New Law Gives Trade Creditors Help Reclamation Creditors Gain Significant Advantage in 546(c)
Status of Reclamation Claims
Currently, under §2-702 of the Uniform Commercial Code (UCC), an unpaid seller has the right to reclaim goods sold to a buyer that the seller believes has become insolvent. UCC §2-702 states as follows:
Where the seller discovers that the buyer has received goods on credit while insolvent, he may reclaim the goods upon demand made within 10 days after their receipt....
Under §546(c) of the current Code, reclamation rights under the UCC are recognized in bankruptcy cases so long as written notice is provided to the seller 10 days after receipt of the goods, or, if the 10-day period runs after the bankruptcy petition date, the written notice must be provided within a 20-day period from the receipt of the goods.
Even though the seller of goods may have a valid reclamation claim under the Code, the successful payment of this claim may be threatened and denied altogether if the goods have been sold to a good-faith purchaser for value in the ordinary course. Under UCC §2-702(3), a seller's right of reclamation is subject to the rights of a buyer in the ordinary course or other good-faith purchaser. Incorporated within the definition of "good-faith purchaser" in the UCC1 is a creditor holding a security interest or lien.2
As a result, reclaiming creditors find their valid rights to reclaim goods after proper written demand are subject to subordination to the debtor's secured creditors. If the secured creditor is undersecured, the "valid reclamation claim" will be subordinated and perhaps worthless. Although a reclamation creditor's claim under the current Code is entitled to be treated as an administrative claim or junior lien, bankruptcy courts often allow the debtor/buyer to establish reclamation procedures that effectively avoid immediate payment, do not require the senior lender to marshal assets or liquidate non-inventory assets prior to liquidation of inventory, and effectively create a situation where the reclamation claims are left without value. See Yenkin-Majestic Paint Corp. v. Wheeling-Pittsburgh Steel Corp. (In re Pittsburgh-Canfield Corp.), 309 B.R. 277, 284 (6th Cir. BAP 2004); In re Arico, 239 B.R. 261, 271 (Bankr. S.D.N.Y.). Thus, in recent years it has become increasingly difficult for reclaiming seller/creditors to successfully assert reclamation claims and see them through to actual dollars.3
Proposed Amendments to §546(c)
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (S. 256), as passed by the U.S. Senate on March 10, 2005 (2005 Bankruptcy Code Amendments), incorporates an amendment to §546(c)(1) and (2), which states as follows:
(c)(1) Except as provided in subsection (d) of this section and in §507(c), and subject 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 §§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, but such seller may not reclaim such goods unless such seller demands in writing reclamation of such goods—
[T]he amended Code will provide far greater rights to reclamation creditors than presently exist under the UCC or the current Code.
(A) not later than 45 days after the date of receipt of such goods by the debtor; or
(B) not later than 20 days after the date of commencement of the case, if the 45-day period expires after the commencement of the case,(c)(2) If a seller of goods fails to provide notice in the manner described in paragraph (1), the seller still may assert the rights contained in §503(b)(9).
The 2005 Bankruptcy Code Amendments, which will presumably be signed into law by mid-April and become effective 180 days later, will provide far greater rights to reclamation creditors than currently provided by either the UCC or the current Code. Sellers will be able to reclaim goods sold on credit for a 45-day period before bankruptcy, so long as written notice is provided to the buyer within 45 days of receipt of the goods. The right to reclaim under the 45-day rule is most valuable if there are no superior interests of creditors holding a security interest in the debtor's inventory. The inventory that may be reclaimed under the new Code will far exceed that subject to reclamation under the 10-day period provided by the UCC. Thus, in a case where the security interest of the senior lenders does not extend to all inventory or where the senior lenders are oversecured, reclamation claims may actually have substantial value. The problems faced by reclamation creditors today—that the goods have been consumed or are no longer identifiable, will not disappear and must still be reckoned with if goods are to be reclaimed under the 45-day period. If written demand is not timely served on the debtor/buyer of the goods, the 45-day reclamation claim would not be valid.
