In this issue we'll review reclamation - an essential process to help your company cut its losses in the event a customer becomes insolvent. If the Automatic Stay in bankruptcy cases which we looked at last month seemed somewhat complex, as the saying goes: "You ain't seen nothing yet."

A creditor's right of reclamation is governed not only by the federal Bankruptcy Code, specifically Title 11, Chapter 5, Subchapter III, Section 546(c), but also by Section 2-702 of the Uniform Commercial Code (UCC) and various State non-bankruptcy codes.

Section 546(c) raises complex legal issues and there is a large and expanding body of case law interpreting it.

To help cut through the legalese and give you an understanding of the reclamation process, we'll try to outline, in simple terms, what a creditor's reclamation rights are and how to assert these rights. Should you need to file a demand for reclamation, however, it would be wise to consult a bankruptcy or creditor's rights attorney.

The Nature of the Right of Reclamation

Robert S. Bernstein, Esq., in his excellent Internet piece, "A Short Series on Reclamation for Credit Managers" defines reclamation as "a means by which a seller may 'reclaim' goods that were sold and shipped to a customer on credit prior to the seller learning that the customer was insolvent."

The key word here is insolvent. Your buyer does not have to file bankruptcy in order for you to make a claim for reclamation of goods sold. You can make the claim if he is simply found to be insolvent.

Insolvent, however, is defined differently by the Bankruptcy and U.C.C. codes. Under the Bankruptcy Code, "insolvent" is strictly a balance sheet (financial) state where the debtor's liabilities exceed his assets. Under UCC, insolvency is defined as when the "debtor has ceased to pay its debts in the ordinary course of business, or cannot pay its debts as they become due."

When Does the Seller Have Reclamation Rights?

Five conditions must be met:

The seller sold the goods to the buyer on credit.
The sale of goods was within both the seller's and buyer's ordinary course of business. (Bulk sales, in most instances, will not be considered in the seller's ordinary course of business.)
The seller delivered the goods when the buyer was insolvent.
The seller has made a written demand for return of the goods to the buyer.
The buyer had possession of the goods at the time the written demand was received.

Note:

Under Bankruptcy Code Section 546(c), you only have reclamation rights if you also have the right to reclaim under the non-bankruptcy law (generally U.C.C.) of the state where the goods were sold.
Your reclamation rights will be limited to the merchandise remaining in the debtor's possession at the time the demand for reclamation is received.
Your rights may be secondary to the rights of a holder of a previously perfected lien on the buyer's inventory.

Steps to Take to Assert Your Right of Reclamation

1. Send the buyer a demand for reclamation in writing. (Some states' non-bankruptcy laws allow an oral demand, but that is not recommended.)

Pursuant to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which went into effect on October 17, 2005, the seller's demand period has been increased from within 10 days to within 45 days of the buyer taking receipt of the goods. Or, if the debtor files bankruptcy within the 45 day period, demand must be made no later than 20 days after the petition date. (The UCC Code relieves sellers from the 45-day requirement if the buyer made a written misrepresentation as to solvency within three months preceding his receipt of the goods. The Bankruptcy Code currently allows no such relief.). These deadlines are written in stone. There is nothing you can do to extend them.

