reclamation

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Business Bankruptcy Issues Recent Developments

Text Of Legislation To Repeal Certain Of BAPCPA’s Business Bankruptcy Changes Affecting Retailers Now Available

As reported in a post on the blog earlier this week, on April 2, 2009, Representative Jerrold Nadler (D-NY) introduced a bill entitled the "Business Reorganization and Job Protection Act of 2009." At that time the official text of the legislation was not available.

The bill would repeal changes made by BAPCPA relating to (1) the deadline to assume or reject non-residential real property leases, (2) utility deposits, (3) the Section 503(b)(9) administrative claim, and (4) reclamation. These BAPCPA provisions are among those that have had a significant impact on retailers. For a discussion of the bill’s provisions, you can read this blog’s earlier post on the legislation or the explanation of the bill by the NACM. It will be interesting to follow the bill as it makes its way through the legislative process in Congress.

Business Bankruptcy Issues Recent Developments

Legislation Introduced To Repeal Certain Business Bankruptcy Changes Made By BAPCPA’s 2005 Amendments

On April 2, 2009, Representative Jerrold Nadler (D-NY) introduced a bill entitled the "Business Reorganization and Job Protection Act of 2009." The bill has been co-sponsored by Representative Steve Cohen (D-TN), the Chairman of the Subcommittee on Commercial and Administrative Law of the United States House of Representatives Committee on the Judiciary. As of the date of this post, the bill’s official text has not been printed but the National Association of Credit Management has made available on its website what appears to be a final or near-final draft of the legislation, which you can access by clicking here. I plan to provide an update on the blog once the official version of the bill as introduced becomes available.

Introduction of the bill follows testimony before the Subcommittee on Commercial and Administrative Law by a number of bankruptcy professionals and law professors, including my partner and the Chair of Cooley Godward Kronish LLP‘s Bankruptcy & Restructuring Group, Lawrence Gottlieb. Click here for a prior post about his September 26, 2008 testimony, which focused on the disappearance of reorganizations of retailers since the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as "BAPCPA"). A link to Representative Nadler’s press release on the bill’s introduction can be found here.

The Legislation’s Proposed Changes. The Business Reorganization and Job Protection Act of 2009, introduced as H.R. 1942, would make several major amendments to the Bankruptcy Code. The common theme is that the proposed bill would repeal certain changes made by BAPCPA and restore the statutory language that was in place before BAPCPA was enacted in 2005. The four principal changes are as follows:

  • Real Estate Leases. The bill would change Section 365(d)(4) of the Bankruptcy Code by repealing the maximum 210-day period within which debtors could assume or reject non-residential real property leases. Instead of the current 120-day initial period and up to a 90-day extension, the statute would revert back to the initial 60-day period under the prior law but, more importantly, would allow the bankruptcy court, for cause, to grant further extensions without any time limit.
  • Utilities. Similarly, the bill would repeal Section 366(c) of the Bankruptcy Code, which now requires a deposit of cash or certain cash equivalents to provide adequate assurance of payment to utilities. If enacted, the bill would allow debtors to establish adequate assurance of payment with something short of a monetary deposit, as had been the case under the pre-BAPCPA law.
  • 20-Day Goods Administrative Claim. The bill would also make changes to the law relating to shipments by vendors prior to a bankruptcy filing. It would repeal Section 503(b)(9) of the Bankruptcy Code, added by BAPCPA, which gives an administrative claim to vendors for the value of goods received by a debtor in the ordinary course of business during the 20 days before the bankruptcy petition.
  • Reclamation. Another change the bill proposes to make is to go back to the pre-BAPCPA language in Section 546(c) of the Bankruptcy Code governing reclamation claims, specifically to repeal language that had expanded the potential reclamation claim for vendors to the 45 days before a bankruptcy petition. The bill would reinstate the pre-BAPCPA provisions restricting reclamation to that provided for under the Uniform Commercial Code (generally only a 10 day period) and permitting an administrative claim or secured claim to be provided to a reclaiming vendor in lieu of a return of the goods pursuant to a valid reclamation claim.
  • Effective Date. Finally, the bill proposes that its changes would apply to cases commenced on or after the date of its enactment, meaning it would apply to cases filed after the bill became law but not to cases filed before it became law.

Conclusion. If the Business Reorganization and Job Protection Act of 2009 were enacted, it could have a major impact on Chapter 11 bankruptcy cases, in particular those involving retailers. As explained in a recent article by several of my colleagues, the cumulative changes made by BAPCPA have had a profound impact on retail Chapter 11 cases. Repealing them could enable retailers the opportunity to emerge from Chapter 11 — the way they often did in the years before the BAPCPA amendments were adopted. Otherwise, we are likely to continue to see more retailers forced into going of out business sales in Chapter 11.

