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BRIEFING PAPER

Number 6540, 16 January 2020

What happens to gift cards etc. on insolvency of retailer?

By Lorraine Conway

Contents: 1. Introduction 2. Retail administration 3. Treatment of gift vouchers &

other prepayments on retailer’s insolvency

4. Could insolvency law be changed to protect all prepayments?

2 What happens to gift cards etc. on insolvency of retailer?

Contents Summary 3

1. Introduction 4 1.1 Gift vouchers and other types of consumer prepayments 4 1.2 The nature of the problem 5

2. Retail administration 7 2.1 Outline of the administration process 7 2.2 Distribution to creditors 8

3. Treatment of gift vouchers & other prepayments on retailer’s insolvency 11 3.1 Summary 11 3.2 If a credit card was used to purchase the voucher 11 3.3 If a debit card was used to purchase the voucher 12 3.4 If cash was used to purchase the voucher 12

4. Could insolvency law be changed to protect all prepayments? 14 4.1 Call for reform & Private Members’ Bill 14 4.2 Law Commission’s consultation & report 15 4.3 Government’s response 17

Cover page image copyright: “Closing down” sale 2 by John Thurm. Licensed by CC BY 2.0 / image cropped.

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Summary Many people buy gift vouchers (or gift cards) especially at Christmas. Gift vouchers remove the “headache” of choosing the “right” gift. The danger is that the unspent gift voucher may become worthless if the retailer becomes insolvent. If the retailer continues to trade whilst in administration, the administrator may continue to accept gift vouchers at their face value, though he is under no obligation to do so.

Other types of consumer prepayments are also at risk. A consumer prepayment is where a consumer is required to pay (in full or in part) for goods and services in advance of receiving them. For example, a consumer may be asked to pay a cash deposit when ordering an expensive new sofa. If the business subsequently goes into administration, the consumer may not receive the sofa and may also lose their deposit.

Understandably, consumers are frustrated that a business may continue to trade whilst in administration but refuse to accept their gift vouchers or fail to fulfil an order or return a deposit. If a retailer stops trading altogether and goes into liquidation, the law imposes a strict hierarchy of creditors to be paid out from any remaining assets. Consumers who are in possession of gift vouchers or made other forms of prepayment are classed as unsecured creditors and frequently receive nothing.

On 18 June 2015, the Law Commission published a consultation document, “Consumer prepayments on retailer insolvency”, in which it sought views on whether greater protection was needed for consumers who purchase gift vouchers or make other types of prepayments.1 The consultation closed on 17 September 2015 and the Law Commission published its report with recommendations in July 2016.

In its formal response, published in December 2018, the government said that it would consult on new laws to protect Christmas savers and to change the rules on when property passes to consumers. However, it rejected the Law Commission’s proposal that, a limited change be made to the insolvency hierarchy so to enable a limited group of consumer claims to be paid in advance of floating charge holders.

This Commons briefing paper considers the treatment of gift vouchers and other types of consumer prepayments when a distressed company goes into administration. In doing so, it also outlines the statutory order of distribution to creditors and considers the possibility of a consumer obtaining a refund if the gift voucher was bought with, or a prepayment was made, using a credit or debit card. Finally, this briefing paper looks at the current debate on whether there may be scope for a change in the law in this area.

4 What happens to gift cards etc. on insolvency of retailer?

1. Introduction

1.1 Gift vouchers and other types of consumer prepayments

There are different types of gift vouchers depending on who issues them, including those that can be used in:

• a specific shop;

• a specific chain of shops; or

• a wide range of different traders (for example, for a specific shopping centre) or any club or association of shops

The use of gift vouchers is governed by contract law. The contract is initially between the person who purchases the gift voucher and the company itself. However, the benefit of the contract is effectively assigned to the receiver of the gift. As with any contract, specific “terms and conditions” will attach to the purchase and use of the gift voucher. In many cases, the terms will state that the gift voucher must be used within a specified period; usually this is indicated on the voucher itself, on the trader’s website, in store leaflets or on posters.

Retailers (i.e. both in store and online) vary in whether they impose an expiry date on gift vouchers. For example, some retailers give consumers 6 months to redeem a voucher, others offer more flexible “no expiry” vouchers or may be willing to extend the expiry date if asked. For various reasons expiry dates are useful to the retailer, for example, they:

• prevent the build-up of undeclared liabilities;

• ensure services are provided within a reasonable period; and

• ensure the supply of goods is possible

When a gift voucher has expired a trader does not have to accept it. Legally, the onus is on the recipient of the gift voucher to ensure that they spend it (in full) within the time limit specified in the terms and conditions. That said, some traders may still accept an expired gift voucher as a goodwill gesture.

