The filing of a bankruptcy case typically precludes an unsecured creditor – such as a trade vendor – from having its prepetition claim satisfied in full. While this general principle holds true in most instances, the Bankruptcy Code provides certain remedies that mitigate the harm to unsecured creditors. Once such remedy arises in Section 546(c), which recognizes valid state law reclamation claims in the context of a bankruptcy case.
The concept of reclamation is rather straight-forward. Subject to the rights of a secured creditor with a security interest in such goods or proceeds thereof, a seller that has sold goods to the debtor in the ordinary course of the seller’s business can reclaim those goods if: (i) the debtor received the goods while insolvent and within 45 days of the commencement of the bankruptcy; and (ii) the seller timely makes a written demand for reclamation. See 11 U.S.C. § 546(c).
Reclamation claims for goods sold are subject to prior rights of a secured creditor with a security interest in such goods or the proceeds of such goods. For example, the vast majority of bankrupt business debtors have secured creditors with blanket security interests against all of their assets. Left unsatisfied, unsecured vendors will often find their reclamation claims trumped by the claims of senior secured creditors because the secured creditors’ security interests are prior to the reclamation claimants’ rights. Moreover, the vast majority of bankrupt business debtors who need to fund their bankruptcy cases will typically secure debtor-in-possession (“DIP”) financing and, in many instances, pay off their prepetition secured creditors. As discussed in a recent Delaware bankruptcy court opinion, using DIP financing to satisfy prepetition secured debts may give reclamation claimants an opportunity to prevail on their reclamation claims.
In In re Rechhold Holdings US, Inc., 2016 WL 4479286 (Bankr. D. Del. Aug. 24, 2016), the debtor secured DIP financing that it used to satisfy its prepetition secured creditors. The DIP lender had no affiliation or relation to the prepetition lender with the prior security interest that impeded the rights of the reclamation claimants. Deviating from past holdings from the Second Circuit1, Judge Mary Walwrath held that the DIP financing, which the debtor used to satisfy its prepetition secured creditors, did not constitute an “integrated transaction,” and allowed the reclamation claims. In rendering her decision, Judge Walwrath concluded that the liens granted to the DIP lender did not relate back to the security interests granted to the debtor’s prepetition secured creditor. Thus, the transaction was not “integrated,”2 and for purposes of the pending reclamation claims, the security interests granted to the DIP lender were not prior to the reclamation claimants’ rights.
For creditors, a critical lesson to draw from this decision is to closely scrutinize any request for approval of DIP financing. Debtors often seek approval of post-petition financing through their prepetition lenders, claiming they have no other viable alternatives. If a court approves DIP financing made available by a prepetition lender, then the court will likely find that the transaction is integrated and that the post-petition lien relates back to the prepetition security interest. This would effectively defeat any reclamation claim asserted against a customer with a prior secured lender.
However, if the court is presented with alternatives for DIP financing made available by lenders other than the prepetition secured lender, then the integrated transaction conclusion finds itself on shakier grounds. By creating a firm distinction between prepetition and post-petition lenders, reclamation claimants will create an opportunity to have their reclamation claims recognized if the debtor satisfies the prepetition secured lenders with the DIP financing.
1) See In re Dana Corp., 367 B.R. 409 (Bankr. S.D.N.Y. 2007); In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003).
2) Courts will decide whether a transaction is “integrated” on a case-by-case basis. Most courts will conclude that a transaction is “integrated” where there is unity of parties and/or claims – i.e., the prepetition secured lender is the same party that issues the post-petition DIP financing and receives a security interest that is equal to, or greater than, its prepetition security interest. Courts have also deemed a transaction as “integrated” where the post-petition financing resulted in the simultaneous release of a prepetition lien in exchange for a post-petition lien to secure the post-petition financing. See In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128, 136 (Bankr. S.D.N.Y. 2003).