Reclaiming Reclamation: Revival of a Seller's Remedy

October 12, 2016

A recent decision by the influential Bankruptcy Court in Delaware suggests that sellers to insolvent buyers should not give up too early on a reclamation remedy. The court found that a seller’s right to reclaim goods from an insolvent buyer trumped a post-petition secured creditor’s rights.

In many situations a seller’s attempt to assert a reclamation claim is thwarted by the prior blanket lien of the insolvent buyer’s secured lender. Since the blanket lien includes after-acquired inventory, it is deemed to be superior to the reclamation claim of a seller who ships goods to an insolvent buyer.

Reichhold Holdings, Inc. (“Debtor”) filed a chapter 11 bankruptcy petition in September 2014. Debtor’s prepetition lender was secured by a lien in Debtor’s assets, including inventory.  Debtor obtained post-petition financing from several DIP lenders, secured by a first-priority lien on all property of the estate, including all inventory. This DIP loan was used to satisfy Debtor’s obligation to its prepetition lender.

Shortly after the bankruptcy filing, Covestro (“Seller”), a seller of inventory to Debtor, timely delivered a written reclamation demand.  Although Debtor made a handful of payments, Seller filed a proof of claim seeking the remainder of the value of goods delivered to the Debtor before the bankruptcy case began. The Trustee objected to the claim, arguing that the claim was rendered valueless when the prepetition loan was paid. 

The Trustee argued that even though Seller’s reclamation rights arose before the DIP lenders’ rights arose, the DIP lenders’ rights related back to the prepetition lender’s rights because the DIP loan repaid the prepetition loan. The Trustee argued that it was an “integrated transaction.” Relying on the decisions of In re Dairy Mart Convenience Store, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003) and In re Dana Corp., 367 B.R. 409, 420 (Bankr. S.D.N.Y. 2007), the Trustee further argued that the subsequent post-petition sale of Debtor’s assets, which paid back the DIP loan, extinguished the Seller’s reclamation rights.

Seller argued that its reclamation rights arose before the DIP lenders’ rights, and that the DIP lenders’ lien is separate and distinct from the prepetition lien, and not an integrated transaction.  This position is supported by In re Phar-Mor, a Northern District of Ohio case affirmed by the Sixth Circuit. 301 B.R. 482 (Bankr. N.D. Ohio 2003), aff’d 534 F.3d 502 (6th Cir. 2008).

In holding for Seller, the Delaware court rejected the reasoning of the cases from New York relied upon by the Trustee.  Instead, the court was persuaded by the reasoning in Phar-Mor that the DIP lenders’ rights did not relate back and allow them to step into the shoes of a prepetition lender.  The court held that a post-petition lender did not assume the rights of a prepetition lender, and it was an entirely separate and new lien on a debtor’s inventory.

Here, the court reasoned that when the proceeds from the DIP loan were used to retire the prepetition secured debt, the payment extinguished that lien.  The source of funding to pay the lien and the subsequent security interest were irrelevant; the prepetition lien and the DIP lenders’ lien were completely separate transactions. The seller’s reclamation rights arose before the DIP lenders’ lien on inventory was created, and it was also expressly subject to reclamation rights under section 546. Once the prepetition lender’s lien was eliminated, Seller’s reclamation claim, which was prior to the DIP lenders’ lien, prevailed. Thus, the court overruled the Trustee’s objection and allowed the reclamation claim to go forward.

What should the seller of goods to an insolvent buyer take away from this decision? A seller should not necessarily count out reclamation rights when seeking to protect its interests in a debtor-buyer’s bankruptcy proceedings. As is the law in both the Sixth Circuit and now the District of Delaware, a post-petition lender does not step into the shoes of a prepetition lender whose lien is paid off with the post-petition funds.  The seller should watch the buyer’s case carefully, and if the prepetition lender to the buyer is paid and its lien extinguished, the seller’s reclamation claim may have a chance to defeat a DIP lender’s post-petition lien. 


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