Is Your Inventory Lien Enforceable?

Inventory lenders beware. A 1994 amendment to the Bankruptcy Code may turn the priority scheme on its head.

Section 546(h) of the Bankruptcy Code permits a debtor to return goods which were shipped pre-petition by a supplier to a debtor in exchange for a credit of the purchase price, as long as certain conditions are met.

This provision is troublesome in many respects. First, a debtor is entitled to make a post-petition preferential transfer to a pre-petition creditor, so that the creditor will receive payment in full on a claim which might otherwise have been paid pennies on the dollar.

Second, the statute is silent on the rights of an inventory-secured creditor vis-a-vis the goods to be returned. Can the debtor return the goods only subject to the lien, or only if the debtor can demonstrate that the lender has an adequate equity cushion or is otherwise adequately protected? Unfortunately, there are no reported decisions which address the rights of the secured creditor in this circumstance.

A debtor has a strong incentive to take advantage of the benefits of Section 546(h): The debtor can transfer its slow-moving or excess inventory at full cost.

An inventory lender must closely monitor a debtor's conduct in the early stages of a bankruptcy proceeding to assure itself that 546(h) is not utilized to the lender's disadvantage.