A Sellers Stoppage of Delivery Rights How to Move to the Head of the Line

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May 2003

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Trade creditors have bemoaned the increased frequency
of court decisions that deny relief to trade creditors asserting reclamation
claims where the buyer's lender had a perfected floating security
interest in all of the buyer's inventory. Two recent decisions of the
U.S. Bankruptcy Court in Delaware have granted more favorable treatment to an
unpaid seller, asserting the state law right to stop delivery of goods sold to
an insolvent buyer, notwithstanding the conflicting claim of the buyer's
inventory secured lender. In <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Trico Steel Co. L.L.C., 282 B.R. 318 (Bankr.
D. Del. 2002)</a>, and <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Kellstrom Industries Inc., 282 B.R. 787
(Bankr. D. Del. 2002)</a>, Bankruptcy Judge Mary F. Walrath, relying
on Articles 2 and 9 of the Uniform Commercial Code (UCC), held that an unpaid
seller that properly exercises the right to stop delivery of goods from an
insolvent buyer in bankruptcy is entitled to payment for its goods and has
priority over the buyer's floating inventory secured lender. That moved
the unpaid seller to the head of the line!

<h3>An Unpaid Seller's Stoppage of Delivery Rights</h3>

An
unpaid seller's right to stop delivery of goods in the seller's
possession, or in the possession of a carrier or other bailee, is governed by
state law. Sections 2-702, 2-703 and 2-705 of Article 2 of the UCC deal with an
unpaid seller's stoppage of delivery rights.

Section
2-702(1) provides that "Where the seller discovers the buyer to be
insolvent, he may refuse delivery except for cash including payments for all
goods theretofore delivered under the contract, and stop delivery under this
Article (§2-705)."<a href="#1" name="1a">1</a>

Section
2-703 further states: "Where the buyer...fails to make a payment due on
or before delivery...then with respect to any goods directly affected, and if
the breach is of the whole contract (§2-612), then also with respect to
the whole undelivered balance the aggrieved seller may withhold delivery of
such goods, [or] stop delivery by any bailee as hereinafter provided
(§2-705)..." [language omitted].

Finally, §2-705 states:

<ul>
<li>The seller may stop delivery of goods in the possession of a carrier or other
bailee when he discovers the buyer to be insolvent (§2-702) and may stop
delivery...when the buyer repudiates or fails to make a payment due before
delivery or if for any other reason the seller has a right to withhold or to
reclaim the goods.

</li><li>Against such buyer, the seller may stop delivery until (1) receipt of the goods
by the buyer, (2) acknowledgment to the buyer by any bailee of the goods
except a carrier that the bailee holds the goods for the buyer, (3) such
acknowledgment to the buyer by a carrier by reshipment or as warehouseman or
(4) negotiation to the buyer of any negotiable document of title covering the
goods.
</li></ul>

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U….
§2-705 (2001)</a> (language omitted).

A
seller seeking to stop delivery of its goods has to show that the buyer is
insolvent. Where the buyer is not in bankruptcy, the UCC definition of
insolvency applies. The UCC relies on either an equity or the bankruptcy
definition of insolvency. (See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§1-201(23)</a>). Under the easier-to-prove equity definition, a
buyer is insolvent when it is unable to pay its debts in the ordinary course of
business or as they come due. The Bankruptcy Code uses the harder-to-prove
balance sheet definition under which a debtor is insolvent when its liabilities
exceed its assets at a fair valuation. (See
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1-101(32)</a>).

A
seller, seeking to stop delivery of goods in the possession of a carrier or
other bailee, must instruct the carrier or bailee not to release the goods to
the buyer. The carrier or other bailee must then hold and deliver the goods
according to the seller's instruction. The seller is liable for all
charges and damages incurred by the carrier or other third party resulting from
their holding the goods. (See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§2-705(3)</a>).

