In re Reichhold Holdings US, Inc.: Bankruptcy Court Approves Reclamation Claim on Goods that Secured Postpetition DIP Loan | Practical Law

In re Reichhold Holdings US, Inc.: Bankruptcy Court Approves Reclamation Claim on Goods that Secured Postpetition DIP Loan | Practical Law

In In re Reichhold Holdings US, Inc., the US Bankruptcy Court for the District of Delaware overruled the trustee's objection to a prepetition reclamation claim because the claimant's reclamation rights arose before the postpetition lenders' security interest attached to the claimant's goods, and the prepetition and postpetition financing was not an integrated transaction.

In re Reichhold Holdings US, Inc.: Bankruptcy Court Approves Reclamation Claim on Goods that Secured Postpetition DIP Loan

by Practical Law Bankruptcy & Restructuring
Published on 27 Sep 2016 • USA (National/Federal)
In In re Reichhold Holdings US, Inc., the US Bankruptcy Court for the District of Delaware overruled the trustee's objection to a prepetition reclamation claim because the claimant's reclamation rights arose before the postpetition lenders' security interest attached to the claimant's goods, and the prepetition and postpetition financing was not an integrated transaction.
On August 24, 2016, in In re Reichhold Holdings US, Inc., the US Bankruptcy Court for the District of Delaware overruled the liquidating trustee's objection to a prepetition reclamation claim because the claimant's reclamation rights arose before the postpetition lenders' security interest attached to the claimant's goods, and the prepetition and postpetition financing was not an integrated transaction ( (Bankr. D. Del. Aug. 24, 2016)).

Background

On September 30, 2014 (the petition date), Reichhold Holdings US, Inc. (Debtor) filed a Chapter 11 bankruptcy petition. Before the petition date, Reichhold entered into a prepetition loan and security agreement granting the prepetition lender a lien on substantially all of its assets.
On October 2, 2014, the bankruptcy court approved the Debtor's postpetition financing from a group of lenders. The Debtor used the proceeds of the postpetition financing to pay off the Debtor's prepetition loan.
On October 3, 2014, Covestro LLC, a creditor, served a reclamation demand on the Debtor for goods delivered before the petition date in accordance with section 546(c) of the Bankruptcy Code.
After Covestro filed a proof of claim in the amount of $965,248.14 on December 24, 2014, Covestro and the Debtor entered into a critical vendor agreement in which:
  • The Debtor agreed to make payments to Covestro.
  • Covestro would amend its proof of claim to reflect the payments made.
The Debtor made two payments to Covestro that satisfied the portion of Covestro's claim for goods delivered within 20 days of the petition date. On October 1, 2015, Covestro filed a proof of claim for $411,781.72 for goods delivered between 21 and 45 days prior to the petition date. The liquidating trustee filed a limited objection to the claim arguing it was rendered valueless after the Debtor repaid the prepetition loan (Prepetition Loan) using the proceeds of the postpetition DIP financing (DIP Loan).

Outcome

The bankruptcy court held that Covestro had a valid reclamation right. Section 546(c) of the Bankruptcy Code does not create an independent reclamation right in a claimant. A reclamation claimant must demonstrate a valid reclamation right under applicable state law. Then the claimant must satisfy the following elements under section 2-702 of the Uniform Commercial Code (UCC) and section 546(c) of the Bankruptcy Code:
  • The debtor was insolvent when the good were delivered.
  • A written demand was made not later than 45 days of the debtor's receipt of the goods, or not later than 20 days following the petition date if the 45-day period expires postpetition.
  • The goods were identifiable at the time of demand.
  • The goods were in possession of the debtor at the time of demand.
(In re Hechinger Inv. Co. of Delaware, Inc., 274 B.R. 402, 405 (Bankr. D. Del. 2001); § 546(c), Bankruptcy Code).
Under Pennsylvania law, a seller's reclamation rights are subject to the rights of a buyer in the ordinary course (13 Pa. Cons. Stat. Ann. § 2702(3)), but the bankruptcy court found the DIP Loan was not in the ordinary course of business, noting in In re Pester Ref Co. and United States v. Westside Bank, that "the mere presence of a secured creditor with superior rights under UCC section 2-702(3) does not extinguish a vendor's reclamation rights." (Pester, 964 F.2d 842, 846 (8th Cir. 1992); Westside Bank, 732 F.2d 1258 (5th Cir. 1984). The bankruptcy court determined that the DIP Loan was used to satisfy the Prepetition Loan, but Covestro's reclamation rights remained in force. Covestro had a valid reclamation right under Pennsylvania state law.
The bankruptcy court also overruled the trustee's objection, holding that the Prepetition Loan and DIP Loan were not an "integrated transaction," but "were two different loans by two different lenders at two different times." ( at *4 (Bankr. Del. Aug. 24, 2016)). The bankruptcy court relied on In re Phar-Mor, Inc., which held that the postpetition lien secured on the debtor's inventory was not an assumption of the prepetition creditor's lien that was also secured with the debtor's inventory and a debtor's "decision to grant a security interest in inventory to a subsequent secured lender cannot defeat a seller's reclamation claim." (301 B.R. 482, 498 (Bankr. N.D. Ohio 2003), aff'd, 534 F. 3d 502 (6th Cir. 2008)).
The bankruptcy court rejected the decisions of the US Bankruptcy Court for the Southern District of New York (SDNY) relied on by the trustee:
  • Dairy Mart Convenience Stores, Inc., held that the reclamation goods securing the prepetition loan were effectively used to repay the prepetition loan because the goods or their proceeds were used to secure the postpetition loan from which the prepetition loan was paid. Therefore, the rights of the postpetition loan related back to the rights of the prepetition loan, making the liens an "integrated transaction." (302 B.R. 128, 135 (Bankr. S.D.N.Y. 2003)).
  • In re Dana Corp., adopted the reasoning in Dairy Mart, in its holding "that since the lien chain between prepetition and DIP lenders remained unbroken, the DIP lender's rights should relate back to the prepetition lender's rights." (367 B.R. 409, 421 (Bankr. S.D.N.Y. 2007)).
The bankruptcy court noted that the US Court of Appeals for the Sixth Circuit explicitly rejected Dana Corp. and Dairy Mart (see Phar Mor, 534 F. 3d at 507). The bankruptcy court agreed with Dairy Mart but only for the limited proposition that a vendor's reclamation claim rights would likely be defeated if a prepetition loan lender foreclosed on its collateral because foreclosure is one of the prior rights of a secured lender to which a reclaiming seller's rights are subject.

Practical Implications

This decision demonstrates the conflicting opinions on the issue of enforcing reclamation claims in cases with prepetition and postpetition loans, each secured with the same assets of the debtor, including a vendor's reclaimed goods. Postpetition lenders and parties involved may be well advised to require in their postpetition financing agreements that prepetition lenders foreclose on their collateral prior to satisfaction of any liens (or exercise some other right that overrides reclamation) to defeat reclamation rights (see Practice Note, Lender's Remedies and Enforcement Issues).