope of potential exposure is much more than the face value of the unredeemed cards. Companies should be aware that their potential exposure under the theories advanced in the Card Compliant litigation could far exceed the face value of their unredeemed gift cards. Many states provide for penalties and interest for any abandoned property that is not paid over to the state in a timely manner. For example, Delaware abandoned property laws provide for penalties on unpaid amounts from 50% of the amount past due, up to 75% in cases involving fraud. With respect to interest, Delaware imposes interest at .5% a month on late payments (capped at 50%). Most state false claims acts also provide for treble damages, a per occurrence penalty, and imposition of costs and attorneys’ fees.
In addition to understanding these implications, companies should both assess their level of potential exposure under the Card Compliant theory, and also analyze options for restructuring their gift card programs in case plaintiff’s theory is adopted. These proactive steps can help minimize any adverse impacts that may flow from the ultimate decision in the case.
Breton Leone-Quick, is a member in the litigation practice of Mintz, Levin, Cohn, Ferris, Glovsky, and Popeo, P.C., a full service law firm employing approximately 450 attorneys worldwide with headquarters in Boston.
Steve Ganis, of counsel at the firm, has over 20 years of government and private-sector experience as a financial services regulatory lawyer.