Augments expanded Reclamation Rights
Robert S. Bernstein, Esq.
Creditors are discovering new ways to help collect debts from bankrupt customers since the passage of the 2005 amendments to the The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).
The amendments offered unsecured creditors powerful new collection rights, including Section 503(b)(9) of the Code, which grants the seller of goods an “administrative expense claim” for any goods delivered to the debtor during the 20 days preceding the bankruptcy filing.
Generally speaking, administrative expense claims are high priority – above unsecured claims, but below secured (lien) claims – and it is expected they will be paid in full by the case. As a result, 503(b)(9) should allow an otherwise unsecured creditor to receive a greater percentage of its claim than would other unsecured creditors. While there is no absolute guarantee of payment, these administrative expense claims must be paid in full in order to confirm a Plan of Reorganization in a Chapter 11. This provides some additional leverage.
The Purpose of Section 503(b)(9):
Under most state laws, a credit seller has the right to “reclaim” goods (get them back or get a lien for the value), from a defaulting buyer. Most state laws require a reclamation notice be given within 20 days of the delivery. Some require as few as 10 days. Recognizing the difficulty with these short timeframes, earlier changes to the Bankruptcy Code enabled creditors to give notice within 20 days after the bankruptcy filing. The right still only covered deliveries in the 10 days before the bankruptcy.
The 2005 amendments expanded the notice rights to provide that, when goods are sold to a debtor within 45 days of a bankruptcy filing, the seller has a right to reclaim those goods, so long as the seller gives notice within the first 20 days of the bankruptcy. Failure to provide this notice results in a waiver of the reclamation right. Sellers often miss this “notice deadline” and lose their right to reclaim their goods. Further, because the rights of a reclaiming seller are subject to the rights of a prior, properly perfected lienholder on the type of goods sold, this reclamation right is often illusory.
Section 503(b)(9) was inserted into the Bankruptcy Code as a way of offering relief to sellers of goods whose reclamation right is rendered meaningless – either by failing to give the required notice or because of a prior lienholder’s rights.
Asserting a Claim
The process of asserting a 503(b)(9) claim is relatively simple. Sometimes, the debtor will simply agree to grant the seller an administrative expense claim in the full amount of the goods received by the debtor. If the debtor refuses to cooperate, the seller can file a motion with the court, seeking to have the claim allowed.
Creditors that intend to file a 503(b)(9) claim in a bankruptcy case should be aware that courts are often inclined to grant “503(b)(9) procedures orders” proposed by the debtor. These orders usually set deadlines for filing 503(b)(9) claims and are often used by debtors to avoid many of their 503(b)(9) obligations. These Orders should, but may not, provide a streamlined procedure, short of filing a Motion for Administrative Claim with the Court.
Creditors’ Experiences with Section 503(b)(9):
Creditors have had mixed results in the first two years following the addition of section 503(b)(9) to the Code. For starters, obtaining an allowed administrative claim requires an upfront investment. The creditor must do one of two things: 1) get the debtor to agree to allow the 503(b)(9) claim; or, 2) if the debtor refuses to agree, file a motion with the court. This means that the creditor often has to hire an attorney and expend resources upfront.
More importantly, debtors will often challenge the 503(b)(9) claim in an attempt to get the creditor to negotiate the amount. Debtors will often claim that they received the goods outside of the required 20-day window. This forces the creditor to show evidence, though supporting documentation and testimony. Debtors sometimes take this position solely as a negotiation tactic. Debtors know that it will cost the creditor valuable time and money to litigate the case and that the creditor may be willing to settle for less in order to avoid litigation.
Unfortunately, the Code does not require that the administrative claim be paid in full immediately after the Court allows the claim. Instead, the Code only sets the relative priority of the claim. In Chapter 11, a requirement for the confirmation of a Plan is that administrative expense claims be paid “in full and in cash.” If the case is ultimately declared “administratively insolvent” – i.e. the debtor does not generate sufficient cash to pay its administrative claims – then 503(b)(9) creditors will probably not receive the full amount of their claims.
