Bankruptcy Rights of Suppliers

What suppliers can do when a customer cannot pay


In all 50 United States, the relationship between sellers and buyers of goods and services in the commercial setting is generally governed by the Uniform Commercial Code, which is commonly referred to as the “UCC.” The basic rights and remedies of sellers, including suppliers of goods and services, and their customers generally can be found in Article 2 of the UCC. The remedies for suppliers when a customer is bankrupt or otherwise insolvent can be found in Subchapter 7 of Article 2. These UCC remedies are recall of goods in transit and reclamation of goods received. The Bankruptcy Code expands on these rights by providing special treatment for 20-day claims – sums due for goods and services provided within 20 days prior to a bankruptcy filing and by allowing setoff and recoupment against sums due by the supplier to the customer.

• Recall of Goods

UCC § 2-705 provides suppliers with the right to stop delivery of goods in the possession of a carrier if he discovers the buyer to be insolvent. This right applies to delivery of all sizes, no matter how small or large. A second and related right to recall goods in transit under the same provision of the UCC allows for the stoppage of the delivery by carload, truckload, planeload or larger shipments in the additional situations where the buyer repudiates or fails to make payment due before delivery or if, for any other reason, the supplier has the right to withhold or reclaim the goods. In either case, the goods must not yet have been received by the buyer.

Thus, once a supplier becomes aware of a buyer’s insolvency, the prudent action is to determine immediately whether there are goods in transit that one may wish to recall. Recall under UCC § 2-705 is generally not a violation of the automatic stay for the simple reason that the goods have not yet become the property of the debtor/buyer.

• Reclamation

UCC § 2-702 provides a supplier with two very important remedies once it is discovered that a buyer in receipt of goods is insolvent. The basic remedy is that the supplier may refuse delivery, except for cash, or may stop future delivery altogether. Thus, it is common practice for suppliers in a bankruptcy setting to refuse to continue providing goods or services other than on a cash-on-deliver (C.O.D.) basis. This right under UCC § 2-702 also serves as the basis for renegotiation of trade terms after a bankruptcy filing. The other right provided to suppliers under UCC § 2-702 is the right to reclaim goods that are already received.

The UCC provides that where a seller discovers that the buyer has received goods on credit while insolvent, he may reclaim the goods upon demand made within 10 days after the receipt. Additionally, if there is a misrepresentation of solvency made to the supplier in writing within three months before the delivery, the 10-day limitation does not apply at all. The Bankruptcy Code was recently amended to extend this 10-day period to 45 days. Bankruptcy Code § 546(c)(1) expands the reach back to 45 days, and also provides additional time – up to 20 days after the filing date – to make a reclamation demand for goods shipped within the 45 days prior to the bankruptcy filing.

On its face, it appears that the reclamation benefits under the Bankruptcy Code substantially improved the position of suppliers in the bankruptcy context. However, recent court decisions highlight a number of very substantial hurdles confronting a supplier seeking to assert the right to reclaim goods already received. In order to recover, the supplier must make a detailed written demand within the required timeframe, which is 10 days after receipt outside of bankruptcy and 20 days if the buyer has filed bankruptcy. In addition, the supplier must be able to establish that he did not become aware of the insolvency until after receipt of the goods. This would apply to each particular shipment at issue. Most significantly are a number of cases recently decided that tend to establish that the right of reclamation is subject to the rights of other creditors who have obtained liens on the buyer’s inventory and that extend to the supplier’s goods upon receipt by the debtor. Essentially, where the supplier has an inventory finance arrangement by a bank or other financial source, the right to reclamation has proven to be essentially illusory.

• 20-day Claims

In 2005, Congress dramatically improved the rights of suppliers by amending the Bankruptcy Code with the insertion of § 503(b)(9) to enhance the standing of suppliers with respect to sums due for goods shipped within 20 days prior to the filing of the bankruptcy. Even though the so-called “20-day claims” continue as pre-petition unsecured claims in the bankruptcy case, § 503(b)(9) elevated the status of these unsecured claims and assigned a priority to these claims in the bankruptcy payment scheme equal to that of all other administrative claims. This special claim status is provided with respect to “the value of any goods received by the debtor within 20 days before the date of the commencement of a case ... in which the goods have been sold to the debtor in the ordinary course of the debtor’s business.”

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