reclamation

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Recent Developments

New Bankruptcy Resource: The Absolute Priority Newsletter

As a member of the Bankruptcy & Restructuring Group at Cooley Godward Kronish LLP, I wanted to let you know that we have just launched a new quarterly newsletter called Absolute Priority. The newsletter give updates on current developments in bankruptcies and workouts with the goal of keeping you "ahead of the curve" on these issues. You can access a copy of the first edition here and can register to receive future editions.

The inaugural edition is focused on the first year of experience under the October 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (known as BAPCPA). It includes articles on:

A two-page chart on M&A transactions involving Chapter 11 cases and an update on some of the bankruptcy and workout matters we have handled recently are also included. The newsletter starts with a welcome from my partner, Lawrence Gottlieb, the Chair of our Bankruptcy & Restructuring Group, and a note from another of my partners, Adam Rogoff, the editor of Absolute Priority.

I hope you find Absolute Priority informative and helpful.

Business Bankruptcy Issues The Financially Troubled Company

20 Day Goods: New Administrative Claim For Goods Sold Just Before Bankruptcy

In a recent post about a vendor’s reclamation rights, I discussed how the 2005 amendments to the bankruptcy laws, known as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (called "BAPCPA"), extended a vendor’s right to reclaim goods once a bankruptcy petition has been filed. This post focuses on another of BAPCPA’s important changes affecting vendors, specifically, the new provision giving vendors an administrative claim for certain pre-petition goods sold.

Expanded Reclamation Right. As mentioned in my earlier post, a new 45 day bankruptcy reclamation right was added to Section 546(c) of the Bankruptcy Code. Prior to this change, the Bankruptcy Code had merely incorporated the Uniform Commercial Code’s 10-day reclamation period. Now, once a bankruptcy is filed, a vendor can assert a reclamation demand for goods received within 45 days of the bankruptcy filing. However, in some cases a vendor may not be able to reclaim its goods. The reasons can include a failure to make a timely reclamation demand, the existence of a secured lender with a lien on the goods in question, or the debtor’s prior sale of the goods. 

A Brand New Administrative Claim For Vendors, Even If Reclamation Fails. If a vendor’s reclamation claim fails, another new Bankruptcy Code section, Section 503(b)(9), gives vendors an important additional right: 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, administrative claims are paid in full instead of only cents on the dollar as with general unsecured claims. 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.

  • Section 546(c)(2) of the Bankruptcy Code expressly provides that even if a seller of goods fails to provide the required notice to have a post-bankruptcy reclamation claim, the vendor may still assert this special Section 503(b)(9) administrative claim. 
  • This administrative claim applies in all types of bankruptcy cases, including Chapter 11 reorganization cases, Chapter 7 liquidation cases, and Chapter 13 cases.
  • Vendors who sold goods during the 21 to 45 day period before the bankruptcy filing will have to rely on reclamation alone as to those goods.
  • In either case, vendors and debtors should keep good records of shipments and deliveries of all goods received during the 45 days before the bankruptcy filing.

Unresolved Issues. This provision has been in effect for only a year and there are still a number of unanswered questions about how it will actually work in bankruptcy cases. Reviewing these questions may give you a sense of some of the issues to keep in mind when considering whether you (if you’re a vendor) or your vendors (if you’re a debtor) will have an administrative claim for "20 day goods." These issues include:

  • Since the vendor is entitled to an administrative claim for the "value of any goods received by the debtor," does that mean the invoice price or some other amount?
  • Does the term "goods" include services bundled with the goods?
  • Does the term "goods" include intellectual property-based products, such as boxed software or other similar items, which the debtor resells or sublicenses?
  • Does the "received by the debtor" requirement exclude goods that have been drop-shipped to a debtor’s customer at the debtor’s direction?
  • What does the requirement that the goods have been "sold to the debtor in the ordinary course of such debtor’s business" really mean?
  • Does the vendor have to file a pleading to be paid on this administrative claim, given that this new section requires "notice and a hearing"?
  • Can the debtor pay for the goods at the beginning of the case, much as it would for goods purchased after the bankruptcy filing, as a way of treating qualifying vendors as "critical vendors"?
  • Can the debtor wait to pay for these "20 day goods" until a plan of reorganization goes effective, as it can for certain other administrative claims?
  • If a Chapter 11 case converts to a Chapter 7 case, will this "20 day goods" administrative claim be treated as a Chapter 7 administrative claim, ahead of all unpaid Chapter 11 administrative claims, including those for goods sold during the Chapter 11 case?
  • Will the existence of this administrative claim provision give vendors who actually got paid before the bankruptcy for "20 day goods" a new defense to a claim that the payment was preferential? 

Get Good Advice. These issues, and the potential for a valuable administrative claim, are yet another reason for vendors to get good legal advice as soon as they learn of a bankruptcy filing. Debtors also need to get good advice, both legal and financial, so they can factor in how the requirement to pay for these pre-petition goods as an administrative claim will impact their cash needs.

Stay Tuned. This provision has been in effect for only one year, and applies only to cases filed after BAPCPA took effect on October 17, 2005. No formal court decisions have addressed, much less answered, these open questions. I expect bankruptcy courts will start to answer some of these questions in the coming months, and I’ll keep you updated on those developments. 

Business Bankruptcy Issues The Financially Troubled Company

Reclamation: Can A Vendor “Get The Goods” From An Insolvent Customer?

Although vendors sell goods to get paid, it doesn’t always work out that way. If the customer is insolvent or files bankruptcy, the vendor may be stuck with an unpaid account. To make matters worse, some customers (especially those with limited prospects for financing) may even "load up" on inventory and then file bankruptcy without paying. Regardless of why it happens, no one wants to ship goods and not get paid.

