Reclamation Rights Can Take the Sting Out of Your Customer’s BankruptcySpring 1997
You just shipped to a customer on normal credit terms and now discover that the customer filed a bankruptcy petition! Had you known of the customer’s problems before shipping, you would have had various options to protect yourself, such as taking a purchase money security interest in the goods sold, getting a letter of credit or selling on a C.O.D. or cash in advance basis. Now, it’s too late for that. What can you do?
There is a "morning after" remedy that sometimes works for the unsecured seller who discovers that its buyer is insolvent (and, thus, is unlikely to pay for the goods sold). That remedy is known as the right of reclamation.
The Reclamation Remedy
The right of reclamation allows a seller of goods to demand return of, or "to reclaim," goods sold on credit, if the seller discovers that the buyer received the goods while the buyer was insolvent. If you act quickly, and observe the required legal formalities, even a bankruptcy court will require the buyer either to return your goods or to put your claim very high on the priority payment list (i.e., as an "administrative expense"). This does not always guaranty payment, but it improves your chances dramatically.
There are restrictions on the reclamation remedy, such as:
Protection for the Buyer’s Bank
- Generally, the seller must make its demand quickly, within 10 days of the buyer’s receipt of the goods. In the case of a bankruptcy filing, the 10-day limitation for making the reclamation demand is extended to 20 days if the goods are received by the buyer fewer than 10 days before the buyer files its bankruptcy petition.
- Only identifiable goods which are still in the possession of the buyer may be reclaimed.
- The seller’s right to reclaim is also "subject to" the rights of a buyer in the ordinary course or other good faith purchaser. This means that, if the buyer has sold your goods to the buyer’s customer, you cannot reclaim them.
- If the buyer has consumed your goods or incorporated them into the buyer’s own goods by the time you make your return demand, you are also out of luck.
An additional limit on reclamation protects the buyer’s secured lender (usually, a bank), if the buyer’s inventory is collateral for the bank’s loan. Typically, the bank’s interest in inventory as collateral is in the form of a "floating" lien that includes all newly acquired inventory, as and when the buyer takes physical possession of it. Under this arrangement, then, as soon as your goods were received by the buyer, they became part of the bank’s collateral. And, of course, the bank does not want that collateral returned to you, but sold, so the bank can get paid.
Until recently, if the bank could show that it had publicly recorded, or "perfected," its interest in the buyer’s inventory, the seller’s right to reclaim was considered extinguished. However, a recent case decided by the Seventh Circuit Court of Appeals (the federal appeals court for Wisconsin, Illinois, and Indiana) is good news for the reclaiming seller. The Court rejected the concept that a seller’s reclamation right was extinguished by the bank’s perfected lien. Instead, if the seller promptly and correctly asserts its reclamation claim in the bankruptcy court, and if it turns out that the bank has sufficient collateral to be paid in full, then the seller is still entitled to have its claim for the goods paid as an administrative priority claim.
Since making a reclamation demand is a relatively simple process, and can greatly improve your chances of being paid, you should always review with your attorney the possibility of making a reclamation demand, as soon as you learn that a customer has filed a bankruptcy petition.