Greenbaum, Rowe, Smith & Davis LLP

• GreenbaumLaw.com
• Newsletter Homepage
• Past Issues
• Subscribe

Seller Beware!

By Lawrence P. Maher, Esq. and Jill R. Bier, Esq.

 

A seller of commercial goods is particularly vulnerable in the current climate of economic instability. Buyers that purchase goods for inventory typically get credit terms from their manufacturers or distributors. When those buyers encounter financial problems, they are most likely to extend or ignore payables to those manufacturers or distributors. If a buyer’s financial problems persist and result in insolvency, unsecured sellers will probably lose any chance of recovery.

 

Recent high-profile bankruptcies emphasize the seller’s dilemma and necessitate reevaluation of the historic relationship between the sellers of commercial inventory and their buyers. When “Big Box” retailers such as K-Mart and specialty stores like Linens ’N Things, National Liquidators, Circuit City, and the Bombay Company filed bankruptcy it had a devastating impact on their vendors. While those retailers were well-stocked with inventory to continue their business in Chapter 11 or conduct liquidation sales, the unsecured sellers that supplied that inventory were relegated to the lowest class of creditors to receive any possible dividends in the bankruptcy cases. These cases and current economic trends raise the fundamental question of what rights and remedies are available to protect a seller.

 

A seller is most likely to be paid if it obtains security (a legal mechanism to assure payment) for the amounts due from the buyer. It is appropriate for the seller to require a purchase money security interest in the goods that are being sold to secure repayment of the purchase price. The purchase money security interest is obtained pursuant to Section 9-324 of the Uniform Commercial Code that requires the seller to (i) obtain a security agreement from the buyer; (ii) perfect the security interest, which is achieved by filing a financing statement with the appropriate governmental entity; (iii) notify a lender or any other holder of a conflicting security interest in the inventory within timeframes stipulated in the code. Even if the buyer has financed its inventory and granted a “blanket lien” to its lender, the seller that complies with Section 9-324 will have rights to the goods that were sold to the buyer that are superior to the lender holding the blanket lien. Therefore, a seller that has obtained a purchase money security interest in goods will have a priority right to recover the goods if payment is not received and will be treated as a secured creditor if the buyer files bankruptcy. Secured creditors usually are paid before unsecured creditors in a bankruptcy case and, although that payment may be for only a percentage of the value of the goods, it may not be a total loss.

 

Under certain circumstances a seller may request alternative forms of security, such as letters of credit or guarantees, but the purchase money security interest is the most prevalent form of security. Manufacturers and distributors are aware that a seller that requires security from its customers may face a competitive disadvantage. The seller may have long-standing relationships with customers for the sale of goods on credit terms and a seller soliciting prospective new customers will be pressured to extend terms that are customary in the marketplace. When faced with these competitive realities a seller must decide whether to insist on security from a buyer or accept the risk of a total loss if that buyer becomes insolvent.

 

Even if goods have been sold without the benefit of security, a vigilant seller has some possible remedies when it discovers that the buyer is insolvent. Section 2-702 of the Uniform Commercial Code permits a seller to refuse to deliver goods to an insolvent buyer until it receives payment for the goods that were ordered, any other goods previously delivered under the same purchase order and, arguably, all other open accounts with the buyer. In addition, the seller can stop any shipments and repossess any goods in the possession of a carrier or bailee, a party holding the goods, before they are delivered to the insolvent buyer or its agent. Section 2-702 also authorizes a seller to reclaim goods that have already been delivered to an insolvent buyer so long as the buyer still has the goods and seller makes demand for return of the goods within ten days after the goods are received by the buyer. Unfortunately, the right to reclaim goods from an insolvent buyer is subordinate to the rights ofthe holder of a perfected security interest in the goods. Therefore, to the extent that most commercial buyers will have granted a blanket lien on their inventory, the seller’s reclamation claim to the delivered goods will not have priority.

 

Amendments to the Bankruptcy Code in 2005 slightly improved the positions of unsecured sellers in a bankruptcy case. Section 546(c)(1) increased the amount of time for sellers to give a reclamation notice from ten days to forty-five days after a buyer/debtor receives the goods. If bankruptcy is filed during that forty-five day period, the seller has twenty days after filing to give notice and preserve the reclamation claim. Although the reclaiming seller will still be subordinate to a lender with a security interest in the buyer’s inventory, the reclaiming seller has the opportunity to improve its position over general unsecured creditors of the bankrupt buyer. Additionally, Section 503(b)(9) was added to the Bankruptcy Code in 2005 to provide that a seller can receive an administrative expense claim, which will have priority over general unsecured creditors, for the value of any goods received by the debtor within twenty days before the bankruptcy petition was filed. The seller is entitled to this administrative expense claim without the necessity of any demand or reclamation notice to the debtor.

 

Sellers of commercial goods must remain ever vigilant about protecting their rights bearing in mind the competitive marketplace. That vigilance must be even greater during difficult economic times when the risk of loss is greater.