Vendors – take note! The Delaware bankruptcy court In
re Reichhold Holdings US Inc. recently issued an important
ruling for vendors asserting reclamation rights. Under section
546(c) of the Bankruptcy Code, a vendor may reclaim goods sold on
credit to an insolvent debtor that has filed bankruptcy.
Reichhold addressed an issue plaguing reclamation
claimants: does a postpetition lender's subsequently
perfected security interest trump the vendor's reclamation
rights when the proceeds from the postpetition loan ("DIP
loan") were used to repay the debtor's
prepetition loan. Judge Walrath ruled in favor of the
vendor in this case and held that the vendor's reclamation
rights survived the lender's DIP loan. This case is significant
because it offers a more favorable outcome for reclamation
claimants than similar bankruptcy cases decided in New York.
At the time of filing, Reichhold was a borrower under a
prepetition credit facility with Oaktree Capital Management, L.P.
Oaktree maintained a blanket lien on substantially all of
Reichhold's assets, including inventory. Upon filing for
bankruptcy, Reichhold obtained a DIP loan from a different group of
lenders. The DIP loan was secured by a first priority lien on all
pre and postpetition property of the estate, including inventory.
The DIP loan repaid Oaktree's prepetition loan.
Within days of the bankruptcy filing, one of Reichhold's
suppliers, Covestro LLC, delivered a written reclamation demand to
Reichhold. Reichhold argued that the reclamation demand was
rendered valueless when the prepetition loan was repaid, as the
postpetition lender's liens trumped Covestro's reclamation
The Delaware bankruptcy court focused on whether the
postpetition lender's rights (which were granted after
Covestro's reclamation rights arose) "related back"
to the prepetition lender's rights. The court concluded that
the pre and postpetition loans were separate transactions and that
repayment of the prepetition loan from the DIP loan did not affect
Covestro's reclamation rights. This represents a significant
departure from holdings by New York bankruptcy courts. Unlike
Delaware, New York bankruptcy courts conclude that pre and
postpetition loans constitute an "integrated
transaction." More specifically, New York cases contend that
since the lien chain between prepetition and postpetition lenders
remains unbroken, the postpetition lender's rights "relate
back" to the prepetition lender's rights and therefore
trump vendor's reclamation claims.
Judge Walrath disagreed with this reasoning, noting that it is
"too much of a stretch" to conclude that a repayment of
the prepetition loan from the DIP loan was repayment from the
"sale" of the reclaiming creditor's goods. As noted
by Judge Walrath, the DIP loan's first priority lien did not
attach to property that was "subject to valid, perfected and
non-avoidable liens (or to valid liens in existence as of the
Petition Date that are subsequently perfected as permitted by
section 546(b) of the Bankruptcy Code."
According to Judge Walrath, it was irrelevant that (a) funds
obtained from the DIP loan were used to satisfy the prepetition
loan and/or (b) Reichhold granted the DIP lenders a lien in
inventory to obtain such funds. As emphasized in the opinion,
"Covestro's reclamation rights arose
before the DIP Lenders' security interest
attached, and the DIP Lenders' lien was expressly subject to
reclamation rights under section 546." Therefore, the court
ruled in favor of Covestro and overruled the debtor's objection
to the reclamation claim.
While bankruptcy courts have tended to chip away at reclamation
claimants' rights, reclamation claims still remain a tool for
trade creditors to maximize recovery in chapter 11 cases. In light
of Reichhold, Delaware offers a more vendor-friendly forum
than New York. While assessing options and seeking to reduce risk,
credit managers will want to closely review the debtor's
proposed financing arrangements to determine (a) if the
postpetition lender will be granted a lien on debtor's
inventory and (b) whether there is a provision stating that the new
loan is subject to liens perfected after bankruptcy under section
546(b). If the proposed DIP loan lacks such a provision, credit
managers should consider participating early in the case and
objecting to financing orders that do not allow for reclamation or
provide a carve-out from the DIP lender's collateral to secure
payment of these claims.
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