United States: Reclamation - An Uncertain Remedy

Section 546(c), Bankruptcy Code is the exclusive remedy for a reclaiming seller when the buyer is in bankruptcy. In re Julien Co., 44 F.3d 426 (6^th Cir. 1995).² A reclaiming seller who fails to prove all the elements of a reclamation claim under Section 546(c) cannot avail itself of a common law fraud remedy because Section 546(c) is the exclusive remedy for reclaiming creditors. In re MGS Marketing, 111 B.R. 264 (9^th Cir. BAP 1990); In re Flagstaff Foodservice Corp., 56 B.R. 899 (Bankr. S.D. N.Y. 1986).³

A reclaiming seller must be a "seller of goods" in order to bring a reclamation claim under Section 546(c). In re Grossinger’s Associates, 125 B.R. 106 (Bankr. S.D. N.Y. 1991) and In re East Texas Steel Facilities, Inc., 117 B.R. 235 (Bankr. N.D. Tex. 1990). In Grossinger’s Associates, the seller erected canopies for debtor’s hotel and was not just a supplier of structural steel.

A seller has the burden of proving all of the elements of a valid reclamation claim. Matter of Adventist Living Centers, Inc., 52 F.3d 159, 162 (7^th Cir. 1995); In re Mayer Pollock Steel Corp., supra, at 959. The court in Matter of Continental Airlines, Inc., 125 B.R. 415, 417 (Bankr. D. Del. 1991) set out the elements of a reclamation claim under Section 546(c): (1) Debtor was insolvent when the seller delivered the goods to him; (2) Seller made written demand for return of the goods within 10 days of the delivery of the goods; (3) Seller could identify the goods at the time of the demand; (4) The goods were in the possession of the debtor at the time of demand. Once a reclaiming seller presents evidence of debtor’s insolvency at the time of the delivery of the goods, the burden of proof shifts to the debtor to rebut seller’s proof of insolvency. Matter of Continental Airlines, Inc., 125 B.R. at 417.

Only goods received by the debtor while insolvent are subject to reclamation. Matter of Griffin Retreading Co., 795 F.2d 676, 679 (8^th Cir. 1986); In re Buyer’s Club Market, Inc., 100 B.R. 35, 36 (Bankr. D. Colo. 1989). The Bankruptcy Code defines the term "insolvency" at Section 101 (32)(A) to mean "financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation . . . (emphasis supplied) " This definition is referred to as the "balance sheet test." Bankruptcy Code definitions apply to all sections of the Code, and the "balance sheet" definition of insolvency should be used in reclamation proceedings. In re Diamond Lumber, Inc., 102 B.R. 77 (Bankr. N.D. Tex. 1988). The reclaiming creditor must prove that the debtor was insolvent at the time the goods were delivered. In re Julien, supra, at 431; In re Mayer Pollock Steel Corp., supra, at 959-60; In re Storage Technology Corp., 51 B.R. 206 (D. Col. 1985). "Fair valuation" within the context of the "balance sheet" test for determining the issue of insolvency in reclamation actions involves an estimate of what can be realized out of the assets within a reasonable time either through collection or sale at the regular market value. Storage Technology, supra, at 208. The "equity" definition of insolvency, the inability of the debtor to pay its bills as they come due, will not support a reclamation claim. In re Furniture Distributors, 45 B.R. 38 (Bankr. D. Mass. 1989). Debtor’s bankruptcy schedules are probative evidence of insolvency. In re Flagstaff Foodservice Corp., 56 B.R. 899, 905 (Bankr. S.D. N.Y. 1986). While the schedules are probative evidence of insolvency, they are not dispositive of the issue of insolvency. In re Flagstaff Foodservice Corp., 56 B.R. at 907. While the schedules may show that debtor was insolvent on the date of the filing of the petition, claimant must still show that debtor’s financial condition did not change materially from date of the delivery of the materials to the date of the filing of the petition. In re Penthouse Travelers of Aripeka, Inc., 120 B.R. 226 (Bankr. M.D. Fla. 1990).

