Decoding the Code: Reclamation Under Section 546(c) of the Bankruptcy Code

This is the second post in our “Decoding the Code” Series.  The Series intends to discuss various sections of the Bankruptcy Code in a clear and easy to understand manner.  Today’s post addresses enforcement of reclamation rights in a bankruptcy case.

Let’s decode the basics:

What is reclamation and what is the process to reclaim goods once a company has filed for bankruptcy?

Reclamation is the right of a seller[1] to take back certain goods sold on credit terms to an insolvent buyer.  This right is codified in section 2-702(2) of the Uniform Commercial Code.  If the buyer files for bankruptcy before a seller’s right to reclaim its goods has been established, the seller must look to section 546(c) of the Bankruptcy Code to enforce its reclamation rights.

The process to reclaim under section 546(c) is more specific than the process under the UCC.  For instance, section 546(c) requires a written reclamation demand whereas the UCC is silent as to this point.  In addition, the bankruptcy court may enter an order establishing specific procedures for dealing with reclamation claims.  A seller must comply with such order and must act promptly to assert a reclamation demand in the debtor’s bankruptcy case. The seller has the burden of establishing each of the following elements entitling it to reclamation, namely that:

(1) it has a statutory or common law right of reclamation;

(2) the goods were sold in the “ordinary course” of the seller’s business;

(3) the debtor received the goods within 45 days before the petition date and the debtor was insolvent at the time the goods were received; and

(4) the seller made a written demand for reclamation either (a) within 45 days after the date of the debtor’s receipt of the goods, or (b) if the 45-day period expires after the bankruptcy petition date, then within 20 days after the petition date.

Section 546(c) provides creditors with 45 days to make such demand while the UCC only provides creditors with 10 days. The written demand should identify (1) the nature of the goods[2] being reclaimed, (2) the quantity or dollar value of the goods, (3) when the reclaimed goods were delivered, and (4) the invoice numbers and/or purchase order numbers covering the goods in question. The demand should also clearly request the return of the identified goods, and demand that the goods be segregated pending resolution of the reclamation demand. Providing all this information will diffuse any argument by the debtor that the information provided in the reclamation demand did not permit the debtor to identify immediately the specific goods being reclaimed.

If you assert a reclamation demand, what other actions are required?

Courts disagree on whether a seller must do more than serve a timely written demand for reclamation.  Some courts have ruled that a seller need only make a demand which proves entitlement to reclamation.  Other courts have taken the position that the mere submission of a written demand is insufficient to meet the requirements of the statute, and that a seller must diligently assert its rights through judicial intervention or risk losing its right to reclaim its goods under section 546(c).  For example, courts have suggested that sellers should file an adversary proceeding for reclamation of its goods in the buyer’s bankruptcy case, along with a request for a temporary restraining order that prohibits the buyer from disposing of or altering the goods, or, at a minimum, grants the seller access to the goods and to the buyer’s records.  In addition, if relevant to the circumstances of the buyer’s bankruptcy case, a seller should consider (1) filing an objection to a debtor-in-possession financing facility that seeks to place a lien on the goods subject to the reclamation, (2) filing an objection to going-out-of-business sale procedures that would permit the debtor to sell the goods subject to reclamation, or (3) filing an objection to any sale of the debtor’s assets that includes the right of the debtor to sell the goods subject to reclamation.  The seller may also want to communicate with other reclamation creditors to coordinate reclamation efforts.

If I do not file a reclamation demand, what are my other options?

If a seller does not make a written reclamation demand or if the bankruptcy court determines that reclamation is not possible because the goods are, for example, no longer in the debtor’s possession or have been commingled with other goods, a seller may be entitled to an administrative expense claim under section 503(b)(9) of the Bankruptcy Code.  Section 503(b)(9) grants administrative priority for the value of any goods sold to the debtor in the ordinary course of the debtor’s business and physically received by the debtor within 20 days before the bankruptcy filing.  The time for filing a section 503(b)(9) claim is not fixed by the Bankruptcy Code or the Federal Rules of Bankruptcy Procedure.  Some courts set a separate bar date for section 503(b)(9) claims while others have applied the general claims bar date to section 503(b)(9) claims.  A seller should verify whether the bankruptcy court has entered an order in the buyer’s case that establishes procedures for filing administrative expense claims.

What are the limitations on reclamation rights?

  • Rights of Secured Creditors Trump Reclamation Rights: A seller’s right of reclamation is subordinate to any rights of secured creditors in the same goods. For example, a secured creditor may have a valid security interest or floating lien on all of the debtor’s inventory, which can defeat a seller’s ability to get its goods back. Although the right of reclamation is subject to superior, perfected security interests of other creditors in the goods, subordination does not automatically result in the extinguishment of a seller’s reclamation right; if the goods have value beyond the secured party’s claim, the reclaiming seller may be able to assert its right of reclamation. Moreover, the seller still may assert a claim for an administrative expense under section 503(b)(9) if it sold goods to the debtor in the ordinary course of the debtor’s business which were received by the debtor within 20 days prior to the bankruptcy filing.
  • Reclamation Rights Do Not Extend To Sold Goods: If the goods subject to a reclamation claim are sold, whether before or after the seller’s reclamation demand, the seller loses its reclamation right and may instead be entitled to an administrative expense claim under section 503(b)(9) of the Bankruptcy Code. The seller also may not reclaim raw goods if they have been converted into a finished product.
  • Reclamation Rights Do Not Extend To Goods Not in Debtor’s Possession: Both the Uniform Commercial Code and the Bankruptcy Code require that a debtor must have received the goods for them to be reclaimed. Therefore, goods that are delivered to the debtor’s customer, rather than to the debtor, will not be able to be reclaimed.


Stay tuned for our next installment of “Decoding the Code.”

[1] For purposes of this discussion, when the term seller is used, it refers to the original seller or the claim purchaser.  It is assumed that when the claim is purchased, all rights to defend and enforce the claim are also purchased and a power of attorney is included with the transferred rights.

[2] For purposes of this blog post, it is assumed that the items to be reclaimed would be considered goods.  This is a critical distinction because section 546(c) of the Bankruptcy Code applies to reclamation of “goods,” but not to services.  Although “goods” is not defined in the Bankruptcy Code, generally, courts will consider whether the predominant purpose of the transaction at issue was to supply goods or to provide services.  Although beyond the scope of this blog post, we note that, for example, the issue of whether electricity is a “good” for purposes of reclamation is the subject of great debate in the courts.