News of a customer's insolvency can be devastating to a vendor selling on open account. However, the right of reclamation may afford a vendor a cost-effective method of recovery for goods recently shipped.

Reclamation is the right of a seller to recover possession of goods delivered to an insolvent buyer. The remedy of reclamation is needed when an unsecured vendor is unable to retrieve goods or stop them in transit. A reclaiming vendor need not prove fraud, although the premise of reclamation is that the vendor was defrauded. Under the common law and the old Uniform Sales Act, the seller could only exercise its reclamation rights if it proved the buyer obtained delivery by misrepresenting its solvency. However, The Uniform Commercial Code (UCC) has expanded this remedy where the buyer does not misrepresent solvency.

ELEMENTS OF A RECLAMATION CLAIM

Courts have settled on the following elements to establish a valid reclamation claim under the Bankruptcy Code:

(1) the seller sold goods on credit to the debtor in the ordinary course of business of both;

(2) the seller delivered the goods to the debtor at a time when the debtor was insolvent;

(3) the seller made a written demand for the return of the goods within ten days, or, in certain cases, twenty days after the goods were delivered to the debtor; and

(4) the debtor had possession of the goods at the time of the reclamation demand or the goods were not in the hands of a buyer in the ordinary course or a good faith purchaser at the time of the demand.

STEPS FOR A SUCCESSFUL RECLAMATION

Reclamation Letter

A vendor initiates reclamation by delivering a reclamation letter (see attached letter*) within ten days, or in certain cases twenty days, after the goods were delivered. The reclamation letter should include a detailed description of the merchandise in question, a statement of the delivery date to the debtor, and a demand for immediate return of the goods. The reclamation letter should also demand an accounting. An accounting is crucial, because the right to reclaim may be defeated by the debtor's resale of the goods to a buyer in the ordinary course of business.

If the accounting is not delivered or not accurate, the vendor should be prepared to immediately demand a right to inspect both the inventory on hand and the books and records pertaining to sales of said goods for the period between the date of delivery of the goods and the date of the reclamation letter. The letter should be delivered to the debtor by facsimile and certified mail.

Initiating Proceedings

If the buyer files a bankruptcy proceeding prior to the preparation of the reclamation letter (or at any time thereafter), the seller should promptly contact debtor's counsel in order to stipulate with debtor either to the immediate return of the goods or for the debtor to sell the goods, provided the seller is granted an administrative claim or a lien under the Bankruptcy Code. Courts are divided as to whether a reclaiming vendor may simply rely on a proper and timely notice, or must initiate an adversary proceeding, to enforce its rights. The risk the vendor faces, if it fails to seek court enforcement of its reclamation right, is that it cannot meet its burden of proving that the goods, subject to the reclamation demand, were in the possession of the debtor at the time such demand was made.

If there are no bankruptcy proceedings, the seller must initiate legal action in state court pursuant to the UCC. The seller should bring a complaint for replevin and a writ of attachment against the proceeds of any sale of goods protected by the reclamation demand.

SPECIAL PROBLEMS FOR VENDORS

Insolvency at the Time of Delivery of the Goods

A vendor has the burden to establish that the debtor was insolvent at the time the debtor received the goods. The UCC's definition of insolvency is expansive. The UCC defines insolvency as an entity "who either has ceased to pay its debts in the ordinary course of business or cannot pay its debts as they become due or is insolvent within the meaning of the federal bankruptcy law". The Bankruptcy Code, on the other hand, adopts only a balance sheet test to determine solvency. An entity is insolvent if "the sum of such entity's debts is greater than all of such entity's property, at a fair evaluation". Unfortunately for vendors, most courts have determined the Bankruptcy Code to require the customer to be insolvent within the more restrictive definition set forth in the Bankruptcy Code.

Possession of Goods

Courts strictly enforce the requirement that the goods be in the possession of the debtor when reclamation is demanded. If the debtor has transferred the goods to a good faith purchaser before the reclamation demand is made, the reclaiming vendor loses all reclamation rights to the goods.

Reclamation Where there is a Secured Creditor

Courts have taken conflicting views as to whether an existing inventory lender primes a reclaiming vendor's claim. One view is that the existence of a senior lien on goods merely subordinates the reclaiming vendor's rights to those of the lienholder, i.e., it does not extinguish the vendor's right of reclamation. Those courts allowing administrative claims to reclaiming vendors notwithstanding the value of the lienholder's collateral have done so on the grounds of "fairness".

On the other hand, some courts have determined that a secured creditor's rights will extinguish all of the reclaiming vendor's rights. Therefore, only those goods that were sold to the debtor prior to the filing were subject to any security interest.

A Lien Versus a Claim in the Bankruptcy Court

The vendor should insist upon a lien on the assets of the bankruptcy estate, rather than an administrative claim. An administrative claim will not get satisfied if the bankruptcy case is administratively insolvent. A vendor's lien under the Bankruptcy Code is measured by the price realized by the debtor for the goods sold. As such, an agreement as to the amount of the lien or claim is advisable, so as to avoid recovering less than the resale price of the goods.

*

(date)

VIA FACSIMILE AND OVERNIGHT MAIL

(Debtor)

Re: (Debtor's Case Name)

Dear (Debtor's Officer):

This letter constitutes a notice of demand for the return of certain goods purchased by the above-captioned debtor ("Debtor") from (Creditor) (the "Seller"). Please take notice that pursuant to (State) Commercial Code 2702, 11 U.S.C. section 546 (c), and by virtue of the Debtor's insolvency, the Seller hereby demands the return of all the (description of goods) (the "Goods") currently in your possession and delivered to you on or after (Delivery Date) pursuant to the invoices, dated (Invoice Date and Invoice(s) Number(s). Unless you authorize the return of the Goods immediately, further appropriate measures will be taken.

Please contact the undersigned immediately to make arrangements to allow the Seller to reclaim the Goods. I look forward to hearing from you shortly.

Sincerely,

(Credit Manager)

EXHIBIT "A"