Case 15-12054-KG Doc 741 Filed 06/16/16 Page 1 of 7 UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE In re: Chapter 11 CITY SPORTS, INC., et al., Case No. 15-12054 (KG) Debtors. Jointly Administered RESPONSE OF THE COMMONWEALTH OF MASSACHUSETTS TO THE DEBTORS’ SECOND OMNIBUS OBJECTION TO CLAIMS The Commonwealth of Massachusetts, Office of the Attorney General (“Commonwealth”), hereby files this response (“Response”) to the Debtors’ Second Omnibus (Substantive) Objection to Certain Claims [Dkt. 712] (“Omnibus Objection”). The Debtors object to the Commonwealth’s Proof of Claim1 on behalf of Massachusetts consumers holding unredeemed gift cards on two grounds: (1) that the Proof of Claim is misclassified as a priority unsecured claim pursuant to the Bankruptcy Code, 11 U.S.C. § 507(a)(7); and (2) that it is not supported by the Debtors’ books and records. Both arguments are without merit. The Debtors fail to acknowledge published precedent of this Court holding that gift card claims are entitled to priority status pursuant to 11 U.S.C. § 507(a)(7). See In re WW Warehouse, Inc., 313 B.R. 588 (Bankr. D. Del. 2004). Further, the Debtors have acknowledged the existence of the unredeemed gift card purchases in writing to the Commonwealth. The Debtors cannot now claim the opposite, that the gift cards are “not supported by [their] books and records.” As set forth below, the Debtor’s Omnibus Objection as to the Commonwealth’s Proof of Claim should be denied. 1 A true and correct copy of the Commonwealth’s Proof of Claim is attached as Exhibit 1 to the Affidavit of Francesca L. Miceli (“Miceli Aff.), filed concurrently herewith. 1 Case 15-12054-KG Doc 741 Filed 06/16/16 Page 2 of 7 I. Unredeemed Gift Cards are Entitled To Priority Status Pursuant to the Bankruptcy Code, 11 U.S.C. § 507(a)(7). The Commonwealth qualifies as a priority creditor under 11 U.S.C. § 507(a)(7) for each unredeemed gift card held by a Massachusetts consumer with a value up to $2,775. Pursuant to the Bankruptcy Code, priority unsecured creditor status is reserved for those, “unsecured claims of individuals, to the extent of $2,775 for each such individual, arising from the deposit, before the commencement of the case, of money in connection with the purchase, lease, or rental of property, or the purchase of services, for the personal, family, or household use of such individuals, that were not delivered or provided.” 11 U.S.C. § 507(a)(7). The two limitations imposed on those seeking priority distribution under Section 507(a)(7) are (1) that the claim arise from the deposit of money and (2) that the services or goods remain undelivered. This Court has previously recognized that money paid for a gift certificate is a “deposit” for the purchase of future property or services under Section 507(a)(7). See In re WW Warehouse, Inc., 313 B.R. 588 (Bankr. D. Del. 2004). In re WW Warehouse, Inc. is directly on point. As is the case here, the debtor in WW Warehouse, Inc., prior to the debtor’s bankruptcy, sold gift certificates to the public entitling consumers to apply, in whole or in part, the face amount of the certificate to the future purchase of merchandise offered for sale by the debtor. 31 B.R. at 590. Before the outstanding gift certificates could be redeemed, the debtor filed bankruptcy. Id. The Chapter 11 debtor-retailer objected to priority claims filed by individuals holding unredeemed gift certificates to purchase merchandise from debtor. Id. Analyzing the term “deposit” as used in the Bankruptcy Code provision granting (now) seventh-level priority to unsecured claims asserted by consumers, this Court determined that deposits should not be limited only to partial payments made for specific merchandise and, accordingly, held that the unredeemed gift certificates were entitled to priority status. Id. at 591-95. 2 Case 15-12054-KG Doc 741 Filed 06/16/16 Page 3 of 7 Notably, “[b]ecause this Court [] observed a pattern of treating claims arising from gift certificates in retail bankruptcies as general unsecured claims,” it set forth its detailed reasoning in a published decision, relying upon both the plain meaning of the statutory language and its legislative history – [m]indful…not to invade Congress’ policy-making arena.” Id. at 590, 592. The Court found “nothing in th[e] [ordinary-meaning, dictionary] definitions [of “deposit”] “that suggests that, when applied to a consumer purchase, a deposit must only be a partial payment of a purchase price and for specific merchandise.” Id. at 592 (emphasis in original). The Court further found that, even if there had been a statutory ambiguity, “the legislative history leaves no doubt that gift certificates are indeed