You ship on open account, the debtor receives the goods and fails to pay according to invoice. What to do? Article 2 of the Uniform Commercial Code provides that a vendor may recover possession of goods delivered to an insolvent buyer. However, a vendor's failure to strictly comply with the provisions of the Bankruptcy Code reclamation requirements, not merely state law reclamation requirements, may open the door for a preference lawsuit. A bankruptcy court, In re M.P.G., Inc., 222 B.R. 862 (Bankr. W.D. Ark. 1998), recently ruled that a vendor reclaiming goods based on an oral reclamation demand-not in writing-resulted in a bankruptcy preference, even though the debtor filed bankruptcy after the vendor had reclaimed the goods (the reclamation was within the preference period).

Reclamation: State Law Right And Interplay With The Bankruptcy Code

Reclamation is the right of a vendor, the seller, to recover possession of goods delivered to an insolvent buyer, upon demand made within ten days after receipt of the goods, which is provided under Article 2-702 of the Uniform Commercial Code (UCC). 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 UCC has expanded this remedy where the buyer does not misrepresent solvency. If the debtor has misrepresented its solvency in writing within three months before delivery, the ten-day demand period does not apply.

What is the effect of a vendor's right of reclamation upon a debtor's bankruptcy filing? The requirements for reclaiming goods under state law (Article 2 of the UCC) differ from a vendor reclaiming under bankruptcy law. In most states, a demand to reclaim under Article 2 of the UCC need only be made within ten days after delivery of goods. Bankruptcy Code section 546(c) requires that a reclamation demand be in writing.

The Vendor Reclaims Goods

In In re M.P.G., Inc., a vendor shipped goods to the debtor on credit, with payment due in one week. The debtor failed to pay on time. The vendor orally demanded return of the goods. The vendor repossessed the goods and sold them. Within 90 days of reclamation, the debtor filed Chapter 11 bankruptcy. A Chapter 11 trustee was appointed and investigated all payments made by the debtor to vendors within the 90 days prior to the bankruptcy filing, including the debtor's return of any goods to vendors.

The Trustee Sues The Reclaiming Vendor For A Bankruptcy Preference

The bankruptcy trustee sued the vendor for a bankruptcy preference contending that the vendor failed to comply with the reclamation provisions of the Bankruptcy Code as the vendor reclaimed the goods from the debtor by making an oral reclamation demand. The vendor argued that it repossessed the goods in compliance with Article 2 of the UCC, as it had made a demand on the debtor for return of the goods within ten days after they were received.

The Bankruptcy Preference Laws

The Bankruptcy Code vests the debtor (or trustee if one is appointed) with far-reaching powers to recover nearly every transfer of assets by a debtor 90 days prior to a bankruptcy filing (one year for an insider). The Bankruptcy Code's definition of a preferential transfer is broadly construed by courts to include the transfer of goods from the buyer (debtor) back to the vendor. The question for the court was whether the oral reclamation demand was a sufficient form of reclamation demand given the debtor had filed bankruptcy within 90 days of the reclamation.

The Reclamation Is A Preference

The court noted that the requirements for demanding reclamation under state law differ from those under the Bankruptcy Code. The court held that Bankruptcy Code section 546(c) supersedes Article 2 of the UCC and requires that a vendor's reclamation demand be in writing: "[state] law requires only that 'demand' to reclaim be made within ten days after delivery of the goods while section 546(c) of the Bankruptcy Code requires that written demand be made within ten days after delivery of goods. A majority of courts construe section 546(c) as the exclusive procedure for exercising the right of reclamation against a buyer who has previously filed for bankruptcy. Thus, under the majority view, a demand for reclamation must be in writing when the buyer is in bankruptcy."

The court concluded that as the reclamation demand was not in writing, and that the reclamation was made during the preference period, the vendor lost the shield of immunity provided by the Bankruptcy Code's reclamation provision and the reclamation was an avoidable preference.

Your Reclamation Demand Should Be In Writing

The bankruptcy court in In re M.P.G., Inc., reminds vendors that a reclamation demand should be in writing even if the debtor is not in bankruptcy. Below is a form of reclamation demand letters a vendor may consider sending to an insolvent debtor, prior to bankruptcy and in bankruptcy.

Example:

NON-BANKRUPTCY RECLAMATION DEMAND LETTER
[date]

VIA FACSIMILE AND OVERNIGHT MAIL [OR HAND DELIVERY]
[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, and by virtue of the Debtor's insolvency, the Seller hereby demands the segregation and return of all the [Reference goods] (the "Goods") currently in your possession and delivered to you on or after [Delivery Date] pursuant to the invoices, dated [Invoice Date and Invoices Numbers. Invoices may be attached]. 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 Executive] EXHIBIT "A" BANKRUPTCY RECLAMATION DEMAND LETTER [date] VIA FACSIMILE AND OVERNIGHT MAIL [OR HAND DELIVERY] [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 segregation and return of all the [Reference goods] (the "Goods") currently in your possession and delivered to you on or after [Delivery Date] pursuant to the invoices, dated [Invoice Date and Invoices Numbers. Invoices may be attached]. 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 Executive]