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Sua Sponte

Alan I. Nahmias
Encino, CA
anahmias@prnlaw.com

Sitting on the tarmac at JFK, as I watch the sun set through my airplane window, heading back from the CLLA’s just-concluded Eastern Region meeting in New York, I keep reflecting on two words: “pride” and “commitment.” These qualities represent much of the Bankruptcy Section’s contribution to the New York meeting, but rather than giving you a conference overview, I’d like to discuss in some detail one important accomplishment.

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Case Analysis

Michael P. DiLaura
Jaffe, Raitt, Heuer, & Weiss, P.C.
mdilaura@jaffelaw.com

Vendors’ Reclamation Claims Not Entitled to Administrative Expense Priority

Summary: In Yenkin-Majestic Paint Corp. v. Wheeling-Pittsburg Steel Corp., 309 B.R. 277 (6 th Cir. B.A.P. 2004), the Bankruptcy Appellate Panel for the Sixth Circuit affirmed the United States Bankruptcy Court for the Northern District of Ohio’s finding that pursuant to 11 U.S.C. § 546(c) and applicable state law, several vendor reclamation claims had no administrative expense priority due to the post-petition lender’s prior floating liens and were, therefore, general unsecured claims. The Yenkin court reasoned that because (i) the post-petition lender was given superpriority status and (ii) the value of each individual vendor’s reclamation claim did not exceed the secured indebtedness, unless there were traceable goods and/or proceeds after the secured lenders were paid in full, the reclamation claims would be of no value.

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Case Law Update

Paige E. Barr
Kenneth B. Moll & Associates
peb@kbmoll.com

Eleventh Hour Fax of Proof of Claim Is Not a Timely Proof of Claim When Notice of Bar Date Requires Mailing. Notice of Claims Bar Date required creditors to mail their proofs of claim to a designated post office and to be received by the claims agent by November 15, 2002. However, the creditor in this case faxed its proof of claim to counsel for the trustee on November 15, 2002. The court upheld the bankruptcy court finding that faxing the proof of claim was unacceptable since the notice of the claims bar date specifically stated that claims must be mailed to the post office. Thus, the proof of claim was not timely. In re Outboard Marine Inc., 2004 U.S. App. LEXIS 21580 (7th Cir. Oct. 18, 2004).

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Sua Sponte

Sitting on the tarmac at JFK, as I watch the sun set through my airplane window, heading back from the CLLA’s just-concluded Eastern Region meeting in New York, I keep reflecting on two words: “pride” and “commitment.” These qualities represent much of the Bankruptcy Section’s contribution to the New York meeting, but rather than giving you a conference overview, I’d like to discuss in some detail one important accomplishment.

During the New York Conference, our Section meets twice, typically Thursday night and Sunday morning. The agenda for each day’s meeting is always full, and time to take up new matters tends to be scarce. Nevertheless, prior to this past weekend’s meetings, the invaluable Sarah Jolie, who somehow always makes sure the trains arrive on time and that there is order in our Section, discussed with me what other topics might be added to the agenda which would be of interest and benefit to our Section. After conferring, we agreed to slot time to discuss the future direction of our Section, not just where the Section would be six to twelve months from now, but in three to five years and beyond.

With that subject placed on the agenda as only a broad concept, much time was spent Thursday afternoon exchanging views and positions on where the Section seemed to be headed and whether the direction might need any adjustment. Most of those in attendance agreed that perhaps it was time to reexamine our Section’s objectives and how best to accomplish whatever those were deemed to be. From the discussions, it became apparent that the best course of action would be to form a Strategic Planning Committee.

Anyone who has spent any time in organizations like the Commercial Law League recognizes that committees like this are often formed with some reticence or resistance to change by the organization’s members, and obtaining sincere commitments from those best in a position to help can be difficult. What I saw over the past few days, however, convinced me that I have spent the last fifteen years with the right professional organization. Rather than twisting arms to get people to volunteer or calling upon old friends for favors, I was overwhelmed by the almost unanimous support for the concept and agreement by virtually all in attendance at the Executive Council meetings to serve on the Committee.

Pride and commitment. Our members are proud of what we have built our Section into, committed to maintaining its status as one of the nation’s preeminent professional organizations devoted to the field of bankruptcy law, and willing to do the hard work necessary to sustain this lofty position.

