Reclamation of Property

BY JAY WINSTON, WINSTON & WINSTON, P.C.

Unfortunately, when a creditor receives a notice of bankruptcy, the creditor usually throws up his hands, puts the paper aside and notifies his bookkeeper to provide him with all the open invoices so he can file a proof of claim. Sometimes he will comment to the bookkeeper as follows:

“Do you know we just shipped him some merchandise yesterday – how unlucky can you be.”

About two or three weeks later, our office will receive the invoices with instructions to file a proof of claim. Unfortunately, if the creditor knew the law, he would also learn that luck has nothing to do with his loss. The Uniform Commercial Code permits a creditor to reclaim merchandise which is sold to a debtor when they are insolvent under certain conditions. The creditor must act quickly, aggressively and carefully in compliance with the statutes of the respective state in which they are located.

Several general situations are presented wherein a creditor may reclaim property.

If the seller discovers the buyer to be insolvent, and if…
The seller discovers that the buyer has received the goods on credit and the buyer was insolvent at the time he received the goods, the seller may reclaim the goods after complying with statute.
The buyer pays for the goods with a check and the check is dishonored, the seller may reclaim the goods – also under certain conditions and after compliance with the statute.
The seller delivers the goods to a carrier and discovers that the debtor is insolvent, the seller may reclaim the goods. Section 2-705 deals with the stoppage of delivery in transit in possession of a carrier.

Section 2-702 of the Uniform Commercial Code covers subdivision A & B set forth above as follows:

When the seller discovers the buyer to be insolvent, he may refuse delivery except for cash including payment for all goods theretofore delivered under the contract and stop delivery under this article (Section 2-705).
Where the seller discovers that the buyer has received goods on credit while insolvent, he may reclaim the goods upon demand made within 10-days after the receipt, but if misrepresentation of solvency has been made to the particular seller in writing within 3 months before delivery, the 10-day limitation does not apply. Except as provided in this subsection, the seller may not base a right to reclaim goods on the buyer’s fraudulent or innocent misrepresentation of solvency or of intent to pay.
The seller’s right to reclaim under subsection 2 is subject to the rights of a buyer in ordinary course or other good faith purchaser under this article (Section 2-403). Successful reclamation of goods excludes all other remedies with respect to them.

The theory of subsection 2 is that any receipt of goods on credit by an insolvent buyer amounts to a misrepresentation of solvency and is fraudulent as against the particular seller. The 10-day limitation starts from the time of the receipt of the goods and normally excludes the day that the merchandise is actually received. If a written misrepresentation is dated within 3 months prior to the delivery and addressed to the seller, the 10-day limitation is not applicable.

In subsection 3, the act states that the reclamation bars any other remedies with regards to the goods – the creditor must take the goods back and cannot sue for damages.

Under Section 2-507 of the UCC, subsection 2 states as follows:

“where payment is due and demanded on the delivery to the buyer of goods or documents of title, his right as against the seller to retain or dispose of them is conditional upon his making the payment due”

Accordingly, under UCC Section 2-507, 2-511 and 2-546(c) of the Bankruptcy Code, it appears that the creditor has the right to reclaim goods where the merchandise was delivered against payment by cash or check.

Under Section 2-546(c) of the Bankruptcy Code, the seller has a right to reclaim goods if the debtor has received such goods while insolvent and they were sold to the debtor in the ordinary course of such seller’s business. The seller may not reclaim the goods unless such seller demands in writing reclamation of such goods within 10-days after receipt of such goods by the debtor. Once the debtor has received notice and is obviously uncooperative, an immediate decision must be made as to whether a reclamation proceeding should be commenced in state court. The important part of the state action is to obtain a temporary restraining order so that the debtor does use, transfer or dispose of the merchandise that belongs to the creditor.

If this proceeding precipitates an immediate bankruptcy, the creditor may proceed in the bankruptcy court for a reclamation. On the other hand, the bankruptcy court does have the right to deny reclamation even if the creditor can prove his right to reclamation on condition that the court awards a priority claim or in the alternative secures the claim with a lien. The bankruptcy court may at their option may grant a partial return of goods, or grant a lien on the property of the creditor or perhaps on other property.

Before a reclamation can be made the following criteria is suggested:

The goods have to be sold initially on credit to the debtor.
The principle reason a debtor would become aware of the insolvency is because the debtor is not paying his bills, but this inability to pay the bills is not sufficient to prove insolvency. The courts tend to look at a balance sheet definition of insolvency wherein the liabilities must exceed the assets. A minority of the courts adopts the failure to pay the debts as they become due. Information as to whether the debtor is insolvent at the time the creditor seeks to reclaim the goods can be established by a careful examination of the bankruptcy schedules together with an examination of prior financials of the bankrupt.
If the bankrupt is a public corporation, the monthly public filings of financial statements and other financial information is available. Credit reports might be another source of information as to whether the debtor was insolvent.
The 10-day period may commence with an oral communication, but most of the courts require a written communication and the bankruptcy code specifically states that it must be a 10-day written communication. Certified mail or overnight express is suggested.
Reference should be made in the letter to Section 2-702 (if that is the section you are proceeding under). Identify all the merchandise and goods that were sold, preferably by enclosing the invoices initially sent to the debtor. The letter should contain a notification to the bankrupt that the merchandise must be protected, segregated and maintained by the debtor until such time as the seller can reclaim the goods.

Consultation with counsel is recommended as soon as possible, especially as to the preparation of the 10-day notification.