There is nothing to stop an expiry term being included within a contract. To be enforceable, the term must be described appropriately within the sale particulars. In most cases, the expiry date is usually very clear and so the recipient of the gift voucher would have little argument if the voucher expires without being redeemed. However, if a gift voucher does not have an expiry date on it and the store refuses to let the consumer use it, then the consumer may have a breach of contract claim (much would depend on the exact circumstances). In addition, the consumer may have a cause of action under the Consumer Protection from Unfair Trading Regulations 2008. Specifically, these Regulations provide consumer protection from unfair or misleading trading practices, misleading omissions and aggressive sales tactics.

5 Commons Library Briefing, 16 January 2020

For many consumers, gift vouchers solve the dilemma of choosing the right gift. For businesses, revenue obtained from the sale of gift vouchers provides a cheap source of working capital and can “lock in” consumers to a brand. The Gov.UK website2 cites the following research by the UK Gift Card and Voucher Association (UKGCVA):

• The UK gift voucher/card industry is worth around £5 billion.

• Every year 6% of vouchers bought by consumers go unused as they lay forgotten in people’s wallets and drawers.

• In 2013, some £2.5 billion worth of gift vouchers/cards and vouchers were sold in UK retail stores and £2.25 billion were purchased by businesses as staff or customer rewards.

However, there are many other types of consumer prepayments. For example, in respect of expensive or bespoke goods or services (e.g. new furniture, bathrooms and fitted kitchens) it is not unusual for a retailer to ask the consumer to pay a cash deposit with the order. Consumer prepayments are also governed by contract law. In the event of a dispute, much would turn on the terms and conditions agreed between the two parties.

1.2 The nature of the problem High-profile retailer insolvencies have highlighted the lack of protection for consumers buying gift vouchers or making other prepayments. For example, unused gift vouchers worth £4.7 million remained in circulation when the electrical chain Comet collapsed in December 2012.3 Home furnishings retailer Paul Simon held £2.4 million in customer deposits when it went into administration in April 2014.4

On insolvency, many retailers enter a period of administration. An insolvency practitioner is appointed as an administrator and may be able to keep the business trading while working out the best way of dealing with it. Whether or not gift vouchers or other types of consumer prepayments are worthless if a retailer goes into administration will depend, in large part, on the financial state of the business. There are various possibilities, for example:

• An administrator may decide to honour gift vouchers or fulfil customer orders during a period of trading, though they are under no obligation to do so.

• If the business is sold as a “going concern”, the subsequent purchaser of the business may choose to honour consumer prepayments.

• A company may have acted to protect prepayments while it was still trading, perhaps by taking out insurance or a bond or by placing the prepayments in a ring-fenced account (although this is unlikely).

2 Gov.UK press release, “Millions wasted as people don’t spend gift vouchers”, 27

December 2014, [online] (accessed 2 December 2019) 3 “Consumer Prepayments on Retailer Insolvency”, Law Commission, 14 July 2016

[online] (accessed 2 December 2019) 4 Ibid

6 What happens to gift cards etc. on insolvency of retailer?

The important point to note is that insolvency law does not give consumers any special protection. Along with trade suppliers and many others, consumers are unsecured creditors who will not receive anything until secured creditors (typically banks and investment funds) and preferential creditors (such as employees) have been paid. More detailed information about the administration process and the order of payment is outlined below.

7 Commons Library Briefing, 16 January 2020

2. Retail administration

2.1 Outline of the administration process This section is concerned with retail administrations. It should be noted, however, that administration is only one of several insolvency processes that may be applied to an insolvent retail company. However, other insolvency processes, such as liquidation or receivership, are unlikely to involve a period of continued trading.

Box 1: Administration in a nutshell

• In a nutshell, administration is a legal process that requires the appointment of a licensed insolvency practitioner as administrator.

• At its heart, it is a company rescue procedure. When an administration order is in place, a moratorium (often described as a “protective cloak”) is placed around the company to protect it from legal actions whilst a survival plan or an orderly wind down of the company’s affairs is being achieved.

• If there is a sale of all or part of the company's business, administrators can elect to distribute the proceeds of sale directly to the creditors.