Two
recent decisions of the U.S. Bankruptcy Court in Delaware upheld an unpaid
seller's right to stop delivery of goods, notwithstanding the competing
claim of the buyer's floating inventory secured lender. In <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Trico Steel Co. L.L.C., 282 B.R. 318 (Bankr.
D. Del. 2002)</a>, the seller sought to stop delivery of the goods
in the possession of a carrier that the buyer had engaged. In <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Kellstrom Industries Inc., 282 B.R. 787
(Bankr. D. Del. 2002)</a>, the seller sought to withhold delivery of
goods in the seller's possession.

<h3>In re Trico SteelCo. L.L.C.</h3>

On Jan. 24, 2002, Cargill Inc. had agreed to sell basic pig iron to Trico. Trico
engaged Celtic Marine Corp. to ship the goods by barge to Trico's
facility in Decatur, Ala. Celtic, in turn, hired Volunteer Barge &
Transportation to transport the goods to Decatur. On March 7, 2001, Trico hired
stevedores to load approximately 25,000 metric tons of goods onto
Volunteer's barges for shipment to Decatur. Volunteer issued two
non-negotiable bills of lading to Celtic as a receipt for the goods.

Cargill had learned that Trico was insolvent while the goods were in transit to
Decatur. On March 23, 2001, Cargill sent a letter instructing Celtic to stop
delivery of the goods in transit. On March 26, Cargill notified Trico that
Cargill was exercising its right to stop delivery of the goods due to
Trico's insolvency.

On March 27, 2001, Trico filed its chapter 11 petition. On March 28, Cargill sent
a second letter to Celtic, offering to indemnify Celtic for Celtic's
losses incurred in complying with Cargill's stoppage of delivery demand.
On March 29, Cargill sent a second letter to Trico reasserting Cargill's
stoppage-of-delivery rights and holding Trico responsible for any action in
contravention of Cargill's rights.

On March 30, 2001, Cargill commenced a lawsuit seeking declaratory judgment, a
temporary restraining order and a preliminary injunction prohibiting Trico from
using, transferring, selling, encumbering or otherwise disposing of the goods
subject to Cargill's stoppage-of-delivery claim. Cargill asserted that it
had satisfied the requirements for stopping delivery of the goods in transit
and had a prior right to the goods. Trico and its inventory secured lender,
Chase Manhattan Bank, disputed Cargill's stoppage-of-delivery rights.
Chase also claimed priority based on its perfected floating security interest
in all of Trico's inventory. Cargill and Trico later agreed to the sale
of the goods, and the escrowing of sales proceeds in excess of $2.7 million,
pending the court's decision on Cargill's stoppage-of-delivery
rights.

Cargill
claimed the right to stop delivery of its goods in transit because Trico had
not received the goods. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§2-103(1)(c)</a> defines "receipt" as taking physical
possession, and Trico was never in physical possession of the goods.

Trico
countered that it had obtained actual physical possession of the goods when it
became responsible for unloading them and hired stevedores to do so. This
amounted to a "receipt" that cut off Cargill's stoppage of
delivery claim.

The
court held that Cargill had an enforceable right to stop delivery of its goods
in transit. Trico could not have obtained physical possession of the goods
until they arrived at Trico's facility in Decatur. The stevedores hired
by Trico and a carrier, Volunteer, had physical possession of the goods; Trico
did not. Cargill's stoppage-of-delivery rights were also unaffected by
the prior passage of title and risk of loss to <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7….
(See In re Marin Motor Oil Inc., 740 F.
2d 220 (3d Cir. 1984)</a>).

The
court also upheld the priority of Cargill's right to stop delivery of
goods in transit over Chase's security interest in the goods. More on
this later!

<h3>In re Kellstrom Industries Inc.</h3>

American
Valley Aviation (AVA) had agreed to sell its inventory of aerospace components
and parts (AVA Goods) to Kellstrom Industries. Kellstrom had agreed to pay
approximately $3.3 million of the purchase price over 24 months. Kellstrom
obtained title to the AVA Goods upon execution of the agreement. However, AVA retained
possession of the goods and agreed to store, pack and ship them according to
Kellstrom's direction.