Some vendors, however, 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. The recent 2005 amendments to the bankruptcy laws, known as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (called "BAPCPA"), made some significant changes that have enhanced a vendor’s rights in a bankruptcy. This post discusses how reclamation rights play out both before and after bankruptcy.

Reclamation before bankruptcy. If the customer has not filed for bankruptcy, a vendor’s reclamation rights are governed by the Uniform Commercial Code (known as the "UCC"). UCC Section 2-702 is the UCC"s reclamation statute. It provides a seller with the right to reclaim goods that a customer received on credit "while insolvent" if the seller makes a demand within ten days after the customer received the goods. This 10-day period means that, absent a bankruptcy, a vendor’s reclamation right will be limited to reclaiming only those goods received by the customer in the ten days prior to the demand.

  • Under the UCC, "insolvent" means (A) having generally ceased to pay debts in the ordinary course of business other than as a result of good faith dispute; (B) being unable to pay debts as they become due; or (C) being insolvent within the meaning of federal bankruptcy law.
  • Under the federal Bankruptcy Code, insolvent means that the entity’s debts exceed the value of its assets at a fair valuation. This is essentially a balance sheet test but, importantly, one using market value and not financial reporting standards such as GAAP. Because they are prepared for a different purpose, GAAP balance sheets tend to overstate asset values and understate actual liabilities compared to the bankruptcy balance sheet test. Companies that might seem solvent under GAAP could be insolvent under the UCC or the Bankruptcy Code.
  • If the customer misrepresented its solvency in writing during the three months before the delivery of the goods in question, then the 10-day limitation does not apply.

The UCC reclamation demand. To exercise a reclamation right before bankruptcy, the vendor must make a demand. The demand should be in writing, directed to the customer, identify which goods are being reclaimed to the extent that information is available, include a general statement reclaiming all goods received by the customer from the vendor during the applicable time period, and demand that the goods be segregated. Vendors should consult with counsel to be sure the demand adequately protects their reclamation rights.

Reclamation after bankruptcy. Because of changes made in the 2005 amendments to the Bankruptcy Code, applicable to all bankruptcy cases filed on or after October 17, 2005, the filing of a bankruptcy now actually expands a vendor’s reclamation rights. These new provisions apply in both Chapter 11 reorganization cases and Chapter 7 liquidation cases. Some of the key changes include:

  • A new, 45-day bankruptcy reclamation right has been added to Section 546(c) of the Bankruptcy Code. Prior to this change, the Bankruptcy Code had merely incorporated the UCC’s 10-day period. Now, once a bankruptcy is filed, a vendor can assert a reclamation demand for goods received within 45 days of the bankruptcy filing.
  • 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 discussed above).
  • 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.
  • As with pre-bankruptcy demands under the UCC, 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 may also want to file a notice of reclamation with the bankruptcy court.

Sold goods and other issues. Whether before or after a bankruptcy filing, a vendor will lose its right to reclaim any goods that the customer sells before or after receiving the vendor’s reclamation demand. 

  • Absent an agreement with the customer or a reclamation program approved by the bankruptcy court (see this example from the Delphi case, which was filed before the new BAPCPA rules took effect), a vendor may be forced to seek and obtain a court order preventing further sales of goods while its reclamation claim is pending. 
  • This "sold goods" problem has probably become more important because BAPCPA removed language from the prior version of Section 546(c) that had allowed a bankruptcy court to give a reclaiming vendor an administrative claim (with priority over unsecured claims and certain other claims) in lieu of a return of the goods.
  • Both the UCC and the Bankruptcy Code require that the debtor itself must have received the goods for them to be reclaimed. Thus, goods that are drop shipped or otherwise delivered first to the debtor’s own customer likely will not be able to be reclaimed.
  • If the debtor made a misrepresentation of its solvency and then filed bankruptcy, it’s unclear whether the 45-day rule in bankruptcy will govern or whether, like under the UCC, no time limit will apply. Keep in mind, however, that often goods shipped as far back as 45 days or longer, and sometimes even as few as 10 days for debtors with fast inventory turns, may already have been sold and thus will not be subject to reclamation. 

Rights of secured creditors. A vendor’s reclamation right is further limited by the possibility that the debtor may have granted a bank or other creditor a security interest in the goods, which will be senior to the reclamation right.  As amended in 2005, Section 546(c) now expressly makes reclamation rights subject to the prior rights of a secured creditor with a security interest in goods or their proceeds.

New administrative claim for 20-day goods. Even if a vendor fails to make a reclamation demand, all may not be lost. A new Bankruptcy Code section, Section 503(b)(9), added by BAPCPA, gives vendors an administrative priority claim for the value of any goods received by the debtor within 20 days prior to the bankruptcy filing if the goods were sold in the ordinary course of the debtor’s business. (I intend to discuss this new provision in a future post.) For now, note that it may be an important "fall back" right for vendors who fail to make a reclamation demand or who are unable to reclaim goods for other reasons.

Impact of new reclamation right on debtors and other creditors. With every new right also comes new burdens. Vendors certainly have greeted as good news the ability to reclaim goods received by a debtor as far back as 45 days. The impact of these changes on debtors, however, remains unclear. Some bankruptcy attorneys wonder whether this expanded reclamation right, together with the administrative claim for 20-day goods and certain other changes made by BAPCPA, will make it more difficult for debtors to reorganize or otherwise to pay unsecured creditors.

As always, get good legal advice. Reclamation can involve a number of twists and turns. Vendors who think they may have reclamation rights should be sure to get legal advice immediately upon learning of a customer’s insolvency or bankruptcy to protect their interests, just as debtors should to know their own rights in response to reclamation demands.