• Usually, however, the administrators will transfer the proceeds to a liquidator, who would then deal with the distribution process in accordance with a strict hierarchy set out in the Insolvency Act 1986 (as amended).

• Consumers who make a prepayment (e.g. they purchase a gift voucher or pay a deposit) are “unsecured creditors” and as such are the last category of external creditors to be paid from any realised company assets.

As outlined in Box 1 (above), the purpose of administration is to intervene in the running and management of an insolvent business (i.e. the company is "unable to pay its debts”). 5 The Enterprise Act 2002 (EA 2002) sets out a hierarchy of statutory objectives of a company in administration (see Box 2 below).

Box 2: Hierarchy of statutory objectives of a company administration

• The first objective is to rescue the company as a “going concern” (i.e. with as much of its business as possible). The procedure is designed to hold a business together while plans are formed to put in place a financial restructuring to rescue the company.

• If the business cannot reasonably be saved, the second objective is for the administrator to perform his functions with the aim of achieving a better return for creditors than would be achieved in liquidation. For example, a better return may result from trading on for a period whilst seeking to sell off the business and or assets.

• Where neither of these objectives can be achieved, administration can also be used simply as a mechanism to liquidate assets and distribute the proceeds to secured or preferential creditors.

Frequently, administrators will attempt to sell the company's business as a “going concern” and then liquidate the company. Sometimes this is all worked out in advance in what is known as a “pre-pack”

5 The business is insolvent within the meaning of section 123 of the Insolvency Act 1986

8 What happens to gift cards etc. on insolvency of retailer?

administration. In brief, a “pre-pack” is a pre-arranged sale by a company in administration of its business or assets (or both) that completes either immediately upon the appointment of the administrator or shortly after the administrator is appointed. The main reason why an administrator might sell on a pre-pack basis, rather than market the business post-appointment, is to preserve the value of the business.

Once a company is in administration it is protected - there is a moratorium (i.e. temporary suspension or freeze) on legal proceedings against the company (often referred to as “a protective cloak”). In effect, the moratorium:

• prevents anyone presenting a petition to wind up the company;

• prevents any creditor from enforcing security over the company’s property;

• prevents the repossession of goods in the company’s possession under a sale or hire agreement;

• prevents any other proceedings, execution, or legal process from being commenced or continued against the company, and no distress may be levied against the company or its property.

This means that while rescue proposals are being prepared, no creditor can take steps (without the administrator’s or court’s permission) to disturb the business or recover any assets. This provides a vital “breathing space” during which time the administrator is expected to assess the company’s financial standing, arrange for the valuation of assets, and produce a proposal either to rescue the company or for the sale of the business and/or its assets. Crucially, the administrator is required to act in the interests of the general body of creditors.

2.2 Distribution to creditors As outlined above, once an administration order is made against an insolvent retailer, all or part of the business may be sold along with other assets. The appointed administrator must then elect either to distribute the proceeds of sale directly to the creditors or to transfer this function to a liquidator (also an authorised insolvency practitioner). In either case, creditors are paid according to a strict order of priority prescribed by the IA 1986 and amended by the EA 2002 (see Box 3 below). Each class of creditor is paid in full before any distribution can be made to the next class.

9 Commons Library Briefing, 16 January 2020

Box 3: Statutory hierarchy of dividend payment

The order of distribution runs in the following descending order:

• Any creditor holding a fixed charge over an asset;

• Expenses of the administration;

• Preferential debts (employees of an insolvent company have a degree of preference under the IA 1986);

• Any creditor holding a “floating charge” over an asset (less preferential debts and the “prescribed part”);6

• All unsecured creditors; and

• Any surplus to shareholders per shareholder rights.

In brief, fixed charge holders (also referred to as “secured creditors”) have their debt secured against a particular asset of the company (e.g. a bank may have a charge/security over a building). The secured creditor will be paid out of the proceeds of sale of those specific assets, after the costs of realisation have been deducted. In other words, fixed charged assets are not available for distribution to the general body of creditors.

Preferential debts are unsecured debts which, by statute, are to be paid in priority to all other unsecured debts.7 Preferential creditors ae primarily employees owed arrears of wages, accrued holiday pay, unpaid contributions to occupational pension schemes and state scheme premiums, all within certain strict limits. Preferential debtors rank equally amongst themselves (after the payment of fixed charges and liquidation expenses) and are required to be paid in full, unless the assets are insufficient to meet them, in which case they share the assets between themselves in proportion to their debts.

