A recent decision from the Bankruptcy Court of the Southern District of New York has rendered the enforcement of reclamation claims that arose 20 days prior to the bankruptcy filing almost impossible in cases in which there is a prepetition lien on inventory.
In In re Dana Corp., 2007 WL 1199221 (Bankr. S.D.N.Y. Apr. 19, 2007) there was $300 million in reclamation claims asserted, but the debtor estimated that valid reclamation claims totaled only approximately $3 million.
The debtor’s prepetition indebtedness was about $381 million. A prepetition lender held a security interest in the debtor’s equipment, inventory, accounts and other assets. As of the petition date, borrowings under the credit facility were less than the value of the collateral securing such indebtedness. The single largest reclamation claim was $9.6 million. The DIP facility (the lender was the same institution before and after filing) provided for replacement liens covering all items that were part of the prepetition lien.
The debtor argued that the lion’s share of the reclamation claims should be denied because (1) the prepetition indebtedness exceeded the value of each individual reclamation claim; and (2) the reclamation claims were valueless because the goods subject to reclamation had been disposed of as part of the transaction to repay the prepetition lienholder’s claims.
The reclamation creditors argued that (1) reclamation rights were subject only to a prior lien; (2) the prepetition debt was satisfied from a source other than the reclaimed goods (namely the postpetition financing—basically a marshalling argument); and thus (3) the reclaimed goods had been liberated from the prior lien and therefore the reclamation claims should be valued in full—meaning paid at 100 cents on the dollar.
Section 546(c) of the Bankruptcy Code permits an exception to the trustee’s strong arm powers, if the seller has a right of reclamation under state law. The recent amendments to the Bankruptcy Code changed section 546(c) by extending the first look-back period before bankruptcy during which goods may be subject to reclamation from 10 days to 45 days. In addition, the grace period that gives a seller additional time after a bankruptcy filing in which to file its notice of reclamation is expanded from 10 days to 20 days.
The seller is also given up to 20 days after the bankruptcy filing to send its reclamation demand, where the 45-day reclamation demand period expires after the bankruptcy filing. Therefore, if the expiration of the reclamation demand period would have been five days after the bankruptcy filing, a reclamation creditor would be granted a 15-day grace period in which to file its demand.
But a more significant change to reclamation in bankruptcy is that section 503(b)(9) automatically gives administrative priority status for all claims related to goods provided to the debtor in the 20 days prior to the bankruptcy petition filing. This provision has had the effect of making reclamation under section 546(c) applicable only for goods provided to the debtor from 20 to 45 days prior to the bankruptcy filing.
A reclamation claim will allow for the return of the goods or an administrative priority claim only if the debtor does not have defenses to the claim. These defenses include: (1) goods were actually paid for, (2) goods are not still in the possession of the debtor and (3) goods are not identifiable.
In the case at hand, the reclamation creditors argued that with respect to the prior lien of the prepetition lender: (1) the reclamation rights were not extinguished by the existence of a prior lien, but only rendered subordinate to the prior lien; and (2) the prepetition lenders were oversecured, and thus the reclamation claimants should recover from any excess value.
Judge Lifland rejected these arguments. The claim of the prepetition secured lender, which held a floating lien on inventory, was paid out of the proceeds of a postpetition credit facility, supported by a new floating lien on inventory. The judge noted that the reclaimed goods, which served as security for the prepetition lender’s debt, were effectively disposed of in satisfaction of that prepetition loan.
The court reasoned that reclamation is an in rem remedy, and reclaiming sellers have no right to compel a lienholder to satisfy its claims from other collateral. The reclaiming creditors have no marshalling rights.
The court found it significant that the prepetition indebtedness totaled approximately $381 million, yet the single largest reclamation claim was approximately $9.6 million. The implication is that the result may have been different if the prepetition indebtedness was smaller than both the collateral securing that indebtedness and a single reclamation claim. But that is only hypothetical as the court did not expressly state this.
Reclamation creditors should be aware that in the event they provided goods to the debtor in the 20-to 45-day window prior to the filing date, they are likely to be entitled only to a general unsecured claim if there is a prepetition lender with a floating lien on all assets. Reclamation creditors also should consider whether they should object to the entry of a final order on a DIP facility. Judge Lifland makes mention that the DIP facility was final, unappealable and contained explicit findings of good faith. Lenders should ensure that the DIP facility expressly states that the replacement lien was a necessary condition of the lenders’ agreement to enter into the DIP facility. The parties also may consider including an express statement in the loan documents that it is their intention for the lien chain to continue unbroken.
Payment of Administrative Claims
In another recent ruling involving reclamation claims, the United States Bankruptcy Court for the District of Delaware addressed the timing of payment of administrative claims. See Inre Global Home Products, LLC, 2006 WL 3791955 (Bankr. D. Del. Dec. 21, 2006).
In Global Home, a reclamation claimant with a claim for goods provided to debtor in the 20 days preceding the bankruptcy filing (such claims are provided automatic administrative priority pursuant to Bankruptcy Code section 503(b)(9)) sought an order from the court requiring immediate payment of the administrative claim.
While Judge Gross did not dispute the validity of the creditor’s administrative claim, he pointed out that the Bankruptcy Code did not provide for the timing of such payments. The court held that the timing is at the court’s discretion and applied a three-pronged test to determine whether the payment should be made immediately. The factors to be considered in determining the timing of payment of administrative claims are: (1) prejudice to debtor from immediate payment; (2) hardship to claimant; and (3) potential detriment to other creditors.
In this case, the judge ruled that the prejudice to the debtor was substantial. The debtor faced limited availability under its DIP financing order, which was dwarfed by the amount of outstanding administrative claims. Therefore, the court determined that no administrative claims should be paid at that time. As for the second factor, the court was not persuaded that the claimant would suffer harm. In fact, the court, in what may be interpreted as dicta, mentioned that a claimant would have to show that immediate payment was necessary to keep the creditor in business. The court did not see a need to reach the third element.
The effect of the ruling was that certain administrative claimants (apparently selected at the discretion of the debtor) would have to wait until plan confirmation for payment of administrative claims.