Gift Vouchers and Consumer Protection
The selling of gift vouchers by distressed retailers such as Comet, Jessops and HMV, in the run up to going into administration has been the subject of much adverse comment in the media in recent weeks. Consumers always seem to be pulling the short straw. Why is this and can anything be done to protect their position better?
The furore is somewhat reminiscent of the savings club controversy some years ago when Farepak went into administration. It will be recalled that Farepak collected consumers money for months and then was unable to make good on its promise of a hamper or gift voucher in time for Christmas. At the time the directors were vilified in the press and by Parliament for creating such a sorry state of affairs., However, last year, nearly six years after Farepak’s collapse, the directors were exonerated in proceedings intended to disqualify them with Mr Justice Peter Smith laying much of the blame for Farepak’s demise at the door of the Bank of Scotland.
Many of Farepak’s customers found it difficult to fathom why there was no legal sanction against directors who had accepted customer money over several months when they must have known that the company was in a precarious position. Likewise, in the case of gift vouchers, it is difficult to believe that the directors might not be at fault. However, as with Farepak, unless the directors have been spectacularly foolish or fraudulent, it is highly unlikely that any director will be successfully sued for his part in any ongoing sale of vouchers.
Why is this?
(1) The cardinal rule for directors at the helm of any distressed company is that they must avoid wrongful trading. When directors know or ought to know that there is no reasonable prospect of the company avoiding insolvent liquidation, they should put the company into administration or liquidation.
(2) Invariably a retailer going into administration does not happen overnight. Typically, the retailer will have been under financial pressure over several months as evidenced by the most recent spate of retail collapses.
(3) Typically directors of a retailer of any size will have had the benefit of insolvency law advice from lawyers and other assistance from insolvency practitioners. On a daily basis the directors will have been considering with the assistance of their lawyers and insolvency practitioners, whether the critical date has been reached or whether a reasonable prospect remains of the company avoiding insolvent liquidation.
(4) Although it might well be the case that the financial affairs of a retailer look bleak for many, many months prior to its demise it is also the case that typically over that same time period, there are on-going negotiations for additional finance, extended credit facilities or for the business to be sold. Each of these scenarios explain why it may be that the retailer continues to trade, gift vouchers continue to be sold and why when the retailer eventually collapses, customers
holding gift vouchers are left holding nothing but paper.
(5) In such cases the directors’ dilemma is obvious. If they stop selling gift vouchers it will deprive their company of vital working capital while negotiations continue in an effort to save the business. If they continue selling gift vouchers many consumers will be out of pocket if the directors’ worst fears materialise.
Directors, therefore, may well not be to blame for the fact that many gift vouchers are sold in the run up to an administration and which may not be redeemed afterwards. In the case of HMV there has been a welcome development in that it appears that HMV gift vouchers will be honoured, but nevertheless, it is an unsatisfactory state of affairs that ordinary retail customers may lose out again in the future.
What, if anything, can be done?
We think it safe to assume that the majority of directors do not want to see their retail customers lose out. Legally, however, it is difficult to provide protection for such customers.
Since the collapse of Farepak some retailers who are in the Christmas savings club business have set up trust arrangements of customer monies that are designed to protect retail customers in the event that the retailer becomes insolvent. However, such trusts operate immediately on receipt of the monies and do not transfer to the company until the goods are purchased some months later. The trust mechanism works because payment to the Christmas savings club company is delayed. The whole point of gift vouchers for the wider retail world is that they are a valuable source of immediate revenue. Legally, the payment by the customer of the face value of the gift voucher constitutes a unsecured loan by the customer to the retailer until the gift voucher is redeemed. If such payments were subject to an immediate trust until redemption, the point of such vouchers would largely be lost. Further, the administrative framework for the operation of such trusts is cumbersome and expensive and, it has to be pointed out, unnecessary, as long as the retailer is trading successfully.
The more usual approach is therefore to attempt to protect retail customers’ monies by the creation of a temporary trust once the company starts experiencing financial difficulties. In recent years there have been frequent cases of directors creating trusts of customer deposits in the last few months or weeks of a company’s trading. This typically happens where the retailer is in the business of supplying relatively high value items such as sofas or computers. Courts furniture is an example of the former, O T Computers is an example of the latter. These arrangements can provide some protection for customers who have paid deposits shortly before the company goes into administration. However where, as in the gift voucher situation, the payment is not characterised as a deposit (which can more readily be the subject of a trust) but rather, as a loan, such arrangements are at risk of being struck down as preferences or transactions at an undervalue. This is because the transfer of the amount represented by the loan to a trust indicates either a desire to put the customer creditor in a better position than he/she would otherwise have been in had the trust not been set up or it makes the customer a donee of a gift. In either case the arrangement is liable to be struck down. Furthermore, such temporary trusts are again invariably expensive and complicated to administer because a valid trust pre-supposes the possibility of tracing each customers’ money which, as the numerous court cases are a testament, is not straightforward.
We are left, unfortunately, with no easy fix other than banning the sale of gift vouchers altogether which would be a shame as they are very popular with consumers and, as mentioned above, provide welcome cash flow for the retailers. Nevertheless the problem erupts sufficiently frequently that we should not simply throw up our hands and say that nothing can be done. The recent announcement that HMV gift vouchers will be honoured, while welcome, is not proof that there is no problem. It is quite possible that Hilco, the restructuring specialist that has emerged as a possible buyer of HMV, agreed to underwrite the HMV vouchers whilst negotiations continue and no doubt the cost of the vouchers will be fed into the price that is ultimately paid. Those holding vouchers issued by Comet, Jessops and the other retailers that will inevitably collapse in the coming months will not be so lucky.
Of course if the voucher has been paid for using a credit card, s. 75 of the Consumer Credit Act 1974 entitles the customer to a refund from the credit card company. However, s.75 is limited to payments in excess of £100. The face value of many vouchers is frequently less than £100.
One possible a solution is to require retailers who wish to issue gift and other vouchers to take out insurance against their non-payment. Inevitably, the requirement of insurance will push up the cost of vouchers to the retailer, but that may be a small price to pay for the advance cash flow that is generated.
The obvious answer is the introduction of legislation to address this specific problem. Retail consumers are a peculiarly vulnerable class of creditor. They are typically the least informed, least resourced and the least secured of any class of creditor in a retail collapse. Bankers have their fixed and floating charges, suppliers have their ROT clauses, their trade insurance and their “cash on delivery”. Consumers, on the other hand, have nothing other than their blind faith in the High Street.
Tailored protections for certain classes of vulnerable creditor are not new. Some years ago the so-called “prescribed part” was introduced by an amendment to the Insolvency Act 1986 to provide a fund of up to £600,000 for general unsecured creditors. In the area of financial services a statutory trust is imposed on investor monies in the event of an insolvency. It is perhaps time that consideration was given to a small statutory ring-fence of a certain percentage of a retailer’s assets on an insolvency to make good the losses that retail consumers suffer as a result of paying deposits, purchasing gift vouchers or being given credit vouchers on a return of goods. All retail customers of an insolvent retailer would be entitled to share in the small pool of ring-fenced assets on a pari-passu basis with the remaining non-consumer creditors sharing the burden of the enhanced benefit to consumers. We do not think legislation would be complicated and it would have the benefit of eliminating the substantial costs of administering the ad-hoc trust arrangements that are cobbled together by directors at the last minute in an attempt to deflect the criticism that retail customers have again been left until last.