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How to Reclaim Something that Isn't There: A Creative Way Around § 546(c)

Bankruptcy Client Alert

Authors: Robert S. Hertzberg and Deborah Kovsky-Apap

7/12/2011

Back in the mists of time, a seller that had a valid reclamation claim but was denied the return of its goods was entitled to an administrative expense claim (a claim with a higher priority than a general unsecured claim and thus a better chance of getting paid) or a lien on the debtor’s assets. The 2005 amendment to § 546(c) of the Bankruptcy Code changed all that by stripping away those alternative remedies. Now, unless a seller is actually able to get its hands on the goods before the debtor sells or consumes them, the seller will lose its reclamation claim and be stuck with a (likely worthless) general unsecured claim.1

Or will it?

A recent decision of the Bankruptcy Court for the District of Nebraska suggests that all hope may not be lost, even if the goods are no longer available for reclamation.

In In re Professional Veterinary Products, Ltd.,2 a creditor sold pharmaceutical products to the debtor on credit. Some of those products were sold and delivered within 45 days prior to the bankruptcy petition date on August 20, 2010. Since August 25, 2010, the creditor had been asserting its right to reclaim the products under the Uniform Commercial Code and § 546(c) of the Bankruptcy Code. Very sensibly, the creditor took the further step of filing an adversary proceeding to try to enforce its reclamation claim.

The creditor’s efforts, unfortunately, were to no avail. A reclamation claim procedures order stayed the creditor’s adversary proceeding, and in the meantime, the debtor sold substantially all of its inventory to another company – neatly outmaneuvering the reclamation creditor (or so it would seem) by moving the goods out of reach.

The debtor then filed a notice of proposed treatment of reclamation claims, in which it proposed to deny all such claims because, among other things, the inventory had already been sold, with proceeds going to the senior secured lender; and the reclamation claimants had failed to protect their interests in the inventory. The question before the court on the debtor’s motion for summary judgment was whether a reclaiming seller has a remedy even when the goods themselves are no longer available.

It was undisputed that there is no authority under § 546(c) for a court to unilaterally extend a seller’s rights to any assets other than the actual goods. Conventional wisdom would stop right there: no goods, no remedy. The creditor, however, made the creative argument that the court’s reclamation procedure and inventory sale orders – rather than § 546(c) – protected the creditor’s reclamation rights.

The reclamation procedures order provided for notice by reclaiming vendors and evaluation and response by the debtor, and expressly prohibited the vendors from taking any other action with respect to their reclamation claims. This garden-variety procedures order is commonly entered in cases in which there are many reclamation claims, with the purpose of giving the debtor some breathing room and creating an orderly process for the resolution of claims.

The order confirming the inventory sale – entered while the debtor was still enjoying its breathing room from the demands of reclamation claimants – provided that all interests in the inventory would attach to the proceeds. The order defined “interest” to include:

all mortgages, liens, pledges, charges, security interests, interests under conditional sale, capital lease or title retention agreement, encumbrances, options, right of first refusal, judgments, claims, demands, successor liability, defects or other adverse claims, interests, or liabilities of any kind or nature (whether known or unknown, accrued, absolute, contingent or otherwise) in, on or arising from the Sale Assets, but not any easements, zoning restrictions, covenants of record and other non-monetary property interests created by any applicable substantive State law.

The creditor argued – and the court agreed – that the definition of interest was broad enough to encompass reclamation demands.

The court acknowledged the universal view that a reclamation creditor’s failure to diligently pursue its rights results in forfeiture of those rights. But the court also recognized that the creditor had done what it could under the circumstances. Its hands were tied by the reclamation procedures order. The court declined to allow the debtor to use the shield of the reclamation procedures as a sword – particularly where the sale order contained language that could reasonably lead reclamation creditors to believe that their claims attached to sale proceeds.

Although it was still uncertain whether the creditor actually had a valid reclamation claim – there were questions as to the debtor’s insolvency on the petition date, not to mention the inconvenient fact of the senior secured lender – the creditor would not be foreclosed from trying to establish its claim.

Sellers of goods should take note of this decision. Even though it is not a court of appeals decision and thus is not binding precedent, it is interesting and potentially persuasive authority. Under similar circumstances as those in this case, it may well be worthwhile to vigorously pursue a reclamation claim even after the goods are gone.

Endnotes

1 The 2005 amendments to the Bankruptcy Code also added § 503(b)(9), which accords administrative priority to all goods delivered to the debtor within 20 days before the petition date. Because a creditor needs to jump through far fewer hoops to be entitled to a § 503(b)(9) claim, as a practical matter reclamation claims under § 546(c) are usually asserted only with respect to goods shipped between 20 and 45 days before the petition date. In industries with high inventory turnover rates, these goods are very often gone before a reclamation claim is made.

2 In re Professional Veterinary Products, Ltd., 2011 Bankr. LEXIS 1854 (Bankr. D. Neb. May 16, 2011).

Robert S. Hertzberg and Deborah Kovsky-Apap

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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