A floating charge holder is a debenture-holder (usually a bank) which takes the floating charge as security for its financial exposure to the company. Unlike a fixed charge, a floating charge does not attach to a specific item of company property. Instead it is a charge on those company assets which are constantly changing (e.g. stock, book debts and work in progress). If the company defaults on the terms of the loan, then the floating charge is said to ‘crystallise’. At that stage the floating charge is converted to a fixed charge over the assets which it covers at that time. It is important to note that where the floating charge was created after 15 September 2003 a “prescribed part” for payment to unsecured creditors may need to be calculated.8

6 The “prescribed part” set aside for unsecured creditors from realisations of floating

charge assets is up to a maximum of £600,000 7 Schedule 6 to the Insolvency Act 1986 (as amended by the Enterprise Act 2002) 8 A share of the assets subject to a floating charge is reserved for distribution to

unsecured creditors in priority to the charge holder in an administration, liquidation or receivership (section 176A IA 1986). This share is known as the ‘prescribed part’ or sometimes the ‘ring-fenced fund’ and was designed to prevent floating charge holders from benefitting from the abolition of Crown preferential creditors by the EA 2002. The share is quantified in accordance with the Insolvency Act 1986 (Prescribed Part) Order 2003.

10 What happens to gift cards etc. on insolvency of retailer?

Unsecured creditors are all other non-secured and non-preferential creditors and are the last external creditors to be paid. These are often unpaid trade suppliers along with any debts owed to consumers (including those in possession of unredeemed gift vouchers or have made other prepayments) and any other unsecured debts. All unsecured liabilities arising out of obligations incurred before the date of administration rank "pari passu" (i.e. ranking equally) with each other (see Box 4 below).

Box 4: Pari Passu Rule (‘equal in right of payment’)

This rule means that all unsecured creditors in an administration or liquidation must share equally any available assets of the company, or any proceeds from the sale of any of those assets, in proportion to the debts due to each creditor.

Finally, shareholders will be the last class of creditor to receive a distribution and they will only receive a distribution after everyone else has been paid in full. In a compulsory liquidation it is rare for the shareholders to receive anything at all.9

9 It should be noted that shareholders of a company that has gone into liquidation can

be held liable for company debts, but the liability is limited to the value of their shareholding. For instance, if a person’s shareholding s £100 that would be the limit of their liability. If the £100 is fully paid up, the shareholder is deemed to have paid the liability and will not be asked to contribute more by the liquidator. However, where there is uncalled capital (i.e. the £100 stake has not been paid in full) the liquidator can ask the shareholder for the full amount.

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3. Treatment of gift vouchers & other prepayments on retailer’s insolvency

3.1 Summary Appointed administrators can, at their discretion, continue to accept gift vouchers but this is unusual, at least in the early days of administration. For example, HMV administrators, initially stated that they would not accept gift vouchers. However, having reviewed HMV’s financial position, the administrators later announced that they would redeem the vouchers at their full value.10 It is possible, of course, that if all or part of the insolvent business is sold, the new buyer might consider honouring the gift vouchers in order to preserve customer goodwill.

Similarly, not all cash prepayments are lost. Some consumer orders may be fulfilled during a period of trading in administration. Others may be fulfilled by new buyers of the business, as occurred in the cases of retailers Dreams and Dwell.11

Understandably, many consumers are aggrieved when retailers go into administration and refuse to honour gift vouchers or fulfil an order (or return a cash deposit). Legally, unredeemed gift vouchers and other prepayments are categorised as debts owed by the company, so once the company becomes insolvent, the consumers become unsecured creditors and must lodge a claim with the administrator. Effectively, they must join a queue of creditors looking for their money back (see above). The problem is that since unsecured creditors are the last external creditors to be paid (after secured and preferential creditors) they are likely to receive only part of what they are owed, if anything at all.

According to figures cited by the Law Commission, in the event of a retailer’s insolvency, returns to unsecured creditors tend to be derisory – often less than 1p in the pound. For example, in the case of the retailer JJB Sports’ insolvency in 2012, the distribution was 0.34 pence in the pound, meaning that a consumer with a £100 claim received 34p.12

3.2 If a credit card was used to purchase the voucher

In certain circumstances, if a gift voucher is bought using a credit card, the person who bought the voucher (not the recipient) may be able to draw on the protection offered by section 75 of the Consumer Credit Act 1974 (CCA 1974) (see Box 5 below).

