Your reclamation rights Featured

8:00pm EDT July 26, 2008

Many creditors in the 1.5 million bankruptcies filed each year are sophisticated and familiar with the bankruptcy claims process. But if they do no more than file their proof of claim, they may be missing out on valuable rights.

“A lot of businesses hear the word ‘bankruptcy’ in connection with one of their customers, put up their arms and give up,” says Mark Bradshaw, a partner in the Insolvency and Reorganization Practice at Shulman Hodges & Bastian LLP. “They often do not realize that one of the arrows in their quiver is the ability to exercise reclamation rights.”

In October 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) became effective. BAPCPA expanded and clarified reclamation, theoretically making recovery of goods easier. According to Bradshaw, the BAPCPA (which took eight years to finalize) was “the most heavily lobbied piece of legislation in U.S. history” because so many special interests and stakeholders were involved. Though the number of bankruptcy filings declined immediately following its passage, this year they appear to be back up to pre-2005 levels.

“I am definitely seeing an increase and an attitude shift among debtors and trustees,” he says. “Creditors are getting more educated, and reclamation rights are easier to exercise — even though they are still underutilized.”

Smart Business talked to Bradshaw about the reclamation process.

What is the legal definition of ‘reclamation’?

Reclamation rights are governed by Bankruptcy Code Section 546, which applies to all bankruptcy cases, including Chapters 7, 11 and 13. Reclamation is a procedure in a bankruptcy case by which a company can recover from the estate representative goods that have been sold and delivered to the debtor prior to the bankruptcy filing. Under BAPCPA, the creditor still must make a written demand, but it now has essentially 45 days from the date goods were received. If the 45-day period expires after the bankruptcy filing, the vendor is given an additional 20 days to make a demand.

Not many creditors are aware that this option is available, and even fewer are aware that BAPCPA makes it even more accessible.

In what ways has BAPCPA expanded or improved creditors’ rights?

The estate representative — the trustee in a Chapter 7 or a debtor-in-possession in a Chapter 11 — has a lot of power. But if a vendor has properly exercised its reclamation rights, the estate representative is legally bound to cooperate with the vendor to return the product. The reclamation creditor can exercise its rights by making a timely written demand to the debtor asserting its right to reclaim goods. Even though the creditor’s claim may be junior to a lien creditor, such as a lender with a blanket security interest, it is senior to the estate representative.

What limits have been placed on creditors’ rights under the 2005 amendments?

Prior to BAPCPA, there was some confusion or at least uncertainty about how lien creditors were treated. But BAPCPA established an important limitation: If there’s a blanket lien holder, then reclamation rights are still subject to that pre-existing lien. In other words, the reclamation creditor will not jump ahead of a lien creditor that predates the reclamation claim.

If the debtor cannot return goods, what options are available to creditors?

If the reclamation creditor fails to send written notice of reclamation within 45 days or if the goods are no longer in the possession of the debtor, then the alternative is to file an administrative claim. This is covered under Sec. 503(b) of the Bankruptcy Code.

A new subsection of the code grants vendors the right to receive an administrative expense claim for the value of goods delivered within 20 days prior to the debtor’s bankruptcy filing — as long as the goods were sold in the ordinary course of business. Administrative claims have the highest priority, and therefore, they provide creditors with a lot of protection. However, requesting allowance and payment of an administrative claim is more complicated than simply mailing a written reclamation demand to the debtor. A section 503(b) claim is a sophisticated legal document that requires an attorney’s assistance and often a court hearing.

How can you tell that it is a good time to exercise reclamation rights?

A creditor will know if its invoice is not paid when due, but creditors often learn from the debtor itself or fellow vendors that the debtor is having financial trouble. Here, the assistance of an attorney is useful. The attorney can search records to see if there are judgments or pending litigation against the debtor. The attorney can also look at UCC (Uniform Commercial Code) financing statements to see if the debtor’s assets have been pledged to multiple creditors. This is useful to the creditor wanting to reclaim its goods because a lender with an applicable UCC will take priority over reclamation rights. UCC-1s are filed with the secretary of state, so they are a matter of public record. Also available is information about whether the debtor is still in good standing with the state.

If a vendor is providing a substantial amount of goods and/or has concerns about its customer’s ability to pay, that vendor should consult with a bankruptcy attorney to advise how best to protect its rights.

MARK BRADSHAW is a partner in the Insolvency and Reorganization Practice at Shulman Hodges & Bastian LLP. Reach him at (949) 340-3400 or mbradshaw@shbllp.com.