New Amendments Expand Rights of Vendors in Bankruptcy
By: Matthew A. Swanson
Shaw Gussis Fishman Glantz Wolfson & Towbin LLC; Chicago
While much of the publicity surrounding the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) has centered on consumer bankruptcy changes, it contains a number of amendments that expand upon a vendor’s right to reclaim goods shipped prior to a debtor’s bankruptcy case and to seek administrative expense priority. The revised provisions became effective for cases filed on or after Oct. 17, 2005.
Reclamation Defined
Imagine that a vendor has just shipped $100,000 worth of widgets to a customer on normal credit terms. The widgets arrive at the customer’s business the following day, creating an obligation on the part of the customer to pay the vendor within the 30-day terms. The following week, the vendor learns from another supplier that its customer has filed for bankruptcy. Generally speaking, there is a slim chance of the vendor’s $100,000 pre-petition claim being paid in full – this is where the concepts of reclamation and administrative priority come into play.
Under certain circumstances, when a vendor discovers that its customer is insolvent after the vendor has already delivered the customer goods, the vendor can demand that the goods be returned – even if its customer has filed for bankruptcy protection. All vendors should be aware of this right of reclamation, along with the new administrative priority under BAPCPA, and the steps necessary to maintain these claims.
Pre-BAPCPA Law
Under pre-BAPCPA law, a vendor was required to comply with applicable non-bankruptcy law, §2-702 of the Uniform Commercial Code, to establish a valid claim for reclamation, which was protected and limited by §546(c) of the Bankruptcy Code. The burden was on the vendor to prove:
- it sold goods on credit to the debtor in the ordinary course of business;
- it delivered the goods to the debtor at a time when the debtor was insolvent;
- within 10 days after the goods were delivered to the debtor, it made a written demand for the return of the goods (or within 20 days if the 10 days had not expired by the time the bankruptcy was filed);
- the debtor had possession of the goods at the time of the reclamation demand.
Under the UCC, a vendor’s right to reclaim is subject to the rights of a “good faith purchaser” – a description that almost always includes a buyer’s secured lender. In other words, even if a vendor was found to have a valid reclamation claim, if the buyer’s lender had a lien on inventory and the lender was undersecured, the vendor’s reclamation rights were often cut off. In the unusual case where the vendor’s inventory was unencumbered or where there was equity in the inventory above and beyond the lender’s claim, the Code recognized the vendor’s right to take back its goods to receive an administrative priority or to be granted a lien.
Administrative Priority after BAPCPA
The first significant change for vendors under BAPCPA applies to all sellers of “goods,” whether or not they pursue their reclamation rights. Section 503(b) of the Code has been amended to provide vendors with administrative priority for “the value of any goods [sold to the debtor in the ordinary course of business and] received by the debtor within 20 days before the date of commencement of a case….” 11 U.S.C. §503(b)(9).
The significance of having an administrative expense priority for any goods delivered within 20 days of bankruptcy is that a vendor will be paid after secured creditors, but before pre-petition unsecured claimholders. Therefore, a vendor with a valid §503(b)(9) claim should be paid on the same terms as the debtor’s professionals and parties who provide a debtor with goods during the bankruptcy proceeding. Under §503(b), the claim will be allowed “after notice and a hearing,” thus it is likely that counsel will be required to file an appropriate motion before the court, even where the debtor doesn’t disagree with the vendor’s numbers. As for the exact timing of the payment, it is unclear from the amendment whether the debtor must pay these administrative expenses during the case or if it may wait until confirmation of a plan to pay, which is the more likely interpretation given prevailing case law.
Administrative priority under §503(b)(9) is explicitly available regardless of whether or not a vendor of goods makes a formal reclamation demand. 11 U.S.C. §546(c)(2). “The seller may still assert the rights contained in §503(b)(9)” even if reclamation is not allowed. Unlike reclamation claims that may be subject to a variety of defenses (such as consumption of the goods or commingling) and require a vendor to demonstrate that the debtor was insolvent at the time of shipment, §503(b)(9) creates an important new substantive right for vendors independent of traditional state law remedies.
Reclamation after BAPCPA
The second significant change for vendors after BAPCPA is an expansion of the right to reclamation traditionally available under state law. A vendor who has sold goods that the debtor receives before the commencement of a case, in the ordinary course of such vendor’s business and at a time when the debtor was insolvent, may seek to reclaim its goods by making a written demand within 45 days after the debtor receives the goods or within 20 days after the bankruptcy case was filed, whichever is later. 11 U.S.C. §546(c)(1)(A)-(B). The goods that are being sought for reclamation must still be in the debtor’s possession as of its receipt of demand.
The first major change is that BAPCPA enlarges the time frame for making a reclamation demand from 10 days to 45 days, potentially encompassing far more goods if they remain unsold. In other words, a timely served reclamation demand can cover all goods received by the debtor within 45 days of filing. This expansion may be particularly beneficial to vendors who supply a debtor with merchandise that turns over infrequently or where the debtor is stockpiling the vendor’s product in anticipation of seasonal sales.
Second, the Code now explicitly recognizes that a vendor’s reclamation rights are “subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof.” 11 U.S.C. §546(c)(1). Previously, a debtor’s lender had to rely on its status as a “good-faith purchaser” under the UCC – a designation that did not always provide unquestionable priority. See, e.g., In re Reliable Drug Stores, Inc., 70 F.3d 948 (7th Cir. 1995) (discussing the views of legal scholars who disagree with the proposition that a secured creditor is a good-faith purchaser under the UCC).
While former §546(c)(2) provided that the court could deny reclamation “only if” the court granted the vendor an administrative priority claim or a lien, such language did not survive the amendments. In light of the Supreme Court’s focus on plain meaning statutory interpretation, it is not unreasonable to conclude that the bankruptcy court’s power to grant a vendor the replacement remedies under the “old” Code (i.e., an administrative priority or lien) is no longer available and that a vendor only has a right to physically reclaim its goods. In practice, however, it may very well be the case that a debtor will agree to “buy back” the goods subject to reclamation, creating a de facto administrative priority for the value of those goods.
The Impact of the Amendments
At this early point in time, there are a number of questions concerning the BAPCPA amendments discussed above. For example, how do we interpret the terms “value” and “goods” under §503(b)(9)? Will a vendor be barred from reclaiming its goods even where a debtor’s secured lender with an interest in such goods is oversecured? Notwithstanding the uncertainty surrounding the changes, it is clear that the foregoing amendments will have a substantial impact on certain types of debtors (particularly retailers) as administrative claims must be paid in full as a condition to confirming a plan. Such amendments may also stress a debtor’s relationship with secured creditors that will have to cash out suppliers with §503(b)(9) claims if they want their debtor to come out of bankruptcy.