Reclamation Demand Against Customer that later files Bankruptcy
. . . should be in writing or risk preference action.
By Scott E. Blakeley

News of a major customer's insolvency can be devastating to a vendor selling on open account. However, the right of reclamation may afford a vendor a costeffective method of recovery for goods recently shipped if the customer has not filed bankruptcy, or, if the customer files bankruptcy, a priority claim for the reclaimed goods.

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.

One element for a vendor to prevail on its reclamation demand under the Bankruptcy Code is written demand for the return of the goods within ten, or in certain cases twenty, days after the goods were delivered to the debtor, and the goods are identifiable at the time of demand. 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 In re Zeta Consumer Products Corporation, 291 B.R. 336 (Bankr. D. N.J. 2003), recently ruled that a vendor reclaiming goods based on an oral reclamation demand 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 The 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 needed when an unsecured vendor is unable to retrieve goods or stop them in transit. 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 Zeta Products, a vendor shipped goods to the debtor on credit. The debtor failed to pay on time. The vendor orally demanded return of the goods. The vendor repossessed the goods. Within 90 days of reclamation, the debtor filed Chapter 11 bankruptcy. The debtor investigated all payments it had made 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 debtor sued the vendor for a 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 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: '[i]n the context of a bankruptcy proceeding, only a written demand will suffice to preserve the seller's immunity from the trustee's avoiding powers.'

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 S hould Be In Writing

The bankruptcy court in Zeta Products reminds vendors that a reclamation demand should be in writing even if the debtor has not filed for bankruptcy. Below is a form of reclamation demand letters a vendor may consider sending to an insolvent debtor, prior to bankruptcy and in bankruptcy.

NON-BANKRUPTCY RECLAMATION DEMAND LETTER

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]