In Part I of this article (published in the February 1999 ABI Journal), I examined the basic elements of a reclamation action brought pursuant to Bankruptcy Code §546(c). This article will discuss how the Bankruptcy Code resolves disputes between the reclaiming seller and a secured creditor.

Uniform Commercial Code (UCC) §2-702(3) states:

The seller's right to reclaim under subsection (2) is subject to the rights of a buyer in ordinary course or other good faith purchaser under this Article (§2-403). Successful reclamation of goods excludes all other remedies with respect to them.¹

Section 2-702(3) limits the right of reclamation to the rights of a buyer in the ordinary course of business or other good faith purchaser.² Under §2-702(3), a creditor with a perfected security interest will be treated as a good faith purchaser, and a reclaiming seller will be subordinate to a creditor with a perfected security interest in the goods.³

The majority position is that a reclaiming seller is entitled to an administrative priority claim in any surplus proceeds after the secured creditor's claim has been satisfied or released.⁴ A recent opinion that adopted the majority position is In re Victory Markets Inc.⁵ In this case, the debtor contended that the reclaiming seller was not entitled to an administrative priority claim because two secured creditors had superior interests in the goods. The court denied the reclaiming seller an administrative priority claim. The court adopted the majority position, and it stated:

This court finds, as it did in Roberts Hardware, that while the right of reclamation is subject to superior perfected claims of other creditors, this subordination does not automatically result in the extinguishment of the seller's reclamation claim. However, a reclaiming seller is also not automatically entitled to an administrative priority claim or substitute lien in the entire amount of its claim merely because the seller's right of reclamation is subject to a superior perfected claim. Instead, the reclaiming seller retains a priority interest in any goods remaining and in any surplus proceeds remaining after the superior secured creditor's interests have been satisfied or released. If the seller's right to reclaim is worthless because the superior secured creditor's claim exceeds the value of the goods, the seller's request to reclaim is not denied by the court but rather is of no value, and therefore the remedies of an administrative priority claim or lien under §546(c)(2) are unavailable to the seller.⁶ (Citations omitted).

The court gave the following rationale for adopting the majority position:

Code §546(c) does not give a seller any greater rights then it has outside of bankruptcy; rights that have no value in the non-bankruptcy context will similarly have no value in the bankruptcy context. Granting a seller an administrative priority claim in bankruptcy when the right to reclaim is entirely subordinated by the rights of a superior secured creditor would be to give the seller greater rights than possessed outside of bankruptcy, and this would clearly be contrary to the concept of equal treatment of creditors under the Code. If the secured creditor's rights are superior to the seller's, the seller is left with a non-priority unsecured claim as to the value of the goods subject to the superior secured creditor's claim, and a right of reclamation as to the goods or value which are in excess of the creditor's claim.⁷ (Citations omitted).

The minority position is that when a reclamation claim is denied, the reclaiming seller is entitled to an administrative priority claim or a lien in the full amount of the reclamation claim.⁸

In Ohio Farmers Grain and Supply Association v. Melvin Liquid Fertilizer Co. Inc.,⁹ the court ruled that a reclaiming seller whose reclamation claim was denied was entitled to an administrative priority claim secured by a subordinate lien. The court reasoned that §546(c) operates as a limitation on the powers of a debtor-in-possession (DIP). Furthermore, the failure to provide an administrative priority claim would result in a DIP receiving a windfall.

The majority position is the better reasoned position. First of all, granting a reclaiming seller an administrative priority claim for the entire value of the goods regardless of whether there is a surplus after the secured creditor's claim has been satisfied or released is poor policy. Unless otherwise displaced, property rights are determined by non-bankruptcy law.¹⁰ The Supreme Court has stated:

Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests by both state and federal courts within a state serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving "a windfall merely by reason of the happenstance of bankruptcy."¹¹

Absent a bankruptcy case, §2-702(3) mandates that a reclaiming seller's rights to the goods are subordinate to a creditor with a perfected security interest in the goods.¹² The mere fact that the debtor has filed a bankruptcy case should not enlarge a reclaiming seller's rights. The majority position correctly interprets §2-702(3) because it acknowledges that a reclaiming seller's claims in the goods are subordinate to a creditor with a perfected security interest in the goods, and that the value of the reclaiming seller's claim is dependent upon the surplus remaining after the secured creditor's claim being satisfied or released. The preceding is the result that would have occurred absent the filing of a bankruptcy case, and there is nothing in the language of §546(c) that indicates that Congress intended to supercede non-bankruptcy law. Accordingly, the majority position is the more tenable interpretation of the applicable statutes.

The policy of creditor equality also favors the adoption of the majority position. If there is no residual value in the goods after the secured creditor's claim has been satisfied or released, then the reclaiming seller has no interest in the goods that require protection. The purpose of an administrative priority claim is to protect the reclaiming seller's interest in the goods or proceeds of the goods. However, granting a reclaiming seller an administrative claim for the entire value of the goods when there is no residual value left for the reclaiming seller provides the reclaiming seller a windfall. Although the reclaiming seller is a general unsecured creditor, the reclaiming seller would be granted an administrative priority claim at the expense of the general unsecured creditors. Such a result is contrary to the policy of creditor equality. Consequently, the policy of creditor equality also favors the adoption of the majority position.

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Footnotes

¹ UCC §2-702(3). Return to article

² In re Victory Markets Inc., 212 B.R. 738, 742 (Bankr. N.D.N.Y. 1997). Return to article

³ Mitsubishi Consumer Electronics America Inc. v. Steinberg's Inc., 226 B.R. 8, 10 (Bankr. S.D. Ohio 1998). Return to article

⁴ Mitsubishi Consumer Electronics America Inc. v. 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); Sandoz Pharmaceuticals Corp. v. Blinn Wholesale Drug Co. Inc. (In re Blinn Wholesale Drug Co. Inc.), 164 B.R. 440 (Bankr. E.D.N.Y. 1994). Return to article

⁵ 212 B.R. 738 (Bankr. N.D.N.Y. 1997). Return to article

⁶ Id. at 742-43. Return to article

⁷ Id. at 743. Return to article

⁸ Islay Klondike Co. v. Sunstate Dairy & Food Products Co. (In re Sunstate Dairy & Food Products Co.), 145 B.R. 341 (Bankr. M.D. Fla. 1992); Ohio Farmers Grain and Supply Association v. Melvin Liquid Fertilizer Co. Inc. (Melvin Liquid Fertilizer Co. Inc.), 37 B.R. 830 (Bankr. S.D. Ohio 1984). Return to article

⁹ 37 B.R. 830 (Bankr. S.D. Ohio 1984). Return to article

¹⁰ Butner v. United States, 440 U.S. 48 (1979). Return to article

¹¹ Id. at 55. Return to article

¹² UCC §2-702(3). Return to article