10 “HMV will accept gift vouchers”, BBC News, 21 January 2013, [online] (accessed 2

December 2019) 11 Ibid 12 “Consumer prepayments on retailer insolvency”, Law Commission consultation paper

No.221, 18 June 2015, [online] (accessed 2 December 2019)

12 What happens to gift cards etc. on insolvency of retailer?

Similarly, if a consumer used a credit card to make a prepayment (for example, to pay a deposit on an order for a good or service), they may also be able to rely on the CCA 1974.

Box 5: Joint and severable liability - section 75 of the Consumer Credit Act 1974

• This provision makes the credit provider ‘jointly and severally liable’ with the retailer for any breach of contract or misrepresentation by the company, provided the item costs between £100 and £30,000. This protection applies to purchases made over a counter, online or by phone.

• Of course, in some cases, gift vouchers will be for values significantly below £100 and section 75 will not be relevant.

3.3 If a debit card was used to purchase the voucher

If a gift voucher was bought using a debit or prepaid card (such as a Visa, MasterCard or American Express card) the buyer of the voucher (and not the recipient) may have the benefit of a “chargeback” scheme (see Box 5 below). Chargeback provisions can be used to reverse transactions in certain circumstances, including where a retailer fails to deliver goods or services which have been paid for.

Similarly, a consumer might also have the benefit of chargeback in respect of prepayments made for goods or services.

Box 5: Chargeback

• Chargeback allows customers to claim back money spent on goods which do not arrive or are faulty, or where the trader has become insolvent.

• There is usually no minimum or maximum limit to the amount that can be claimed (e.g. Chargeback can apply to card transactions under £100) but there are time limits. Usually, a consumer must make a Chargeback claim within 120 days of when they bought the goods or service, but this can vary; the consumer will need to check the precise terms of their Chargeback agreement to find out the time limit for their card provider.

• It is important to note that the provision of chargeback schemes is not a legal requirement; it is part of the card issuer’s terms and conditions. As such, there are no guarantees that a card provider will be able to get a customer’s money back for them.

3.4 If cash was used to purchase the voucher If the purchaser of the gift voucher paid by cash (or a cheque) they will have no option but to lodge a claim with the administrator (or liquidator if one has been appointed) as an unsecured creditor. They should do this as soon as possible after a retailer has gone into insolvency. They would be in the same situation if they gave a cash deposit (or made another type of cash prepayment).

In respect of cash prepayments, the Law Commission found that the heaviest losses fell on consumers from less well-off socio-economic groups. According to figures cited by the Law Commission, these cash buyers lost around £8.5 million in the MFI insolvency in 2008 and £1.5 million following the insolvency of Homeform in 2011.13 An analysis of

13 “Consumer Prepayments on Retailer Insolvency”, Law Commission, 14 July 2016

[online] (accessed 2 December 2019)

13 Commons Library Briefing, 16 January 2020

case histories provided by Citizens Advice suggested that the average amount lost in the cases reported to them was around £700.14

14 Ibid

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4. Could insolvency law be changed to protect all prepayments?

4.1 Call for reform & Private Members’ Bill As already mentioned, when a retail business becomes insolvent consumers who have made some sort of prepayment (e.g. purchased a gift voucher or paid a deposit) may be protected. For example:

• it may be possible to seek a refund from their credit card issuer;

• the administrators or purchasers of the business may decide to honour the transactions; or

• the business may have taken steps (prior to insolvency) to safeguard consumer prepayments (by way of insurance or a bond).

However, if none of these protections apply, affected consumers must file a claim in the insolvency to share in any distribution of realised assets. As an unsecured creditors, consumers often receive negligible amounts (sometimes nothing at all). The Government has explained the consumer’s position as follows:

When making prepayments, consumers are effectively lending the business money, but without being in a position to assess the credit risk, unlike other lenders. For example, some trade creditors are able to gain varying levels of protection by using retention of title clauses, credit insurance or changed payment terms. It has also been argued that the current statutory hierarchy creates a perverse incentive for lenders with both secured and floating charges. Often a business will attempt to trade its way out of difficulty by taking further unprotected prepayments, even when their chances of delivering to the consumer are minimal. The lender has little reason to prevent or discourage a business doing this as further unprotected prepayments could increase the return to the lender if the business eventually becomes insolvent. Businesses which take large cash payments from consumers without providing any form of protection before insolvency can cause significant bad publicity, public disquiet and risk undermining confidence in their sector and the law in this area.15

In January 2013, Sir Tony Baldry MP called on the Government to consider changes to insolvency law, so that consumers who make prepayments or purchase gift vouchers are adequately protected.16 He argued that a gift voucher should be treated in the same way as a banker’s draft (i.e. a consumer should know that they will either be able to redeem the gift voucher or get their money back). To achieve this, he suggested that retailers should be required to keep monies raised from gift vouchers in a separate account.

