A Sellers Stoppage of Delivery Rights How to Move to the Head of the Line

A Sellers Stoppage of Delivery Rights How to Move to the Head of the Line

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Trade creditors have bemoaned the increased frequency of court decisions that deny relief to trade creditors asserting reclamation claims where the buyer's lender had a perfected floating security interest in all of the buyer's inventory. Two recent decisions of the U.S. Bankruptcy Court in Delaware have granted more favorable treatment to an unpaid seller, asserting the state law right to stop delivery of goods sold to an insolvent buyer, notwithstanding the conflicting claim of the buyer's inventory secured lender. In In re Trico Steel Co. L.L.C., 282 B.R. 318 (Bankr. D. Del. 2002), and In re Kellstrom Industries Inc., 282 B.R. 787 (Bankr. D. Del. 2002), Bankruptcy Judge Mary F. Walrath, relying on Articles 2 and 9 of the Uniform Commercial Code (UCC), held that an unpaid seller that properly exercises the right to stop delivery of goods from an insolvent buyer in bankruptcy is entitled to payment for its goods and has priority over the buyer's floating inventory secured lender. That moved the unpaid seller to the head of the line!

An Unpaid Seller's Stoppage of Delivery Rights

An unpaid seller's right to stop delivery of goods in the seller's possession, or in the possession of a carrier or other bailee, is governed by state law. Sections 2-702, 2-703 and 2-705 of Article 2 of the UCC deal with an unpaid seller's stoppage of delivery rights.

Section 2-702(1) provides that "Where the seller discovers the buyer to be insolvent, he may refuse delivery except for cash including payments for all goods theretofore delivered under the contract, and stop delivery under this Article (§2-705)."1

Section 2-703 further states: "Where the buyer...fails to make a payment due on or before delivery...then with respect to any goods directly affected, and if the breach is of the whole contract (§2-612), then also with respect to the whole undelivered balance the aggrieved seller may withhold delivery of such goods, [or] stop delivery by any bailee as hereinafter provided (§2-705)..." [language omitted].

Finally, §2-705 states:

  • The seller may stop delivery of goods in the possession of a carrier or other bailee when he discovers the buyer to be insolvent (§2-702) and may stop delivery...when the buyer repudiates or fails to make a payment due before delivery or if for any other reason the seller has a right to withhold or to reclaim the goods.
  • Against such buyer, the seller may stop delivery until (1) receipt of the goods by the buyer, (2) acknowledgment to the buyer by any bailee of the goods except a carrier that the bailee holds the goods for the buyer, (3) such acknowledgment to the buyer by a carrier by reshipment or as warehouseman or (4) negotiation to the buyer of any negotiable document of title covering the goods.
U.C.C. §2-705 (2001) (language omitted).

A seller seeking to stop delivery of its goods has to show that the buyer is insolvent. Where the buyer is not in bankruptcy, the UCC definition of insolvency applies. The UCC relies on either an equity or the bankruptcy definition of insolvency. (See UCC §1-201(23)). Under the easier-to-prove equity definition, a buyer is insolvent when it is unable to pay its debts in the ordinary course of business or as they come due. The Bankruptcy Code uses the harder-to-prove balance sheet definition under which a debtor is insolvent when its liabilities exceed its assets at a fair valuation. (See 11 U.S.C. §1-101(32)).

A seller, seeking to stop delivery of goods in the possession of a carrier or other bailee, must instruct the carrier or bailee not to release the goods to the buyer. The carrier or other bailee must then hold and deliver the goods according to the seller's instruction. The seller is liable for all charges and damages incurred by the carrier or other third party resulting from their holding the goods. (See UCC §2-705(3)).

Two recent decisions of the U.S. Bankruptcy Court in Delaware upheld an unpaid seller's right to stop delivery of goods, notwithstanding the competing claim of the buyer's floating inventory secured lender. In In re Trico Steel Co. L.L.C., 282 B.R. 318 (Bankr. D. Del. 2002), the seller sought to stop delivery of the goods in the possession of a carrier that the buyer had engaged. In In re Kellstrom Industries Inc., 282 B.R. 787 (Bankr. D. Del. 2002), the seller sought to withhold delivery of goods in the seller's possession.

In re Trico SteelCo. L.L.C.

On Jan. 24, 2002, Cargill Inc. had agreed to sell basic pig iron to Trico. Trico engaged Celtic Marine Corp. to ship the goods by barge to Trico's facility in Decatur, Ala. Celtic, in turn, hired Volunteer Barge & Transportation to transport the goods to Decatur. On March 7, 2001, Trico hired stevedores to load approximately 25,000 metric tons of goods onto Volunteer's barges for shipment to Decatur. Volunteer issued two non-negotiable bills of lading to Celtic as a receipt for the goods.