Kellstrom
had previously entered into a loan and security agreement with Bank of America
(BOA). BOA asserted a security interest in all of Kellstrom's inventory,
including the AVA Goods.

On
Feb. 20, 2002, Kellstrom filed chapter 11. AVA withheld delivery of the AVA
Goods in its possession pending Kellstrom's payment of the balance of the
purchase price. Kellstrom moved for bankruptcy court approval of the sale of
its assets, including the AVA goods. Kellstrom argued that its acquisition of
title resulted in a constructive delivery and Kellstrom's receipt of the
AVA Goods that cut off AVA's stoppage of delivery rights. AVA asserted
that its right to stop delivery of goods in its possession precluded their sale
until Kellstrom paid for them.

The
court upheld AVA's right to stop delivery because AVA, and not Kellstrom,
had actual physical possession of the AVA Goods. Neither the passage of title,
nor any constructive delivery of the goods to Kellstrom, resulted in
Kellstrom's obtaining actual physical possession. The court also held
that AVA's stoppage of delivery rights were not impaired by BOA's
security interest.

<h3>Priority of an Unpaid Seller's Stoppage of Delivery Rights over the Buyer's LenderÆs Security Interest in Inventory</h3>

In
both Trico Steel and Kellstrom
Industries, the court upheld the priority
of an unpaid seller's stoppage of delivery rights over the security
interest of the buyer's secured lender. In each case, the court relied on

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 2</a>, which governs stoppage of delivery rights, and found
inapplicable <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 9</a>, which deals with consensual security interests.

In
Kellstrom Industries, the court considered
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§9-110</a>,<a href="#2" name="2a">2</a> which deals with the rights of a holder of an Article
2 security interest under Article 9, stating as follows:

<blockquote>
A security interest arising under §2-401, 2-505, 2-711(3)...is subject to
this article. However, until the debtor obtains possession of the goods:

<ul>
<li>the security interest is enforceable, even if §9-203(b)(3) has not been
satisfied;

</li><li>filing is not required to perfect the security interest;

</li><li>the rights of the secured party after default by the debtor are governed by
Article 2...; and

</li><li>the security interest has priority over a conflicting security interest created
by the debtor.
</li></ul>
</blockquote>

U.C.C. §9-110 (2001) (language omitted)

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§9-110</a> is clear that a <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 2</a> security interest-holder is subject to <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 9</a>. However, §9-110 is silent on whether an unpaid
seller's right to stop delivery of goods is subject to Article 9.
Official Comment 5 to §9-110 discusses a seller's stoppage of
delivery rights as follows:

<blockquote>
This
Article does not specifically address the conflict between (i) a security
interest created by a buyer...and (ii) the seller's...right to withhold
delivery under §2-702(1) [or] 2-703(a)...the seller's...right to
stop delivery under §2-705...or the seller's right to reclaim under
§2-507(2) or 2-702(2). These conflicts are governed by the first sentence
of §2-403(1), under which the buyer's secured party obtains no
greater rights to the goods than the buyer had or had the power to convey...

</blockquote>

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U….
§9-110</a> Official Comment at 5 (2001) (language omitted).

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§2-403(1)</a> states that "A purchaser of goods acquires all title
which his transferor had or had power to transfer except that a purchaser of a
limited interest acquires rights only to the extent of the interest..."
BOA's security interest rose no higher than Kellstrom's rights in
the goods. Both interests were subordinate to AVA's right to stop
delivery of the goods in its possession. Kellstrom and BOA could terminate
AVA's stoppage of delivery rights and sell the goods after paying
AVA's claim in accordance with <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§2-702(1)</a>.

