Reclamation Overview

ection 546(c) of the Bankruptcy Code gives the seller the right to reclaim goods sold on credit to an insolvent debtor after the debtor has filed a bankruptcy action. However, §546(c) does not create a substantive right to reclamation. It allows a seller to reclaim goods only to the extent there is a statutory or common law right to do so. In re Coast Trading Co. Inc., 744 F.2d 686, 692 (9th Cir. 1984)¹

Exclusive Remedy

Section 546(c) is the exclusive remedy for a reclaiming seller when the buyer is in bankruptcy. In re Julien Co., 44 F.3d 426 (6th Cir. 1995).² A reclaiming seller who fails to prove all the elements of a reclamation claim under §546(c) cannot avail itself of a common-law fraud remedy because §546(c) is the exclusive remedy for reclaiming creditors. See In re MGS Marketing, 111 B.R. 264 (9th Cir. BAP 1990); In re Flagstaff Foodservice Corp., 56 B.R. 899 (Bankr. S.D.N.Y. 1986).³

Seller of Goods

A reclaiming seller must be a "seller of goods" in order to bring a reclamation claim under §546(c). See In re Grossinger's Associates, 125 B.R. 106 (Bankr. S.D.N.Y. 1991) and In re East Texas Steel Facilities Inc., 117 B.R. 235 (Bankr. N.D. Tex. 1990). In Grossinger's Associates, the seller erected canopies for the debtor's hotel and was not just a supplier of structural steel.

Elements of Proof

A seller has the burden of proving all of the elements of a valid reclamation claim. See Matter of Adventist Living Centers Inc., 52 F.3d 159, 162 (7th Cir. 1995); In re Mayer Pollock Steel Corp., 157 B.R. (Bankr. E.D. Pa. 1993). The court in Matter of Continental Airlines Inc., 125 B.R. 415, 417 (Bankr. D. Del. 1991), set out the elements of a reclamation claim under §546(c): (1) The debtor was insolvent when the seller delivered the goods to him; (2) the seller made written demand for return of the goods within 10 days of the delivery of the goods; (3) the seller could identify the goods at the time of the demand; and (4) the goods were in the possession of the debtor at the time of demand. Once a reclaiming seller presents evidence of debtor's insolvency at the time of the delivery of the goods, the burden of proof shifts to the debtor to rebut the seller's proof of insolvency. Matter of Continental Airlines Inc., 125 B.R. at 417.

---

One of the most difficult hurdles that a reclaiming seller must overcome is the requirement that the seller must identify the goods that are subject to the reclamation claim.

---

Insolvent Debtor

Only goods received by the debtor while insolvent are subject to reclamation. See Matter of Griffin Retreading Co., 795 F.2d 676, 679 (8th Cir. 1986); In re Buyer's Club Market Inc., 100 B.R. 35, 36 (Bankr. D. Colo. 1989). The Bankruptcy Code defines the term "insolvency" in §101(32)(A) to mean "financial condition such that the sum of such entity's debts is greater than all of such entity's property at a fair valuation (emphasis added). This definition is referred to as the "balance sheet test." Bankruptcy Code definitions apply to all sections of the Code, and the "balance sheet" definition of insolvency should be used in reclamation proceedings. In re Diamond Lumber Inc., 102 B.R. 77 (Bankr. N.D. Tex. 1988). The reclaiming creditor must prove that the debtor was insolvent at the time the goods were delivered. See In re Julien, supra at 431; In re Mayer Pollock Steel Corp., supra at 959-60; In re Storage Technology Corp., 51 B.R. 206 (D. Col. 1985).

"Fair valuation" within the context of the "balance sheet" test for determining the issue of insolvency in reclamation actions involves an estimate of what can be realized out of the assets within a reasonable time either through collection or sale at the regular market value. Storage Technology, supra at 208. The "equity" definition of insolvency, the inability of the debtor to pay its bills as they come due, will not support a reclamation claim. In re Furniture Distributors, 45 B.R. 38 (Bankr. D. Mass. 1989).

