Reclamation Remedy of Last Resort or Fools Errand

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Oct 2000

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You are an unsecured seller of goods, and you have just learned that a major customer is insolvent and
suspended payments to its creditors last week. Delivery of your latest shipment of goods was confirmed
the day before, so you no longer have the ability to withhold delivery or stop the goods in transit. Your
customer receives your customary trade credit terms. Not willing to wait passively for a bankruptcy or
receivership, you call your lawyer and demand that he take action now. Your lawyer might advise you that,
short of initiating a lawsuit, you may have the right to reclaim your goods under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Commercial
Code §2702(2)</a>.<a href="#2" name="2a">2</a> What he means is that you may be able to retrieve your goods from your buyer and solve
your problem.

This article is a brief overview of the requirements that must be satisfied by a seller in order to
successfully effect a reclamation remedy and the limitations on that remedy.<a href="#3" name="3a">3</a> As this article discusses, the
requirements are often difficult to meet and the limitations so far-reaching that the successful reclaiming
seller may be the exception, rather than the rule.

<h3>Requirements for Reclamation</h3>

In order to invoke reclamation, all of the following requirements must be met:

<ul>
<li>The buyer must have received the goods on credit while insolvent. Under §1201(23), a person is "insolvent"
if that person has ceased to pay its debts in the ordinary course of business, cannot pay its debts as they
become due, or is insolvent within the meaning of the federal bankruptcy law (i.e., the seller's debts exceed
assets at fair valuation).<a href="#4" name="4a">4</a>

</li><li>The seller must demand return of the goods within 10 days after receipt by the buyer. This often presents
the most significant barrier to exercising the remedy because the seller often does not learn of the
insolvency within this time period, or if so, fails to act quickly enough. A seller that has missed the deadline
might be able to proceed, however, if the buyer made a misrepresentation of its solvency in writing within
three months of the delivery of the goods, or if the seller was not a credit seller. An example of this type
of misrepresentation is the case where a seller accepts a check in payment that is later dishonored. An
exception to this rule occurs if the buyer becomes a debtor under the Bankruptcy Code within the 10-day
period, the seller will have 20 days from the date the buyer receives possession of the goods to make the
demand. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §546(c)</a>

</li><li>The demand need not take a particular form, and need not be in writing unless the buyer becomes the
subject of bankruptcy proceedings. As a practical matter, the seller will always want to make the demand
in writing,<a href="#5" name="5a">5</a> even if only to confirm a prior oral demand, simply to make a record that the seller has met
the 10-day requirement. Absent contractual requirements to the contrary, under §1201(26), the date of
delivery, rather than receipt of the notice, should be the basis for compliance with the 10-day requirement.</li></ul>

<h3>Limitations on Right to Reclaim</h3>

The right to reclaim goods is subject to significant limitations, including the following:

<ul>
<li>Ordinary course buyer prevails. A seller's rights are subject to a buyer in the ordinary course of
business or other subsequent good-faith purchaser (§2702(3)). A "buyer in the ordinary course" is a
person who, in good faith and without knowledge that the sale to him is in violation of the ownership
rights or security interest of a third party in the goods, buys in the ordinary course from a person in the
business of selling goods of that kind (§1201(9)). Section 2403 (cited in §2702(3)) provides that a person
with voidable title has the power to transfer title to a good-faith purchaser for value. Although the phrase
"good-faith purchaser for value" is not defined in the Uniform Commercial Code, guidance may be
obtained from the definition of "good faith," which means "honesty in fact in the conduct or transaction
concerned (§1201(32))."

</li><li>Secured creditor typically prevails. A secured creditor with a perfected security interest in the goods
in question (e.g., a lender with a floating lien on inventory and after-acquired property) will generally
prevail over a seller's attempts to reclaim goods. A secured creditor is generally considered a "good-faith
purchaser for value" under §§2702(3) and 2403. Also, a secured creditor's lien will generally have
priority over unsecured claims, including reclamation claims. See §§9301 and 9504(4). As a practical
matter, it should be noted that even in the case of a sale or other disposition of the buyer's assets by a
receiver or assignee, the sale may be structured in cooperation with a secured creditor to take advantage
of the secured creditor's priority rights to defeat any otherwise valid reclamation rights.

</li><li>A bankruptcy trustee may prevail if a seller fails to comply with bankruptcy law. A seller must meet
the requirements of §2702, and if the buyer is the subject of bankruptcy proceedings, the requirements
of the Bankruptcy Code as well. These requirements include (a) that the demand be in writing (<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
Oil Corp. v. Marin Motor Oil Inc. (In re Marin Motor Oil Inc.), 740 F.2d 220 (3d Cir. 1984)</a>), and (b)
that the sale must have been made in the ordinary course of the seller's business (<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §546(c)</a>).
Unlike the reclamation right under the Uniform Commercial Code, there is no exception for
misrepresentations regarding solvency that may extend the 10-day demand period. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §546(c)</a>.
The seller also needs to be aware that the bankruptcy court has the power to deny reclamation, even if
properly asserted, if necessary for the reorganization of the debtor. In that case, the seller will likely
receive an administrative claim (i.e., a claim that is senior to general unsecured creditors, but junior to
most secured creditors) or a lien on other property of the debtor. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §546(c)(2)</a>.

</li><li>Goods that are no longer identifiable (e.g., commingled with other fungible goods or incorporated into
other goods) may not be subject to reclamation. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Packing Corp. v. Rosenberg (In re Landy Beef Co.),
30 B.R. 19 (Bankr. D. Mass. 1983)</a>.</li></ul>

In conclusion, a seller must monitor its buyers and move quickly to implement a potential reclamation
remedy or risk loss of that remedy. Because initiation of the remedy requires only notice, a prudent seller
will give the notice even if the merits of the case might be in question, but should carefully review all
of the facts and circumstances before initiating legal proceedings or taking other action involving
substantial cost because of the many ways in which the remedy may ultimately be defeated.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Richard J. Maire Jr. is a partner in the Los Angeles office of Manatt Phelps & Phillips LLP. <a href="#1a">Return to article</a>

<a name="2">2</a> All citations are to the California Uniform Commercial Code. <a href="#2a">Return to article</a>

<a name="3">3</a> For a more detailed analysis of special issues and problems in asserting a reclamation right against a debtor subject to bankruptcy
proceedings, see Baker, Keith M., "Reclamation: An Uncertain Remedy," ABI Journal, July/August 2000. <a href="#3a">Return to article</a>

<a name="4">4</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §101(32)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §546(c)(1)</a>. <a href="#5a">Return to article</a>

Journal Authors

Richard J. Maire

Journal Date

Sunday, October 1, 2000 - 12:00