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Bitten by a bankrupt business? Bite back

However, as soon as a business files for bankruptcy, warranties, gift cards and advance payments managed in-house by that business come under the sway of a bankruptcy court. If the company at some point is bought by another company or manages to emerge from bankruptcy, then consumers will probably get paid. But if the company can't salvage a viable business or find a buyer, they begin the liquidation process. At that point, many customers with ties to the business probably aren't going to get what's coming to them.

Gift cards are a frequent casualty. "There's nothing specifically in the bankruptcy law that requires those cards to be honored," says Rao. "So it's really going to be whether or not the judge will permit it."

The Bombay Co., a nationwide furniture and home goods retailer that filed for bankruptcy last year, won approval to pay off gift cardholders. The only catch: Cardholders got 25 cents on the dollar -- not exactly a great deal. A few months after The Sharper Image filed for bankruptcy, it allowed consumers to cash in their gift cards, as long as their purchases totaled twice the value of their cards.

Even when the court approves the continued use of the cards -- as in the bankruptcies of Linens 'n Things and Circuit City -- if a company's bankruptcy reorganization fails and it's forced to close stores and liquidate, the time frame for using gift cards shrinks dramatically. So it pays to redeem the cards at the first scent of bankruptcy trouble.

If a company can't win approval to accept the cards -- and in some cases, it won't even request it -- then gift cardholders must fill out a court document called a proof of claim and submit it to the bankruptcy court. At that point, you become a creditor of the bankrupt business. You won't be the only one seeking payment.

Those who made advance payments, say for an annual subscription to a magazine or a year's membership to a gym, are in a similar boat. Unless there's some kind of a settlement worked out on their behalf by the failing business, they'll be part of the bankruptcy, too.

Retrieving a deposit

If you put down a large deposit for a product or service, whether it was to get in line for an in-demand new car or a not-yet-built condo, a failed business is especially bad news.

Depending on state law, such deposits may be required to be held in escrow by a third party, and many builders and other businesses that take large deposits do just that. In that case, it's easy to get your money back. If the deposit was on a condo in California's Inland Empire area, where property values have tanked, you'd probably be happy just to get your deposit back.

Unfortunately, many businesses will cannibalize these deposits and put them into their general pool of funds. If that's the case, you, too, will be joining the list of creditors in the business bankruptcy.

So what does that mean, exactly? Think of bankruptcy like a pyramid. At the top of the pyramid are secured creditors. They're the most likely to get paid before the bankrupt business's assets run out. At the bottom are unsecured creditors, and there are typically many more unsecured creditors than secured creditors. Ultimately, the bankruptcy judge decides who gets paid and who doesn't.

As a consumer, your objective should be to get as far up the pyramid as you can because, undoubtedly, by the time they get to the very bottom of the pyramid, the business' assets will be gone. After all, if the business had the assets to pay off all its creditors, it probably wouldn't be in bankruptcy.

One way you can climb to the middle of the pyramid is by filling out a proof of claim.

"If they do file a proof of claim, they are entitled to a priority as a consumer-type claim," says Rao. "If it's a deposit that was left or for some payment for goods that weren't provided, they are able to have a priority on up to $2,425. So as long as their claim is less than that amount, they would get a priority. If it's more than that, they would at least have a priority for the first $2,425."

If your deposit was much more than $2,425 -- say $50,000 for the aforementioned condo -- you'll need to find legal help. "When there's that much money at stake, a consumer really ought to consult with an attorney," says Rao.

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