Business Bankruptcy Issues

The Terrible Twos? A Look At BAPCPA’s Impact On Business Bankruptcy Cases At Its Second Anniversary

Tomorrow, October 17, 2007, marks the second anniversary of the effective date of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, known as BAPCPA.  BAPCPA was enacted primarily to make sweeping changes to the consumer provisions of the Bankruptcy Code. However, BAPCPA also made significant revisions in the business bankruptcy arena.  When it was passed, bankruptcy lawyers, creditors, and potential debtors had many questions about how these changes would play out as new cases made their way through the system. Two years out, we now have answers to some of those questions.

In this post I’ll look at a few of BAPCPA’s more substantial revisions and how courts have addressed them so far. These include new rules governing real estate leases, reclamation, the "20 day goods" administrative claim, key employee retention plans, cross-border bankruptcy cases, and an important preference defense. As we walk down memory lane, I’ll also point you to earlier posts where you can find more details on these issues.

Commercial Real Estate Leases. Under BAPCPA, if the debtor is the tenant under an unexpired commercial lease, it must either assume or reject the lease within 120 days of the filing of bankruptcy. The court can extend this time period without the landlord’s consent for 90 additional days, making a total of 210 days, but any further extensions require the landlord’s prior written consent. If the lease is not assumed (or assumed and assigned) within this period, the lease automatically will be deemed rejected and the debtor will have to move out. 

  • Before BAPCPA, debtors initially had only 60 days to assume or reject leases but there was no statutory limit on extensions of that period. Cumulative extensions of a year or more, over a landlord’s objection, were not uncommon under the pre-BAPCPA version of the Bankruptcy Code. That is no longer possible under BAPCPA.
  • Below market leases can represent a significant asset, particularly for retailers with many store leases, and BAPCPA has forced these debtors to move very quickly to assume and assign leases or to sell designation rights to make the most of the 210 day maximum period. In a number of cases, this 210 day limit has depressed the value of the debtor’s leases and the recovery for its creditors.
  • For more on real estate leases, you may want to read "Commercial Real Estate Leases: How Are They Treated In Bankruptcy?" previously posted on this blog.

Reclamation. When a debtor becomes insolvent or files bankruptcy, some vendors may be able to take advantage of a special, although limited, right to get back or "reclaim" certain of the goods. This reclamation right is part of both the Uniform Commercial Code and the Bankruptcy Code. BAPCPA made some changes in the reclamation area and post-BAPCPA cases have put some meat on the bones of those changes. A new, 45-day bankruptcy reclamation right was added to Section 546(c) of the Bankruptcy Code, expanding the Uniform Commercial Code’s 10-day rule. Under BAPCPA, 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. The reclamation demand must be in writing and made within 45 days of the receipt of the goods by the customer (now the debtor in bankruptcy).  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.

Two decisions from earlier this year have helped clarify the impact, and highlight the limitations, of BAPCPA’s reclamation changes.

  • In January 2007, Judge Christopher S. Sontchi of the U.S. Bankruptcy Court for the District of Delaware refused to issue a temporary restraining order in favor of a reclamation claimant in the Advanced Marketing Services case who sought to prevent the sale of goods it was trying to reclaim. The Court cited the superior rights of the secured creditor, which had a lien on the goods. A discussion of the case and a copy of the Court’s decision is available at this earlier post.
  • Then, in April 2007, Judge Burton R. Lifland of the U.S. Bankruptcy Court for the Southern District of New York applied the "prior lien defense" in favor of a secured creditor by valuing all reclamation claims in the Dana Corporation case at zero. You can find a discussion of that case and a copy of the decision at this previous post.

The "20 Day Goods" Administrative Claim. Although the post-BAPCPA decisions have not been favorable to vendors in the reclamation area, recent developments have underscored the value of the new Section 503(b)(9) administrative claim. That new provision, added by BAPCPA, gives vendors an administrative priority claim for "the value of any goods received by the debtor within 20 days before" the date a bankruptcy petition was filed "in which the goods have been sold to the debtor in the ordinary course of such debtor’s business."  For an overview of the new provision, you may find the post entitled "20 Day Goods: New Administrative Claim For Goods Sold Just Before Bankruptcy," of interest.

Key Employee Retention Plans. One of BAPCPA’s most notable changes was the significant restrictions imposed on key employee retention plans, known as KERPs. Prior to BAPCPA, KERPs were a very popular way of making sure that a company could retain its most important officers and employees to guide it through bankruptcy. Citing perceived abuses, however, Congress added language in BAPCPA that requires debtors to satisfy nearly impossible standards before courts would be permitted to approve payment of retention bonuses (or severance payments) as administrative claims to officers and other insiders of a bankrupt company. In short, a debtor would have to show that the individual was essential the the survival of the business and that he or she had a bona fide job offer from another business at the same or greater rate of compensation.

Debtors looking to compensate key officers have moved away from retention plans entirely and instead have turned to incentive plans. 

