Helpful Remedies for Trade Creditors When Customers File for Bankruptcy


by Michael Eversden and Rob Diederich

Eversden, Michael     Diederich, Robert
meversden@mcgrathnorth.com
rdiederich@mcgrathnorth.com
(402) 341-3070

Trade creditors often find themselves, especially in hard economic times, in the familiar scenario where struggling customers purchase goods on credit approaching or exceeding their credit limits—in some cases making rosy predictions to creditors about the customers’ prospects for success—only to file for bankruptcy, stiff unsecured creditors for goods purchased in the days leading up to the bankruptcy filing, and use the goods purchased to support the customer’s operations in bankruptcy. Prior to 2005, trade creditors were generally rewarded for their willingness to work with debtors in these situations with general unsecured claims for unpaid shipments, unless their claims were reclamation claims entitled to administrative-expense status. In most cases, this resulted in creditors receiving distributions on their claims in tiny bankruptcy dollars, i.e., distributions worth a fraction of the value of the goods shipped. In 2005, Congress, in connection with its enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”), sought to remedy this situation to some degree by adopting two provisions that significantly alter the relationship between debtors and trade creditors.

§ 503(b)(9) Claims

The most significant change was the addition of § 503(b)(9) of the Bankruptcy Code. That section provides that a creditor must be allowed an administrative claim for “the value of any goods received by the debtor within 20 days before the date of commencement of [the bankruptcy case] in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.” 11 U.S.C. § 503(b)(9). In effect, this section puts claims for goods sold to a debtor in the twenty days before the debtor’s bankruptcy at the same level of priority as the expenses the debtor incurs in administering its bankruptcy case. Those expenses must be paid in full before any amounts are paid to general unsecured creditors, so in many cases, this means that creditors meeting the requirements of § 503(b)(9) will receive full payment for shipments received by the debtor within the twenty-day period, rather than the fractional distribution they otherwise would have received.

The text of section 503(b)(9) indicates certain limitations on such claims. First, the preferred treatment is available only for shipments of goods, so service providers would not be entitled to an administrative claim on the basis of this section. Second, only shipments the debtor receives within twenty days prior to the debtor’s bankruptcy filing may attain administrative-expense status. Third, the shipments must have been made in the ordinary course of business. The Bankruptcy Code does not give any guidance as to the parameters of  the phrase “ordinary course” of business as used in this section, although in practice, debtors have been arguing that courts should analogize to the ordinary-course analysis used in the context of recovering preferential transfers. In other words, debtors are arguing that courts should examine the relationship between the debtor and the creditor to determine, for example, whether there have been any unusual collection or payment activities.

Obtaining an administrative claim under § 503(b)(9) is not automatic; creditors must take affirmative action to have such a claim allowed. The procedure for doing so, however, is not uniform. Absent any contrary direction from the court, a creditor must file a motion in the customer’s bankruptcy case, requesting that its claim under § 503(b)(9) be allowed as an administrative expense. In some cases, courts have established separate procedures for § 503(b)(9) claims, including setting a separate deadline and adopting a special claim form for such claims. In other cases, courts have simply provided for a deadline to file requests for allowance of § 503(b)(9) claims, without specifying the vehicle by which a claim should be asserted. In still others, the courts have done nothing specific to deal with § 503(b)(9) claims, resulting in § 503(b)(9) claims being handled in the same way as other administrative claims.

Creditors having allowed claims under § 503(b)(9) may have difficulty compelling the debtor to make immediate payment. Several courts have held that bankruptcy courts retain the discretion to order or deny immediate payment of administrative claims under § 503(b)(9). Some have held that in order to compel immediate payment, a creditor must show that the payment will not prejudice the debtor and that the creditor has an immediate need for payment.

The bottom line for trade creditors is that § 503(b)(9) provides a new and significant benefit to them but they must remember that filing a proof of claim is not enough to protect their administrative claim under this section. In order to protect their claim, creditors should seek good legal advice soon after their customers’ bankruptcy filing, in order to determine the proper procedures to be followed in a given case. McGrath North’s bankruptcy attorneys have experience dealing with these claims and are well equipped to protect the rights of creditors in these circumstances.

Reclamation Claims

The second important change made by the BAPCPA relates to creditors’ reclamation claims. Under prior law, creditors who delivered goods to a debtor that later filed for bankruptcy had the same right to reclaim goods as they would have had under the UCC, namely, to demand reclamation of the goods from an insolvent buyer within ten days after the buyer’s receipt of the goods. If the ten-day period expired after the bankruptcy filing, the seller would have twenty days after the debtor’s receipt of the goods to make such demand.

The BAPCPA extended the ten-day reach-back period such that sellers of goods may now assert a right of reclamation for goods delivered forty-five days before the bankruptcy. In addition, the former ten-day post-petition period for asserting a reclamation right was extended to twenty days. Thus, a creditor may now make a demand as late as twenty days after the filing of a bankruptcy petition for goods delivered up to forty-five days before the bankruptcy filing.

In order to take advantage of the reclamation right provided under 546(c), a creditor must make a timely written demand for the goods. In addition, the goods must have been received within the requisite time period, and the goods must be in the debtor’s physical possession and identifiable at the time of reclamation. Lastly, a seller’s reclamation right is subject to the prior rights of a holder of a security interest in the goods or the proceeds of the goods. Since in most cases debtors’ secured lenders have blanket security interests, this restriction significantly limits the value of a reclamation claim.

In spite of the apparently limited application of the reclamation remedy detailed above, the Sixth Circuit Court of Appeals recently gave new import to reclamation in Phar-Mor, Inc. v. McKesson Corp., 534 F.3d 502 (6th Cir. 2008). The court in that case held that while a reclamation claim was subject to the claims of secured creditors, the claim was nevertheless entitled to administrative-priority status, based on the fact that the creditor had a valid reclamation claim under state law and that the language of the version of 546(c) that was in effect at the time the bankruptcy case was filed required the court to grant the claimant either an administrative claim or a lien on the proceeds of the goods. The Phar-Mor decision was based on the pre-BAPCPA version of 546(c), which was significantly different than the version enacted under the BAPCPA. As such, its applicability to post-BAPCPA cases is the subject of vigorous debate. Nevertheless, the case has breathed new life into a remedy that was once nearly left for dead.  McGrath North’s attorneys have extensive experience dealing with reclamation claims.

Proposed Legislation

Although the BAPCPA strengthened a trade creditor’s rights vis-à-vis a bankrupt debtor, Congressman Jerrold Nadler (D-NY) recently introduced a bill, the Business Reorganization and Job Preservation Act of 2009 (H.R. 1942), which would repeal the provisions of BAPCPA granting those rights, thus eliminating a trade creditor’s right to a § 503(b)(9) administrative claim, and reducing the forty-five day reach-back period for reclamations to the pre-BAPCPA ten-day period.  If the bill is passed, trade creditors will lose valuable rights granted to them under the BAPCPA.

McGrath North is sensitive to the effects the proposed legislation may have on trade creditors and will continue to monitor any developments relating to such bill.  In the meantime, trade creditors continue to possess valuable rights against bankrupt debtors.  If you should need any assistance with a reclamation or § 503(b)(9) claim, please do not hesitate to contact the authors or one of the other members of McGrath North’s Financial Services Group.

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