A debtor's bankruptcy schedules are probative evidence of insolvency. In re Flagstaff Foodservice Corp., 56 B.R. 899, 905 (Bankr. S.D.N.Y. 1986). While the schedules are probative evidence of insolvency, they are not dispositive of the issue of insolvency. In re Flagstaff Foodservice Corp., 56 B.R. at 907. While the schedules may show that debtor was insolvent on the date of the filing of the petition, the claimant must still show that debtor's financial condition did not change materially from date of the delivery of the materials to the date of the filing of the petition. In re Penthouse Travelers of Aripeka Inc., 120 B.R. 226 (Bankr. M.D. Fla. 1990).

Written Demand to Debtor for Return of Goods Within 10 Days

A reclaiming seller must serve a written demand for reclamation on the buyer; an oral reclamation demand will not sustain a reclamation claim under §546(c). In re Julien Co., 44 F.3d at 431-432. The plaintiff in In re Charter Co., 52 B.R. 263, 265-66 (Bankr. M.D. Fla. 1985), failed to send a written demand for reclamation within 10 days from the date of delivery of the goods to the insolvent buyer. The plaintiff argued that the buyer had misrepresented his solvency at the time of purchase and that the 10-day limitation did not apply. The court recognized that under UCC §2-702, a timely demand for reclamation is excused when the buyer made a written misrepresentation of solvency by the seller, but the court rejected the plaintiff's argument, stating that the case law and the unambivalent wording of §546(c) did not support the plaintiff's position. The §546(c) requirement for a written demand for reclamation within 10 days of delivery was absolute and could not be waived. In re Charter Co. at 266.

The plaintiff in In re Rozel Industries Inc., 74 B.R. at 645-46, also failed to give written demand for reclamation in the 10-day period, and argued that §546(c) was merely a "safe harbor" provision shielding a seller's reclamation rights against the avoiding powers of a trustee or debtor-in-possession and that it should still be able to proceed under its state right of reclamation. The court summarily rejected plaintiff's position and made it clear that the §546(c) requirement of a 10-day written notice was absolute. Rozel at 646. See, also, In re Rea Keech Buick Inc., 139 B.R. at 629. The written demand must explicitly state that it is asserting the right to reclamation. Matter of Marin Motor Oil Inc., 740 F.2d 220, 221 (3d Cir. 1984). One court stated that the written demand for reclamation must use the word "reclamation" in the demand. In re Buyer's Club Market Inc., 100 B.R. at 36. Other courts hold, however, that the notice of reclamation is sufficient if it reflects an intention to rescind the sale. In re Graphic Productions Corp., 176 B.R. 65, 73 (Bankr. S.D. Fla. 1994).

The "dispatch rule" applies to reclamation demands. Under the dispatch rule, a reclamation demand is considered made when it is sent rather than when it is received, so long as it is sent in a commercially reasonable manner. Matter of Marin Motor Oil Inc., 740 F.2d at 228 (which expressly rejected the "receipt rule").⁴ The 10-day period begins running from the date debtor actually receives the goods, rather than the date the seller delivers the goods to a common carrier. In re Maloney Enterprises Inc., 37 B.R. 290, 292 (Bankr. E.D. Ky. 1983); Matter of Marin Motor Oil Inc., supra, 740 F.2d at 225-26. Making a demand for reclamation does not violate the automatic stay. In re Production Steel Inc., 21 B.R. 951, 953-54 (Bankr. M.D. Tenn. 1982). Goods shipped more than 10 days prior to the date of the written demand cannot be the object of a reclamation action. In re Landy Beef Co. Inc., 30 B.R. 19 (Bankr. D. Mass. 1983). Finally, the seller's failure to make a timely written demand for reclamation leaves him as an unsecured, non-priority claimant. In re Gibson Distr. Co.-Permian Basin, 40 B.R. at 769.