  • Several courts have approved incentive plans covering insiders but have applied certain factors to judge the reasonableness of the plan, including an assessment of the relationship between the plan and the results to be obtained, the cost of the plan, and whether the plan’s overall scope is fair and reasonable.
  • In May 2007, the Delaware Bankruptcy Court even approved a downward adjustment to an incentive plan’s targets, permitting a bonus to be paid to insiders, when the original plan’s targets turned out to be unrealistic. 
  • For more on this topic, including copies of three significant decisions in the Dana Corporation, Global Home Products, and Nellson Nutraceuticals cases, follow the link to this earlier post on key employee incentive plans.

Chapter 15 On Cross-Border Bankruptcies. BAPCPA added a new chapter to the Bankruptcy Code to adopt an internationally drafted Model Law on Cross-Border Insolvency.  Chapter 15 is used principally by representatives of, or creditors in, foreign insolvency proceedings to obtain assistance in the United States, by a debtor or others seeking to obtain assistance in a foreign country regarding a bankruptcy case in the United States, or when both a foreign proceeding and a bankruptcy case in the United States are pending with respect to the same debtor. Follow the link in this sentence for a detailed overview of Chapter 15.

  • In a recent case involving two Bear Stearns hedge funds, the Bankruptcy Court in the Southern District of New York refused to recognize proceedings pending in the Cayman Islands as either a foreign main or foreign nonmain proceeding, denying those entities Chapter 15 protection in the United States.
  • You can find the details on this case (and a copy of the original and amended decisions) here and here.

Preferences. Before it took effect, one of BAPCPA’s most talked about changes was a revision to the "ordinary course of business" defense to preference claims. BAPCPA dropped the requirement that a preference defendant establish that a transfer was both (i) made in the ordinary course of business or financial affairs between the debtor and the defendant and (ii) made according to ordinary business terms.

  • BAPCPA’s main change was to replace the "and" with an "or", meaning that a preference defendant now has to establish only one of the two prongs (instead of both) to prevail on the defense. When it was enacted, many bankruptcy lawyers believed this change would favor preference defendants. 
  • In something of a surprise, however, the first case interpreting the revised statute applied a brand new standard to the "ordinary business terms" provision. Unlike the prior analysis of that prong, the new standard examined the question from the perspective of both the creditor (as had been done pre-BAPCPA) and the debtor (the new BAPCPA twist). As a result, in that decision the preference defendant lost. For more on the decision, in the In re National Gas Distributors, LLC case, check out this post on David Rosendorf’s BAPCPA Blog.
  • There have been surprisingly few cases interpreting this section, so it remains to be seen whether other courts will follow the National Gas Distributors interpretation.

Another Great BAPCPA Resource. In addition to the BAPCPA Blog, which has posts on many decisions from BAPCPA’s first year, don’t miss Steve Jakubowski’s Bankruptcy Litigation Blog, in particular his BAPCPA and BAPCPA Outline topics. Steve has posted on a range of BAPCPA issues, including major consumer decisions and many business bankruptcy decisions.

Acting Like A Two Year Old? As we begin the third year under BAPCPA, the law is beginning to take early steps toward greater clarity in some areas but much remains to be decided. In particular, few appellate decisions have been issued on BAPCPA’s key changes, giving us little guidance on how the Courts of Appeals will interpret the new law.  As always, stay tuned for more developments and feel free to subscribe to the blog by email or by RSS to your feedreader.

Business Bankruptcy Issues Recent Developments The Financially Troubled Company

The Best Of Both Worlds: Can A Secured Creditor Get A Section 503(b)(9) “20 Day Goods” Administrative Claim Too?

In a decision from August 17, 2007, just released for publication, the Ninth Circuit’s Bankruptcy Appellate Panel (BAP) faced a previously unanswered question under Section 503(b)(9) of the Bankruptcy Code, the section enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as BAPCPA).  Is a Section 503(b)(9) administrative claim available to secured creditors or only to unsecured creditors? You may find the BAP’s answer surprising.

A Section 503(b)(9) Refresher. For those who haven’t dealt with this relatively new section, here are the highlights. Section 503(b)(9) gives vendors an important right beyond the expanded reclamation claim also enacted as part of BAPCPA. Vendors are entitled to an administrative priority claim for "the value of any goods received by the debtor within 20 days before" the date a bankruptcy petition was filed "in which the goods have been sold to the debtor in the ordinary course of such debtor’s business." 

  • In most cases, particularly Chapter 11 cases in which a plan of reorganization is confirmed, administrative claims are paid in full on the effective date of the plan. General unsecured claims, by contrast, often receive only cents on the dollar, and even secured creditors can be "crammed down" and forced to accept payments over a period of time. This new administrative claim is therefore a significant benefit, in effect putting vendors selling goods to a debtor in the 20 days before the bankruptcy filing on par with vendors selling goods after the bankruptcy filing. It’s available even if a seller of goods fails to provide the required notice to have a post-bankruptcy reclamation claim. 
  • For a more detailed analysis of Section 503(b)(9), you may find this earlier post entitled "20 Day Goods: New Administrative Claim For Goods Sold Just Before Bankruptcy" useful, as well as a later post giving an update on a few early court decisions on the section. 
  • For more on the changes BAPCPA made to reclamation, you may want to read an earlier post entitled "Reclamation: Can A Vendor "Get The Goods" From An Insolvent Customer" and this post on some of the limitations of reclamation.

