Though they appear to be the perfect solution to last-minute gift-giving, in today’s economy, gift cards may be the perfect example of throwing good money after bad, thanks to the growing number of retailers filing for bankruptcy.  

“In the Linens 'N Things bankruptcy filing, they told the court they didn’t maintain any reserve for gift cards,” says Anthony Giorgianni of Consumer Reports. “Where did the money go?”

Indeed. 

Compared to a Chapter 7 bankruptcy, which when a company is going out of business, Chapter 11 is filed when it intends to re-organize.  Under Chapter 11, the “secured” creditors get paid off first.  Only if there’s any money left do the “unsecured” creditors get consideration. 

Guess which category gift card holders fall into?  As an “uninsured” creditor of the issuer you get a proportionate share of any assets that might be left after the secured creditors are paid.  That can range from zero to pennies on the dollar.  (If there were enough money to pay off everyone, the company wouldn’t have filed for bankruptcy.)  

The Chapter 11 filing of Mervyn’s department store is enlightening.  There’s not a single mention of the phrase “gift card.”  The list of the 30 largest creditors and the amount they’re owed includes Levi Strauss (more than $12 million), Wicked Fashions ($6 million), and Nike USA ($4.7 millon).  How much do you think gift card holders are going to get?

You’d never know from visiting its Web site that Circuit City is currently going through Chapter 11 www.circuitcity.com. It’s still selling gift cards in 18 different designs! Advertised benefits include:

• Shop online or in stores
• No fees and no expiration dates
• Free replacement if lost or stolen
• Free shipping

Circuit City maintains that it is still accepting its gift cards as it works its way through the re-organization process.  When asked, a salesperson at a store in my area responded, “Absolutely. Yes.”  Neither the stores nor the company’s Web site mentions that a gift card recipient might end up holding nothing more than a cute snowman on a worthless piece of plastic, depending upon what the bankruptcy judge decides.

Even if a company isn’t planning to go out of business, Giorgianni points out that “they may be closing stores.  If the one near you closes, you may be out of luck.”  Your only option might be to buy the product you want from the chain’s Web site and pay shipping and handling charges.  Moreover, your choices could be limited because suppliers are understandably reluctant to ship new merchandise unit they’ve been paid for what they already provided.

“Cards issued by financial institutions, including credit unions and banks, aren’t necessarily safer than those issued by retailers,” says Giorgianni.  

In fact, they’re only as sound as the bank or credit union itself.  Given the sharp increase in troubled financial institutions, that can be a dicey proposition.  Wondering what kind of shape your bank is in?  Good luck finding out.  Although the Federal Deposit Insurance Corporation keeps a “watch list” of problem financial institutions, this is not available to the public.  All we know is that in the first eight months of this year, the number grew from 90 to 117, with experts predicting many more would be added.

What about that MasterCard (MC) or Visa (V) symbol on the card?  

According to Giogianni, “Visa and MasterCard say they won’t make good” on the cards because they didn’t get the money -- the bank did. The logo just indicates the financial institution is using either the Visa or MasterCard network to process charges and payments.

Even if another financial institution steps in, they’re not on the hook to honor gift cards. Giorgianni points to the collapse of NetBank, which was eventually taken over by ING.  NetBank had sold Visa gift cards, but “ING isn’t making good on them.” 

For the above reasons, as well as the terms, conditions, and charges that gift card come with them, Consumer Reports recommends avoiding them until recipients are afforded better protection.  At things stand now, the money that buys gift cards “goes into a pool at the bank,” or into the general operating fund of the retailer, according Giorgianni.  In other words, it’s not set aside in a segregated account as something owned by card holders.

Take the Circuit City gift cards being sold today. 

“Where are they putting the money?” asks Giorgianni.  “Is it someplace so the consumer gets the value, or does it go to some other creditor with a higher priority?”

“If card issuers aren’t going to get serious about protecting the money, maybe consumers should go elsewhere.”   Such as good old-fashioned cash.  He adds, “I think a green piece of paper with George Washington on it is always appropriate and I never have to worry about whether I can spend it.”

 Tips for Those who Give or Receive Gift Cards

1. Use it as quickly as possible. 

2. Be sure you understand the conditions, such as when fees start being subtracted.

3. Write down the card number and keep it in a safe place. You’ll need it in case the card is lost and you need a replacement.

4. If you’re giving a gift card, it’s very important to give the recipient the receipt showing the date it was purchased, the name of the issuer, and the amount.

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.  Click here to access the Your Money Matters Archive