Frederick J. Glasgow Iii, Reclaiming the Defenses to Reclamation

• Publication year: 2011

RECLAIMING THE DEFENSES TO RECLAMATION

INTRODUCTION

The right of reclamation and its place in bankruptcy have been mired in controversy and confusion since before the Bankruptcy Reform Act of 1978 ("the Bankruptcy Reform Act").¹The right of reclamation allows a seller to reclaim goods sold to an insolvent buyer.²Reclamation began as a state right under the common law but is now codified in Sec. 2-702 of the Uniform Commercial Code ("U.C.C.") and has been adopted in almost every state.³

The right of reclamation was formally brought into the Bankruptcy Code ("the Code") in 1978 with the addition of 11 U.S.C. Sec. 546(c).⁴Despite the addition and the subsequent amendments to that section,⁵reclamation's place in bankruptcy continues to be debated.⁶

The purpose of Sec. 546(c) was to resolve some of the confusion surrounding reclamation in the bankruptcy context.⁷During bankruptcy, the trustee⁸of the debtor's estate has the ability to avoid⁹the rights of certain creditors in an asset in order to retain that asset in the estate.¹⁰One such situation occurs when a seller wants to reclaim goods it has recently given to a buyer who has filed for bankruptcy and whose estate is now under the control of a trustee.¹¹A trustee will seek to retain those goods in the estate by avoiding the seller's reclamation rights.¹²

The addition of Sec. 546(c) to the Code prevented many attacks from trustees of debtors' estates who wished to avoid the rights of reclaiming buyers.¹³

Section 546(c) made the avoidance rights of the trustee subject to those of a reclaiming seller.¹⁴Later amendments further clarified the statute's original language and addressed trade creditors' specific concerns.¹⁵

The most recent changes to Sec. 546(c) occurred with the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA").¹⁶These amendments clarified that claims based on Sec. 546(c)

Id. were subject to the rights of a prior secured creditor.¹⁷A secured creditor has a lien on an asset, which holds the creditor's place in line.¹⁸However, the secured creditor only has this advantage up to the value of the secured asset.¹⁹

In addition to the amendments to Sec. 546(c), BAPCPA created a new provision,

Sec. 503(b)(9), which raised new reclamation issues.²⁰Specifically, Sec. 503(b)(9) created unanswered questions about the availability of reclamation rights and administrative expense priorities to reclaiming sellers whose claims are already secured by another lien on the same property.²¹

This Comment argues that BAPCPA confirmed that a fully secured creditor's claim extinguishes a reclaiming seller's right under Sec. 546(c) when both claims are for the same goods, and that this restriction under Sec. 546(c) should be extended to Sec. 503(b)(9) administrative expense claims. Statutory construction, the trend in case law interpreting Sec. 503(b)(9), a judicial framework from an analogous situation, and policy considerations all support this reasoning.

When BAPCPA was enacted, it established a new administrative expense priority, Sec. 503(b)(9).²²Generally, administrative expenses are those expenses incurred by the estate after a debtor has filed for bankruptcy.²³These include expenses for the maintenance of the estate, such as taxes and insurance, and expenses for compensation for professional services rendered to the estate, such as attorneys' or accountants' fees.²⁴Because these types of expenses are considered necessary, they are given priority over other claims when estate assets are distributed.²⁵

A Sec. 503(b)(9) administrative expense, like Sec. 546(c), allows a seller of goods to regain some of the value of those goods from a buyer who has filed for bankruptcy.²⁶The difference between the two is that while Sec. 546(c) allows the seller to reclaim the goods themselves, Sec. 503(b)(9) allows the seller to recover the value of the goods the buyer received.²⁷Similar to reclamation, the reason for granting this administrative priority was to prevent debtors from acquiring goods when they were aware of their imminent insolvency and inability to pay.²⁸However, the enactment of Sec. 503(b)(9) and the lack of statutory language surrounding it have created ambiguity. Specifically, it is unclear whether a prior secured lien should extinguish an administrative claim granted by Sec. 503(b)(9), as it extinguishes the right to reclaim under Sec. 546(c).