The Brown & Cole Stores Case. It was against this backdrop that the BAP analyzed the question before it in the In re Brown & Cole Stores, LLC case. Brown & Cole is a privately held grocery chain operating in Washington state. Its principal supplier and wholesaler, Associated Grocers, Incorporated (AGI), is a cooperative whose largest shareholder is Brown & Cole itself. In Brown & Cole’s Chapter 11 case, AGI asserted a "20 day goods" claim of more than $6 million, and also asserted that it was a secured creditor with a pledge of AGI’s own stock owned by Brown & Cole. Brown & Cole alleged a number of claims against AGI and argued that it had a right of setoff on those claims against any "20 day goods" claim.

When AGI moved for allowance of a Section 503(b)(9) claim, Brown & Cole argued that AGI was not eligible for that administrative claim because it was a secured creditor. The bankruptcy court rejected that argument and granted AGI’s motion. It also denied Brown & Cole’s request for a setoff of its own prepetition claims against the administrative claim, among other reasons because of what the bankruptcy court found to be Brown & Cole’s inequitable conduct in ordering goods just prior to its bankruptcy filing.

The BAP’s Decision. After hearing the appeal, the BAP issued its opinion and identified the first question presented as "Is a secured claim entitled to an administrative priority pursuant to section 503(b)(9)?" The opinion’s introduction shows that the BAP was aware of the interest creditors would have in its decision:

This case presents us with an issue of first impression regarding new section 503(b)(9) (“§  503(b)(9)”) of the Bankruptcy Code, as amended in 2005. We expect that the issue is of great importance to many sellers of goods to troubled companies. The new provision gives expense-of-administration priority (“administrative priority”) to a claim for the value of goods received by a debtor within 20 days before the commencement of the case and sold in the ordinary course of business (“twenty-day sales”). The bankruptcy court granted administrative priority to a claim that may also be secured and denied the debtor’s claim of setoff. We AFFIRM the grant of administrative priority; we REVERSE the denial of setoff.

(Footnotes omitted.)

Secured Creditors Are Entitled To Section 503(b)(9) Claims. In reaching its holding, the BAP majority rejected Brown & Cole’s primary argument that the Court should interpret Section 503(b)(9) as applying only to unsecured claims. Brown & Cole argued that at the same time as it added Section 503(b)(9), BAPCPA amended another subsection of Section 503 dealing with tax claims, specifically Section 503(b)(1)(B)(i), to clarify that it was available to "secured or unsecured" creditors.  In contrast, Congress did not include the words "secured claim" in Section 503(b)(9). This difference, Brown & Cole argued, should lead the BAP to hold that the "20 day goods" administrative claim is not available to secured creditors. The BAP’s response was clear:

We reject that invitation. The provision is not ambiguous; as such, we must enforce it according to its terms and should not inquire beyond its plain language. Lamie, 540 U.S. at 534. Apart from finding no ambiguity in § 503(b)(9), we note that Congress also declined to put the word  “unsecured” into the same statute. The obvious conclusion, therefore, is that all claims arising  from twenty-day sales are entitled to administrative priority.

(Footnote omitted). The BAP majority also rejected a policy argument advanced by Brown & Cole (B&C), and adopted by Judge Alan Jaroslovsky in his dissent:

We can do nothing about B&C’s contention that giving priority to a secured creditor may be inequitable to other creditors. First, it is up to Congress to decide which creditors have leverage and which do not. More importantly, if AGI’s twenty-day sales claim is fully secured, then payment of it by B&C will free the value of the security for that claim for the benefit of other  creditors. If AGI’s claim proves to be undersecured or unsecured, then to deny administrative priority would be to ignore the statute, something we cannot do.

In a footnoted response to the dissenting opinion, Judge Dennis Montali, writing for himself and Judge Randall L. Dunn, expanded on the point:

The dissent is concerned that we are ignoring bankruptcy policy that permits a Chapter 11 debtor to “cramdown” a secured claim in full over time. Congress gave tremendous leverage to a twenty-day sales claimant such as AGI by permitting it to demand full payment as of confirmation, and in doing so, perhaps dramatically affecting the outcome of the case. The fact that the claim is also secured represents less leverage (albeit more than held by non-priority general unsecured claims) than having administrative priority. It is not our place to reallocate that leverage. In any event, if the dissent’s view were the law, the holder of a twenty-day sales claim could simply waive its security, obtain administrative priority, and have equally powerful influence over the outcome of the case.

