Reclamation Claims and Lien Priority

On August 24, 2016, Judge Mary F. Walrath of the Delaware Bankruptcy Court overruling an objection to claim for reclamation.   The decision was issued in the Reichold Holdings US, Inc. Bankruptcy (Case No. 14-12237) in the Delaware Bankruptcy Court.  A copy of the Opinion is available here.

While the background to this dispute is laid out in detail in the Opinion, it can be easily summarized.  A prepetition lender had a lien on substantially all the Debtor’s assets, including inventory.  Covestro LLC (the “Claimant”) supplied goods to the Debtor within the 45-day reclamation period.  Claimant issued a reclamation demand to the Debtor within days of the Debtor’s bankruptcy filing and later filed a proof of claim for all goods provided within the reclamation period.  As part of the DIP financing, the prepetition loan was paid in full and the DIP lender obtained a first priority lien on all prepetition and postpetition property of the Debtor’s estate, including inventory.  The DIP loan was repaid from the sale of the Debtor’s assets and a plan of liquidation was confirmed.  Opinion *1-3.

The Liquidation Trustee objected to Covestro’s claim, arguing that its security interest was rendered valueless when the Prepetition Loan was repaid.  Opinion at *3.  However, Judge Walrath disagreed, holding that once the prepetition lien was repaid, the reclamation lien became the first priority lien.  “The function of a lien is to secure a debt; once that debt is repaid, the lien and the rights of the lien-holder terminate.”  Opinion at *8.  The DIP lien was expressly subject to reclamation rights.  Id.  Judge Walrath held that if the prepetition lien holder had foreclosed on the inventory, the analysis would be different.  However, “Covestro’s goods were not sold and their proceeds were not paid to the Prepetition Lender.”  Opinion at *9 (emphasis in original).

Judge Walrath concluded by opining that “Because Covestro’s rights arose before the DIP Lenders had any rights in the goods, the Court concludes that the DIP Lenders do not have prior rights in the goods.”  Id.  The Court thus overruled the Liquidating Trustee’s objection to the claim.

John Bird is a bankruptcy attorney with the law firm of Fox Rothschild LLP.  John is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach John at (302) 622-4263 or at [email protected].