Delaware Bankruptcy Court sides with Sixth Circuit in deciding that Vendors may have a reclamation right remedy despite a senior secured lender‘s lien.

 Section 546 of the Bankruptcy Code recognizes a vendor’s right to reclaim goods if unpaid for, and supplied to a debtor within forty-five days of the bankruptcy filing, while the debtor was insolvent. This right, known as a “reclamation right,” is created under section 2-702 of the Uniform Commercial Code, as adopted by applicable state law. Typically, claims based on reclamation rights lose value as a result of a senior secured lender’s lien on all the debtor’s assets. A recent Delaware ruling changes the treatment of such claims, benefiting vendors of insolvent buyers.On August 24, 2016, in In re Reichold Holdings US, Inc,[1] the Delaware Bankruptcy Court found that reclamation rights maintain their senior secured priority status, over the rights of a postpetition senior secured lender where the reclamation rights are deemed to arise before the secured lender’s lien, and the proceeds of a postpetition loan were used to pay off the senior secured prepetition debt.In Reichold, Reichold Holdings US, Inc.’s (the “Debtor”) prepetition debt was secured by a security interest in “substantially all of the Debtor’s assets, including inventory.”  Further, the Debtor entered into a postpetition financing agreement for a loan (the “DIP Loan”), which granted a first priority lien on all prepetition and postpetition property of the Debtor’s estate, including inventory, but subject to valid, unavoidable liens in existence as of petition date. The prepetition debt was repaid with the DIP Loan.The vendor in Reichold, Covestro LLC (“Covestro”) supplied goods to the Debtor on credit, within 45 days of the bankruptcy filing. Covestro timely sought to exercise its reclamation rights within three days of the bankruptcy filing. Pursuant to an agreement between the parties, the Debtor paid the portion of the outstanding amount owed to the Covestro which would give rise to an administrative claim under section 503(b)(9). To recover the remaining balance, Covestro filed a proof of claim asserting reclamation rights, to which the liquidation trustee (the “Trustee”) objected.The Trustee objected to Covestro’s proof of claim asserting that the DIP lender’s rights related back to the prepetition lender’s rights. The DIP Loan repaid the prepetition loans, and as such the Trustee argued that the reclamation rights were extinguished or rendered “valueless,” because DIP lender stepped into the shoes and priority status of the prepetition lender.  The Trustee also argued that the prepetition and postpetition loan formed a single “integrated transaction.” In re Dairy Mart Convenience Store, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003); In re Dana Corp., 367 B.R. 409, 420 (Bankr. S.D.N.Y. 2007). The Trustee also argued that the payment of the prepetition debt is the equivalent of a postpetition sale of the Debtor’s assets, therefore also extinguishing Covestro’s reclamation claim.The Delaware Bankruptcy Court disagreed, reasoning that the rights of a lien-holder terminate when the debt is repaid, therefore the prepetition lender’s rights were terminated upon repayment, leaving the reclamation claim as first in line.The Court found that the reclamation claim had priority because it arose before the DIP lender’s rights, and since the prepetition lender’s rights were terminated, the DIP Loan did not cut off the reclamation rights. The Court also referenced the provisions of the order approving the DIP Loan, which carved out liens asserted pursuant to 546(b).The Court followed the Sixth Circuit’s decision to affirm in In re Phar-Mor, where the District Court held that a postpetition lender’s floating lien on the debtor’s inventory was not an assumption of the prepetition creditor’s lien.  In re Phar-Mor, 301 B.R. 482, 498(Bankr. N.D. Ohio 2003), aff’d 534 F.3d 502, 506-07(6th Cir. 2008). The Court qualified its ruling on the fact that the goods and inventory were not sold by the Debtor to repay the prepetition lender.The Court also rejected the Trustee’s Dana Corp argument that the prepetition loan and DIP Loan were one “integrated transaction,” emphasizing that they were two different loans by two different lenders made at two different times.As a result of this decision, vendors should carefully review the terms of postpetition financing on 546 claims. Postpetition lenders should also be aware that they do not automatically step into the shoes of a prepetition lender. [1]In re Reichold Holdings US, Inc., et al, No. 14-12237 (August 24, 2016), available at http://www.deb.uscourts.gov/sites/default/files/opinions/judge-mary-f.walrath/reichhold-memop-order.pdf