Setoff May Be Proper. The BAP (the dissent joined in this part of the majority opinion) also reversed the denial of Brown & Cole’s setoff request, holding that although prepetition unsecured claims (the kind Brown & Cole asserted against AGI) cannot generally be set off against administrative claims because of a lack of mutuality, here the administrative claim itself arose prepetition, specifically in the 20 days before the bankruptcy filing. On the finding of inequitable conduct in ordering goods and receiving just prior to bankruptcy, the BAP held that there was insufficient evidence of inequitable conduct and that a "debtor contemplating reorganization is under no legal obligation to inform suppliers that it is contemplating a bankruptcy filing." The BAP reversed and remanded that issue to the bankruptcy court.

A Dissenting Voice. Judge Jaroslovsky dissented from what he described as the majority’s "overly-sterile conclusion that a fully secured creditor can also have rights under § 503(b)(9)," stating that "[n]ot only is my statutory analysis different, but I see compelling policy reasons for a different result." He found that the plain language of Section 503(b)(9) did not resolve the question of whether secured creditors could be entitled to the administrative priority in light of the change made to Section 503(b)(1)(B)(i). He then turned to the policy issues:

Moreover, some fundamental policy considerations are at stake in this case. While allowing a priority claim to a secured creditor may not have a big impact in most Chapter 7 cases, it can  make a huge difference in a Chapter 11 case like this one. If AGI’s $6 million claim is entitled to priority status, § 1129(a)(9)(A) requires that it must be paid in full in cash upon confirmation. If  it is treated as a secured claim, it still must be paid in full but is subject to cramdown pursuant to § 1129(b)(2)(A). If we incorporate by implication the “secured or unsecured” language into § 503(b)(9), we may be in effect giving a secured creditor veto power over a plan of reorganization when § 1129(b)(2)(A) and sound bankruptcy policy dictate that a secured creditor can be forced  to accept a plan which is fair and equitable to it, honors its secured status and pays its secured claim in full over time.

I would weave the new § 503(b)(9) into the tapestry of American bankruptcy law, preserving the clear intent of Congress to protect recent suppliers of goods to debtors without unraveling other provisions of the Code meant to facilitate reorganization. I prefer this result to the crazy quilt patched together by my brethren.

In his footnote to the prior paragraph, Judge Jaroslovsky stated: "Specifically, I would hold that a creditor would not be entitled to priority status for its twenty-day sales claim to the extent the claim is indubitably secured, applying any security first to claims other than the twenty-day sales claim. I note that AGI might well end up with an allowed priority twenty-day sales claim under this rule."

More Leverage For Secured Vendors. As both the majority and dissent discussed, a secured creditor who has the benefit of a Section 503(b)(9) administrative claim will have considerable leverage in getting paid in full upon confirmation of a Chapter 11 plan. Most secured creditors lend money instead of supplying goods, but a number of vendors do hold collateral for their claims. Even though BAP decisions (in contrast to Court of Appeals decisions) generally are not binding precedent, other courts may find this decision persuasive. If followed widely, secured creditors entitled to assert a Section 503(b)(9) claim will have a noticeable advantage in getting paid. In addition, as the dissent noted, this decision may also make it more difficult for debtors to confirm Chapter 11 plans unless they have the cash to pay all "20 day goods" administrative claims upon their exit from bankruptcy.

Business Bankruptcy Issues Recent Developments

In Important New Ruling, New York Bankruptcy Court Applies Prior Lien Defense To Post-BAPCPA Reclamation Claims

On Thursday, April 19, 2007, in perhaps only the second decision on reclamation since the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) took effect in October 2005, Judge Burton R. Lifland of the U.S. Bankruptcy Court for the Southern District of New York issued this Memorandum Decision in the In re Dana Corporation Chapter 11 bankruptcy case. Employing an analysis similar to that of Judge Sontchi in his January 2007 decision in In re Advanced Marketing Services, Inc. (discussed in this post), Judge Lifland valued all pending reclamation claims in the Dana Corporation case at zero, effectively denying them in their entirety.

A Quick Primer On Reclamation Under BAPCPA. Section 546(c) of the Bankruptcy Code, as amended by BAPCPA, gives vendors the ability to assert a reclamation claim for goods received by a debtor in the 45 days prior to the bankruptcy filing. In addition to extending the reclamation period to 45 days, BAPCPA also added a provision in Section 546(c) making reclamation claims "subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof." This quoted language refers to a secured creditor with a prior senior lien in the same goods, a defense to reclamation often referred to as the "Prior Lien Defense." (For more details on reclamation claims, both before and after a bankruptcy is filed, you may find this earlier post on reclamation of interest.)

