A vendor will find itself in an unpleasant situation when a customer files a Chapter 11 bankruptcy case and has purchased, but not paid for, a substantial amount of goods.

All may not be lost, however. The vendor may receive special treatment under the Bankruptcy Code. Consider the following example:

A vendor sells goods, such as inventory, supplies or equipment, to a major customer. Customer filed a Chapter 11 bankruptcy case on January 1, 2010. Vendor sold and delivered $200,000 worth of goods to Customer within 45 days before the Chapter 11 filing. Of that, Vendor delivered $100,000 worth of goods within 20 days before the filing.

Given the timing of the deliveries and the filing, Vendor has at least two possibilities to explore.

First, Vendor may have a “reclamation claim” under Section 546(c) of the Bankruptcy Code. A vendor’s right of reclamation exists under the following conditions:

  1. The right of reclamation is subject to the rights of any other creditor that has a security interest in the goods or the proceeds of sale of the goods.
  2. The customer must have been insolvent when it received the goods. In most cases, insolvency means that the customer’s debts were greater than the value of its assets.
  3. The vendor sold the goods to the customer in the ordinary course of the vendor’s business.
  4. The customer must have received the goods within 45 days before the bankruptcy filing.
  5. The vendor must make a written demand by 45 days after the customer received the goods, OR by 20 days after the bankruptcy filing if the 45-day period expired after the bankruptcy filing.

If these requirements are met, Vendor may be able to recover the goods that Customer still had when the reclamation claim was made, or the Bankruptcy Court may grant Vendor special treatment to protect its reclamation right. If Customer still has the $200,000 worth of goods when Vendor makes its demand, that amount would apply. If Customer has sold or used some or all of the goods, the reclamation claim would decrease accordingly.

Second, Vendor may have what is called a “503(b)(9) claim, as described in Section 503(b)(9) of the Bankruptcy Code.

“Administrative expense” claims are given priority and are paid in full before general, unsecured claims that arose before the bankruptcy petition was filed. Even though 503(b)(9) claims are actually unsecured prepetition claims, they have the priority of administrative expense claims if the following conditions are met:

  1. The customer received the goods within 20 days before the bankruptcy filing.
  2. The vendor sold the goods to the customer in the ordinary course of the customer’s business.

In the example above, Vendor may have a 503(b)(9) claim for the $100,000 of goods delivered to Customer within 20 days before the bankruptcy filing, regardless of whether Customer still has the goods. If Customer proposes a Plan of Reorganization, the claim must be paid in full before the Plan takes effect. If the case is unsuccessful and prepetition claims do not receive any payment, the 503(b)(9) claim would at least share in any distribution available to pay to administrative claimants.

Congress enacted Section 509(b)(9) in recent years, and there is discussion that it may be amended or repealed. Please be aware that, as in any situation, one or both of Sections 546(c) and 503(b)(9) may change.