Under new §546(c)(2), however, a new and much more powerful right is given to reclaiming creditors that, while not defeating the problems posed by senior debt, will elevate the reclaiming creditors' rights above other unsecured creditors. The new Code gives a reclaiming creditor an administrative claim for the goods delivered within 20 days before the commencement of the case, so long as the goods were sold in the ordinary course of the debtor's business.4 Under this provision, the reclaiming creditor need not provide written notice and will have an administrative claim entitled to payment prior to any unsecured creditors receiving distribution under a plan. The seller holding an administrative claim under §546(c)(2) will have the right to seek immediate payment on account of its administrative claim under §502(a)(9). There is no requirement that the creditor reclaiming under §546(c)(2) prove that the goods are still in the possession of the buyer/debtor or that the goods have not been consumed. The reclaiming creditor under this section merely must show the delivery of goods within 20 days before the commencement of the case.
Sellers holding the right to payment of the administrative claim based on receipt of goods by the debtor within 20 days prior to the commencement of the case must file an administrative claim and seek payment. If the debtor or the lender states in response that there are no available assets to pay administrative claims, the administrative claim-holder has the right to seek assurance that such claims will be paid or to seek conversion of the case. Aggressive administrative claim-holders may want to seek a carve-out from the collateral securing the lender's lien or an assignment of other assets to insure payment. The right to an administrative claim for the goods received during the 20-day period will eliminate much of the expense currently incurred by reclaiming creditors to prove that the goods are still in the possession of the debtor. Although debtors may attempt to stall the payment of administrative claims until the end of the case, as administrative claims are not required to be paid until confirmation of a plan, administrative creditors are entitled to adequate assurance that their administrative claims will actually be paid. If the debtor is unable to assure that this will happen, the case should be converted to a liquidation under chapter 7, as a plan is not likely to be confirmable.5
Just as debtor's counsel is unlikely to continue to work without the assurance that it will be paid, reclamation creditors asserting administrative claims under §502(b)(9) should not be required to sit by and wait to see whether their claims will actually be paid. To protect debtor's counsel and other professionals, a carve-out from the secured assets subject to the secured creditor's lien is often provided to protect professionals' fees. Similarly, other administrative creditors should be entitled to the same protection if their administrative claims are not to be immediately paid. The assertion of the right to immediate payment or to a carve-out will undoubtedly be a source of much litigation during the early days of new chapter 11 cases.
Protection of Reclamation Administrative Claims
To preserve their rights under the new amendments to §546(c)(2), reclamation creditors must become active during the early stages of chapter 11 cases. Reclaiming creditors must send written notice to the debtor/buyer within 45 days of the debtor's receipt of goods and, upon failure to provide written notice, must assure either that administrative claims will be protected or paid immediately, if equity exists beyond secured claims, and if not, that the case does not proceed without assurance that administrative claims will be paid at confirmation. The peril faced by creditors holding administrative claims at the commencement of a chapter 11 case is that if the case does not proceed well, there will not be sufficient assets to pay administrative claims. Reclaiming creditors should not have to shoulder that risk without adequate assurance that there will be sufficient assets one or two years from the commencement of the case.
The amendment to §546(c)(2) will create litigation early in new chapter 11 cases as reclamation creditors will be given much greater rights to reclaim goods shipped and received by the debtor during the 45 days prior to the commencement of the case. More importantly, reclaiming creditors who do not want to pay for the fight over whether or not goods shipped have been consumed will be able to simply assert an administrative claim entitled to payment in the amount of all goods received by the debtor during the 20 days prior to the commencement of the case. Debtors unable to provide assurance that the 20-day administrative claims will be paid should not be able to proceed with the case. Thus, the amended Code will provide far greater rights to reclamation creditors than presently exist under the UCC or the current Code. Reclamation creditors will have greater leverage, and lenders and debtors must now take reclamation claims seriously. Although the rules of the game have not completely changed, reclamation creditors have new cards with which to play. They will still be subject to being trumped by senior secured claims, but should be able to use newly acquired administrative claims to good advantage.
1 See UCC §§1-201(32), (33); revised UCC §§1-201(b)(29) and (3). Return to article
2 UCC §2-702(3) states:
The seller's right to reclaim under subsection (2) is subject to the rights of a buyer in the ordinary course or other good-faith purchaser under this article. Successful reclamation of goods excludes all other remedies with respect to them. Return to article
3 See Nathan, Bruce S., "Reclamation Rights Trumped by UCC's Floating Inventory Security Interest," ABI Journal, November 2004. Return to article
4 New §503(b)(9) states:
the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor's business. Return to article
5 Conversion to a chapter 7 case, however, will create a right to payment for the chapter 7 trustee, which will be ahead of chapter 11 administrative creditors. See §507(a)(1)(C). Return to article