The Reclamation Claims Process. As is typical in large Chapter 11 cases, a reclamation procedure was established in the Dana Corporation case. After setting a deadline for the filing of reclamation claims, the following events unfolded:

  • As debtor and debtor in possession, Dana Corporation filed a motion seeking bifurcation of the Prior Lien Defense from the more fact-based defenses it also intended to advance.
  • The Bankruptcy Court granted the motion and entered this bifurcation order, which separated out the Prior Lien Defense for discovery, briefing, and decision while staying discovery and other efforts relating to the remaining defenses.
  • The debtor then filed an initial brief on the Prior Lien Defense and related arguments, asserting that the scores of reclamation claims filed by creditors all were "subject to" pre-existing liens on the goods in question, rendering the reclamation claims valueless. Relying on the pre-BAPCPA case of In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003), the debtor argued that the use of DIP financing with liens on the goods in question to satisfy prepetition loans meant that those goods were effectively disposed of, were not subject to reclamation, and that reclamation claims based on them were valueless.
  • Many reclamation claimants filed objections to the debtor’s motion (this objection is representative of the types of arguments advanced). They contended that reclamation claims are valueless only if the goods sought to be reclaimed are actually used to pay the lien of the secured creditor to which they are "subject." Relying on In re Phar-Mor, Inc., 301 B.R. 482, 497 (Bankr.N.D. Ohio 2003), amended on rehearing, 2003 Bankr. LEXIS 2009 (Bankr.N.D.Ohio Dec. 18, 2003), they argued that the prepetition loans were repaid with funds from the DIP loans, not from liquidation of the goods subject to the reclamation claims.
  • The debtor then filed this reply brief, again arguing that Dairy Mart is still good law and that its principles made all reclamation claims valueless in this case.

The Dana Corporation Decision. In his 21-page decision, Judge Lifland made two important rulings. First, he addressed whether amended Section 546(c) creates a new federal common law of reclamation or whether it still relies on the Uniform Commercial Code and other state law:

The Reclamation Claimants contend that the deletion of the reference to state law in the amended section 546(c) no longer incorporates the state law right of reclamation, and instead creates a brand new federal bankruptcy law right. I disagree.

*           *           *

It is not a section dedicated to granting an independent federal right of reclamation nor does it create a coherent comprehensive federal scheme for reclamation. First, Congress did not use the language of creation – Congress did not say that “a seller may reclaim goods when….”

*          *          *

Moreover, if amended section 546(c) was a new federal reclamation right arising under the Bankruptcy Code, it would not be subject to the avoiding powers. [footnote omitted]

Second, having concluded that amended Section 546(c) did not supplant existing reclamation law, Judge Lifland examined Phar-Mor, Dairy Mart, and related case law and ruled that the Prior Lien Defense made the reclamation claims valueless in this case:

Here, the prepetition collateral, including the reclaimed goods, was subject to the Prepetition Lien. Pursuant to the Interim DIP Order, the Debtors were authorized to use the Prepetition Lenders’ cash collateral, with the Replacement Lien providing a replacement security interest in all of the Debtors collateral subject to the DIP Lien, including the prepetition collateral and the proceeds thereof. The DIP Lien granted to the DIP Lenders pursuant to the Interim DIP Order and the Final DIP Order, provided a security interest in, and lien upon, all of the collateral constituting the prepetition collateral. Thus the lien chain continued unbroken. Cf. Dairy Mart, 302 B.R. at 184 (holding that the transaction of releasing the prepetition lien and simultaneously granting the lien to the post-petition lender, must be viewed as an integrated transaction). The grant of the DIP Lien was a necessary condition of the DIP Lenders’ agreement to enter into the DIP Facility. Pursuant to the Final DIP Order, the Prepetition Indebtedness was refinanced and paid off using the proceeds of the DIP Facility on the payoff date. Because the reclaimed goods or the proceeds thereof were either liquidated in satisfaction of the Prepetition Indebtedness or pledged to the DIP Lenders pursuant to the DIP Facility, the reclaimed goods effectively were disposed as part of the March 2006 repayment of the Prepetition Credit Facility. Accordingly, the Reclamation Claims are valueless as the goods remained subject to the Prior Lien Defense.

Recognizing Another BAPCPA Change: Section 503(b)(9)’s New Administrative Claim. Although the Bankruptcy Court was considering only BAPCPA’s amended Section 546(c) and reclamation claims, the decision makes several comments about the impact of another of BAPCPA’s changes, the new "20 day goods" administrative claim. (A February 2007 update post described the first few decisions on this new Section 503(b)(9) administrative claim.) These include the following: 

The issues before the Court today relate solely to the Prior Lien Defense to reclamation rights under section 546(c) of the Bankruptcy Code and not to the rights to an administrative expense under the newly enacted section 503(b)(9) of the Bankruptcy Code. This new provision presents other issues concerning, inter alia, the valuing of the subject goods; what constitutes the actual receipt of the goods; how is the claim asserted; when is it to be paid; is it subject to the claims processing and omnibus bar date orders, etc.? These issues will not, and need not, be parsed here. Suffice it to say that in light of the section 503(b)(9) amendment, section 546(c) is no longer an exclusive remedy for a prepetition seller.

