By: Dean Katsionis
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
Section 546(c) of the Bankruptcy Code preserves a vendor’s right to reclaim goods sold to an insolvent debtor within forty-five days of the debtor’s bankruptcy filing.[1] Courts have had to address whether a post-petition lender’s subsequently perfected security interest defeats the vendor’s reclamation rights when a post-petition loan is used to repay the debtor’s prepetition secured loan, which are generally subject to reclamation rights.[2] In In re Reichold Holdings US, Inc., the United States Bankruptcy Court for the District of Delaware overruled a liquidating trustee’s objection to a vendor’s reclamation claim, holding that the vendor’s reclamation rights arose before a post-petition DIP lender’s liens attached, and as such, those liens were subject to the prior reclamation rights of the vendor.[3]
In the instant case, Reichold Holdings US, Inc. (the “Debtor”), filed a voluntary petition under chapter 11 in September 2014.[4] Prior to bankruptcy, the Debtor was a borrower under a credit facility (the “Prepetition Loan”), in which a lien, subject to reclamation claims, was granted on “substantially all of the Debtor’s assets, including inventory.”[5] The Debtor later obtained post-petition financing in the form of a DIP loan from a separate group of lenders (the “DIP Lenders”), which was secured by a first priority lien on all of the Debtor’s pre- and post-petition property, also including inventory.[6] That lien, however, was preempted by any preexisting “valid, perfected and non-avoidable liens.”[7] Ultimately, the DIP loan was used to repay the Prepetition Loan, and the DIP loan itself was later repaid from the Debtor’s asset sale in 2015.[8]
Prior to filing, Covestro, the claimant-vendor in Reichold, supplied goods on credit to the Debtor within the required forty-five day reclamation period under Section 546(c), giving rise to a valid lien on those goods.[9] Immediately following the Debtor’s bankruptcy filing, Covestro filed a proof of claim (the “Reclamation Claim”) seeking to recover “the value of goods delivered to the Debtor between 21 and 45 days prior to the commencement of the Debtor’s bankruptcy case.”[10] The Debtor filed a limited objection on the ground that the reclamation claim was “rendered valueless when the Prepetition Loan was repaid” by the DIP loan.[11]
The Court here focused on whether the DIP Lenders’ rights, granted after Covestro’s reclamation rights arose, “relate[d] back” to the rights of the Prepetition Loan.[12] The Debtor, relying on decisions by the Bankruptcy Court for the Southern District of New York, argued that the two liens of the Prepetition Loan and the DIP loan were an “integrated transaction” because the proceeds of the DIP loan repaid the Prepetition Loan.[13] Consequently, according to the Debtor, “the goods securing the prepetition lender’s debt were effectively used to repay that [post-petition] debt.”[14] Conversely, Covestro argued that the DIP loan’s first priority lien was “distinct and separate from the Prepetition Lender’s lien, and arose after Covestro’s rights arose.”[15]
Noting a split in authority, the Reichold Court ruled in favor of Covestro.[16] The Court elaborated that once the prepetition loan was repaid and the respective lien satisfied, Covestro’s reclamation rights took priority, thus superseding the rights of the DIP Lenders.[17] The fact that the proceeds of the DIP loan were used to repay the Prepetition Loan, or that the DIP lenders were granted a lien on inventory in return for those funds, was immaterial.[18] This holding rests on temporal grounds and the notion of when in time particular rights arose. Covestro’s reclamation rights came into existence before the DIP Lenders’ lien attached, and further, that lien was “expressly subject to reclamation rights under section 346.”[19]
This decision ultimately exposes the inconsistent holdings on enforcing reclamation claims in instances where pre- and post-petition liens are secured with the same property of the debtor, including reclaimed goods of a vendor. In light of this ruling, reclamation claims still remain a viable option for vendors seeking to maximize recovery from an insolvent debtor filing for chapter 11.[20] Further, the Court’s discussion on the split in authority here shows that the bankruptcy court of Delaware offers a more vendor-friendly forum than that of the New York.
[1] 11 U.S.C.A. §546(c) (2006) (“[S]ubject to the prior rights of a holder of a security interest in such goods or the proceeds thereof, the rights and powers of the trustee under sections 544(a), 545, 547, and 549 are subject to the right of a seller of goods that has sold goods to the debtor, in the ordinary course of such seller's business, to reclaim such goods if the debtor has received such goods while insolvent, within 45 days before the date of the commencement of a case under this title[.]”).
[2] See In re Pester Ref. Co., 964 F.2d 842, 846 (8th Cir. 1992); See also United States v. Westside Bank, 732 F.2d 1259, 1263 (5th Cir. 1984). These were two cases in which the holdings show that the mere presence of a secured creditor with superior rights does not necessarily eliminate a vendor’s reclamation rights.
[3] See In re Reichold Holdings US, Inc., et al., 2016 WL 4479286 at *8 (Bankr. D. Del. 2016).
[4] See Reichold, 2016 WL 4479286 at *1.
[5] See Id. at 1, 8.
[6] Id. at *2.
[7] Id.
[8] See Id.
[9] See Id. at 2-3; § 546(c).
[10] Reichold, 2016 WL 4479286 at *3 (“On October 1, 2015, Covestro filed a proof of claim (the “Reclamation Claim”) seeking $411,781.72 as an administrative expense. The Reclamation Claim sought the value of goods delivered to the Debtor between 21 and 45 days prior to the commencement of Debtor’s bankruptcy case.”).
[11] See Id.
[12] Id. at *5.
[13] See Id. at 5-6 (citing In re Dana Corp., 367 B.R. 409, 420 (Bankr. S.D.N.Y. 2007); In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003)) These decisions explain that a post-petition loan supported by a new floating lien on a debtor’s goods may relate back to a prepetition loan so long as the proceeds of the post-petition loan are used to repay the prepetition loan. This proposition is ultimately rejected by the Reichold Court.
[14] Id. at *6 (citing Dairy Mart, 302 B.R. at 136).
[15] Id. at *7 (citing In re Phar-Mor, 301 B.R. 482, 498 (Bankr. N.D. Ohio 2003) (“[A] debtor’s decision to grant a security interest in inventory to a subsequent secured lender cannot defeat a seller’s reclamation rights.”) There, the Sixth Circuit affirmed that “a post-petition lender’s floating lien on the debtor’s inventory did not constitute an assumption of the prepetition creditor’s lien, but an entirely new lien that did not defeat an intervening reclaiming seller’s rights.”
[16] Id. at *8.
[17] Id.
[18] See Id.
[19] See Id.
[20] Id. at *4 (citing Circuit City Stores, Inc., 441 B.R. 496, 505 (Bankr. E.D. Va. 2010) (“[A] reclaiming seller must be able to prove that it had a valid right of reclamation under state law.”) This suggests that the law of the state controlling the reclamation issue in a particular case will be dispositive of whether or not a seller has a right of reclamation as seen in this instance.