Note that "takes receipt of goods" is defined differently in the two Codes. UCC 2-103(1)(c) defines it as "taking physical control of goods." According to Bankruptcy Code case law, "taking receipt" is defined as the point at which "the buyer can no longer stop delivery of the goods".
You need proof that you made a written demand. We recommend you fax the demand letter, keep the fax confirmation sheet, and also, either overnight the letter with signature requested or send it certified return receipt requested. All three wouldn't be a bad idea. Your demand is effective as of the dispatch date.
The contents of your demand letter are extremely important.
- Address it to the attention of a specific person, preferably an officer, at the buyer's corporate headquarters. Copy the buyer's legal and/or bankruptcy counsel, if known. Also send a copy to the address to which you shipped the goods, again to the attention of a specific person.
- Identify your company and all names under which you have sold goods to the buyer.
- Specifically state that the letter "is a demand for reclamation rights pursuant to Section 2-702 of the Uniform Commercial Code", or "Section 546 of the Bankruptcy Code". Under the Bankruptcy Code, your letter must explicitly state it is "asserting the right of reclamation under 11 U.S.C. Section 546 and applicable state law."
- Fully and adequately describe the shipped goods. Include the date shipped/received, and the location to which the goods were shipped. Attach copies of invoices or other documentation.
- Demand the goods be accounted for and an inventory taken of what's on hand at the time the demand is received. Request that you be immediately supplied with the results of the inventory.
- Request the goods "be immediately segregated" until arrangements can be made for their return. In a bankruptcy case, until action can be taken under Section 546 to acknowledge your reclamation claim.

2. If you're making reclamation due to the buyer filing bankruptcy, immediately file a reclamation Proof of Claim with the clerk of the Bankruptcy Court (use the standard Proof of Claim form) and follow, if necessary, with a motion or adversary proceeding to ensure the claim is acknowledged. (As mentioned above, conferring with a bankruptcy/creditor's rights attorney is a very good idea.)

Notice alone is not adequate to protect your rights. If possible, immediately visit the buyer's premises to ensure that your goods have been segregated. You must have the buyer's permission to visit, however, and he is not obligated to grant your request.

What Action Will The Bankruptcy Court Take
As A Result Of Your Reclamation Demand?

The Bankruptcy Court can take one of four actions in response to your demand for reclamation:

Grant your request for (re)possession of the goods.
Deny reclamation but grant your claim as an administrative expense priority. The administrative expensive priority allows your claim to be paid prior to all other priority claims and all unsecured claims. However, secured claims still have priority.
Grant you a lien on the goods to be reclaimed or some other property of the estate, effectively converting your unsecured claim to a secured claim.
Deny your reclamation rights.

Bankruptcy Reform Act of 2003 (H.R. 975)

Section 1227 of Bill H.R. 975 (titled Bankruptcy Reform Act of 2003) extends the seller's rights to reclamation under the Bankruptcy Code. (To learn more about this bill, visit the Library of Congress's Thomas Legislative Information on the Internet.)

The reclamation period is extended from 10 to 45 days or, if the 45 day period expires after commencement of the case, within 20 days from commencement.
The seller's failure to provide notice to the debtor as required does not extinguish his right to assert a claim for an administrative expense for the value of the goods and services received by the debtor within 20 days before the commencement of the bankruptcy case.

H.R. 975 was passed by the House of Representatives on March 19, 2003. On March 21, it was placed on Senate Legislative Calendar No. 50 under General Orders. There is some question whether the bill will pass the Senate. However, if it does, President Bush is expected to sign it.

Protecting Your Company

We offer two suggestions:

Send out regular "requests for certification of solvency" to all your buyers receiving credit terms. Many companies do this quarterly. That way, if a buyer becomes insolvent, you have a better chance of finding out in time to make your reclamation demand. Also, if the buyer claims solvency, then later doesn't "pay up" because he was really insolvent, you have the legal right to reclaim your goods under the UCC Code.
If you find out a buyer has filed bankruptcy, immediately determine if any of your shipments were received by the buyer within the last 20 days. Send a reclamation demand letter referring to these shipments. It can't hurt, even if it is later determined that you do not have reclamation rights.

Further Information on Reclamation Rights

An excellent resource for further information is "A Short Series on Reclamation for Credit Managers" by Robert S. Bernstein of Bernstein, Bernstein and Strickland P.C.

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Disclaimer: This article is not intended to be legal advice and is not a substitute for competent legal advice on the referenced subject.

Information provided by ABC-Amega Inc. Since 1929, providing first party accounts receivable collections outsourcing and third party debt collection for management of your commercial receivables portfolio. For further information on our receivable management services, email info@abc-amega.com.

Reclamation Rights