*         *          *

In addition, amended 546(c) provides for an administrative claim: "If a seller of goods fails to provide notice in the manner described in paragraph (1), the seller still may assert the rights contained in section 503(b)(9)." 11 U.S.C. § 546(c)(2). New section 503(b)(9) in turn allows the seller an administrative expense claim equal to "the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business." 11 U.S.C. § 503(b)(9). There is no shortage of commentary on the interplay of sections 503(b)(9) and 546(c).5

[Footnote 5]

With the introduction of section 503(b)(9) priority, reclamation claims under amended section 546(c) have decreased importance because goods delivered to a debtor in the 20 days prior to bankruptcy will have automatic priority. Thus, reclamation rights are now mainly beneficial for goods delivered in the 21 to 45 days prior to the bankruptcy filing under amended section 546(c). However, with the expansion of the reclamation period, the likelihood of early administrative insolvency will increase, and debtor companies will need greater financial resources to reorganize. See Charles J. Shaw and Brent Weisenberg, Effect of a Preexisting Security Interest in the Debtor’s Inventory on the Rights of Reclamation Creditors, 2005 Norton Ann. Surv. Of Bankr. Law Part I §15 (Sept. 2006) (hereinafter “Norton Survey”).

Where Does This Decision Leave Creditors And Debtors? While valuing all reclamation claims at zero, Judge Lifland was careful to mention the existence of the new administrative claim for goods delivered to the debtor in the 20 days prior to the bankruptcy. This comment is significant and reveals how BAPCPA has changed the old reclamation equation. While the jury is certainly still out, the early post-BAPCPA reclamation decisions in Advanced Marketing Services (Delaware) and Dana Corporation (Southern District of New York) suggest that creditors may have even more difficulty establishing reclamation claims. If so, instead of reclamation, the new 20 day goods administrative claim may turn out to be the more valuable right for creditors — and the more costly obligation for debtors — in this post-BAPCPA world.

Business Bankruptcy Issues Recent Developments The Financially Troubled Company

The New Section 503(b)(9) Administrative Claim: The Latest On What Courts And Debtors Have Been Doing

A couple of months ago I posted on the new "20 day goods" administrative claim enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"). BAPCPA, which took effect in October 2005, added Section 503(b)(9) to the Bankruptcy Code giving vendors an administrative priority claim for "the value of any goods received by the debtor within 20 days before" the date the bankruptcy petition was filed, as long as "the goods have been sold to the debtor in the ordinary course of such debtor’s business." 

In my earlier post, I posed a number of unresolved questions about this new section and predicted that courts would soon start to address those issues. Well, in the past couple of months we have in fact seen decisions answering at least a few of the questions raised by Section 503(b)(9).

The First Court Decisions. In late December 2006, bankruptcy courts in the District of Delaware and the Eastern District of Pennsylvania issued what appear to be the first two decisions on when and under what circumstances Section 503(b)(9) administrative claims must or should be paid. As explained below, in both decisions the bankruptcy court held that the administrative claimant was not necessarily entitled to payment prior to, in a Chapter 11 case, confirmation of a plan of reorganization.

  • In the first decision, issued December 21, 2006, Judge Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware denied a creditor’s motion for payment of a Section 503(b)(9) administrative claim in the In re Global Home Products, LLC Chapter 11 bankruptcy case. The court held that the timing of payment of administrative claims is left to the discretion of the court. In so doing the court quoted with approval from an article that described Section 503(b)(9) as a "rule of priority, rather than payment." The court relied on a non-Section 503(b)(9) decision for the three factors to assess when considering when an administrative claim should be paid, chiefly, (a) the prejudice to the debtor, (b) hardship to the claimant, and (c) potential detriment to other creditors. The court applied those factors and denied the creditor’s request for immediate payment.
  • In the second decision, issued a week later on December 28, 2006, Judge Eric Frank of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania denied a motion for immediate payment of Section 503(b)(9) claims filed by several creditors in the In re Bookbinders’ Restaurant, Inc. Chapter 11 bankruptcy case. Although the debtor agreed that the creditors were entitled to allowance of a "20 day goods" administrative claim, it opposed the immediate payment of those claims. The court held that the timing of payment was a matter of the court’s discretion but agreed to hold an evidentiary hearing to consider evidence to guide the exercise of that discretion.

A Few Early Take-Aways. In both of these decisions, the courts held that they have discretion to defer payment until the end of a Chapter 11 bankruptcy case, when a plan of reorganization is confirmed.

  • Creditors who can establish that failing to pay their Section 503(b)(9) claim would cause them hardship, but not prejudice the debtor or other creditors, may still be able to obtain immediate payment. As these cases show, however, creditors will find it challenging to meet that standard.
  • Interestingly, the Bookbinders court rejected what it called an "equal protection" argument by the creditors, who asserted that they should be paid immediately because vendors delivering goods to the debtor post-petition were being paid on their administrative claims. The court drew a distinction between the two claims, explaining that the creditors delivering goods post-petition were paid not under Section 503(b) but instead under Section 363(c)(1) of the Bankruptcy Code. That latter section allows a debtor in possession or trustee to enter into post-petition ordinary course of business transactions, and to pay for them, without court approval.
  • Finally, DIP financing orders can impact the timing of paying Section 503(b)(9) claims. In some cases the DIP budget may not include funds to pay these claims and in others the DIP order may expressly prohibit their payment. Section 503(b)(9) creditors may want to review proposed DIP financing motions carefully with this in mind.