I am pleased to announce that former Chair and current Treasurer of our Section, Jay Welford, who has devoted countless hours of both his professional and personal lives, has agreed to co-chair the Committee with one of our newest members, Alan Ramos. While Alan may be new to our Section, I know him from other professional affiliations to be a capable and tireless worker who sets his standards impossibly high, yet always seems to meet or exceed them. Assisting the Committee as its Special Advisor will be Max Moses, former Executive Director of the Commercial Law League, who has graciously agreed to give of his valuable time and limitless experience. Additionally, the Honorable Judith Fitzgerald, Chief Judge for the United States Bankruptcy Court of the Western District of Pennsylvania and former President of the NCBJ and Program Chair for our NCBJ events; Fred Luper, former President of the Commercial Law League and a longstanding Bankruptcy Section member; and former Bankruptcy Section Chair Judy Miller have all joined the Committee as members.

It is presently envisioned that the Committee, which now exceeds 15, but is still open to anyone else interested in joining, will hold its first conference call during the early part of December, with a follow up call to take place some time in mid to late January. Thereafter, it is our hope that a planning conference can be held over a long weekend, perhaps in March of 2005, in a location yet to be determined.

I offer my sincerest thanks to each of you who have volunteered to chair or serve on the Committee, as well as those of you who have not, but would still like to do so. If you have not yet joined the Committee and would like to, you may do so by contacting either of its Co-Chairs, Jay Welford [jwelford@jaffelaw.com] or Alan Ramos, [ or me [

I look forward to reporting back to you next month on the initial results of the Committee’s efforts. Until then, I hope that each of you and your families have a wonderful and safe Thanksgiving.

Alan I. Nahmias
Plotkin, Rapoport & Nahmias
16633 Ventura Boulevard, Suite 800,
Encino, CA 91436-1836
Phone: 818-995-2555
Fax: 818-907-9261

Email: anahmias@prnlaw.com
Web site: www.prnlaw.com

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Case Analysis

Vendors’ Reclamation Claims Not Entitled to Administrative Expense Priority

Summary: In Yenkin-Majestic Paint Corp. v. Wheeling-Pittsburg Steel Corp., 309 B.R. 277 (6th Cir. B.A.P. 2004), the Bankruptcy Appellate Panel for the Sixth Circuit affirmed the United States Bankruptcy Court for the Northern District of Ohio’s finding that pursuant to 11 U.S.C. § 546(c) and applicable state law, several vendor reclamation claims had no administrative expense priority due to the post-petition lender’s prior floating liens and were, therefore, general unsecured claims. The Yenkin court reasoned that because (i) the post-petition lender was given superpriority status and (ii) the value of each individual vendor’s reclamation claim did not exceed the secured indebtedness, unless there were traceable goods and/or proceeds after the secured lenders were paid in full, the reclamation claims would be of no value.

Facts: On November 16, 2000 (“Petition Date”), Pittsburg-Canfield Corporation and its affiliate entities (“Debtors”) filed voluntary petitions under the chapter 11 of the Bankruptcy Code. Yenkin-Majestic Paint Corporation, Valspar Corporation and Mississippi Lime Company (collectively the “Vendors”) each sold goods on credit to the Debtors prior to the bankruptcy filing in the ordinary course of both the Vendors’ and Debtors’ business practices. Each of the Vendors timely demanded reclamation of certain goods delivered to the Debtors in accordance with UCC § 2-702.

The Debtors’ pre-petition inventory served as collateral for loans made by its Pre-Petition Lenders in the amount of approximately $115 million. The Vendors alleged that the value of the pre-petition inventory was $245 million. Thus the Vendors argued that as of the Petition Date, the Pre-Petition Lenders were oversecured by at least $130 million.

The Debtors’ Post-Petition Financing Order, approved by the bankruptcy court one month after the Petition Date, provided: (i) the Pre-Petition Lenders were paid in full; (ii) all liens or security interests of the Pre-Petition Lenders were assigned and transferred to the post-petition lenders (the “DIP Lenders”); (iii) the DIP Lenders were granted superpriority status pursuant to § 364(c) of the Bankruptcy Code; and (iv) the DIP Lenders’ advances were also secured by a floating first priority, perfected lien upon all of the Debtors’ inventory and proceeds thereof. The Post-Petition Financing Order authorized the Debtors to borrow up to $290 million.

