Magazine article Business Credit

The Growing Threat of Floating Inventory Liens to Reclamation Claims

Magazine article Business Credit

The Growing Threat of Floating Inventory Liens to Reclamation Claims

Article excerpt

Introduction

Over the last few years, this writer has frequently written and spoken about the utility of an unpaid trade creditor's state law reclamation rights when the creditor's customer files bankruptcy. Bankruptcy law recognizes a trade creditor's state law right of reclamation of goods delivered to its customer shortly before the customer's bankruptcy.

A trade creditor that satisfies all of the requirements for reclamation may recover far more on its claim, (and possibly as much as 100 percent of its claim), in its customer's bankruptcy case than the creditor would otherwise receive where the claim is treated as a general unsecured claim. Under present law, the creditor may recover the goods, receive payment for the goods, be granted a security interest in the debtor's other assets to secure payment of the reclamation claim, or be granted an administrative priority claim that must be paid in full before any payment can be made to the holders of general unsecured claims.

A growing number of courts have denied relief to a reclaiming trade creditor where all of the debtor's inventory is subject to a prior perfected floating inventory lien. With the upcoming NACM Credit Congress in Seattle-and this author speaking on, among other topics, reclamation, it is indeed timely that yet another court recently addressed this issue. Unfortunately for trade creditors, the United States Bankruptcy Court in Delaware has also stated that relief on a reclamation claim will be denied where the debtor had an existing perfected unpaid floating inventory secured lender, the amount of the lender's claim exceeded the value of the goods subject to the reclamation claim and the secured lender received payment from the proceeds of the sale of the reclamation goods. If this trend continues, the availability of reclamation as an additional source of recovery for trade creditors will be drastically curtailed. But trade creditors should not fret--help in the form of the proposed bankruptcy legislation is on the way!

Grounds for Reclamation Relief

A trade creditor's right of reclamation arises under state law. Section 2-702 of the Uniform Commercial Code (the "UCC"), enacted by the states, contains the requirements that a trade creditor must satisfy to recover on its reclamation claim. The present version of Section 546(c) of the Bankruptcy Code recognizes a trade creditor's state law reclamation rights, and adds some additional requirements that a creditor must satisfy to recover on its reclamation claim if its customer files bankruptcy.

Briefly stated, a trade creditor seeking reclamation of its goods must satisfy all of the following requirements under UCC Section 2-702 and the present version of Section 546(c) of the Bankruptcy Code:

1. With one exception, a trade creditor must send a written demand for reclamation of its goods within ten days of the debtor's receipt of the goods. Where the ten-day period expires after the bankruptcy filing date, the creditor must send its reclamation demand within twenty days of the debtor's receipt of the goods.

2. The trade creditor sold the goods to the debtor on credit terms in the ordinary course of the creditor's business.

3. The debtor was insolvent when it received the goods.

4. The debtor was in possession of the goods when it received the reclamation demand.

The Impact of a Floating Inventory Lien on a Trade Creditor's Reclamation Claim

UCC Section 2-702(3) erects a significant hurdle to a trade creditor's reclamation rights--they are subject to the rights of a buyer in the ordinary course of business or a good faith purchaser. For example, a creditor's right of reclamation is cut off where the debtor had sold the reclamation goods prior to the demand. A lender with a perfected floating lien in all of the debtor's existing and future inventory is also a good faith purchaser under the Uniform Commercial Code. …

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