A reclaiming seller must serve a written demand for reclamation on the buyer; an oral reclamation demand will not sustain a reclamation claim under Section 546(c). In re Julien Co., 44 F.3d at 431-432. The plaintiff in In re Charter Co., 52 B.R. 263, 265-66 (Bankr. M.D. Fla. 1985) failed to send a written demand for reclamation within 10 days from the date of delivery of the goods to the insolvent buyer. Plaintiff argued that the buyer had misrepresented his solvency at the time of purchase and that the 10 day limitation did not apply. The court recognized that under UCC § 2.702 a timely demand for reclamation is excused when the buyer made a written misrepresentation of solvency by the seller, but the court rejected plaintiff’s argument stating that the case law and the unambivalent wording of Section 546(c) did not support the plaintiff’s position. The Section 546(c) requirement for a written demand for reclamation within 10 days of delivery was absolute, and could not be waived. In re Charter Co. at 266. The Plaintiff in In re Rozel Industries, Inc., 74 B.R. at 645-46, also failed to give written demand for reclamation in the 10 day period, and argued that Section 546(c) was merely a "safe harbor" provision shielding a seller’s reclamation rights against the avoiding powers of a trustee or debtor-in-possession and that it should still be able to proceed under its state right of reclamation. The court summarily rejected plaintiff’s position and made it clear that the Section 546(c) requirement of a 10 day written notice was absolute. Rozel at 646. See also In re Rea Keech Buick, Inc., 139 B.R. at 629. The written demand must explicitly state that it is asserting the right to reclamation. Matter of Marin Motor Oil, Inc., 740 F.2d 220, 221 (3^rd Cir. 1984). One court stated that the written demand for reclamation must use the word "reclamation" in the demand. In re Buyer’s Club Market, Inc., 100 B.R. at 36. Other courts hold, however, that the notice of reclamation is sufficient if it reflects an intention to rescind the sale. In re Graphic Productions Corp., 176 B.R. 65, 73 (Bankr. S.D. Fla. 1994).

The "Dispatch Rule" applies to reclamation demands. Under the dispatch rule, a reclamation demand is considered made when it is sent rather than when it is received, so long as it is sent in a commercially reasonable manner. Matter of Marin Motor Oil, Inc., 740 F.2d at 228 (which expressly rejected the "receipt rule").⁴ The 10 day period begins running from the date debtor actually receives the goods, rather than the date the seller delivers the goods to a common carrier. In re Maloney Enterprises, Inc., 37 B.R. 290, 292 (Bankr. E.D. Ky. 1983); Matter of Marin Motor Oil, Inc., supra, 740 F.2d at 225-26.

Making demand for reclamation does not violate the automatic stay. In re Production Steel, Inc., 21 B.R. 951, 953-54 (Bankr. M.D. Tenn. 1982).

Goods shipped more than 10 days prior to the date of the written demand cannot be the object of a reclamation action. In re Landy Beef Co., Inc., 30 B.R. 19 (Bankr. D. Mass. 1983).

Seller’s failure to make a timely written demand for reclamation leaves him as an unsecured, non priority claimant. In re Gibson Distr. Co.-Permian Basin, 40 B.R. at 769.

A reclaiming seller must identify in its written demand for reclamation, the goods subject to such reclamation. In re Braniff, 113 B.R. 745, 752 (Bankr. M.D. Fla. 1990); In re Landy Beef Co., supra, at 21. The goods subject to reclamation must be identifiable. In re Morken, 182 B.R. at 1016. One of the most difficult hurdles that a reclaiming seller must overcome is the requirement that the seller must identify the goods that are subject to the reclamation claim.

There is scant law on this critical area of reclamation claims. The court in Braniff held that if the written reclamation demand was not sufficiently detailed in the description of the goods subject to reclamation, then the reclamation claim must fail as a matter of law. Braniff, 113 B.R. at 752. The court in Braniff, however, tells reclaiming creditors by way of dicta that if they can devise a formula by which they can trace the product, establish the time frame in which it was delivered to the seller, and convince the court that the formula traces the product within the time frame with a fair degree of accuracy, then it does not have to physically identify its goods to sustain a reclamation claim. Braniff, at 755.

