Treatment of Customer Deposits After a Retailer Files for Bankruptcy

Retailers of consumer products that must be delivered to the consumer, such as furniture or appliances, typically require a significant deposit from the customer before the retailer will order the product from its supplier.  In many cases, these Customer Deposits can be as large as 50% or more of the retail price charged by the retailer.  From a consumer’s perspective, you should be aware that when you give a deposit to a retailer, you are essentially making a loan to that retailer.

Impact on Customers

When a retailer spirals into bankruptcy, all of its assets are immediately frozen, often leaving millions of dollars in Customer Deposits on account of orders that were not yet completed and/or delivered to customers.  Consumers who are owed refunds of their deposits have to get in line and compete with the retailer’s other creditors for any cash that is ultimately available.  In many cases, however, there is nothing the consumer can do but accept the fact that they have lost all or most of the deposit paid to the bankrupt business.

Deposits Paid by Credit Card

It is recommended that consumers pay deposits to retailers by using credit cards rather than by writing a check or paying cash.  The Fair Credit Billing Act allows consumers to dispute charges with the credit card issuer for unshipped merchandise and have the charge removed from their account.  To protect themselves from these chargebacks, the credit card processors may reserve or withhold other funds due to the retailer.

Recovery on Customer Deposits

Bankruptcy Code Section 507(a)(7) establishes apriority for unsecured claims of individuals arising from Customer Deposits towards the purchase of goods that were not delivered up to a maximum of $2,600.  The remaining portion of the un-refunded deposit would become a general unsecured claim. Consumers owed deposits are only paid after all of the secured creditors and administrative expenses of the bankruptcy (such as bankruptcy lawyers’ fees) are paid.  As priority creditors, holders of deposits would be paid up to $2,600 before any general unsecured obligations of the retailer are satisfied.

Difficulties of Fulfilling Customer Merchandise Orders

At the time of the bankruptcy filing, the retailer most likely has not yet received a large number of orders that are subject to Customer Deposits.  In addition, many of the retailer’s vendors likely still possess merchandise that was special-ordered for the retailer’s customers, but the goods were not yet shipped to the retailer.  Due to the financial constraints imposed by its lenders, particularly if the retailer is liquidating, it may not have the funding available to finance the purchase or delivery of this inventory.

As a result, unless the retailer is able to fulfill or ship merchandise on account of unfulfilled Customer Deposit orders, the retailer faces sizable claims in the bankruptcy, including:
  • Priority claims asserted by its customers for Customer Deposits that have not been honored;
  • Chargebacks incurred and/or reserves established by the retailer’s credit card processors;
  • General unsecured claims resulting from the non-priority portion of unfulfilled orders; and
  • General unsecured claims from the retailer’s vendors for goods ordered for its customers.
What other challenges do retailers face around unfilled Customer Deposits?

Blog-subscribe-ad_CB.JPG