15 16 “HMV accused of theft over gift vouchers debacle’, Guardian, 16 January 2013,

[online] (accessed 2 December 2019)

15 Commons Library Briefing, 16 January 2020

On 12 February 2013, Michael McCann MP introduced a Private Members’ Bill (under the Ten Minute Rule), to amend the IA 1986 to make purchasers of gift vouchers preferential creditors during the administration of a company. The Bill had its first reading in the House of Commons but failed to make any further progress.

4.2 Law Commission’s consultation & report In September 2014, the Department for Business, Innovation and Skills (BIS) (now the Department for Business, Energy and Industrial Strategy BEIS)) asked the Law Commission to examine the protections given to consumer prepayments and to consider whether such protections should be strengthened. The Law Commission focused on payments made by consumers, as defined in section 2(3) of the Consumer Rights Act 2015. It was therefore concerned with payments made by individuals “acting for purposes that are wholly or mainly outside [their] trade, business, craft or profession”.

Explaining the need for this his review, the Law Commission said that a several high-profile retail insolvencies had highlighted the lack of protection for consumers making prepayments.17 The Commission acknowledged that the issues were complex and went to the heart of the insolvency regime:

In 1982, the Cork report rejected greater protection for consumers, noting that consumers typically lose small and affordable amounts while the effect on suppliers can be catastrophic. But following the Farepak collapse, the Treasury Select Committee described the existing safety net as “inadequate and incomplete”. The OFT carried out a review, and ministers asked the Department for Business, Innovation and Skills to consider providing more protection for consumers.

The project will consider possible ways forward, gathering empirical evidence about the scale of the problem and consulting on possible solutions. These include, for example, the order in which claims are paid in insolvency, the discretion administrators may exercise in consumers’ favour, voluntary protection in certain sectors and TSI’s Consumer Code Approval Scheme, as well as the rules relating to the passing of property in a contract for the sale of goods.18

The Law Commission published a consultation paper on 18 June 2015, “Consumer prepayments on retailer insolvency”, in which it sought views on whether greater protection was needed for consumers .19 Although various consumer groups called for a change to insolvency law, so that all consumers who have made prepayments or hold gift vouchers are paid in priority to other creditors, the Law Commission provisionally concluded that this would not be practical or proportionate given the other interests involved, including those of employees, secured creditors and other unsecured creditors (such as suppliers). The

17 “Protecting consumer prepayments on retailer insolvency”, Law Commission,

undated, [online] (accessed 2 December 2019) 18 Ibid 19 Consumer prepayments on retailer insolvency”, Law Commission consultation paper

No.221, 18 June 2015, [online] (accessed 2 December 2019)

16 What happens to gift cards etc. on insolvency of retailer?

Law Commission also thought that the mandatory safeguarding of all prepayments would impose a regulatory burden on businesses.20 Instead, the Law Commission invited views on other options, including encouraging issuers of gift vouchers to implement protection voluntarily through trust arrangements or industry-led development of insurance products.

The consultation closed on 17 September 2015 and the Law Commission laid its report before Parliament on 13 July 2016.21 The report sets out the Commission’s five recommendations to improve consumer protection, namely:

• Regulating Christmas and similar savings schemes, which pose a particular risk to vulnerable consumers.

• Introducing a general power for Government to require prepayment protection in sectors which pose a particular risk to consumers.

• Giving consumers more information about obtaining a refund through their debit or credit card issuer.

• Making changes to the rules on when consumers acquire ownership of goods.

• As a last resort, making a limited change to the insolvency hierarchy, to give a preference to the most vulnerable category of prepaying consumers; specifically, it is proposed that a limited group of consumer claims be paid in advance of floating charge holders. In making this proposal, the Law Commission acknowledged that his would be a political decision.

