• Circuit City Decision May Erode Trade Creditor Reclamation Claims Under 503(B)(9)
  • April 23, 2010
  • Law Firm: McCarter & English, LLP - Newark Office
  • A recent decision of a Bankruptcy Court in the Eastern District of Virginia, In re Circuit City Stores, Inc., Case No. 08-35653, 2010 Bankr. LEXIS 44 (Bankr. E.D. Va. January 6, 2010)  threatens to undermine the recovery rights of trade creditors that delivered goods to a debtor in bankruptcy during the 20-day period prior to the filing of the bankruptcy case.  The decision is in stark contrast with the holding of the Bankruptcy Court in the Eastern District of Michigan and has created uncertainty as to the appropriate treatment of reclamation claims under the Bankruptcy Code.  

    The Bankruptcy Code grants creditors a priority claim for the value of goods received by a debtor within the 20-day period prior to its bankruptcy filing.  See 11 U.S.C. §503(b)(9).  These so-called reclamation claims must generally be paid in full before a Chapter 11 debtor can emerge from bankruptcy.  Section 503(b)(9) was added to the Code in 2005 to encourage vendors to continue the shipment of goods to financially troubled companies by granting a high priority of distribution to vendors with such claims.  Because reclamation claims are ordinarily paid in full, debtors have been looking for ways to reduce this obligation by seeking to disallow reclamation claims under §502(d) of the Bankruptcy Code.  

    Section 502 of the Bankruptcy Code deals with the allowance and disallowance of general unsecured claims that are afforded no special priority in the distribution of assets of the estate.  The language of §502(d), however, is broad, providing for the disallowance of "any claim" of any claimant who received property or other transfers from the debtor that are determined to be voidable as preferences (i.e., any transfers received from the debtor in the 90-day period prior to the filing of the bankruptcy case) or fraudulent conveyances.    

    In the bankruptcy case of Plastech Engineered Products Inc., the debtor argued that §503(b)(9) claims should be disallowed under §502(d) until the §503(b)(9) claimants returned alleged preferential transfers.  Many §503(b)(9) claimants objected.  After considering briefs filed by the debtor and the §503(b)(9) claimants, the Bankruptcy Court for the Eastern District of Michigan rejected Plastech's arguments.  The Court ruled that §502(d) is a valid objection only to pre-petition claims filed under § 501.  Because the reclamation claims are not covered under §501, the Court concluded that §502(d) is inapplicable to them.  In re Plastech Engineered Products Inc., et al., 394 B.R. 147 (Bankr. E.D. Mich. 2008). 

    Confronted with the same issue, the court in Circuit City came to the opposite conclusion, holding that §502(d) is applicable to reclamation claims under §503(b)(9).  Despite a Fourth Circuit binding precedent that ruled that administrative expenses under §503(b) cannot be disallowed pursuant to §502(d), the Circuit City Court distinguished §503(b)(9) claims from other administrative expenses under §503(b) by finding that §503(b)(9) claimants must file proofs of claim like run-of-the-mill prepetition, unsecured creditors under §501.  Given this requirement, the Circuit City Court found that reclamations fell within the purview of §502(d).    

    Circuit City may seriously erode the purpose of §503(b)(9) and turn §503(b)(9) claims into no more than a coin of exchange to settle preference litigation as opposed to a reward for trade creditors who remained loyal to debtors despite the threat of bankruptcy.  A motion has been filed by some of the creditors to reconsider this decision.  Additionally, some of the creditors have appealed the decision.  The appeals are stayed until the motion for reconsideration is decided.