Sad Case for Reclamation Claims in Bankruptcy Scenario: Not Dead but Barely Breathing

In 2006, after passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Kohner, Mann & Kailas, S.C. (KMK) questioned whether reclamation claims in bankruptcy had become obsolete even though BAPCPA had doubled the period that a reclamation claim could cover in bankruptcy, from 20 to 45 days. Despite the expansion of the reclamation time period, BAPCPA also added a provision that declared reclamation claims were expressly subject to (inferior to) secured claims.  KMK posited that this priority for secured claims would negate most reclamation claims in bankruptcy, and KMK’s experience in the last 12 years has confirmed this fear—cases have consistently ruled that secured claims triumph over reclamation claims.  A recent decision from the Indianapolis, Indiana bankruptcy court illustrates this unfortunate outcome.
 
To refresh your recollection, under the Uniform Commercial Code, a seller that discovers the buyer has received goods on credit while insolvent may seek to reclaim the goods by making a written demand for their return within 10 days after receipt by the debtor.  Under pre-BAPCPA law, the filing of a bankruptcy petition gave the creditor until 20 days after the goods were received to make the written demand.
 
Under BAPCPA, if the demand is made within 20 days after the bankruptcy filing date, a creditor can make a written demand for the return of goods received by the debtor as early as 45 days prior to the filing of the case.  If the demand is made, the trustee’s right to use the property is subject to the reclaiming creditor’s rights in the goods.
 
However, even prior to BAPCPA, the reclaiming creditor was always subject to the rights of a good faith purchaser (e.g., a customer that purchased the goods from the debtor before the demand was made), and many case decisions also concluded that a lender with a perfected security interest was a good faith purchaser with rights superior to a reclaiming creditor.  Since a secured creditor’s interest usually attached immediately upon receipt of the goods by the debtor, the reclaiming creditor often lost its reclamation rights to a secured creditor, but some uncertainty in the law gave the reclaiming creditor leverage to argue for some recovery in light of its reclamation rights.  However, under BAPCPA, the secured creditor’s priority interest was made explicit and KMK predicted that the reclaiming creditor’s leverage would evaporate.  A good example is the H. H. Gregg case before the Indianapolis bankruptcy court.
 
In that case, the appliance store, H. H. Gregg, filed  bankruptcy. Whirlpool made a reclamation demand 4 days later, and then filed a lawsuit against the debtor and the secured lenders in the case trying to vindicate its reclamation demand.  Whirlpool’s leading argument was that the secured lenders were not good faith purchasers under the Uniform Commercial Code because they continued to lend to the debtor on the eve of bankruptcy, knowing that the debtors were receiving product (and more collateral for the secured lender’s loans) for which the debtors would not be able to pay.
 
While the bankruptcy court was mildly sympathetic to Whirlpool’s plight, the court concluded in its December 4, 2017 opinion that the express language of the Bankruptcy Code that made reclamation claims subordinate to secured claims carried the day.  Accordingly, Whirlpool’s lawsuit was dismissed.
 
Whirlpool has appealed the decision to the Seventh Circuit Court of Appeals in Chicago, the federal appeals court that also covers cases filed in Wisconsin and Illinois.  The Seventh Circuit’s ruling may determine once and for all whether reclamation claims have any viability in a bankruptcy case at all, or perhaps it might breathe new life into such claims. KMK will keep you informed.
 
However, all is not lost. There was no mention in the Whirlpool case about Whirlpool’s Bankruptcy Code Section 503(b)(9) claim, which provides for an administrative priority claim for the value of goods received by the debtor in the 20 days prior to the bankruptcy petition date (this administrative claim was also added to the Bankruptcy Code by BAPCPA).  Unlike a reclamation claim, a creditor can preserve its 503(b)(9) claim without a written demand within days or weeks of the petition date, and this claim has administrative priority whether or not the goods have been sold or disposed of by the debtor at the time the case was filed, and whether or not there is a secured creditor with a lien in the goods.  In the last 12 years since BAPCPA has been enacted, at least where funds exist for the payment of administrative claims, KMK has an excellent track record of securing payment of these claims.  Therefore, while KMK still recommends issuing a reclamation demand in the appropriate case, we believe a creditor is even better advised to protect its rights under the 20-day administrative claim of Section 503(b)(9).
 
If you have questions about reclamation claims, contact Attorney Samuel Wisotzkey at 414-962-5110 or  swisotzkey@kmksc.com.