Bankruptcy Judge Jeffrey J. Graham of Indianapolis advanced a straightforward rationale for deciding who comes out on top when a reclamation claim collides with the blanket lien of a secured lender.
Under Judge Graham’s view of Section 546(c)(1), a lender with a valid secured claim on inventory should always prevail over a reclamation claim.
In a typical fact pattern, a trade supplier delivered goods to a retailer within 45 days of the retailer’s chapter 11 filing. The supplier took all steps required for a valid reclamation claim under UCC § 2-702 and Section 546(c)(1) of the Bankruptcy Code.
The retailer’s lender had a floating lien on all assets and proceeds. After bankruptcy, the lender negotiated a typical DIP financing arrangement with a priming first priority lien on all assets. The DIP financing order said that reclamation claims “in no event” would “be deemed to have priority over the DIP Liens.”
The supplier argued that the lender was not in good faith because it continued to lend on the eve of bankruptcy when it knew suppliers were not being paid. Therefore, the supplier contended that its reclamation rights were not subject to the lender’s security interest because the lender did not qualify as a “good faith purchaser” under UCC § 2-702(c).
Although BAPCPA amendments to Section 546 may have generated as many questions as they answered, Congress modified the statute in subsection (c)(1) to say that the rights of a reclamation creditor are “subject to the prior rights of a holder of a security interest in such goods or proceeds thereof.”
Judge Graham said that the amendment “drastically altered how a reclamation claim is treated in bankruptcy.” The amendment, he said, “explicitly renders” a reclamation claim “subordinate to a secured creditor’s prior lien rights — without reference or resort to the UCC to ascertain whether the secured creditor is a good faith purchaser.”
Therefore, Judge Graham had no occasion to determine whether the bank was a good faith purchaser. The “only relevant inquiry,” he said, was whether the bank “had a valid security interest in the [supplier’s goods] that arose prior to” the reclamation claim.
Judge Graham agreed with the outcome in In re Dana Corp., 367 B.R. 409 (Bankr. S.D.N.Y. 2007), but disagreed with In re Phar-Mor, Inc., 301 B.R. 482 (Bankr. N.D. Ohio 2003), which held that the reclamation claim took precedence when the DIP loan paid off the prepetition secured credit. Unlike Phar-Mor, he said that the lender’s prepetition and postpetition lien rights both related back to a time before the reclamation claim was made, given how the DIP financing was structured.
Judge Graham relied on the provision in the DIP financing order that provided that reclamation rights “in no event” would have priority over DIP liens.