The reclaiming vendor must prove that the debtor possessed the goods at the time of the reclamation demand. In re Pester Refining Co., 964 F.2d 842, 846 (8^th Cir. 1992); In re Rawson Food Service, Inc., 846 F.2d 1343, 1347-49 (11^th Cir. 1983); In re Arlco, 239 B.R. at 266. A seller of goods is only entitled to reclaim goods that the debtor had on hand at the time of the demand for reclamation was made. In re Morken, 182 B.R. at 1016; In re Buyer’s Club Market, Inc., 100 B.R. 37, 38 (Bankr. D. Colo. 1989).⁵ The seller in a reclamation case has the burden of proving that the debtor possessed the goods when it received the reclamation demand. This is a fairly stringent requirement. In re Adventist Living Ctrs. Inc., 52 F.3d 159, 163 (7th Cir. 1995); Matter of Flagstaff Foodservice Corp., 14 B.R. 462, 469 (Bankr. S.D. N.Y. 1981). There is no presumption that the goods remained with the debtor simply because the goods were delivered. In re Adventist Living Ctrs. Inc., supra, at 163 and In re Rawson Food Service Inc. at 1350 N. 11.

In Adventist Living Centers, the reclaiming seller did not take a prompt and accurate inventory of the goods on hand on the date of the reclamation demand. The Seventh Circuit rejected the seller’s assertion that it could accurately estimate the amount of goods on hand based on delivery invoices and other such records, and the court rejected seller’s reclamation claim. The court in In re Landy Beef Co. Inc., 30 B.R. at 21, however, looked at the normal business practice of debtor in disposing of goods to determine what product was on hand on the date of the reclamation demand.

A seller’s right to reclamation is subject to the right of a good faith purchaser. UCC § 2-702(3); Matter of Reliable Drug Stores, Inc., 70 F.3d 948, 950 (7^th Cir. 1995); In re Coast Trading Co., 744 F.2d 686, 690 (9^th Cir. 1984). State law usually deems a secured creditor having a security interest in a debtor’s property, including an after acquired security interest, to be a good faith purchaser for value, thus having rights superior to those of a reclaiming seller.⁶ In re Pester Refining Co., 964 F.2d at 846.

Courts generally recognize that a credit seller’s right to reclamation is "subject to" the prior lien of a secured creditor. The courts, however, have split into three lines of authority as to the effect of the words "subject to":

1. Reclamation Right Extinguished By Prior Lien. The Ninth Circuit in In re Coast Trading Co., Inc., 744 F.2d at 690-692, held that reclaiming seller’s right to reclamation and any claim for priority is extinguished by the existence of the claim of a secured creditor.
2. Reclamation Right Not Extinguished By Prior Lien; Claimant, However, Is Entitled Only To Priority Claim In Lieu Of Reclamation. Several courts have held that when a secured creditor precludes a seller from reclaiming goods subject to the secured claim, the rights of the reclaiming seller are not cut off by the existence of the secured creditor; the court can award the reclaiming seller an administrative priority in lieu of the reclamation claim.⁷ In re Mayer Pollock Steel Corp., 157 B.R. at 960.
3. Reclamation Right Not Extinguished, But If Claim Is Worthless Outside Bankruptcy It Is Worthless Inside Bankruptcy. The Eighth Circuit in In re Pester Refining Co., supra, held that a seller’s right to reclaim is not extinguished because secured creditors assert a perfected security interest in the goods sought to be reclaimed. Pester at 846. The Eighth Circuit, however, went to state "[w]hen the secured creditors have satisfied their claims out of the goods to be reclaimed, granting § 546(c)(2) relief would afford the reclamation seller something it does not have under the UCC--a priority interest in the buyer’s assets other than the goods to be reclaimed." Pester at 847. Therefore, if the secured creditor satisfies its claim out of the goods otherwise subject to reclamation, the reclamation is not extinguished, but is valueless. Since the claim has no value, a court cannot grant the seller an administrative priority under Section 546(c)(2). The underlying rationale for this holding is that Congress did not expand the right of reclamation in bankruptcy over the rights a reclaiming seller would have under the UCC.⁸ If the secured creditor is over secured and satisfies its claim out of goods other than the goods sought to be reclaimed, or all of the goods subject to reclamation are not needed to satisfy the secured claim, then the reclaiming seller will be entitled to a priority claim, but only to the extent of the value of the goods not used to satisfy the secured claim. Pester, 964 F.2d at 847.