Cargill had learned that Trico was insolvent while the goods were in transit to Decatur. On March 23, 2001, Cargill sent a letter instructing Celtic to stop delivery of the goods in transit. On March 26, Cargill notified Trico that Cargill was exercising its right to stop delivery of the goods due to Trico's insolvency.

On March 27, 2001, Trico filed its chapter 11 petition. On March 28, Cargill sent a second letter to Celtic, offering to indemnify Celtic for Celtic's losses incurred in complying with Cargill's stoppage of delivery demand. On March 29, Cargill sent a second letter to Trico reasserting Cargill's stoppage-of-delivery rights and holding Trico responsible for any action in contravention of Cargill's rights.

On March 30, 2001, Cargill commenced a lawsuit seeking declaratory judgment, a temporary restraining order and a preliminary injunction prohibiting Trico from using, transferring, selling, encumbering or otherwise disposing of the goods subject to Cargill's stoppage-of-delivery claim. Cargill asserted that it had satisfied the requirements for stopping delivery of the goods in transit and had a prior right to the goods. Trico and its inventory secured lender, Chase Manhattan Bank, disputed Cargill's stoppage-of-delivery rights. Chase also claimed priority based on its perfected floating security interest in all of Trico's inventory. Cargill and Trico later agreed to the sale of the goods, and the escrowing of sales proceeds in excess of $2.7 million, pending the court's decision on Cargill's stoppage-of-delivery rights.

Cargill claimed the right to stop delivery of its goods in transit because Trico had not received the goods. UCC §2-103(1)(c) defines "receipt" as taking physical possession, and Trico was never in physical possession of the goods.

Trico countered that it had obtained actual physical possession of the goods when it became responsible for unloading them and hired stevedores to do so. This amounted to a "receipt" that cut off Cargill's stoppage of delivery claim.

The court held that Cargill had an enforceable right to stop delivery of its goods in transit. Trico could not have obtained physical possession of the goods until they arrived at Trico's facility in Decatur. The stevedores hired by Trico and a carrier, Volunteer, had physical possession of the goods; Trico did not. Cargill's stoppage-of-delivery rights were also unaffected by the prior passage of title and risk of loss to Trico. (See In re Marin Motor Oil Inc., 740 F. 2d 220 (3d Cir. 1984)).

The court also upheld the priority of Cargill's right to stop delivery of goods in transit over Chase's security interest in the goods. More on this later!

In re Kellstrom Industries Inc.

American Valley Aviation (AVA) had agreed to sell its inventory of aerospace components and parts (AVA Goods) to Kellstrom Industries. Kellstrom had agreed to pay approximately $3.3 million of the purchase price over 24 months. Kellstrom obtained title to the AVA Goods upon execution of the agreement. However, AVA retained possession of the goods and agreed to store, pack and ship them according to Kellstrom's direction.

Kellstrom had previously entered into a loan and security agreement with Bank of America (BOA). BOA asserted a security interest in all of Kellstrom's inventory, including the AVA Goods.

On Feb. 20, 2002, Kellstrom filed chapter 11. AVA withheld delivery of the AVA Goods in its possession pending Kellstrom's payment of the balance of the purchase price. Kellstrom moved for bankruptcy court approval of the sale of its assets, including the AVA goods. Kellstrom argued that its acquisition of title resulted in a constructive delivery and Kellstrom's receipt of the AVA Goods that cut off AVA's stoppage of delivery rights. AVA asserted that its right to stop delivery of goods in its possession precluded their sale until Kellstrom paid for them.

The court upheld AVA's right to stop delivery because AVA, and not Kellstrom, had actual physical possession of the AVA Goods. Neither the passage of title, nor any constructive delivery of the goods to Kellstrom, resulted in Kellstrom's obtaining actual physical possession. The court also held that AVA's stoppage of delivery rights were not impaired by BOA's security interest.

Priority of an Unpaid Seller's Stoppage of Delivery Rights over the Buyer's LenderÆs Security Interest in Inventory

In both Trico Steel and Kellstrom Industries, the court upheld the priority of an unpaid seller's stoppage of delivery rights over the security interest of the buyer's secured lender. In each case, the court relied on UCC Article 2, which governs stoppage of delivery rights, and found inapplicable UCC Article 9, which deals with consensual security interests.

