Web prepared, posted and Copyright © November 30, 2000, by the American Bankruptcy Institute.
By: Alan D. Lasko There is nothing like asking for cash on the barrelhead when a company is selling goods. It's simple, satisfactory and safe. Unfortunately, it's no longer practical in today's world to ask customers to pay cash up front for their purchases. Today, many companies regularly provide goods to customers on an unsecured basis as the normal course of business, and obviously with this practice come certain risks. Foremost to consider is the risk of financial loss in the event that a customer is insolvent or becomes insolvent before payment for a purchase of goods. A vendor also faces the risk that a customer may file for bankruptcy after the receipt of goods it has previously ordered. Since a customer's financial troubles can quickly become a vedor's as well, it is important to know what rights exist when attempting to reclaim goods. It is also important to know what steps can be taken when one suspects a potential insolvency. Know the OptionsWhen a customer to whom an order has been shipped is found to be insolvent or declares bankruptcy, there are several options available. First, one can stop delivery of an order and sell the merchandise to someone else after notice is given to the initially intended buyer. Second, certain "steps can be taken" to reclaim the goods that have already been delivered under the Uniform Commercial Code (UCC) or the Bankruptcy Code. Third, absent bankruptcy's automatic stay, a lawsuit can be instituted seeking monetary damages. Fast Action Can Eliminate LossesIf the goods are in transit when the insolvency is discovered, the seller has the right to ask the carrier to return the goods or to deliver them to another buyer. Acting quickly to stop delivery allows a seller to get full value for the merchandise in a timely fashion and is the simplest way to avoid loss. Of course, this alternative is not completely without cost or risk. The seller is responsible to pay the carrier for any costs or damages resulting from the stoppage of goods in transit. The seller and the carrier can also be held responsible for damages suffered by the customer resulting from an unjustifiable stop order. One action that can be taken to provide some measure of protection for the seller is to provide formal written notice to the buyer, as well as to the carrier, of the intention to stop delivery. Once Goods Are Delivered, Available Time to Act Is LimitedThe UCC gives a seller the right to reclaim goods if they were sold in the normal course of business and the buyer is insolvent at the time of delivery. Under the UCC, insolvency can be determined by either a "balance-sheet test," where the fair value of liabilities exceeds the fair value of assets, or by the buyer's inability to pay debts as they come due. Most states allow 10 days from the date of delivery to provide notice of the seller's intent to reclaim its goods, and the goods in question must be still in the hands of the buyer. However, under the UCC, if the buyer has misrepresented his solvency within three months of delivery, the 10-day limitation does not apply. It is important for the seller of goods to quickly determine and document the buyer's status and then note whether or not there has been any misrepresentation. The UCC does not indicate the manner in which this notice should be given, but caution dictates that it should be in writing. A request to reclaim goods from an insolvent customer, if made during the time set down in the UCC, sometimes results in the prompt return of merchandise. If the buyer refuses to release the goods, an order can be sought in state court to have the buyer return the goods. Bankruptcy Complicates ReclamationThe Bankruptcy Code establishes certain limitations upon a seller's reclamation rights that are not found in the UCC. Additionally, bankruptcy courts frequently require that when a buyer files for bankruptcy within 10 days after the delivery of goods, a seller must begin an adversary proceeding to assert his right of reclamation. Once a buyer has sought relief from creditors through bankruptcy, he must be able to provide documentation that the sale took place during the normal course of business. In addition, the insolvency test no longer allows the seller to consider a buyer's ability to pay debts as they come due. Now only the balance-sheet test applies. Finally, although the UCC does not state how notice to reclaim goods should be given, the Bankruptcy Code requires written notice. Furthermore, the Bankruptcy Code also states that the buyer must receive written notice within 10 days of the delivery of goods. However, the Bankruptcy Code also states that "...if such 10-day period expires after the commencement of the case, but before 20 days after receipt of such goods by the debtor...the court may deny reclamation to a seller with such a right of reclamation that has made such a demand only if the court (A) grants the claim of such a seller priority as a claim of a kind specified in §503(b) of this title, or (B) secures such claim by a lien." 11 U.S.C. §546(c). Thus, the vigilant reclaiming seller may be able to obtain either reclamation or, alternatively, an administrative expense claim, and perhaps even a lien to secure payment of such claim. The Bankruptcy Code recognizes the seller's right to reclaim goods and generally places that right above any claims to the merchandise made by general unsecured creditors or by a trustee in bankruptcy court. Unfortunately, the law is not clearcut when it compares the rights of a seller doing business on credit to the rights of secured creditors. One should note that a minority of lower courts have held that a reclamation seller is entitled to an administrative claim for the full value of his goods, notwithstanding the existence of secured creditor(s) holding a perfected lien covering those goods. However, the majority of courts have held that a seller seeking to reclaim goods has no more rights during a bankruptcy proceeding than he would under the UCC. The UCC states that the rights of a buyer attempting to reclaim goods are subject to the rights of a secured creditor. This means that a reclamation seller's rights in a bankruptcy are only better than those of other unsecured creditors, and that the best a seller can hope for is an administrative claim in the surplus proceeds of the reclamation goods after secured creditors have been paid. Proper Preparation Helps Minimize LossesQuick action to reclaim goods after a bankruptcy can help to minimize losses; that may mean immediately filing a reclamation lasuit, i.e., an adversary proceeding, in the bankruptcy court. Careful pre-bankruptcy planning can reduce the risk of loss. Since both the UCC and the Bankruptcy Code allow sellers little time to stake a claim on their unpaid goods, it is best to take steps to increase the likelihood of reclamation before the sale. Any business that sells goods on an unsecured basis takes a risk. When the sale is large and there is any doubt regarding the buyer's solvency, that risk becomes incrementally greater. The best course of action a seller can take is to be diligent regarding the company with whom he is doing business. Looking up a customer in the Dun & Bradstreet ratings and reviewing past payment habits are some of the means available to determine whether or not a potential buyer is a good risk. However, if one is about to engage in a substantial sale and there are any doubts concerning the buyer, the best defense against potential loss is to prepare the documents needed in order to be granted, and then to obtain, a purchase-money security interest in the goods. If a perfected purchase-money security interest has been properly obtained, this will provide priority over any existing secured creditor when it comes to reclaiming the goods or receiving full value on an administrative priority claim. Obtaining a purchase-money security interest improves one's position in the priority heirarchy of bankruptcy so as to equal a secured creditor in the eyes of the court. This increases one's chances to reclaim all or most of the value of the merchandise that was sold. Without it, one may be relegated to the position of unsecured creditor if there is an existing perfected secured creditor with a floating inventory lien. While it is possible that a reclaiming creditor will still come before other unsecured creditors in relation to the goods, the chances of receiving little or nothing can be great. The use of the reclamation provision of the UCC and the Bankruptcy Code provides a company with some ability to recover the value of goods shipped to an insolvent customer. The interplay between these two statutory schemes must be considered and must be accompanied by quick action by a seller if it hopes to maximize the possibility of recovery.
