Pre-Petition Claims: Increased Protection for Suppliers

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12.01.2005

Diane P. Furr

After 7 years of battles in Congress, the Bankruptcy Abuse Prevention And Consumer Protection Act of 2005 (“Act”) became law on April 20, 2005. With certain exceptions, the new Act will apply to bankruptcy cases filed on and after October 17, 2005. The new Act greatly enhances and dramatically expands the rights of suppliers who provide goods to a debtor shortly before the debtor files bankruptcy.

Revised Reclamation Rights

In the area of reclamation rights, the reach-back period has been extended. Previously, under Bankruptcy Code Section 546(c), a supplier had to send a reclamation notice within ten days after the debtor’s receipt of the goods. If the customer filed a bankruptcy petition within the ten day period, the vendor had up to 20 days after the filing of the bankruptcy to send the notice.

Under the new Act, a supplier will be able to reclaim goods sold to the debtor in the ordinary course of business if the supplier demands reclamation within 45 days after delivery. Also under the new Act, if the customer files bankruptcy within the 45 day period, the supplier will still have an additional 20 days after the commencement of the case to demand reclamation of the goods.

The new Act curiously deletes the language which entitles a creditor with a valid reclamation to an administrative expense claim, and therefore creates confusion on whether a supplier who makes a valid reclamation claim will be entitled to an administrative expense claim or will be limited to taking the goods back.

In addition, the new Act apparently eliminates the requirement that the reclamation claim be valid under the Uniform Commercial Code. Previously, Bankruptcy Code Section 546(c) expressly required a reclamation claim be valid under other “statutory, common law.” The new Act eliminates this cross reference to applicable non-bankruptcy law and instead refers to the right of reclamation. Could this mean that a supplier seeking reclamation will no longer have to worry about whether the goods were still in the debtor’s possession or in their original form when the reclamation demand was received?

One other change in the new Act which codifies prior reclamation case law is the provision that any reclamation demand is “subject to the prior rights” of a secured creditor with a security interest in inventory of the debtor. Therefore, if a secured creditor with a lien on inventory is undersecured, the suppliers will likely not receive a reclamation claim. This change incorporates into the new Act a growing consensus of bankruptcy cases that have been decided for secured creditors over reclamation creditors in such fact scenarios.

Priority for Payment of Pre-Petition Unsecured Claims

The real silver lining in the new Act gives trade creditors an alternative to reclamation. New Section 546(c) provides that a supplier is entitled to an administrative expense priority claim under Section 503(b) of the Bankruptcy Code, regardless of whether a senior lien on the inventory exists, equal to “the value of any goods” received in the ordinary course by the debtor within 20 days before the bankruptcy filing. This provision is intended to do away with the race for “critical vendor” status which has recently been widely criticized. There is no requirement that the goods still be on hand and no provision to defeat this administrative claim if the secured lender is undersecured.

This is a bonanza for unsecured trade creditors but comes at a price. In many cases, payment of 20 days’ worth of open accounts with trade vendors may be very expensive and add significantly to the burden on the debtor in possession. It is also unclear when the payment must be made. We suspect debtors will wait until confirmation and then add these costs to the administrative claims that must be paid in order to confirm a Plan.

With these and other favorable changes such as those in the area of preferences, there are now added protections for suppliers who provide goods immediately before a debtor’s bankruptcy filing and trade creditors have reason to celebrate!

Physical Address: 301 Fayetteville Street, Suite 1900, Raleigh, NC 27601

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12.01.2005