Goods Must Be Identified at Time of Demand

A reclaiming seller must identify in its written demand for reclamation the goods that are subject to such reclamation. In re Braniff, 113 B.R. 745, 752 (Bankr. M.D. Fla. 1990); In re Landy Beef Co., supra at 21. The goods subject to reclamation must be identifiable. In re Morken, 182 B.R. at 1016. One of the most difficult hurdles that a reclaiming seller must overcome is the requirement that the seller must identify the goods that are subject to the reclamation claim.

There is scant law on this critical area of reclamation claims. The court in Braniff held that if the written reclamation demand was not sufficiently detailed in the description of the goods subject to reclamation, then the reclamation claim must fail as a matter of law. Braniff, 113 B.R. at 752. However, the court in Braniff tells reclaiming creditors by way of dicta that if they can devise a formula by which they can trace the product, establish the time frame in which it was delivered to the seller and convince the court that the formula traces the product within the time frame with a fair degree of accuracy, then it does not have to physically identify its goods to sustain a reclamation claim. Braniff at 755.

Goods Must Be in Possession of Debtor at Time of Demand

The reclaiming vendor must prove that the debtor possessed the goods at the time of the reclamation demand. See In re Pester Refining Co., 964 F.2d 842, 846 (8th Cir. 1992); In re Rawson Food Service Inc., 846 F.2d 1343, 1347-49 (11th Cir. 1983); In re Arlco, 239 B.R. at 266. A seller of goods is only entitled to reclaim goods that the debtor had on hand at the time of the demand for reclamation was made. See In re Morken, 182 B.R. at 1016; In re Buyer's Club Market Inc., 100 B.R. 37, 38 (Bankr. D. Colo. 1989).⁵ The seller in a reclamation case has the burden of proving that the debtor possessed the goods when it received the reclamation demand. This is a fairly stringent requirement. See In re Adventist Living Ctrs. Inc., 52 F.3d 159, 163 (7th Cir. 1995); Matter of Flagstaff Foodservice Corp., 14 B.R. 462, 469 (Bankr. S.D.N.Y. 1981). There is no presumption that the goods remained with the debtor simply because the goods were delivered. See In re Adventist Living Ctrs. Inc., supra at 163 and In re Rawson Food Service Inc. at 1350 N. 11.

In Adventist Living Centers, the reclaiming seller did not take a prompt and accurate inventory of the goods on hand on the date of the reclamation demand. The Seventh Circuit rejected the seller's assertion that it could accurately estimate the amount of goods on hand based on delivery invoices and other such records, and the court rejected the seller's reclamation claim. The court in In re Landy Beef Co. Inc., 30 B.R. at 21, however, looked at the normal business practice of the debtor in disposing of goods to determine what product was on hand on the date of the reclamation demand.

Right of Reclamation Subject to Prior Lien of Secured Creditors

A seller's right to reclamation is subject to the right of a good-faith purchaser. See UCC §2-702(3); Matter of Reliable Drug Stores Inc., 70 F.3d 948, 950 (7th Cir. 1995); In re Coast Trading Co., 744 F.2d 686, 690 (9th Cir. 1984). State law usually deems a secured creditor having a security interest in a debtor's property, including an after-acquired security interest, to be a good-faith purchaser for value, thus having rights superior to those of a reclaiming seller.⁶ In re Pester Refining Co., 964 F.2d at 846.

Courts generally recognize that a credit seller's right to reclamation is "subject to" the prior lien of a secured creditor. The courts, however, have split into three lines of authority as to the effect of the words "subject to":