What Debtors Have Been Doing. In an attempt to exert a degree of control over Section 503(b)(9) claims, some debtors have filed motions seeking to establish procedures to handle these claims, not unlike the procedures used in past cases for reclamation claims. In the Seattle case of In re Brown & Cole Stores, LLC, for example, the debtor filed a motion for an order establishing procedures for Section 503(b)(9) claims. The court granted the motion and entered a Section 503(b)(9) procedures order which, among other things:

  • Required creditors to file Section 503(b)(9) claims by a special bar date;
  • Required the debtor to file a report evaluating such claims 21 days after the special bar date;
  • Gave creditors 15 days thereafter to file a reply to the debtor’s position;
  • Made the debtor’s position binding in the event a creditor did not timely respond; and 
  • Reserved to the court the right to resolve any disputes. 

The order effectively reserved the issue of when valid Section 503(b)(9) claims would be paid but made the procedures the exclusive method for determining the validity and amount of such claims. I expect that other debtors will pursue similar procedures for handling these "20 day goods" claims.

Don’t Touch That Dial. These early decisions are the first in what should be many future rulings on the questions posed by Section 503(b)(9). I’ll continue to update you on how courts are interpreting this new administrative claim and, over time, we should begin to see more clarity on how debtors, vendors, and courts will address this new BAPCPA provision.

Business Bankruptcy Issues Recent Developments

Delaware Bankruptcy Court Denies Reclamation Claimant’s TRO Request To Stop Sale Of Goods

In a recent post, I discussed how Section 546(c) of the Bankruptcy Code, as revised by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), gives vendors the ability to assert a reclamation claim for goods received by a debtor in the 45 days prior to the bankruptcy filing. In addition to extending the reclamation period to 45 days, BAPCPA also added a provision in Section 546(c) making reclamation claims "subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof." This quoted language refers to a secured creditor with a senior lien in the same goods.

The Advanced Marketing Services case. Section 546(c)’s expanded reclamation rights, and how they may be impacted by the "prior rights" of a secured creditor, recently played out in the Chapter 11 bankruptcy case of In re Advanced Marketing Services, Inc. pending in the United States Bankruptcy Court in Delaware.

Simon & Schuster, Inc., a reclamation claimant, filed a complaint against the debtor, Advanced Marketing Services, Inc. ("AMS"), seeking to reclaim more than $5 million worth of goods that the debtor allegedly received in the 45 days prior to the bankruptcy filing. (You can access the pleadings from the Simon & Schuster litigation by clicking on the appropriate links in this post.)

  • In an effort to gain control over the goods at issue, Simon & Schuster filed an application for a temporary restraining order (known as a "TRO") seeking a court order to prevent AMS from selling the goods. 
  • The debtor opposed the TRO, challenging whether Simon & Schuster had the right to reclaim the goods.
  • The debtor’s secured creditor, Wells Fargo Foothill, Inc., also filed an opposition to the TRO, arguing that the reclamation claim was subject to its prior rights as a prepetition secured creditor and as a debtor in possession ("DIP") lender. In this case, the DIP loan has been structured as a "creeping roll up" in which prepetition obligations are to be satisfied by the use of cash collateral and the DIP lender in turn receives a postpetition lien as that cash collateral is used.
  • Simon & Schuster filed a reply brief responding to the opposition papers filed by the debtor and the secured creditor.

The Court’s Decision. In a decision issued by the Bankruptcy Court yesterday, Judge Sontchi denied Simon & Schuster’s application for a TRO without prejudice, holding that Section 546(c) made Simon & Schuster’s reclamation rights subject to the prior rights of the secured creditors. (The Bankruptcy Court also noted that it would have reached the same result under pre-BAPCPA bankruptcy and UCC law.)

  • The Bankruptcy Court held that the secured creditors had superior prepetition and postpetition liens in the goods Simon & Schuster sought to reclaim and that Simon & Schuster therefore could not establish that it was likely to prevail on the merits of its reclamation claim.
  • The Bankruptcy Court also rejected any attempt to require "marshaling" by the secured creditor, which if ordered could have required the secured creditor to satisfy its claim first from collateral other than the goods that Simon & Schuster sought to reclaim.

Stay Tuned. As one of the first decisions on this reclamation issue under BAPCPA, the Advanced Marketing Services decision is an important one. However, it’s not the last word on how the respective rights of reclaiming vendors and secured creditors will be decided in Chapter 11 cases. Reclamation issues are often fact dependent and results may vary in different cases. Also, vendors unable to prevail on a reclamation claim may still have a "20 day goods" administrative claim, and this fact may influence how debtors treat vendors in future cases.