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Satisfaction of a Prepetition Loan by a DIP Loan Does Not Extinguish Vendor’s Reclamation Rights Under Section 546(c)

In re Reichhold Holdings US, Inc., No. 14-12237 (MFW), 2016 WL 4479286 (Bankr. D. Del. Aug. 24, 2016)

In this Memorandum Opinion, the Court overruled a limited reclamation claims objection asserted by a liquidating trustee, who argued that a creditor’s reclamation rights were cut-off by a postpetition loan that refinanced a prior perfected prepetition loan.  In doing so, the Court sided with the Sixth Circuit Court of Appeals and rejected a line of cases from the Bankruptcy Court for the Southern District of New York. 

After Reichhold Holdings US, Inc. (the “Debtor”) filed its chapter 11 petition, Covestro LLC (“Covestro”) made a reclamation demand for goods delivered within 45 days of the petition date under Bankruptcy Code section 546(c).  The Debtor made payments to satisfy the 503(b)(9) portion of Covestro’s claim for goods sold within 20 days of the petition date.  However, Covestro remained unpaid for goods sold between 21 and 45 days of the petition date and accordingly, filed a proof of claim asserting administrative expense priority on account thereof (the “Reclamation Claim”).  The Debtor—and later the liquidating trustee (the “Trustee”)—objected to the Reclamation Claim, arguing that it was rendered valueless when the Debtor’s fully secured prepetition, first priority loan (the “Prepetition Loan”) was repaid by the Debtor’s postpetition financing (the “DIP Loan”) provided by a group of lenders (the “DIP Lenders”).

Bankruptcy Code section 546(c) confirms a vendor’s right to reclaim goods sold to a debtor under state law.  However, a reclamation right is subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof. 

In Reichhold, the Trustee relied on several bankruptcy cases from the Southern District of New York to argue that the DIP Lenders’ rights related back to the prepetition lender’s rights and thus, cutoff Covestro’s reclamation rights because the DIP Loan repaid the Prepetition Loan, treating the two liens as an “integrated transaction.”  Op. at *6-7 (citing In re Dana Corp., 367 B.R. 409 (Bankr. S.D.N.Y. 2007); In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003)).  In addition, the Trustee argued that Covestro’s reclamation goods (or proceeds therefrom) secured the Prepetition Loan and were used to repay that loan by serving as collateral for the DIP Loan, and therefore, were “effectively disposed of” and rendered valueless. 

The Court, however, disagreed with the Trustee, opting to follow the reasoning of the court in In re Phar-Mor, as affirmed by the Sixth Circuit.  In Phar-Mor, the court held that a post-petition lender’s lien on inventory did not constitute an assumption of the prepetition creditor’s lien, but an entirely new lien that did not defeat an intervening reclamation claim.  301 B.R. 482, 498 (Bankr. N.D. Ohio 2003).  Here, like in Phar-Mor, the Court held that the pre- and post-petition loans were distinct—not integrated—such that once the Prepetition Loan was repaid, the liens securing that debt and the rights of the prepetition lender terminated, subjecting the DIP Loan to Covestro’s already existing reclamation rights.  Whether or not the DIP Loan was secured by the reclaimed goods was irrelevant to the Court.  What mattered was when the parties’ respective rights arose and here, the vendor’s rights arose prior to those of the DIP Lenders, and therefore, the Trustee’s objection was overruled.