Holding On To Reclamation Rights Under In re Reichhold Holdings

ABI Journal, January 2017

Section 546 of the Bankruptcy Code has long been considered a provision with all bark and no bite. Other than In re Phar-Mor Inc., the majority of bankruptcy court decisions concerning the priority of  reclamation rights under § 546 (c) of the Bankruptcy Code versus the priority of a post-petition loan facility have concluded that the reclamation rights of sellers of goods are inferior to the rights of post-petition lenders, essentially rendering § 546 (c) a nullity where post-petition financing is required.

For example, under In re Dana Corp. and similar decisions, a post-petition security interest can extinguish reclamation rights simply by using the funds of the post-petition loan to pay off prepetition debt that was secured by a floating lien on the inventory. Under these decisions, the sellers of goods had diminished rights in bankruptcy such that a debtor could extinguish a seller’s reclamation rights that might otherwise have existed outside of bankruptcy. Given the impact of these decisions, many critics opined that § 546 (c) would essentially be rendered nugatory.3 However, the recent decision in  Reichhold Holdings indicates that this area of law is simply premature and will likely be the subject of litigation for years to come.

Rights of Reclamation under the UCC

Generally, in states that have adopted the Uniform Commercial Code (UCC),4 under § 2-702 of the UCC a seller of goods who sells goods to a third party, on credit, obtains a right to reclaim such goods under state law if the seller makes a demand within 10 days after receipt of goods. The official comments to subsection (2) note: “Subsection (2) takes as its base line the proposition that any receipt of goods on credit by an insolvent buyer amounts to a tacit business misrepresentation of solvency and therefore is fraudulent as against the particular seller.”5

Thus, the UCC makes it clear that the drafters intended to protect sellers from buyers who were aware of their ailing financial condition yet chose to continue to buy goods on credit without considering the repercussions of their actions on third-party sellers. By providing an immediate remedy to sellers, this provision encourages sellers to continue to do business with buyers who might otherwise be heading toward bankruptcy. It also helps protect sellers of goods by providing them with an immediate remedy in the event that they discover a buyer is insolvent.

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