This Comment suggests that given the lack of legislative history,

Sec. 503(b)(9) should be read in light of Sec. 546(c), meaning that courts should not grant an administrative expense to a reclaiming seller under Sec. 503(b)(9) when another creditor has a superior right to the goods. Part I examines the origins of the controversy surrounding reclamation rights in bankruptcy and administrative claims in Sec. 546(c). Moreover, Part I argues that the newly amended Sec. 546(c) does not create a new federal right to reclamation, but instead continues to carry with it state law concepts, and concludes that BAPCPA affirmed previous judicial limitations on a seller's right to reclamation under Sec. 546(c). Part II examines the text of Sec. 503(b)(9) and the sparse legislative history surrounding its enactment and concludes that the judicial limitations on a seller's right to reclamation should be extended to

Sec. 503(b)(9). Part III analyzes the limited case law that addresses Sec. 503(b)(9) and points out trends that help in understanding Sec. 503(b)(9)'s relationship with the rest of the Code. Part IV explores a case that courts could use as a model for analyzing Sec. 503(b)(9) issues. Finally, Part V addresses the negative policy concerns that will ensue if Sec. 503(b)(9) is not limited by judicial restrictions on a seller's right to reclamation.

I. THE Sec. 546(c) CONTROVERSY ON ADMINISTRATIVE CLAIMS

A. Development and Deepening of the Controversy

Prior to 2005, Sec. 546(c) was the sole provision of the Code in which a seller could enforce its reclamation right.²⁹Courts required strict adherence to the requirements of Sec. 546(c) for the seller to reclaim its goods.³⁰One area of controversy revolved around whether a seller could receive an administrative claim for its property when the property already had a preexisting secured lien.³¹

A lien is an interest that a creditor has in a debtor's property that is attached to the property because the debtor owes the creditor money, and the lien will remain until the debt it secures is paid.³²Historically, a secured creditor's prior lien, if it was equal to or exceeded the value of the goods, eliminated a reclaiming seller's rights in the same goods and barred the reclaiming seller from recovery in any form.³³This is known as the "prior lien defense."³⁴The relevant part of Sec. 546(c) stated:

[T]he rights and powers of a trustee . . . are subject to any statutory or common-law right of a seller of goods that has sold goods to the debtor, in the ordinary course of such seller's business, to reclaim such goods . . . but . . . the court may deny reclamation to a seller with such a right of reclamation that has made such a demand only if the court grants the claim of such a seller priority as a claim of a kind specified in section 503(b) of this title; or secures such a claim by a lien.³⁵

The lack of clarity in the statute as to the parameters of the prior lien defense caused courts to disagree about whether a prior secured lien, such as a floating lien on inventory,³⁶was able to extinguish the rights of a reclaiming seller in the same goods.³⁷Nonetheless, the majority of courts believed that a reclaiming seller's right was extinguished when the goods were fully secured by a prior lien.³⁸The prior lien defense issue was ultimately resolved by the

Id.

BAPCPA amendment, which enabled a prior secured interest to extinguish a reclaiming seller's right in the same goods under Sec. 546(c).³⁹

B. Solidifying the Prior Lien Defense: In re Dana Corp.

The substantive modifications to Sec. 546(c) in BAPCPA were relatively clear: (1) the period from which goods could be reclaimed was extended from ten days before the petition to forty-five days; (2) the period in which to file a post-petition claim was extended from ten days to twenty days; and (3)

Sec. 546(c)(2) now referred to a new Code section, Sec. 503(b)(9), which addressed administrative expense claims for sellers that have sold goods to a debtor within twenty days of its petition date.⁴⁰However, the effect of Congress's decision to remove the phrase "the rights and powers of a trustee under . . . this title are subject to any statutory or common law right of a seller of goods" and replace it with "the rights and powers of the trustee . . . are subject to the right of a seller of goods" was not clear.⁴¹The removal of the references to state law and common law created many questions, including: (1) whether the amended Sec. 546(c) created a new federal right to reclamation and (2) whether the prior lien defense still applied to Sec. 546(c).⁴²

The U.S. District Court of the Southern District Court of New York was the first to address these issues in its decision in In re Dana Corp.⁴³The court found that Sec. 546(c) did not create a new federal right, and the seller's reclamation right was still subject to the prior lien defense.⁴⁴The debtors, Dana Corporation and its subsidiaries, were large international manufacturers of automotive equipment.⁴⁵After filing for bankruptcy and receiving demands from sellers for the reclamation of their goods, the debtors first asserted various fact intensive defenses and were able to lower substantially the aggregate amount of the claims.⁴⁶Next, the debtors asserted the prior lien defense, which they argued rendered all of the reclamation claims valueless.⁴⁷

The debtors argued that their pre-petition indebtedness was secured by liens on almost all of their assets, including the goods the sellers sought to reclaim.⁴⁸

Thus, the debtors argued, and the court agreed, that the prior...