FACT SCENARIO: You are a major manufacturer of office furniture and sales are at an all time high. Your biggest customer has continued to purchase its inventory from you, but payments have become less punctual. You recently learned that the customer has ordered 100 chairs, which need to be delivered in 30 days. You are somewhat apprehensive about selling the customer the chairs because the customer currently owes you more than $50,000, and you have not received a payment from them within the past 60 days. If you sell the customer the chairs, what remedies are available to you if you learn that the customer is insolvent?
THE SELLER'S RIGHTS: "Insolvent" is defined in section 1-201 of Maryland's Uniform Commercial Code as either a person who has ceased to pay his debts in the ordinary course of business, cannot pay his debts as they become due, or is insolvent within the meaning of the Bankruptcy Code. Under the Bankruptcy Code, "insolvency" is defined as a balance sheet test-- liabilities must exceed assets.
When a customer is insolvent or on the verge of insolvency, a seller has several options available to protect its interests. The first situation occurs where the customer is not in bankruptcy and the goods have not yet been shipped. If you learn that the customer is insolvent, you can either stop delivery or refuse to deliver the chairs, unless the customer agrees to pay cash in advance.
On the other hand, if you learn of the customer's financial troubles after the chairs have been shipped, you may, if the customer is insolvent, demand reclamation or the return of the chairs under section 2-702 of Maryland's Uniform Commercial Code. In order to trigger your reclamation rights, you must make demand within 10 days after the customer receives the chairs. Once 10 days has elapsed from the date of receipt, a general right to reclamation has been lost. If, however, the customer has misrepresented his solvency within the last 3 months, then the 10-day limitation does not apply. In some circumstances, this remedy may have limited utility, particularly if the chairs are being bought by the customer for resale and are shipped out to the ultimate customer within days of their receipt. The demand for reclamation is only effective if the goods are still in the possession of the customer and will not be successful if the chairs are already delivered to a good faith purchaser.
In the event that the customer files bankruptcy, the rules are slightly different. Section 546 of the Bankruptcy Code also recognizes a right to reclamation; however, the demand for reclamation must be made in writing. In addition, the 10-day period to make your demand for reclamation extends to twenty days if the customer filed for bankruptcy during the 10-day period. For instance, if the customer files bankruptcy nine days after the goods are received, this will trigger an additional eleven days within which to assert reclamation rights. In such circumstances, a written demand for reclamation may be filed at any time within twenty days from when the goods are received.
The bankruptcy court has the power to grant alternative relief such as an administrative priority claim in the bankruptcy or it may grant a lien to secure the claim. Entitlement to either an administrative priority claim or a lien is an invaluable remedy in that while general unsecured creditors rarely receive full payment out of the bankruptcy, priority and secured claimants very often receive payment in full.
As a matter of good credit practice, if you are insecure about the customer's ability to pay, you should periodically demand in writing adequate assurance that the customer is financially able to pay. As noted above, a misrepresentation as to solvency will eliminate the 10-day limitations on reclamation rights.
The Bankruptcy Code also enables the court to fashion a remedy, other than simply return of the goods. This might be desirable for both parties if the goods are specially manufactured for the customer and would have no utility if they were returned.
For more information on reclamation and related subjects, please contact Lynn Kohen, an associate in the Creditors Rights Department of Tydings & Rosenberg LLP at 410/752-9748 or by e-mail at lkohen@tydingslaw.com.