Businesses have all but abandoned traditional paper gift certificates for more convenient electronic gift cards. Gift cards are now prominently displayed for sale on websites and in retail establishments of all kinds. But while enticing customers, gift cards have also recently engendered enforcement litigation by state attorneys general, consumer class action litigation against retailers, and, in the particular area of franchising, suits by franchisees against their franchisors. Moreover, state statutes are evolving rapidly as gift cards proliferate and federal regulation may not be far behind. Businesses that have gift card programs or are planning to roll them out should be aware of the laws and legal issues relating to this popular form of payment.
Gift Card Litigation By Franchisees Against Franchisors
Claims relating to gift card programs have already surfaced in litigation in at least two franchise systems.
In January 2006, a franchisee of The Coffee Beanery Ltd. sued its franchisor for violation of the Maryland Franchise Act and negligent and intentional misrepresentation for allegedly failing to disclose material information in its Uniform Franchise Offering Circular about, among other things, The Coffee Beanery's gift card program. The franchisee alleged that the franchisor failed to disclose that participation in the program was mandatory, that the franchisee had to purchase equipment in order to participate, and that the franchisee would incur fees and charges in connection with the program.
Administration of a gift card program may present even greater risks. In 2004, Bruster's L.P., an ice cream chain, was sued by a group of its franchisees, alleging that Bruster's improperly retained proceeds from the franchisees' sale of the franchisor's gift cards and failed to report to the franchisees regarding Bruster's use of those funds. The franchisees are seeking an accounting and the imposition of a constructive trust on the gift card funds held by the franchisor. The case is still pending.
State Law Issues
Businesses that have national or multi-state gift card programs face daunting compliance challenges. There is no federal law regulating gift card practices. However, a bill is pending in Congress (H.R. 85) to eliminate gift card expiration dates and fees. In addition, in response to increasing consumer complaints, the House Energy and Commerce Committee is also considering whether uniform regulation is needed. At the state level, there has been a flurry of activity aimed at protecting consumers from gift card practices perceived to be unfair or deceptive. The substantial increase in gift card use has also prompted some states to review their unclaimed property ("escheat") laws. The significant variations in state laws can present a legal minefield.
A. Prohibition of or Restrictions on Expiration Dates and Fees
Much of the recent legislative activity relating to gift cards has focused on the permissibility of imposing expiration dates and fees on gift cards. There is no clear trend in how states approach these issues. Of the 26 states that have enacted laws that regulate gift cards or gift certificates, eight prohibit expiration dates. The majority of the 26 states allow expiration dates but require that they be disclosed conspicuously, and in some instances require that the card remain valid for a certain number of years (from one to seven years).
The question of whether a gift card issuer may "diminish" its value by charging inactivity or "dormancy" fees, service fees, replacement fees, activation or reactivation fees, and the like, is also hotly debated. A few states flatly prohibit fees. A few others permit so-called "dormancy fees" only under limited circumstances, or prohibit fees until a certain time period has elapsed. Still others, while not restricting the fees that can be charged, have imposed strict disclosure requirements, usually mandating disclosure of the type and amount of fees on the gift certificate or gift card itself.
Some gift card statutes regulating expiration dates and fees incorporate the penalties and remedies available for violation of the state's unfair trade practices or consumer protection laws. Other gift card statutes establish their own remedies and penalties for violations. Arizona, for example, imposes a $500 civil penalty as the exclusive remedy for a violation. Consumers have filed class action lawsuits in California and Illinois for violations of state laws prohibiting expiration dates, or for other gift card practices that are alleged to constitute unfair or deceptive trade practices, including refusing to redeem gift cards for cash or to replace lost, damaged or stolen gift cards. In addition, the attorneys general of New York, Connecticut and Massachusetts have pursued enforcement actions for violations of their states' gift card laws.
B. Applicability of Unclaimed Property (Escheat) Laws
States typically require holders of abandoned property to file reports with the state identifying the property and the owner, if known. If the property remains unclaimed for a specified period, the state ultimately will succeed to ownership of it. The exploding market for gift cards, coupled with their unique character as essentially unspent money, has brought this obscure area of law to unaccustomed prominence. The question is whether, and when, unused gift cards are deemed to be abandoned property that escheats to the state. Again, states have reached different conclusions, and others are still debating these issues.
A majority of states deem gift certificates that have been unused for a certain period of time (most commonly three years) to be abandoned property. Many states have not yet determined whether to treat an electronic gift card the same as a paper gift certificate for purposes of the unclaimed property laws. Arizona, Indiana, Maryland, and Rhode Island unconditionally exclude gift certificates from their abandoned property laws. Massachusetts and South Carolina, while not providing an express exemption, recently enacted legislation deleting references to "gift certificates" from the unclaimed property provisions. Other states have taken a selective approach to the issue: Alabama, Arkansas, Ohio, Minnesota, New Hampshire, and Virginia provide exemptions for specifically defined types of gift certificates. Still other states link the unclaimed property issue to the expiration date and/or fee issue: California, Illinois, North Carolina, Tennessee and Texas exclude gift certificates that do not contain expiration dates, or for which expiration dates are not enforced, or if fees are not charged. Idaho, on the other hand, exempts from its unclaimed property laws gift certificates "with an expiration date prominently displayed on their face."
In recent interpretations of escheat laws, the attorney general of Colorado and a state court in New York, respectively, found that unspent gift card or gift certificate funds must be paid to the state, even if the gift card or certificate expired before the property could be deemed "abandoned" under the statute. The Colorado opinion found that electronic gift cards fall within the ambit of "intangible personal property," which is subject to escheat unless expressly exempted. In the New York case, decided in January 2006, the court held that the statutory requirement that unused gift certificates escheat after five years, with no exemption for expired gift certificates, represented the public policy of the state long before the gift certificate issuer began to sell gift certificates. This public policy trumped the issuer's contract rights regarding an expiration date.
The Colorado and New York opinions defeat a gift card issuer's expectation that it will be entitled to retain for itself unspent gift card balances after the card expires. The impact of these opinions is significant, since, according to the National Retail Federation, sales of gift cards during the 2005 holiday season alone were estimated to exceed $18.5 billion. Based on historical redemption rates, approximately 10% of the value of those cards will never be used, which means that absent application of the escheat laws, issuers would expect to retain unspent gift card balances worth over $1.8 billion.
Failing to comply with state escheat laws can be costly. States typically impose penalties for failure to report or deliver abandoned property to the state and assess interest on unreported or unpaid amounts. California, for example, imposes penalties of $100 per day up to $10,000 for willful failure to report abandoned property and $5,000 to $50,000 for willful failure to deliver abandoned property to the state, and assesses 12% interest on undelivered abandoned property. In Texas, failure to timely deliver abandoned property to the state subjects holders to a penalty of 5% of the property's value, which increases by an additional 5% if the property remains undelivered 30 days after the due date, plus 10% interest. Texas classifies a willful failure to report or deliver abandoned property as a misdemeanor.
In the absence of uniform federal law, as electronic gift card sales continue their explosive trajectory, more states are likely to enact gift card laws and to amend outdated laws concerning paper gift certificates. Navigating this evolving landscape of state gift card laws demands constant vigilance and guidance.
Tacie H. Yoon is Of Counsel in Wiley Rein & Fielding's Franchise and Litigation Practices, representing franchisors in a wide range of matters. Ms. Yoon can be reached at (202) 719-7152.