Vendors – take note! The Delaware bankruptcy court In re Reichhold Holdings US Inc. recently issued an important ruling for vendors asserting reclamation rights. Under section 546(c) of the Bankruptcy Code, a vendor may reclaim goods sold on credit to an insolvent debtor that has filed bankruptcy. Reichhold addressed an issue plaguing reclamation claimants: does a postpetition lender’s subsequently perfected security interest trump the vendor’s reclamation rights when the proceeds from the postpetition loan (“DIP loan”) were used to repay the debtor’s prepetition loan. Judge Walrath ruled in favor of the vendor in this case and held that the vendor’s reclamation rights survived the lender’s DIP loan. This case is significant because it offers a more favorable outcome for reclamation claimants than similar bankruptcy cases decided in New York.
Based in Durham, North Carolina, Reichhold was a leading manufacturer of unsaturated polyester resins and coating resins utilized in a variety of consumer goods. Despite efforts to reduce its expenses, Reichhold ultimately filed chapter 11 on September 30, 2014.
At the time of filing, Reichhold was a borrower under a prepetition credit facility with Oaktree Capital Management, L.P. Oaktree maintained a blanket lien on substantially all of Reichhold’s assets, including inventory. Upon filing for bankruptcy, Reichhold obtained a DIP loan from a different group of lenders. The DIP loan was secured by a first priority lien on all pre and postpetition property of the estate, including inventory. The DIP loan repaid Oaktree’s prepetition loan.
Within days of the bankruptcy filing, one of Reichhold’s suppliers, Covestro LLC, delivered a written reclamation demand to Reichhold. Reichhold argued that the reclamation demand was rendered valueless when the prepetition loan was repaid, as the postpetition lender’s liens trumped Covestro’s reclamation claims.
The Delaware bankruptcy court focused on whether the postpetition lender’s rights (which were granted after Covestro’s reclamation rights arose) “related back” to the prepetition lender’s rights. The court concluded that the pre and postpetition loans were separate transactions and that repayment of the prepetition loan from the DIP loan did not affect Covestro’s reclamation rights. This represents a significant departure from holdings by New York bankruptcy courts. Unlike Delaware, New York bankruptcy courts conclude that pre and postpetition loans constitute an “integrated transaction.” More specifically, New York cases contend that since the lien chain between prepetition and postpetition lenders remains unbroken, the postpetition lender’s rights “relate back” to the prepetition lender’s rights and therefore trump vendor’s reclamation claims.
Judge Walrath disagreed with this reasoning, noting that it is “too much of a stretch” to conclude that a repayment of the prepetition loan from the DIP loan was repayment from the “sale” of the reclaiming creditor’s goods. As noted by Judge Walrath, the DIP loan’s first priority lien did not attach to property that was “subject to valid, perfected and non-avoidable liens (or to valid liens in existence as of the Petition Date that are subsequently perfected as permitted by section 546(b) of the Bankruptcy Code.”
According to Judge Walrath, it was irrelevant that (a) funds obtained from the DIP loan were used to satisfy the prepetition loan and/or (b) Reichhold granted the DIP lenders a lien in inventory to obtain such funds. As emphasized in the opinion, “Covestro’s reclamation rights arose before the DIP Lenders’ security interest attached, and the DIP Lenders’ lien was expressly subject to reclamation rights under section 546.” Therefore, the court ruled in favor of Covestro and overruled the debtor’s objection to the reclamation claim.
While bankruptcy courts have tended to chip away at reclamation claimants’ rights, reclamation claims still remain a tool for trade creditors to maximize recovery in chapter 11 cases. In light of Reichhold, Delaware offers a more vendor-friendly forum than New York. While assessing options and seeking to reduce risk, credit managers will want to closely review the debtor’s proposed financing arrangements to determine (a) if the postpetition lender will be granted a lien on debtor’s inventory and (b) whether there is a provision stating that the new loan is subject to liens perfected after bankruptcy under section 546(b). If the proposed DIP loan lacks such a provision, credit managers should consider participating early in the case and objecting to financing orders that do not allow for reclamation or provide a carve-out from the DIP lender’s collateral to secure payment of these claims.