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You conclude that a new customer is too risky to extend terms, so you insist on COD. You authorize shipment on the condition that your delivery driver picks up the check from your customer. The goods are delivered, but several days later the check is returned �NSF.� You immediately contact your shipper to stop further deliveries to the debtor, and return any product in transit to your warehouse. You also make a reclamation demand for the goods the debtor recently received.
Unfortunately, the shipper reports that it cannot honor the stop shipment demand as the goods had already been delivered to the debtor. Further, the debtor responds to the reclamation demand by advising that your goods have already been used in the ordinary course of its operations. You rightfully complain that that had you received prompt notice of the �NSF� you could have stopped some shipments reaching the debtor, and perhaps reclaimed that product that reached the debtor.
A new law may be better protect vendors from the too common situation above. On October 28, 2004, a federal law accelerating check processing, known as Check 21, went into effect (the official name, Check Clearing for the 21st Century Act). This is federal legislation affecting all states. Check 21 changes the way that checks are processed in the United States, as well as the technology of check payment and acceptance. Under Check 21, financial institutions are allowed to process checks electronically, instead of transporting the paper.
What is the impact of Check 21 and a vendor�s right to stop goods in transit, as well as return goods based on a reclamation demand? Does check 21�s �farewell to the float� mean greater protections for the vendor unwittingly accepting payment by check from an insolvent customer?
A. Stopping Goods in Transit
Article 2 of the Uniform Commercial Code deals with the rights of a vendor to stop goods in transit where the goods are in the hands of other bailees, such as a carrier or warehouseman. However, once the goods have been received by the buyer, the right of stoppage is lost.
The vendor may stop goods where the buyer breaches the contract or fails to make payment when due. The vendor gives notice of stopping goods to the buyer with a stop order or stop notice. The notice should be given to the carrier or bailee. Under the UCC, the vendor�s right to stoppage is lost upon the buyer�s receipt of goods. Receipt is defined under the UCC as physical possession. Stoppage of goods does not consider when title passes.
Courts generally recognize the right of the vendor to stop goods in transit after the buyer has filed bankruptcy. However, the vendor should seek relief from the automatic stay prior to selling the goods. Stopping goods in transit should not be considered a preference, as the buyer did not have an interest in the goods.
The remedy of stopping goods in transit is a time-of-the-essence remedy for the vendor. The vendor must promptly notify the carrier upon learning of the NSF check. Check 21 may better protect the vendor�s stoppage rights, as the vendor may be immediately notified by its bank of the NSF, which may permit the vendor to stop the goods that are in transit.
Article 2 of the Uniform Commercial Code provides a vendor selling goods on COD the right to reclaim goods when the customer�s check is returned NSF. Bankruptcy Code section 546(c) recognizes a vendor�s reclamation right where the customer is in bankruptcy and the cash sale was in the ordinary course of business.
A vendor selling goods on cash shortly before the customer�s bankruptcy may find the check returned NSF, even with Check 21�s accelerated clearing. The vendor should assume that the customer�s check will be returned NSF and send its reclamation demand immediately upon learning of the customer�s bankruptcy filing.
With Check 21, perhaps the check will clear prior to the customer�s bankruptcy filing; however, the reclamation demand may protect the vendor from the risk that the time periods for making a reclamation demand would run out prior to the vendor�s receipt of confirmation that the customer�s check had been dishonored. Again, due to Check 21, the vendor should receive prompt notification that the check has been dishonored.
Courts have settled upon the following elements to establish a valid reclamation claim under the Bankruptcy Code:
A vendor initiates reclamation by delivering a reclamation letter (see letter attached) within ten days, or in certain cases twenty days, after the goods were delivered. The reclamation letter should include a detailed description of the goods in question, a statement of the delivery date to the debtor, and a demand for the 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.
If the buyer files bankruptcy prior to making the reclamation demand (or at any time thereafter) the vendor should promptly contact debtor�s counsel in order to stipulate with the debtor for the immediate return of the goods or for the debtor to sell the goods, provided the vendor is granted an administrative claim or a lien under the Bankruptcy Code.
If there are no bankruptcy proceedings, the vendor must initiate legal action in state court pursuant to the UCC. The vendor should bring a complaint for replevin and a writ of attachment against the proceeds of any sale of goods protected by the reclamation demand.
A vendor has the burden to establish that the debtor was insolvent at the time the debtor received the 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. As a result of Check 21, the vendor may more easily establish this element as the vendor may be able to make a more timely reclamation demand, given the prompt notice under chapter 21 of the NSF check.
Some courts have determined that a secured creditors right 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.
Although difficult to get, 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.
Like a vendor�s stoppage rights, Check 21 should aid the vendor making a reclamation demand as the vendor should learn earlier of the NSF and, therefore, make a more prompt reclamation demand.
C. Overview Of Check 21
Approximately 75 percent of trade credit transactions are conducted by check. Check 21 focuses on the delay caused by a paper check being transported through the banking system.
Check 21 permits the depository bank, if it so chooses, to �truncate� the original check. Truncating a check means to take the check out of physical circulation by transforming it using a computer scanner into a digital image, also known as a substitute check. This digital image becomes the legal equivalent of the original check, provided it meets the criteria set out in the legislation. Truncating the check permits banks to process the digital image for payment in hours rather than days. As a result of image technology, check delays attributable to weather or air travel are gone.
D. Check 21 Makes the Remedies of Stopping Goods in Transit and Reclamation More Valuable
Check 21 better protects vendors from the risks of an NSF check, especially the typically lengthy time it takes to learn that the check does not clear, especially an outof- state check has not cleared. As a result of image technology, vendors will receive notice of the NSF check and can take steps to protect the sale, including a more timely demand to stop goods in transit or reclamation demand.
Reprinted by permission from The Trade Vendor Quarterly Blakeley & Blakeley LLP Spring 05