While the court can order immediate payment of these claims, they often decline to do so. The courts have tended to be very debtor friendly on this issue. In two recent cases, In Re Bookbinders and In Re Global Home Products, LLC, creditors attempted to force immediate payment of 503(b)(9) claims. In both cases, creditors urged the court to order immediate payment of the claims, arguing that there may not be enough assets left at the end of the bankruptcy to pay the 503(b)(9) claims in full. In both cases, the courts’ reasoned that the Code did not explicitly provide for immediate payment. The courts in both cases denied the creditors’ request for immediate payment of their 503(b)(9) claims. Unfortunately, in the Global Home Products case, 503(b)(9) creditors ultimately received less than 50 percent of their claims under the debtor’s Plan.
While a 503(b)(9) creditor appears to face an uphill battle, it is not all bad news. In fact, section 503(b)(9) has greatly increased the potential for recovery for large numbers of unsecured creditors nationwide. Notwithstanding the difficulties of allowance and payment that 503(b)(9) creditors face, they stand in a better position than a general unsecured creditor. Section 503(b)(9) claims are given the same priority status as the debtors’ attorneys’ and other professionals’ fees. In the grand scheme of the bankruptcy system, this is about the best position in which a trade creditor can sit..
Since many 503(b)(9) motions are lightly contested, they can be handled by experienced creditors’ rights counsel at a modest price. In fact, a valid 503(b)(9) claim is often stipulated to by the debtor early in the case. Often the debtor will agree to allow the claim in full, if the creditor agrees to forego payment until a plan can be confirmed. This system benefits all parties because if all 503(b)(9) creditors demanded immediate payment in full, many debtors would not have sufficient cash flow to meet those demands, and would terminate operations shortly after entering bankruptcy. Since debtors rarely enter bankruptcy with significant cash reserves, such an outcome would likely result in 503(b)(9) creditors receiving far less than 100 percent of their claims.
If a creditor is willing to accept a reduced amount on its 503(b)(9) claim, then it should consider “claim traders” – companies that purchase bankruptcy claims from creditors. Claim traders are often very interested in 503(b)(9) claims and, depending on the circumstances of the particular debtor and its prospects for reorganizing, are often willing to pay a very large percentage of the claim.
How Creditors Should Plan On Using Section 503(b)(9):
When a creditor receives notice that one of its customers filed bankruptcy, the creditor should immediately check its records to determine whether it delivered goods to the debtor within 20 days of the bankruptcy filing. If so, the creditor should consider its reclamation notice options and consider whether to pursue the 503(b)(9) claim. There is time to consider the latter. The former has strict notice deadlines. Obviously, the 503(b)(9) considerations are determined by the size of the claim. Amount a particular creditor is willing to spend to protect the claim depends on the size and nature of the creditors’ business.
As a general rule, the creditor should always attempt to obtain the debtor’s consent to allowance of the 503(b)(9) claim. Should the debtor refuse to agree to allow the claim, then the creditor again must decide whether the claim is worth a further investment in time and money.
Section 503(b)(9) is not a guaranteed path to full recovery on an unsecured claim. The process can lengthy and result in a reduced payment several months or years after the bankruptcy was filed. However, the right to payment granted by section 503(b)(9) is substantially better than the rights afforded to a general unsecured creditor. In practice, section 503(b)(9) has proven to be a valuable tool to unsecured creditors seeking to recover a portion of the debt. In fact, in the right circumstances, section 503(b)(9) can be used to obtain a full recovery on an otherwise uncollectable debt. Accordingly, when a customer enters bankruptcy, before writing off the debt as uncollectable, creditors should always analyze the prospect of a 503(b)(9) claim. It just might prove to be invaluable.
Bob Bernstein practices at Bernstein-Burkley, P.C. in Pennsylvania.
www.bernsteinlaw.com Bernstein, board-certified in Creditors’ Rights and in Business Bankruptcy, is Managing Partner of the Firm. Bernstein recently published Get P.A.I.D., A Guide to Getting Paid Faster (2007 Business Credit Publications LLC), which is available at getpaidsystem.com and amazon.com (search keyword: get p.a.i.d.) and could be ordered from major retail outlets.