A reclaiming seller must demonstrate to the court that he has diligently pursued his reclamation claim in order to prevail, and if he fails to diligently pursue the reclamation claim then he loses that right. In re McLouth Steel Products Corp., 213 B.R. 978, 987 (E.D. Mich. 1997); Matter of Crofton & Sons, Inc., 139 B.R. 567, 569 (Bankr. M.D. Fla. 1992).

A seller must also prove that the sale of the goods in question was made in the ordinary course of the business of the seller. In re Arlco, 239 B.R. at 266; In re Morken, 182 B.R. at 1016.

The Fifth Circuit in a non-bankruptcy case, United States v. Westside Bank, 732 F.2d 1258 (5^th Cir. 1984) held that when a seller of goods has met the requirements of UCC 2.702 and when all prior lien holders have been satisfied, the seller will be accorded a priority status which will extend to proceeds that are traceable to the goods. Several courts, however, have held that no reclamation rights exist in the proceeds from the resale of goods sought to be reclaimed. In re Coast Trading Co., 744 F.2d 686, 691 (9^th Cir. 1984).⁹

Two courts have held that a seller is entitled to interest calculated from the date of the reclamation demand when a court grants the seller an administrative priority claim in lieu of reclamation. In re Wheeling-Pittsburg Steel Corp., 74 B.R. 656, 661 (Bankr. W.D. Pa. 1987); In re Mesa Refining, Inc., 66 B.R. 36, 38-9 (Bankr. D. Colo. 1986). Other courts, however, have denied a seller’s claim to interest on its reclamation claim because there is no specific statutory authority for doing so. In re Western Farmers Ass’n., 6 B.R. 432, 437 (Bankr. W.D. Wash. 1980) (a pre-bankruptcy code case). See also In re American Int’l Airways, Inc., 77 B.R. 490, 494-95 (Bankr. E.D. Pa. 1987).

The Eighth Circuit in In re Pester Refining Co., 964 F.2d at 849, held the reclaiming seller is entitled to post-judgment interest from the date of a judgment. The court, however, left open the question whether the plan could curtail post-judgment interest.

A court has discretion to allow some administrative claims to be paid prior to the effective date of the plan of reorganization. Matter of Isis Foods, Inc., 27 B.R. 156 (W.D. Mo. 1982) and In re Verco Indus., 20 B.R. 664, 665 (BAP 9^th Cir. 1982). Normally, however, an administrative claim is paid on the effective date of the plan. 11 U.S.C. § 1129(a)(9)(A).

1 In re Arlco, Inc., 239 B.R. 261 (Bankr. S.D. N.Y. 1999); In re 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); In re Morken, 182 B.R. 1007 (Bankr. D. Minn. 1995).

2 In re Mayer Pollock Steel Corp., 157 B.R. 952 (Bankr. E.D. P.A. 1993); Matter of Leeds Bldg. Products, Inc., 141 B.R. 265 (Bankr. N.D. Ga. 1992); In re Rea Keech Buick, Inc., 139 B.R. 625 (Bankr. D. M.D. 1992); In re Video King of Illinois, Inc., 100 B.R. 1008 (Bankr. N.D. Ill. 1989); In re Energy Co-Op, Inc., 94 B.R. 975 (N.D. Ill. 1988); In re Rozel Industries, Inc., 74 B.R. 643 (Bankr. N.D. Ill. 1987); In re Gibson Distributing Co. Inc.-Permian Basin, 40 B.R. 767 (Bankr. W.D. Tex. 1984).

