Reclamation Claim; Bankruptcy Reclamation; UCC Reclamation Claim

This essay is published for informational purposes. It is not legal advice and is not considered a substitute for legal advice provided by an attorney.

If a creditor/seller learns that the buyer is insolvent before a delivery is made, the seller has the right to withhold delivery.  Under state law, a seller may have the right to require the buyer to return any goods the insolvent buyer obtained from the seller subject to specific conditions and requirements under the Uniform Commerical Code.  A creditor’s demand will typically be faxed to the debtor, sent by overnight delivery, and also sent by mail with return receipt requested. The written demand should contain specific language, including instructions that the debtor must set aside and safeguard any of the goods sold in its inventory.  The Bankruptcy Code gives the sellers of goods a priority claim for unpaid goods delivered within 20 days of a debtor's bankruptcy filing. This longer priority claim period has increased the likelihood of a payment to creditors for goods shipped prior to the filing date.these claims.

Insolvency under the UCC is defined to include the so-called equity rule (inability to pay debts as they mature) as well as the bankruptcy definition (liabilities exceeding assets).  A creditor's right to reclamation of its inventory under the U.S. Bankruptcy Code is subordinate to the  rights of another creditor with a perfected security interest in the bankrupt debtor’s inventory. For this reason, both the debtor and another creditor with a security interest in inventory will generally oppose an unsecured creditor’s reclamation demand since the return of inventory would reduce the value of the secured creditor’s collateral.

If a customer files for bankruptcy protection, state laws no longer apply and the creditor must explore their right to reclamation under the U.S. Bankruptcy Code.  The Bankruptcy Code provides additional protection to suppliers / creditors.  The Bankruptcy Code allows vendors to make a written reclamation demand for goods transferred to a debtor in the 45-days immediately preceding the Chapter 11 debtor's bankruptcy filing. If the 45 day period expires after the bankruptcy filing, the vendor is given an additional 20 days to make a demand (thereby potentially giving the vendor up to 65 days to recovery goods).

The Code allows creditors to file an administrative expense claim for goods delivered to a customer within 20 days prior to the customer's bankruptcy filing.  This administrative claim makes recovery of the money owed by the debtor more likely. By making a timely written demand for reclamation, a creditor protects its remedies in the debtor’s bankruptcy.  The Bankruptcy Court can deny a creditor's reclamation rights.  If the reclamation demand is denied by the U.S Bankruptcy Court, the Court can grant the creditor lien rights in the inventory or another asset which would convert the creditor’s claim into a secured claim.  Often, the Court will deny reclamation but grant a claim for an administrative expense priority relating to the value of the goods subject to the reclamation demand.  The creditor would be required to reduce its unsecured, non-priority claim by an amount equal to the value of any merchandise returned or any administrative claim or secured claim approved by the Court.

The Bankruptcy Court can take one of four actions in response to a reclamation claim.  The Court can:

1. Grant the request for repossession of the goods;
2. Deny reclamation but grant the claim as an administrative expense priority. This administrative expensive priority allows the claim to be paid prior to all other priority claims and all unsecured claims. However, secured claims still have priority.
3. Grant a lien on the goods to be reclaimed or some other property of the estate, effectively converting an unsecured claim to a secured claim;
4. Deny the reclamation rights.

One final comment:  Reclamation is a very technical provision of the U.S. Bankruptcy Code, and creditors should seek legal advice as to if and how a reclamation claim may be properly filed with the debtor and/or the Bankruptcy Court.

Edited by Michael C. Dennis.