deposits.” Id. at 590. The legislative history states: The [seventh] priority…has been added as a result of testimony before the subcommittee on civil and constitutional rights concerning problems that consumers have encountered with bankrupt retail businesses with whom consumers have deposited money for goods or services. The bill gives a priority in the distribution of assets of a bankruptcy debtor to consumers who have deposited or made partial payments for the purchase or lease of goods, or the purchase of services, that were not delivered or provided. The priority comes after administrative expenses and wages, but before taxes. There is no similar provision in current law. A consumer that pays money on a lay-away plan or as a deposit on merchandise, or that buys a service contract or a contract for lessons or gym membership, is a general unsecured creditor of the business to which he has given his money. Very few creditors are aware of their status as general unsecured creditors. If the merchant involved files under the bankruptcy laws, the consumer is usually left holding the bag. Though he assumed his deposit was tantamount to a trust fund, he gets nothing from the estate of the debtor, because the assets available provide little return to unsecured creditors. Because of his ignorance and his inability to bargain with a retail merchant, he is unable to do a credit investigation or obtain special terms from the merchant, as a true creditor may do. A recent example is the W.T. Grant bankruptcy. All customers who held “Grant Script” have essentially lost their deposits. In order to remedy this problem and to reorganize the position of consumer creditors as different from those of business creditors, the bill provides a priority for consumer creditors of a bankrupt business.... Id. at 594 (citing H.R. Rep. No. 595, 95th Cong., 1st Sess. 188 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News 5963, 6148– 49) (emphasis added); see also In re Salazar, 430 3 Case 15-12054-KG Doc 741 Filed 06/16/16 Page 4 of 7 F.3d 992, 996 (9th Cir. 2005) (“Merchants’ violation of consumers’ expectations and trust is precisely what Congress responded to when it passed [11 U.S.C. § 507(a)(7)]. That Congress’s concern had bounds is shown by its express limitation of the amount of the priority. There is no reason to think that it buried a further limitation in the word ‘deposit.’”). Analyzing this history, the WW Warehouse Court stated, “To relegate gift certificate holders to the status of general unsecured creditors perpetuates the very problem Congress sought to remedy.” Id. at 595. The Debtors Omnibus Objection fails to acknowledge this prevailing law and the extensive reasoning provided by the Court supporting its decision. Instead, the Debtors cite a partial hearing transcript containing an off-the-cuff statement made in an unrelated bankruptcy case as the sole authority for their untenable position. See Omnibus Objection at p. 4, n.2. Indeed, In re WW Warehouse, Inc. remains good law and, even in recent decisions finding consumer creditors not entitled to priority status under 11 U.S.C. § 507(a)(7), courts have cited In re WW Warehouse, Inc. favorably while distinguishing the facts in their cases and finding that the consumers in those cases immediately received services for their funds. See In re Palmas del Mar Country Club, Inc., 443 B.R. 569 (Bankr. D.P.R. 2010) (up-front country club membership payments are not “deposits” for goods or services that were to be provided in the future); In re Four Star Financial Services, LLC, 469 B.R. 30 (C.D. Cal. 2012) (same, for initiation fees to purchase campground memberships). These courts observed, “[a]ll of the courts applying section 507(a)(7) priority find that a payment was made for some services and benefits that were expected in the foreseeable future but were never delivered….In th[ose] [cases], as well as those in the legislative history, where the priority was found to apply, an element of future assurance or security existed.” Four Star Financial Services, 469 B.R. at 34 (citing In re WW Warehouse, Inc.); Palmas, 443 B.R. at 574. 4 Case 15-12054-KG Doc 741 Filed 06/16/16 Page 5 of 7 The same analysis applied in WW Warehouse is applicable to the gift certificates at issue here. Consumers deposited funds with City Sports in exchange for gift cards to be applied toward the future purchase of City Sports merchandise. As WW Warehouse found, Consumers do not purchase gift certificates, whether they be in the form of paper or a plastic card similar to a credit card, as the ultimate purchase. Consumers expect merchants to apply some or all of the face value of the gift certificate toward the ultimate purchase.