Some stakeholders, including Citizens Advice, expressed support for the Law Commission’s proposal to make a limited change to the insolvency hierarchy. 22 However, R3 (the industry body for insolvency practitioners) was not in favour of the proposal, arguing it would increase the complexity and cost of administering retail insolvencies and delay the time it would take to resolve such cases, to the detriment of all creditors. R3 also pointed out that categories of preferential debts were reduced significantly by the Enterprise Act 2002, which removed the Crown’s preferential status for tax and social security contribution debts. At the same time, a share of floating charge assets (the prescribed part) was made available to unsecured creditors.23 Others suggested that the proposal could decrease further the sums available to other unsecured creditors, including employees for the non-preferential part of their claims and small suppliers.

20 Ibid 21 Law Commission, Consumer Prepayments on Retailer Insolvency (July 2016) Law Com

No 368, [online] (accessed 2 December 2019) 22 “Government Response: Law Commission Report on Consumer Prepayments on

Retailer Insolvency – Government Response”, Department for Business, Energy & Industrial Strategy, December 2018, [online] (accessed 2 December 2019

23 Ibid. It should be noted that R3 made this comment before the Chancellor announced in his Autumn 2018 Budget new proposals for some Crown debts such as VAT, PAYE, and employees’ national insurance contributions to be given higher priority than unsecured creditors from April 2020.

The Law Commission accepts that consumers are less able to assess a business’s credit risk and fail to realise they are making an unsecured loan to the company.

17 Commons Library Briefing, 16 January 2020

4.3 Government’s response In its formal response, published in December 2018, the government said that it would consult on new laws to protect Christmas savers and to change the rules on when property passes to consumers. The relevant extract is reproduced below:

The government will explore options for taking forward the proposals to grant the Secretary of State a power to require protection of consumer prepayments in sectors which, in the opinion of the Secretary of State, pose a significant risk to consumers and to mandate protection for consumer prepayments in schemes such as Christmas savings clubs and others where it becomes apparent that there are significant risks to consumers. This includes further consultation on the detail of the proposals and in particular exploring the technicalities of how we would implement the proposals to transfer of ownership of goods in advance of any legislation.

On the proposal to amend the hierarchy of creditors on insolvency to promote the interests of a certain group of consumers, the government is aware that implementation of the proposals could have unintended consequences. It is therefore not intending to bring forward changes to the creditor hierarchy in insolvency.

However, following the March 2018 consultation on insolvency and corporate governance the government announced in August that it intends to increase the cap on the proportion of funds that can be ring-fenced and paid over to unsecured creditors in the event of insolvency.24

However, it said it would not be pursuing the Law Commission’s proposal that a small change be made to the insolvency hierarchy to enable a limited group of consumer claims to be paid in advance of floating charge holders. The government said there were wider political issues to consider:

The question of how far losses should fall on consumers, suppliers, other creditors (including HMRC), banks or other institutional lenders and whether to extend the class of creditor paid ahead of other unsecured creditors has been considered on a number of occasions including:

a) by the Coalition government, in response to the joint House of Commons committees’ report on the impact of the closure of City Link on employment (the government rejected the Committees’ call for all of a company’s workers, regardless of whether they were directly employed by the company, to be afforded preferential status); and

b) in a 2016 Westminster Hall debate on small shops regulation in which the government rejected a call for money recovered in an insolvency from ‘head clients’ to be ringfenced and shared down the supply chain to particular suppliers;

c) through a 2018 consultation on insolvency and corporate governance, including looking at how to best protect SMEs in a supply chain in the event of a large customer’s insolvency.

24 “Government Response: Law Commission Report on Consumer Prepayments on

Retailer Insolvency – Government Response”, Department for Business, Energy & Industrial Strategy, December 2018, [online] (accessed 2 December 2019

18 What happens to gift cards etc. on insolvency of retailer?

In his Autumn 2018 Budget statement the Chancellor announced proposals for some Crown debts such as VAT, PAYE, and employees’ national insurance contributions to be afforded higher priority than unsecured creditors from April 2020.

The government is aware that implementation could have unintended effects on other areas of the market.

The government recognises the concerns when individual consumers may lose money in an insolvency situation. However, in its view this recommendation could increase the cost of capital, harm enterprise and lead to calls for preferential status for other groups of creditors which would adversely affect the amount available to other unsecured creditors, which would lead to far greater losses to the wider economy. The Law Commission suggest that there are value judgments to made when considering the insolvency hierarchy and set the measure out as an option should the government feel the need to act. The government has decided not to pursue this measure.25

25 Ibid

BRIEFING PAPER Number 6540 16 January 2020

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