The Unsecured Trade Creditors Committee met at ABI's Annual Spring Meeting on April 29, 2000, in Washington, D.C. Bruce Nathan (Davidoff & Malito; New York) reported on the Reclamation Manual being prepared by the reclamation task force that he chairs. A report also was given on the status of Assignments for the Benefit of Creditors: A Practical Guide, was being prepared by a task force chaired by Geoffrey Berman (Development Specialists Inc.; Los Angeles). The draft of that manual has been completed and is in final revisions. The guide is set to be published in time for the Winter Leadership Conference. Lynnette R. Warman (Jenkens & Gilchrist PC; Dallas) reported on the activities of the publication committee. Copies of the most recent News & Views, issued in April 2000, were distributed. Lynnette also requested submissions for Cracking the Code from committee members. Anyone with ideas for a topic or article should contact Lynnette Warman at lwarman@jenkens.com. Doug Fox (Mannesman Rexroth Corp.; Lehigh Valley, Pa.) and Deborah Thorne (Fagel & Haber; Chicago) were cited for their excellent contributions to News & Views. Tom Grace (Locke Liddell & Sapp; Houston) provided an update on the work of the Ad Hoc Task Force for Credit Manager Involvement. The task force is developing a speaker's bureau that will be offered to all 50 affiliate NACM groups. The task force is also looking at the possibility of a booth for our committee at the NACM Credit Congress and is exploring ways to increase our presence on the NACM web site. There was a discussion regarding the topic for our continuing education program at the 2000 Winter Leadership Conference. Larry Ahern (Gullett, Sanford, Robinson & Martin PLLC; Nashville, Tenn.) agreed to arrange for a program, with the topic to be determined by the end of July. There was discussion regarding plans for the 2001 NACM Legislative Conference, and it was agreed that a cocktail reception would be preferred to another educational program, as that would provide more opportunities for interaction between our members and NACM members. A committee, comprised of Jim Jensen (Northwest Hardwoods; Portland, Ore.), Joe Bodoff (Bodoff & Associates; Boston) and Steve Darr (KPMG Peat Marwick; Boston), was formed to work on this. Plans were completed for the Preference Manual project, which will be chaired by David Wheeler (Moore & Van Allen; Charleston, S.C.). The manual will be written for non-attorneys and will review preference law and its defenses; it will include a section for frequently asked questions and practice tips. It will also contain an appendix of state preference laws. The continuing education program at the meeting was presented by John Penn (Haynes and Boone LLP; Ft. Worth, Texas), Tom Grace and Jim Jensen. The program was titled "I'm Your Lawyer, But Not in This Case" and generated a spirited discussion regarding the representation by one attorney or multiple creditors in a single case. The next meeting of the UTCC will be at the Winter Leadership Conference Nov. 30 to Dec. 2, 2000, in Scottsdale, Ariz. The UTCC will meet on Saturday, Dec. 2, 2000, from 8:00-9:15 a.m. For more information or to get involved in committee activities, send an e-mail to Sandra Schirmang (Kraft Foods; Northfield, Ill.) at sschirmang@kraft.com or to Judy Thompson (Poyner & Spruill LLP; Charlotte, N.C.) at jdthompson@poynerspruill.com. —Judy Thompson
The UTC Committee will meet at the upcoming conferences:
The next issue of News & Views will be published in the spring. Call Lynnette Warman at (214) 855-4792 or e-mail lwarman@jenkens.com for more information.
The UTCC will be meeting at the 2000 ABI Winter Leadership Conference in Scottsdale, Ariz., on Saturday, Dec. 2, 2000, from 8:00-9:15 a.m. "Current Issues of Interest to Secured Creditors" (Lawrence R. Ahern III, Gullett, Sanford, et al., Nashville, Tenn.; Kim Martin Lewis, Dinsmore & Shohl LLP, Cincinnati; Sandra Schirmang, Kraft Foods Inc., Northfield, Ill.) I. Committees |
