As a business owner, there are few moments as exciting as closing a big contract, especially after a long sales process.
To make sure the customer is satisfied, you take special precautions to ensure that their order is prepared to exacting standards, checking every detail three times. You also draw down on your line of credit to purchase the raw materials to execute the order. You then have your employees work overtime to make sure the first shipment goes out early. You appear to have done everything right.
So when you find out that this customer – the one you worked so hard to satisfy – can’t pay you because they are insolvent, it hurts. The inventory you shipped has already been delivered and is sitting in the bankrupt customer’s warehouse. What can you do?
Reclamation: Getting the Goods Back
The law provides certain protections to companies that have shipped goods to insolvent customers. The process, known as reclamation, is limited in scope, but in many cases is sufficient to retrieve the last shipment sent to the customer. Reclamation is a powerful tool because it allows you to avoid the long and expensive process of being repaid through the bankruptcy court. It is important however to understand its limitations.
There are two types of reclamation: reclamation before a bankruptcy petition is filed, and reclamation after a bankruptcy petition is filed. In either case, in order to reclaim, you must contact the customer in writing telling them that you are reclaiming, identify the specific items that are being reclaimed and instruct them to segregate (set apart) the goods. If it is a post-bankruptcy reclamation, this notice can also be filed with the bankruptcy court.
Reclamation Before Bankruptcy
A company does not have to file bankruptcy for you to take advantage of your rights under reclamation. Reclamation before bankruptcy is governed by the Uniform Commercial Code (UCC). According to the UCC section 2-702(2), if the seller has sold and delivered goods and then discovers that the buyer is insolvent, the seller has 10 days from the day the goods are received by the buyer to reclaim them.
It doesn’t cover anything shipped before that. If the buyer misrepresented their solvency during the three months prior to delivery of the goods, then the 10-day limitation does not apply.
For the purposes of reclamation, insolvency is defined in the UCC as follows: “(a) having generally ceased to pay debts in the ordinary course of business other than as a result of good faith dispute; (b) being unable to pay debts as they become due; or (c) being insolvent within the meaning of federal bankruptcy law.” Under bankruptcy law, insolvent means that the debts of the company exceed the fair value of the assets.
Important Limitations in Reclamation
There are some important limitations to reclamation under the UCC:
Possession: If the goods delivered are no longer in the possession of the buyer (usually because they resold them) then your rights under reclamation are lost.
Competing interests: If someone else has a “perfected security interest” in the goods, then they have preference over you with respect to ownership in the goods. A security interest is “a property interest created by agreement or by operation of law over assets to secure the performance of an obligation.” When an interest has been “perfected” it means that it has been legally registered which guarantees its preference over other interests.
One shot deal: Once you accept reclamation, you waive your rights to any other type of compensation related to the goods. This is important. If the goods shipped were highly customized for the customer and selling them to someone else will be difficult or impossible, then you may want to consider pursuing the company for the money owed instead of reclaiming the goods. This is risky since the company is insolvent. You have to choose between the lesser of two evils.
Reclamation After Bankruptcy
Regardless of whether the company files for Chapter 7 or Chapter 11 bankruptcy, you have the right to reclaim goods received by the buyer in the 45 days prior to the bankruptcy filing. Once filed, you have 20 days to submit the written reclamation notice.
Always be Prepared to Present a Reclamation Action
Anticipating a possible reclamation is important. When it happens, you have little time to protect your interests. You should:
- Include a standard clause in your sales contracts where the buyer acknowledges that they are solvent. If they aren’t solvent, then you can make the claim that they misrepresented their solvency and you have more than the 10 day limit.
- Have a boilerplate reclamation form prepared for each customer. It’s worth making the minimal effort to fill these out (even if you don’t need them) in advance so you don’t waste time when you need them. As with any financial matters that also deal with legal issues, it is wise to consult your attorney on the preparation of this boilerplate.
- Always know your customer. Obtain credit information prior to closing a sale. Talk to other suppliers who are actively working with them. If something seems off, then maybe the big contract really is too good to be true.
- Work with an attorney experienced in reclamation. Reclamation can be tricky and there are additional options available beyond those presented in this article. If the value of the inventory in question is significant, it pays to contract expert advice.