• New Bankruptcy Provisions Aid Suppliers
  • October 19, 2005 | Author: Jeffrey Davis
  • Law Firm: DLA Piper US LLP - San Diego Office
  • On October 17, 2005, many of the provisions of the recently enacted Bankruptcy Abuse, Prevention and Consumer Protection Act of 2005 go into effect. Although most of the better known provisions of that legislation are directed towards individual consumer debtors, two of the act's provisions provide substantially increased protection for manufacturers, wholesalers, suppliers, and any other company that supplies goods in the ordinary course of its business to a company that files for bankruptcy. Timely and aggressive enforcement by suppliers of these new rights could result in a marked increase in amounts recovered in the bankruptcies of their customers.

    Suppliers' Reclamation Rights Expand and Simplify

    The first important change expands and, at the same time, simplifies the reclamation rights of suppliers who discover that their customer has filed bankruptcy. Under prior law, a supplier who delivered goods to a company which shortly thereafter filed bankruptcy was forced to rely on state law reclamation rights, and then had only a ten-day (extended to twenty days in some cases) period after delivery of the goods to make a legally enforceable demand to reclaim the unpaid goods from the debtor-purchaser. Thus, even if a supplier learned about its customer's bankruptcy in time to make a reclamation demand within ten days, the supplier was faced with having to make an appropriate demand under differing statutory and common law schemes. Many suppliers were not able to react timely and lost valuable rights.

    The new law enacts what is essentially a federal right of reclamation. A seller of goods need not determine the requirements for reclamation under the law of a particular state. Instead, the supplier need only make a written demand for reclamation on the debtor not later than 45 days after the debtor receives the goods. If the 45-day period expires after the beginning of the bankruptcy case, the time within which to make a reclamation demand is extended to 20 days after the date the bankruptcy petition was filed. The new law also eliminates the bankruptcy court's ability to deny reclamation to the seller.

    Law Now Grants Supplier an Administrative Expense Priority Claim

    The seller's ability to reclaim goods is subject to the rights of a party holding a security interest in or a subsequent purchaser of the goods sought to be reclaimed from the debtor. Thus, a seller will be unable to obtain reclamation if the goods have been sold by the debtor or become subject to a blanket lien in favor of the debtor's lender upon delivery. However, a second new provision of the bankruptcy law grants the supplier an administrative expense priority claim for the value of any goods delivered to the debtor within 20 days prior to the commencement of the bankruptcy case, provided the goods were sold to the debtor in the ordinary course of the debtor's business. Administrative expenses are paid before most of the creditors are paid, including prepetition wages and taxes and other vendors, and are usually paid in full.

    The seller may obtain administrative expense treatment even if it doesn't attempt to reclaim the goods sold to the debtor. In instances where the goods being sold are perishable or cannot be sold to another customer, a seller may decide to forego its reclamation rights and instead rely upon receiving administrative expense priority for its claim. The supplier should keep in mind that administrative priority treatment is only available for goods delivered within 20 days prior to filing of the bankruptcy case, while reclamation rights are available for goods that were delivered up to 45 days prior to the bankruptcy filing.

    Suppliers Still Must Act Promptly

    Despite the extension of time for a reclaiming seller to exercise its reclamation rights, it is still critical for the supplier to act promptly to protect its interests. As mentioned above, the rights of a reclaiming seller are subject to not only the rights of a secured creditor, but also to a buyer. The longer it takes for a seller to exercise its reclamation rights, the more likely it will be that the debtor has sold or commingled the goods or incorporated the goods into finished product that the seller is seeking to reclaim.

    In the event that the debtor has sold the goods, and delivery to the debtor occurred more than 20 days prior to the bankruptcy filing, the reclaiming seller would have neither the right to reclaim nor the right to assert an administrative expense priority claim. Likewise, even if the seller is able to secure administrative claim priority, many smaller Chapter 11 cases are "administratively insolvent," meaning that there are insufficient assets in the estate to pay administrative priority claims in full.

    Accordingly, it is important that all sellers, suppliers, manufacturers and others providing goods to financially strapped businesses carefully monitor potential bankruptcy filings by their customers and have counsel ready to assist them in exercising their rights quickly and properly.