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Reclaiming Goods from Customers Filing for Bankruptcy Protection – It's Possible!

By: Allan H. Ickowitz
04/28/09

So just how bad is it? Cash is in short supply, economic woes continue and the dire conditions extend well beyond the giant Wall Street financial and capital markets. The lack of liquidity, global fiscal concerns, fluctuating energy prices and lack of federal hand outs have also taken a toll on the energy industries given the bankruptcy cases of Flying J, Inc., Pacific Energy Resources Ltd. and numerous others.

Many predict things will get worse before they get better.

Vendors in any industry sell goods to get paid. However, it does not always work out that way. If the customer is insolvent or files bankruptcy, the vendor or supplier can be stuck with significant account receivables. To add to the pain, some customers will load up on inventory before filing for bankruptcy without paying. Matters are even more complicated when trading in fungible goods like crude oil or energy which cannot easily be identified within a larger inventory group. Once the bankruptcy papers are filed, the customer has the protections provided under federal law known as the "automatic stay" under Section 362 of the Bankruptcy Code. Practically, this means no vendors can take legal actions against their customers without approval of the Bankruptcy Court.

Some vendors, however, may be able to take advantage of a special, although limited, right to claw-back or "reclaim" certain goods. Additionally, other vendors may get a priority "administrative expense" claim for the value of certain goods. The reclamation right is part of both the Uniform Commercial Code and the Bankruptcy Code. This alert focuses on the Bankruptcy Code.

My Customer Filed for Bankruptcy, Now What?

Section 546(c) of the Bankruptcy Code provides a 45-day window of time prior to the bankruptcy to reclaim goods if certain conditions are met: (1) The goods must have been sold in the "ordinary course" of the vendor's business and the debtor must have received the goods while insolvent (using the Bankruptcy Code's definition of insolvent); (2) The reclamation demand must be in writing and made within 45 days of the receipt of the goods by the debtor-customer (now the debtor in bankruptcy); (3) If the 45-day period expires after the bankruptcy case is filed, the vendor must make the reclamation demand within 20 days after the bankruptcy filing; (4) the demand should identify the goods being reclaimed, include a general statement reclaiming all goods received by the debtor from the vendor during the 45-day period, and demand that the goods be segregated. Vendors also have the option of filing a notice of reclamation with the Bankruptcy Code although this is not required by the Bankruptcy Code.

The Customer in Bankruptcy Will Still Not Return My Goods Despite a Valid Reclamation Claim.

A vendor's right to reclaim goods from a customer is not automatic and subject to defenses. In order to effectuate the general policy of giving debtors a fresh start, customers in bankruptcy may have a number of defenses based on statute or case law. For example, many courts have provided vendors with administrative priority claims in lieu of returning "sold goods." In the case of fungible goods such as oil, energy or ethanol, some debtors have successfully argued that reclamation is not applicable since those commodities cannot be "segregated" to specifically identify which goods belong to which vendors. Further, a vendor's reclamation right can be limited by the possibility that the debtor may have granted a lender a security interest in the goods, which will be senior to the reclamation right.

Don't Forget to Apply for a Priority Section 503(b)(9) Claim.

Even if a vendor fails to make a reclamation demand or the demand is not granted, other relief is available to minimize the sting. Section 503(b)(9) gives vendors an administrative expense priority claim for the value of any goods received by the debtor within a 20-day window prior to the bankruptcy filing if the goods were sold in the ordinary course of the debtor's business. Administrative priority claims are ahead of all unsecured and equity claims so these claims will generally be of greater value. Of course, a vendor cannot "double dip" and seek a 503(b)(9) claim for any goods that are actually reclaimed.

Suppliers or vendors who have significant receivables for goods sold in the ordinary course of business may have reclamation rights and other rights. It is imperative to get timely legal advice immediately upon learning of a customer's bankruptcy to make the appropriate demands and not waive rights you may otherwise have.

Legislative Update.

On April 2, 2009, the House of Representatives introduced HR 1942 or the "Business Reorganization and Job Preservation Act of 2009". The bill has been dubbed by some as a "repeal" or "claw back" to certain BAPCPA provisions favoring creditors to the disadvantage of commercial debtors. HR 1942 would, among other things, strike the BAPCPA-added Section 503(b)(9), the provision that provides vendors with the administrative expense priority. The amendment not only doubled the amount of administrative time period prior to filing from 10 to 20 days, but also made such administrative expense claims essentially automatic. HR 1942 would also repeal the BAPCPA amendment to Section 546(c), which expanded the reclamation period from 10 days to 45 days from when the debtor received the goods. Nossaman will continue monitoring the status of HR 1942 for further alerts. The full text of HR 1942 may be found here.

Allan H. Ickowitz, Co-Chair of Nossaman's Financial Services Practice Group, is a Bankruptcy Partner with over 30 years of experience. He can be reached at aickowitz@nossaman.com.

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