RECLAMATION: JUST HOW USELESS IS IT?

            The abilityof a seller to reclaim goods shipped to an insolvent debtor is a remedypreserved in the Uniform Commercial Code, and found in the Alabama Code at inSection 7-2-702 of the Alabama Code:

Where the seller discovers that the buyer has receivedgoods on credit while insolvent he mayreclaim the goods upon demand made within 10 days after the receipt, but if misrepresentation of solvency has beenmade to the particular seller inwriting within three months before delivery the 10-day limitation does not apply. Except as provided in thissubsection the seller may     not base aright to reclaim goods on the buyer's fraudulent or innocent misrepresentation of solvency or ofintent to pay.

          The remedy is subject to the rights ofbuyers in the ordinary course of business, and the rights of lien creditorspursuant to Article Two. This article explores the preservation of thereclamation remedy (by putting it beyond the trustee’s reach) under theBankruptcy Code, and the practicalities of its application.

          Here’s the way it might go down:seller properly reclaims goods sold in accordance with applicable state law.The seller’s customer then files bankruptcy within ninety (90) days of thereclamation. The trustee decides the reclaiming creditor has received apreferential transfer, and seeks to recover the value of the goods.

          Section 546(c) addresses thissituation by insulating a properly executed reclamation from consideration as apreference under 11 U.S.C. § 547. Section 546(c) also expands the “look back”period from 10 to 45 days, and, extends the grace period for making the demandfor return from 10 to 20 days.  In anyevent, the reclamation right is also made subject to the “prior rights of aholder of a security interest in such goods or the proceeds thereof,” which inmany cases, is a death sentence for the reclaiming seller.

          The problem is this: in most instancesof inventory with any value, there is going to be a creditor with a “floating”security interest in that inventory. Since the goods and the remedy are subjectto the security interest, the reclamation claim has no value unless the valueof the goods to be reclaimed exceeds the value of the secured lender’sindebtedness. See, In re Dana Corp., 2007WL 1199221 (S.D. NY 2007) [Following Inre Dairy Mart Convenience Stores, 302 B.R. 128 (Bankr. S.D.N.Y. 2003) andholding that “if the value of any given reclaiming supplier’s goods does notexceed the amount of the debt secured by the prior lien, that reclamation claimis valueless].

          Section 546(c)(2) goes on to provide,however, that if a seller fails to give the notice required in 546(c)(1), theseller “still may assert the rights contained in section 503(b)(9)”, i.e. anadministrative expense claim. Section 503(b)(9) states that after notice andhearing the court shall allow as an administrative expense, “the value of anygoods received by the debtor within 20 days before the commencement of a caseunder this title in which the goods have been sold to the debtor in theordinary course of such debtor’s business.” In short, goods delivered within 20 days of bankruptcy will havevirtually automatic priority. For goods delivered between 21 days and 45 days,there is no such priority and the reclamation claim will have to be asserted.

          Now, before you get excited, let’slook at this question: If the goods I sold to the debtor within 20 days ofbankruptcy immediately became subject to a floating security interest, and, ifthe debt secured by the inventory exceeds the value of the inventory so that myreclamation claim essentially has no value, do I still get an administrativeexpense claim? A reading of the statute suggests to me that yes, a sellerdelivering goods within 20 days before the commencement of the bankruptcy getsan administrative expense claim for the value of those goods, even if theycan’t be physically reclaimed because of a prior security interest.

          The administrative expense claim maybe viewed as the “booby prize,” but I think as a practical matter it has realvalue. It will give the seller of those goods a priority over general unsecuredclaims, essentially moving that seller closer to the front of the line. Theclaim is not automatic—the selling creditor will need to file a Proof of Claimusing the approved form, and specifically set forth that the claim is filed asan administrative expense claim under 11 U.S.C. § 503(b)(9). The claimant mustalso attach to and file with its proof of claim supporting documentation.

SUMMARY:under 546(c), a seller must satisfy the following elements: (1) have astatutory or common law right under state law to reclaim the goods; (2) debtormust have been insolvent when the goods were received; (3) seller must havemade a written demand for reclamation within 45 days of receiving the goods,or, if bankruptcy is filed within that 45 day period, within 20 days of thecommencement of the bankruptcy; (4) the sale of good must have been within theordinary course of debtor’s business.

And, ifthe goods enter inventory subject to a security interest and your reclamationclaim is valueless, or, if you didn’t give the required notice and your goodswere delivered within 20 days of bankruptcy, file an administrative expenseclaim under 503(b)(9).

Revised03/16/10