Creditor's Reclamation Rights Rendered Valueless Against Rights of Secured Creditor

In Galey & Lord, Inc. v. Arley Corporation (In re Arlco, Inc.), the United States Bankruptcy Court for the Southern District of New York held that a creditor's reclamation rights were subordinate to the rights of a perfected secured creditor in the debtor's assets. The reclamation claim was rendered valueless because the proceeds from the disposition of the collateral subject to reclamation were applied entirely toward the secured creditor's claim. In addition, the court held that the reclaiming creditor could not assert an administrative claim or replacement lien for the value of the goods subject to reclamation, nor was it entitled to a marshaling of assets remedy.

Reclamation Rights under the Bankruptcy Code

Section 546(c) of the Bankruptcy Code expressly preserves the applicable nonbankruptcy rights of a seller of goods to reclaim goods it has sold to an insolvent debtor if:

  1. it can meet the statutory requirements for reclamation under nonbankruptcy law;
  2. it can prove that it sold the goods to the debtor in the ordinary course of business; and
  3. it made a written demand for reclamation within ten days of the debtor's receipt of the goods.

Under the Uniform Commercial Code ("U.C.C."), which is the basis of a seller's reclamation rights, a seller's right to reclaim goods is subject to the rights of a buyer in the ordinary course or other good faith purchaser. As observed by the court in Galey, most courts treat a holder of a prior perfected, floating lien on inventory as a good faith purchaser with rights superior to those of a reclaiming seller.

Facts in Galey & Lord

Galey & Lord ("G&L") provided textile goods on credit to Arley Corporation, one of the chapter 11 debtors. On May 16, 1997, approximately three weeks before the commencement of the debtors' chapter 11 cases, G&L sent Arley a letter in which it demanded the return of its merchandise pursuant to the relevant U.C.C. section giving it a right of reclamation of the goods provided to Arley. Since 1995, however, CIT Group/Business Credit Inc. held a perfected security interest in substantially all of Arley's assets, including the goods provided by G&L. On June 9, 1997, G&L commenced an adversary proceeding against Arley to reclaim the goods referred to in its letter. On September 15, 1997, the court approved the sale of substantially all of the debtors' assets, and the cases were later converted to liquidation cases under chapter 7. G&L filed a motion for summary judgment asserting that it had complied with the statutory requirements for establishing a claim for reclamation. The chapter 7 trustee maintained that Arley was entitled to judgment as a matter of law because G&L's reclamation claim was subordinate to CIT's claim as a good faith purchaser for value of Arley's assets.

The Bankruptcy Court's Analysis

The court first addressed whether CIT, as the holder of a prior perfected lien on Arley's inventory, was a good faith purchaser for value, thereby entitling it to rights superior to those of G&L, the reclaiming creditor. The court prefaced its analysis by noting that the Bankruptcy Code merely adheres to applicable nonbankruptcy law regarding a seller's right to reclamation, but it does not purport to expand or create any new rights that would otherwise inure to the reclaiming creditor. The court further noted the ample case law reasoning that holders of prior perfected liens on inventory constitute good faith purchasers with rights superior to those of reclaiming creditors. The court concluded that the plain language of the U.C.C. dictates that creditors who acquire security interests in after-acquired property and who act in good faith and take for value, which includes the acquisition of rights as security for total or partial satisfaction of a preexisting claim, are good faith purchasers with rights superior to those of reclaiming creditors.

Specifically, the court rejected G&L's contention that parties such as CIT, which acquired its security interest in Arley's assets pursuant to Article 9 of the U.C.C. (which governs secured transactions), were not good faith purchasers entitled to the protections afforded under the reclamation section of Article 2 of the U.C.C. (which deals with sales). Deriving the U.C.C. definition of a good faith purchaser for value from several subsections of the U.C.C.'s general definitions, the court reasoned that the definition of a "purchaser" is broad enough to include Article 9 secured parties such as CIT. In addition, the court specifically noted that G&L neither challenged the validity of CIT's lien on Arley's inventory nor alleged that CIT had acted in bad faith in its dealings with Arley. The court noted that an entity that advances funds secured by a valid lien on the borrower's assets is a good faith purchaser for value absent a showing of misconduct. Moreover, the court found that CIT's refusal to continue funding Arley without informing G&L did not impact CIT's status as a good faith purchaser for value as long as that decision was commercially reasonable.