In Kellstrom Industries, the court considered UCC §9-110,2 which deals with the rights of a holder of an Article 2 security interest under Article 9, stating as follows:

A security interest arising under §2-401, 2-505, 2-711(3)...is subject to this article. However, until the debtor obtains possession of the goods:
  • the security interest is enforceable, even if §9-203(b)(3) has not been satisfied;
  • filing is not required to perfect the security interest;
  • the rights of the secured party after default by the debtor are governed by Article 2...; and
  • the security interest has priority over a conflicting security interest created by the debtor.
U.C.C. §9-110 (2001) (language omitted)

UCC §9-110 is clear that a UCC Article 2 security interest-holder is subject to UCC Article 9. However, §9-110 is silent on whether an unpaid seller's right to stop delivery of goods is subject to Article 9. Official Comment 5 to §9-110 discusses a seller's stoppage of delivery rights as follows:

This Article does not specifically address the conflict between (i) a security interest created by a buyer...and (ii) the seller's...right to withhold delivery under §2-702(1) [or] 2-703(a)...the seller's...right to stop delivery under §2-705...or the seller's right to reclaim under §2-507(2) or 2-702(2). These conflicts are governed by the first sentence of §2-403(1), under which the buyer's secured party obtains no greater rights to the goods than the buyer had or had the power to convey...
U.C.C. §9-110 Official Comment at 5 (2001) (language omitted).

UCC §2-403(1) states that "A purchaser of goods acquires all title which his transferor had or had power to transfer except that a purchaser of a limited interest acquires rights only to the extent of the interest..." BOA's security interest rose no higher than Kellstrom's rights in the goods. Both interests were subordinate to AVA's right to stop delivery of the goods in its possession. Kellstrom and BOA could terminate AVA's stoppage of delivery rights and sell the goods after paying AVA's claim in accordance with UCC §2-702(1).


A trade creditor's right to withhold or stop delivery of goods has plenty of potency.

The court did the same analysis and reached the same conclusion in In re Trico Steel. Cargill's UCC Article 2 right to stop delivery of goods in the possession of Trico's carrier was not an Article 2 security interest, and therefore not subject to UCC Article 9.3 UCC Article 2 governed the priority dispute between Chase's Article 9 security interest and Cargill's right to stop delivery.

Chase was a UCC Article 2 good-faith purchaser of the goods in the possession of Trico's carrier as a result of Chase's security interest in Trico's inventory. Under §2-705(3), an unpaid seller's right to withhold or stop delivery of goods is not subject to the rights of a good-faith purchaser.4 As such, Chase's security interest in the goods in the possession of Trico's carrier was subject to Cargill's right to stop delivery of the goods, and Cargill was entitled to payment of the escrowed proceeds.

An unpaid seller's UCC Article 2 right of reclamation of goods is not afforded similar priority. A seller's reclamation rights are subject to the rights of a buyer in the ordinary course or other good faith purchaser. (See UCC §2-702(3)). The debtor's floating inventory lender can be a good-faith purchaser. In such event, the lender has priority over a seller's reclamation rights. And courts have frequently denied relief to reclamation creditors where the proceeds of their goods were paid to the lender, rendering their reclamation claims valueless.5

Conclusion

A trade creditor's right to withhold or stop delivery of goods has plenty of potency. A creditor that satisfies all of the UCC Article 2 requirements for stoppage of delivery has a prior right to the goods, with priority over the buyer's floating-inventory secured lender. That could lead to the immediate full payment of the purchase price of the goods, despite the buyer's bankruptcy filing, thereby moving the trade creditor to the front of the line!


Footnotes

1 Official Comment 1 of UCC §2-702(1) further states that passage of title to the goods to the buyer does not affect the seller's stoppage-of-delivery right. Return to article

2 The court relied on Revised Article 9 of the UCC, which became effective on July 1, 2001, as the governing law. Return to article

3 While the prior version of UCC Article 9 governed, it had no bearing on the outcome since the relevant provision is similar to §9-110 of current Article 9. Return to article

4 The court found inapplicable Kunkel v. Sprague Nat. Bank, 128 F.3 636 (8th Cir. 1997), relied upon by Chase, where the delivery of the goods to the buyer had cut off the seller's stoppage of delivery rights. The court also found inapplicable Hong Kong & Shanghai Banking Corp. Ltd. v. HFH USA Corp., 805 F. Supp. 133 (W.D.N.Y. 1992), where the seller had an Article 2 security interest in the goods that was subject to the secured lender's Article 9 rights. Return to article

5 See recent decisions: In re Quality Stores Inc., 289 B.R. 324 (Bankr. W.D. Mich. 2003); In re Bridge Information Systems Inc., 288 B.R. 133 (Bankr. E.D. Mo. 2001); In re Houlihan's Restaurant Inc., 286 B.R. 137 (Bankr. W.D. Mo. 2002); See, also, e.g., In re Primary Health Systems Inc., 258 B.R. 111 (Bankr. D. Del. 2001); In re Arlco Inc., 239 B.R. 261 (Bankr. S.D.N.Y. 1999). Return to article

Journal Date: 
Thursday, May 1, 2003