<blockquote><blockquote>
<hr>
<big><center>
A trade creditor's right to withhold or stop delivery of goods has plenty of potency.
</center></big>
<hr>
</blockquote></blockquote>

The
court did the same analysis and reached the same conclusion in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
re Trico Steel.</a> Cargill's UCC Article 2
right to stop delivery of goods in the possession of Trico's carrier was
not an Article 2 security interest, and therefore not subject to <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 9</a>.<a href="#3" name="3a">3</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 2</a> governed the priority dispute between Chase's Article 9
security interest and Cargill's right to stop delivery.

Chase
was a <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 2</a> good-faith purchaser of the goods in the possession of
Trico's carrier as a result of Chase's security interest in
Trico's inventory. Under §2-705(3), an unpaid seller's right
to withhold or stop delivery of goods is not subject to the rights of a
good-faith purchaser.<a href="#4" name="4a">4</a> As such, Chase's security interest in the goods in
the possession of Trico's carrier was subject to Cargill's right to
stop delivery of the goods, and Cargill was entitled to payment of the escrowed
proceeds.

An
unpaid seller's <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 2</a> right of reclamation of goods is not afforded similar priority. A
seller's reclamation rights are subject to the rights of a buyer in the ordinary
course or other good faith purchaser. (See
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
§2-702(3)</a>). The debtor's floating inventory lender can be
a good-faith purchaser. In such event, the lender has priority over a
seller's reclamation rights. And courts have frequently denied relief to
reclamation creditors where the proceeds of their goods were paid to the
lender, rendering their reclamation claims valueless.<a href="#5" name="5a">5</a>

<h3>Conclusion</h3>

A
trade creditor's right to withhold or stop delivery of goods has plenty
of potency. A creditor that satisfies all of the <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 2</a> requirements for stoppage of delivery has a prior right to the
goods, with priority over the buyer's floating-inventory secured lender.
That could lead to the immediate full payment of the purchase price of the
goods, despite the buyer's bankruptcy filing, thereby moving the trade
creditor to the front of the line!

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Comment 1 of UCC §2-702(1)</a> further states that passage of title to the
goods to the buyer does not affect the seller's stoppage-of-delivery
right. <a href="#1a">Return to article</a>

<a name="2">2</a> The
court relied on Revised Article 9 of the UCC, which became effective on July 1,
2001, as the governing law. <a href="#2a">Return to article</a>

<a name="3">3</a> While
the prior version of <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…
Article 9</a> governed, it had no bearing on the outcome since the relevant
provision is similar to §9-110 of current Article 9. <a href="#3a">Return to article</a>

<a name="4">4</a> The
court found inapplicable <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
v. Sprague Nat. Bank, 128 F.3 636 (8th Cir. 1997)</a>,
relied upon by Chase, where the delivery of the goods to the buyer had cut off
the seller's stoppage of delivery rights. The court also found
inapplicable <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
Kong & Shanghai Banking Corp. Ltd. v. HFH USA Corp., 805 F. Supp. 133 (W.D.N.Y. 1992)</a>, where the seller had
an Article 2 security interest in the goods that was subject to the secured
lender's Article 9 rights. <a href="#4a">Return to article</a>

<a name="5">5</a> See recent decisions: <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Quality Stores Inc., 289 B.R. 324 (Bankr.
W.D. Mich. 2003)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Bridge Information Systems Inc., 288 B.R.
133 (Bankr. E.D. Mo. 2001)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Houlihan's Restaurant Inc., 286 B.R.
137 (Bankr. W.D. Mo. 2002)</a>; See, also, e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Primary Health Systems Inc., 258 B.R. 111
(Bankr. D. Del. 2001)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Arlco Inc., 239 B.R. 261 (Bankr. S.D.N.Y.
1999)</a>. <a href="#5a">Return to article</a>

Journal Authors

Bruce S. Nathan

Journal Date

Thursday, May 1, 2003 - 12:00

Bankruptcy Rule

2003