1. Reclamation Right Extinguished by Prior Lien. The Ninth Circuit in In re Coast Trading Co. Inc., 744 F.2d at 690-692, held that reclaiming seller's right to reclamation and any claim for priority is extinguished by the existence of the claim of a secured creditor.
2. Reclamation Right Not Extinguished by Prior Lien; Claimant, However, Is Entitled Only to Priority Claim in Lieu of Reclamation. Several courts have held that when a secured creditor precludes a seller from reclaiming goods subject to the secured claim, the rights of the reclaiming seller are not cut off by the existence of the secured creditor; the court can award the reclaiming seller an administrative priority in lieu of the reclamation claim.⁷ In re Mayer Pollock Steel Corp., 157 B.R. at 960.
3. Reclamation Right Not Extinguished, But if Claim Is Worthless Outside Bankruptcy, It Is Worthless Inside Bankruptcy. The Eighth Circuit in In re Pester Refining Co., supra, held that a seller's right to reclaim is not extinguished because secured creditors assert a perfected security interest in the goods sought to be reclaimed. Pester at 846. The Eighth Circuit, however, went to state "[w]hen the secured creditors have satisfied their claims out of the goods to be reclaimed, granting §546(c)(2) relief would afford the reclamation seller something it does not have under the UCC—a priority interest in the buyer's assets other than the goods to be reclaimed." Pester at 847. Therefore, if the secured creditor satisfies its claim out of the goods otherwise subject to reclamation, the reclamation is not extinguished, but is valueless. Since the claim has no value, a court cannot grant the seller an administrative priority under §546(c)(2). The underlying rationale for this holding is that Congress did not expand the right of reclamation in bankruptcy over the rights a reclaiming seller would have under the UCC.⁸ If the secured creditor is over-secured and satisfies its claim out of goods other than the goods sought to be reclaimed, or all of the goods subject to reclamation are not needed to satisfy the secured claim, then the reclaiming seller will be entitled to a priority claim, but only to the extent of the value of the goods not used to satisfy the secured claim. Pester, 964 F.2d at 847.

   Diligence in Pursuing Claim

   A reclaiming seller must demonstrate to the court that he has diligently pursued his reclamation claim in order to prevail, and if he fails to diligently pursue the reclamation claim, then he loses that right. See In re McLouth Steel Products Corp., 213 B.R. 978, 987 (E.D. Mich. 1997); Matter of Crofton & Sons Inc., 139 B.R. 567, 569 (Bankr. M.D. Fla. 1992).

   Sale to Buyer Was in Seller's Ordinary Course of Business

   A seller must also prove that the sale of the goods in question was made in the ordinary course of the business of the seller. See In re Arlco, 239 B.R. at 266; In re Morken, 182 B.R. at 1016.

   Reclamation Rights in Proceeds

   The Fifth Circuit in a non-bankruptcy case, United States v. Westside Bank, 732 F.2d 1258 (5th Cir. 1984), held that when a seller of goods has met the requirements of UCC §2-702 and when all prior lienholders have been satisfied, the seller will be accorded a priority status that will extend to proceeds that are traceable to the goods. Several courts, however, have held that no reclamation rights exist in the proceeds from the resale of goods sought to be reclaimed. In re Coast Trading Co., 744 F.2d 686, 691 (9th Cir. 1984).⁹

   Reclaiming Seller's Right to Interest

   Two courts have held that a seller is entitled to interest calculated from the date of the reclamation demand when a court grants the seller an administrative priority claim in lieu of reclamation. In re Wheeling-Pittsburg Steel Corp., 74 B.R. 656, 661 (Bankr. W.D. Pa. 1987); In re Mesa Refining Inc., 66 B.R. 36, 38-9 (Bankr. D. Colo. 1986). Other courts, however, have denied a seller's claim to interest on its reclamation claim because there is no specific statutory authority for doing so. In re Western Farmers Ass'n., 6 B.R. 432, 437 (Bankr. W.D. Wash. 1980) (a pre-Bankruptcy Code case). See, also, In re American Int'l Airways Inc., 77 B.R. 490, 494-95 (Bankr. E.D. Pa. 1987).

   The Eighth Circuit in In re Pester Refining Co., 964 F.2d at 849, held that the reclaiming seller is entitled to post-judgment interest from the date of a judgment. The court, however, left open the question whether the plan could curtail post-judgment interest.

