Following the generally bad press that gift cards received during the holiday season of 2008, a number of retailers have come together to form the Retail Gift Card Association (RGCA), with the aim of building a positive image of closed-loop gift cards. Members of the Association include Best Buy, Subway, Wal-Mart Stores, Home Depot, Kohl’s, Limited Brands, Nike, Applebee’s and Marriott International. This is a good development and consumers will be the ultimate beneficiaries.

However, for this to work, the association must address the reasons underlying the bad publicity they got from the media, legislators and consumer groups. One of the main issues has to do with bankruptcy. As the economy gets worse, more retailers are going bankrupt and there is no uniform standard regarding what happens to outstanding gift cards when a retailer goes bankrupt (whether it is Chapter 7 or 11 bankruptcy).

For example, when the Sharper image went bankrupt in 2008, they initially refused to honor gift cards. After pressure from consumer groups and some state Attorney Generals, the company relented, but only allowed customers to redeem part of their gift cards. Similarly, when the Bombay Company went bankrupt in late 2007, they refused to honor gift cards. Gift card holders had to file a claim with the bankruptcy court and were only able to get 25 cents on the dollar.

Furthermore, when electronics retailer Tweeter went bankrupt in late 2008, the company announced they were only going to redeem outstanding gift cards for only 5 days. It was only after Attorney Generals from a few states, including Maryland and Connecticut stepped in did the company extend the gift card redemption period to run until their liquidation sale was complete.

It is true that many of the major retailers that have gone bankrupt recently have redeemed gift cards, like Circuit City, Linens ‘N Things and Mervyn’s. But without uniform guidelines or standards, examples like the Sharper Image and Tweeter will continue to reflect badly on gift cards in general, thereby hurting all retailers. While consumers have the option of filing a claim with the bankruptcy court should a bankrupt retailer refuse to honor gift cards, that option is not viable since gift card holders are unsecured creditors and would therefore be at the bottom of the pecking order.

Therefore the best thing the association can do is to encourage their members to offer some kind of bankruptcy guarantee where consumers will be assured that they will be able to redeem their gift cards should the card issuer go bankrupt. That will not only generate good publicity but will also boast gift card sales, thereby benefiting the retail industry as a whole.

The least the association can do is at least guide its membership through the process. This could be done several ways. One approach could be to encourage member to set up a reserve fund as a percentage of their gift card sales, like banks do with loan loss reserves. That way, should the retailer go bankrupt, they can use the reserve fund to cover outstanding gift card redemptions. They could also buy insurance to cover their outstanding gift card portfolio. That way, the insurance company picks up the tab when the company goes bankrupt and has to honor outstanding gift card obligations.

Nonetheless, the idea for the association is an excellent one since the bad publicity gift cards received were sometimes over the top. Part of it was because the media hyped the few cases of retailers not honoring gift cards, especially with the Sharper Image and Bombay Company, which had the effect of alarming the public and scaring consumers away from gift cards. This may have been partly responsible for the significant reduction in gift card sales for 2008.

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