Sellers’ Rights to Recover Goods if a Buyer is Insolvent

In today’s tough economic times, more and more companies are finding themselves unable to meet their financial obligations and pay their debts. The ripple effect is being felt throughout the commercial world, in particular by those who do business with these struggling entities. Suppose a manufacturer or a distributor sells goods to a buyer on credit and subsequently learns that the buyer is insolvent and may not be able to pay the invoice when it comes due. Even worse, suppose the seller delivers the goods to the buyer and the buyer then files for bankruptcy. Can the seller reclaim its goods?

Fear not, the sellers of goods to financially distressed buyers do have rights should their buyers be unable to pay their debts or file bankruptcy. In addition to the right of replevin (an article for another day), a seller of the goods has the right to reclamation provided the seller acts quickly. Reclamation is a seller’s right to require an insolvent buyer to return goods purchased on credit. This remedy can prevent the seller from suffering a huge loss due to the buyer’s inability to pay for the goods. In one recent case in South Florida, a cabinet maker demanded reclamation of over $52,000.00 of cabinets sold to an insolvent developer.

The process to preserve the right of reclamation differs depending on whether the buyer has filed for bankruptcy or not. Outside of bankruptcy, a seller’s right of reclamation arises under Section 2-702 of the Uniform Commercial Code (“UCC”). Section 2-702 of the UCC provides several remedies to a seller. First, if the seller discovers that the buyer is insolvent, the seller may refuse to deliver any further goods unless cash payment is received for all goods previously delivered under a contract. Second, if a seller discovers that a buyer has received goods on credit while insolvent, the seller may reclaim the goods upon written demand. It is critical that the written demand be made within 10 days of the buyer’s receipt of the goods. There is only one exception to the 10-day time bar. This ten-day time limit does not apply if the buyer has made a written misrepresentation of solvency (generally a false financial statement) to the seller in writing within three months before delivery of the goods. Once the seller serves the reclamation notice, if the buyer does not agree to return the goods, the seller must file a civil action in order to enforce its right.

If the buyer is in bankruptcy, then the procedure changes. Reclamation in a bankruptcy proceeding is governed by 11 U.S.C. §546(c). Section 546(c) provides that the seller may recover the goods sold to a buyer within 45 days of the buyer’s bankruptcy petition if the buyer has received the goods while insolvent. In bankruptcy, a debtor is presumed to be insolvent 90 days before the date the debtor files his petition in bankruptcy. In order to preserve the right of reclamation in bankruptcy, the seller must serve written notice within 45 days after receipt of the goods by the debtor, or within 20 days after the case is filed if the 45-day period expires after the commencement of the bankruptcy case. If the seller fails to give the debtor written notice within the required time periods, the seller loses the right to reclamation under Section 546(c).

Where the seller has given written notice to the debtor timely, the bankruptcy court may direct the buyer to return the goods to the seller, direct the buyer to immediately pay for the goods, grant the seller a security interest in the buyer’s assets to secure payment of the claim, or grant the seller an Administrative Claim which grants a priority in payment in the bankruptcy process. It should be noted that the rights of sellers to reclamation are dependent on the buyer still having possession of the goods. If the buyer has already sold the goods to a third party, the seller may have lost the right of reclamation since the claims of a seller are subject to those of a buyer in the ordinary course of business.

It should also be noted that a secured creditor is usually deemed a buyer in the ordinary course of business. If the buyer has a secured lender to whom the buyer has granted a broad lien on all inventory, the seller’s reclamation right will be subordinate to the rights of that lender. Although the seller may still have reclamation rights, prior to exercising those rights it may be necessary to satisfy the secured lender’s lien. Under these circumstances, there is a high likelihood that the value of the lien will exceed the value of the goods, rendering the right of reclamation meaningless.

So what happens if the seller misses the deadline or its claim is subject to that of a secured creditor? Is there any other remedy? If the seller fails to timely provide a notice of reclamation, the seller loses its rights to reclamation of the goods, however, it may still assert replevin rights or, in the case of a bankruptcy, the rights contained in section 503(b)(9) of Chapter 11. These rights may also be asserted should a large secured lien render the right to reclamation meaningless. Section 503(b)(9) provides that a seller who sell goods in the ordinary course of business to a buyer in the 20 days before the date of commencement of a bankruptcy case is entitled to an administrative priority equal to the value of the goods sold. An administrative priority is the highest preference given to an unsecured claim in a bankruptcy case, although the claim is still inferior to the claims of secured creditors. While not as favorable as receiving the return of the goods, this remedy will likely provide some level of priority and reimbursement to a seller as it will place the seller’s claim higher in priority to that of other unsecured creditors.

The bottom line for a seller who wants the right to reclaim goods delivered to an insolvent buyer is to act quickly as a seller is faced with a relatively short time deadline under both the UCC and the Bankruptcy Code to assert its reclamation rights. If there is any doubt regarding the solvency of the buyer, contact an attorney to make sure that you secure your legal rights and act on them accordingly. An attorney can properly counsel you regarding the proper form for a reclamation notice and can assure that you don’t inadvertently waive your rights.

For more information regarding this article, please contact Jennifer L. Grosso at 941-552-5557 or jgrosso@williamsparker.com or Lewis Hall at 941-536-2032 or lhall@williamsparker.com.