3 There are three Flagstaff opinions cited in this article: Matter of Flagstaff Foodservice Corp., 14 B.R. 462 (Bankr. S.D. N.Y. 1981); In re Flagstaff Foodservice Corp., 56 B.R. 899 (Bankr. S.D. N.Y. 1986), and In re Flagstaff Foodservice Corp., 56 B.R. 910 (Bankr. S.D. N.Y. 1986).

4 In re Bill’s Dollar Stores, Inc., 164 B.R. 471 (Bankr. D. Del. 1994); In re Flagstaff Foodservice Corp., 56 B.R. 910, 915 (Bankr. S.D. N.Y. 1986) and In re Lawrence Paperboard Corp., 52 B.R. 907, 910 (Bankr. D. Mass. 1985).

5 There are two Buyer Club Market, Inc. cases: In re Buyer’s Club Market, Inc., 100 B.R. 35 (Bankr. D. Colo. 1989) and In re Buyer’s Club Market, Inc., 100 B.R. 37 (Bankr. D. Colo. 1989).

6 See also In re Arlco, 239 B.R. at 273; In re Steinberg’s, Inc., 226 B.R. at 10; In re Victory Markets, Inc., 212 B.R. at 742; Matter of Sunstate Dairy & Food Products Co.,145 B.R. 341, 344 (Bankr. M.D. Fla. 1992); Matter of Leeds Bldg. Products, Inc., 141 B.R. at 268; In re Rea Keech Buick, Inc., 139 B.R. at 629; In re Diversified Food Service Distributors, Inc., 130 B.R. 427, 429 (Bankr. S.D. N.Y. 1991); In re Roberts Hardware Co., 103 B.R. 396, 398 (Bankr. N.D. N.Y. 1988); Lavonia Mfg. Co. v. Emery Corp., 52 B.R. 944, 946 (E.D. Pa. 1985); Matter of Bensar Co., 36 B.R. 699, 703 (Bankr. S.D. Ohio 1984); Matter of McLouth Steel Corp., 22 B.R. 722, 725 (Bankr. E.D. Mich. 1982).

7 In re Marko Electronics, Inc., 145 B.R. 25 (Bankr. N.D. Ohio 1992); Matter of Sunstate Dairy & Food Products Co., 145 B.R. at 345; In re Rea Keech Buick, Inc., 139 B.R. at 629; In re Diversified Food Service Distributors, Inc., 130 B.R. at 430; In re Roberts Hardware Co., 103 B.R. 396 (Bankr. N.D. N.Y. 1988); Matter of Bosler Supply Group, 74 B.R. 250, 254 (N.D. Ill. 1987); In re Davidson Lumber Co., 22 B.R. 775, 776 (Bankr. S.D. Fla. 1982); In re Western Farmers Ass’n, 6 B.R. 432 (W.D. Wash. 1982).

8 See also Matter of Reliable Drug Stores, Inc., 70 F.3d 948 (7^th Cir. 1995); In re Arlco, 239 B.R. at 273; In re Affiliated of Florida, Inc., 237 B.R. 495 (Bankr. M.D. Fla. 1998); In re Victory Markets, Inc., 212 B.R. 738, 743 (Bankr. N.D. N.Y. 1997); In re Blinn Wholesale Drug Co., Inc., 164 B.R. 440 (Bankr. E.D. N.Y. 1994); Matter of Leeds Bldg. Products, Inc., supra, at 269; In re FCX, Inc., 62 B.R. 315 (Bankr. E.D. N.C. 1986).

9 In re Diversified Food Service, 130 B.R. at 430; In re Buyer’s Club Markets, 100 B.R. at 38; In re Bensar Co., 36 B.R. at 701; In re Kentucky Flush Door Corp., 28 B.R. 808, 810 (Bankr. W.D. Ky. 1983).