Having concluded that CIT was a good faith purchaser for value, the court noted that the proceeds realized from the sale of Arley's inventory were applied in satisfaction of CIT's secured claim. G&L could not look to other assets of Arley outside of the purview of its reclamation claim to satisfy its debt because a reclaiming seller is entitled to reclamation only when the surplus collateral consists of the specific goods sold by the reclaiming seller or the proceeds traceable from those goods. Since the proceeds from the sale of the goods subject to G&L's reclamation claim were insufficient to fully satisfy the debt owed to CIT, there were no excess proceeds to satisfy G&L's reclamation claim, which was therefore rendered valueless.

The court rejected G&L's remaining assertions, reasoning that G&L was entitled neither to an administrative claim nor replacement lien, nor to the application of a marshaling remedy. Echoing its previous statement that the Bankruptcy Code does not expand or enhance the rights enjoyed by a reclaiming seller outside of bankruptcy, the court disagreed with those cases holding that a reclaiming seller, which otherwise meets the necessary criteria to establish a valid reclamation claim, is entitled to an administrative claim or replacement lien for the full amount of goods subject to its claim. Instead, the court adopted the majority view: A reclaiming creditor under nonbankruptcy law is not entitled to any enhanced treatment of its claim vis-à-vis other unsecured creditors after the goods subject to its reclamation claim are used to satisfy the claim of a good faith purchaser for value, and the Bankruptcy Code should not confer benefits upon the reclaiming creditor that are not available under nonbankruptcy law. Thus, a reclaiming creditor's statutory right to reclaim is limited to any remaining value attributable to the goods subject to its reclamation claim after satisfaction of a good faith purchaser's claim. The court noted that an administrative claim or lien may be granted when the reclaiming seller's goods or traceable proceeds thereof exceed the value of the superior claimant's claim. However, because all of the inventory subject to G&L's reclamation claim was applied to satisfy CIT's secured claim, G&L's reclamation claim was rendered valueless.

The court also rejected G&L's assertion that the debtors' assets should be marshaled. The equitable principle of marshaling is applicable when a senior secured creditor can collect on its debt from multiple sources of the debtor's assets, while a junior secured creditor has recourse against only one of these sources. Application of a marshaling remedy would compel the senior secured creditor to first attempt to collect on its debt from the property or fund in which the junior secured creditor has no interest, thereby enhancing the possibility that there will be remaining value for the junior secured creditor to realize payment on account of its debt. The court refused to apply this doctrine for two reasons.

  • First, G&L was not a secured creditor. Even though G&L may have had a valid reclamation claim potentially entitling it to a higher priority than general unsecured creditors, its reclamation claim was not a security interest in the debtor's property.
  • Second, the court stated that marshaling is not a remedy that may be raised against a good faith purchaser.


A reclaiming creditor's remedies are entirely dependent on whether any of the goods or proceeds traceable to its claim still remain after satisfaction of the debt owed to a good faith purchaser for value. Although this result severely constrains any advantage that reclamation creditors may enjoy over general unsecured creditors when a good faith purchaser for value has a security interest in reclaimed goods or proceeds, it is consistent with nonbankruptcy law, which does not grant a reclaiming seller a priority interest in the buyer's assets except for the goods subject to reclamation. Thus, as in Galey, the reclaiming creditor's claim to the goods or proceeds attributable to its reclamation claim is subordinate and effectively trumped by the claim of a good faith purchaser for value to such goods and proceeds. In such cases, the reclamation claim may be rendered valueless, leaving the reclaiming creditor in no better position than other similarly situated general unsecured creditors.

Galey & Lord, Inc. v. Arley Corp. (In re Arlco, Inc.), 239 B.R. 261 (Bankr. S.D.N.Y. 1999).