Important Information Creditors Should Know When Customers File For Chapter 11 Bankruptcy Protection

Over the past year and a half a number of high profile retailers filed for bankruptcy protection. These retailers include Sports Authority, Joyce Leslie, Wet Seal, RadioShack, American Apparel, Deb Stores, Quiksilver, City Sports and Hancock Fabrics, many of which left creditors with unpaid accounts and scrambling for answers.  Receiving a distribution in a bankruptcy can take years to resolve and can represent pennies on the dollar.  So what can a creditor do to protect itself and maximize recovery?

In today’s marketplace, while some may fear little can be done, luckily there are rights and remedies whereby a creditor may be able to increase their recovery in a bankruptcy.  Under certain circumstances a vendor may be entitled to a recovery of goods through what is called  a reclamation claim or the right to an administrative claim, paid on par with other post-bankruptcy expenses, for the value of goods shipped by a company, and received by the debtor during the 20 days prior to bankruptcy.

Reclamation Claims

Section 546(c) of the Bankruptcy Code permits a seller to reclaim goods sold to a debtor in the ordinary course of the seller’s business.  In order to qualify for reclamation these claims must meet the following criteria:

• Debtor must have been insolvent when it received the goods.
• The goods were sold in the ordinary course of the seller’s business.
• Goods were received by the debtor within the 45 days prior to the commencement of the bankruptcy case.
• Seller must give written notice within the first 20 days of the bankruptcy.

There are additional limitations to a potential reclamation claim as well.  Goods that are no longer in the debtor’s possession or are no longer identifiable (i.e. raw materials converted into a finished product) are not eligible for reclamation.  The right to reclamation is also subordinate to the liens of secured creditors on the same goods. A secured creditor with a valid security interest or floating lien on the debtor’s inventory can limit a vendor’s right to a reclamation claim subject to the value of the collateral.

It’s All About Timing

An important note is that time is of the essence in filing a reclamation claim as it must be filed within 20 days of the bankruptcy and the debtor must still be in possession of the goods. 

So what happens if you miss the deadline or are otherwise not eligible for a reclamation claim? You may still be entitled to an administrative claim under Section 503(b)(9) of the bankruptcy code.

What are 503(b)(9) Claims?

Section 503(b)(9) provides that a creditor is entitled to an adminis¬trative-expense claim for the value of any goods sold to and received by the debtor within 20 days before the petition date.  An administrative claim provides a vendor with an elevated claim on par with other post-petition administrative claims.  The vendor would receive full payment on account of these goods paid in connection with the debtor’s plan. Note that claims under Section 503(b)(9) must be for goods, meaning that on an invoice for goods and services only the goods will be treated as an administrative claim (not the services). It is also important to note that the goods must be received by the debtor within 20 days of the bankruptcy.  The question of when the goods were received can be subject to shipping terms and when legal possession of the good occurred. An administrative claim for the value of the goods must be filed in the case before the filing deadline (stated in the case, for which you should receive notice). 

This information is intended for you may to be aware of additional options, in the event of a customer filling for Chapter 11 protection.  Note that each case and circumstance will be different and that Friedman’s experienced Corporate Recovery professionals can help you with these and many other situations that may arise in an insolvency or bankruptcy situation.