   Date Reclamation Claims Are Paid

   A court has the discretion to allow some administrative claims to be paid prior to the effective date of the plan of reorganization. Matter of Isis Foods Inc., 27 B.R. 156 (W.D. Mo. 1982), and In re Verco Indus., 20 B.R. 664, 665 (BAP 9th Cir. 1982). Normally, however, an administrative claim is paid on the effective date of the plan. 11 U.S.C. §1129(a)(9)(A).

   ---

   Footnotes

   ¹ In re Arlco Inc., 239 B.R. 261 (Bankr. S.D.N.Y. 1999); In re Steinberg's Inc., 226 B.R. 8 (Bankr. S.D. Ohio 1998); In re Victory Markets Inc., 212 B.R. 738 (Bankr. N.D.N.Y. 1997); In re Morken, 182 B.R. 1007 (Bankr. D. Minn. 1995). Return to article

   ² In re Mayer Pollock Steel Corp., 157 B.R. 952 (Bankr. E.D. Pa. 1993); Matter of Leeds Bldg. Products Inc., 141 B.R. 265 (Bankr. N.D. Ga. 1992); In re Rea Keech Buick Inc., 139 B.R. 625 (Bankr. D. Md. 1992); In re Video King of Illinois Inc., 100 B.R. 1008 (Bankr. N.D. Ill. 1989); In re Energy Co-Op Inc., 94 B.R. 975 (N.D. Ill. 1988); In re Rozel Industries Inc., 74 B.R. 643 (Bankr. N.D. Ill. 1987); In re Gibson Distributing Co. Inc.-Permian Basin, 40 B.R. 767 (Bankr. W.D. Tex. 1984). Return to article

   ³ There are three Flagstaff opinions cited in this article: Matter of Flagstaff Foodservice Corp., 14 B.R. 462 (Bankr. S.D.N.Y. 1981); In re Flagstaff Foodservice Corp., 56 B.R. 899 (Bankr. S.D.N.Y. 1986), and In re Flagstaff Foodservice Corp., 56 B.R. 910 (Bankr. S.D.N.Y. 1986). Return to article

   ⁴ In re Bill's Dollar Stores Inc., 164 B.R. 471 (Bankr. D. Del. 1994); In re Flagstaff Foodservice Corp., 56 B.R. 910, 915 (Bankr. S.D.N.Y. 1986); and In re Lawrence Paperboard Corp., 52 B.R. 907, 910 (Bankr. D. Mass. 1985). Return to article

   ⁵ There are two Buyer Club Market Inc. cases: In re Buyer's Club Market Inc., 100 B.R. 35 (Bankr. D. Colo. 1989) and In re Buyer's Club Market Inc., 100 B.R. 37 (Bankr. D. Colo. 1989). Return to article

   ⁶ See, also, In re Arlco, 239 B.R. at 273; In re Steinberg's Inc., 226 B.R. at 10; In re Victory Markets Inc., 212 B.R. at 742; Matter of Sunstate Dairy & Food Products Co., 145 B.R. 341, 344 (Bankr. M.D. Fla. 1992); Matter of Leeds Bldg. Products Inc., 141 B.R. at 268; In re Rea Keech Buick Inc., 139 B.R. at 629; In re Diversified Food Service Distributors Inc., 130 B.R. 427, 429 (Bankr. S.D.N.Y. 1991); In re Roberts Hardware Co., 103 B.R. 396, 398 (Bankr. N.D.N.Y. 1988); Lavonia Mfg. Co. v. Emery Corp., 52 B.R. 944, 946 (E.D. Pa. 1985); Matter of Bensar Co., 36 B.R. 699, 703 (Bankr. S.D. Ohio 1984); Matter of McLouth Steel Corp., 22 B.R. 722, 725 (Bankr. E.D. Mich. 1982). Return to article

   ⁷ In re Marko Electronics Inc., 145 B.R. 25 (Bankr. N.D. Ohio 1992); Matter of Sunstate Dairy &