As for the DIP Lenders’ superpriority status, the Post-Petition Financing Order provided that the “DIP Credit Facility shall be an allowed administrative expense claim . . . with priority . . . over all administrative expense claims . . . against the Debtors, now existing or hereafter arising, of any kind or nature whatsoever including, without limitation, administrative expenses [specified or ordered pursuant to § 546(c)].” The Vendors did not appeal the Post-Petition Financing Order.

On March 8, 2001, the bankruptcy court entered an order establishing the procedures for the liquidation and treatment of reclamation claims and prohibiting third parties from interfering with the Debtors’ use and disposition of its goods in inventory (the “Reclamation Procedures Order”). In accordance with the Reclamation Procedures Order, Debtors filed a reclamation claims report that set forth the amount of each valid reclamation claim pursuant to its corporate records. The Vendors agreed with the Debtors’ valuation of their reclamation claims in the following amounts: Yenkin-Majestic $107,612; Mississippi Lime Co. $143,353; and Valspar Corp. $203,989. The Reclamation Procedures Order provided that these agreed upon claims were “deemed liquidated without further action by the Debtors or further action of the Court, subject to such further defenses as may exist by reason of liens granted to the Debtors’ secured creditors.”

On January 7, 2003, the Debtors filed a motion requesting the court to determine that the Vendors’ reclamation claims were not entitled to administrative expense status but were merely administrative claims (the “Reclamation Motion”). The Debtors argued that all of the goods subject to the Vendors’ reclamation claims were used in the ordinary course of Debtors’ business and the proceeds were applied to repay the DIP Lenders. The Vendors objected to the Reclamation Motion, arguing, inter alia, that § 546(c) requires a bankruptcy court to grant them an administrative expense claim because the court denied them the right to reclaim the inventory.

The bankruptcy court overruled the Vendors’ objection and granted the Debtors’ Reclamation Motion, holding that the Vendors’ rights under applicable state law limited them to recovery of goods not yet sold. Because the goods had been used in the Debtors’ manufacturing process, they were no longer available for recovery and the Vendors’ rights were extinguished. Accordingly, because the Vendors did not have any rights under state law, they had no right to an administrative priority. The Vendors appealed.

Discussion: On appeal, the Appellate Panel considered whether the Vendors reclamation claims had any value where all of the Debtors’ inventory was encumbered by a properly perfected lien on all of the Debtors’ current and after-acquired inventory and no one Vendor’s goods were of sufficient value to pay either the Pre-Petition Lenders or the DIP Lenders in full.

The Appellate Panel recognized that there are two lines of cases interpreting the rights of reclaiming sellers to receive a lien or an administrative priority under § 546(c). The Vendors relied on a line of cases adopted by bankruptcy courts in Florida, New York, Kentucky and Ohio, arguing that regardless of the value of the reclamation claim of the individual vendors, § 546(c) entitled them to a lien or an administrative expense to the full extent of their valid reclamation claims.

The Appellate Panel criticized this line of cases for its failure to consider that § 546(c) requires the reclaiming seller to have been entitled to a reclamation claim under state law. The Appellate Panel further observed that if the claim is valueless under state law, then it cannot have any value under the Bankruptcy Code. Thus, the Appellate Panel stated, the line of cases relied on by the Vendors wrongly elevated the reclaiming sellers to an unwarranted status above the general unsecured class via one of two methods: (i) granting the reclaiming seller administrative status without considering the value of the original reclamation claim over and above the priority interest of the secured creditor; or (ii) by granting the reclaiming seller a lien in other assets of the bankruptcy estate in which the reclaiming seller originally held no interest.

The second line of cases discussed by the Appellate Panel holds that reclaiming sellers are not entitled to a lien or administrative priority status ahead of the general unsecured creditors in other assets of the bankruptcy estate. The treatment of reclamation claims endorsed by these cases is consistent with a leading bankruptcy treatise as well.

Citing Collier on Bankruptcy, the Appellate Panel stated, “If the goods are not returned to the seller, the seller must be given alternative remedies under § 546(c)(2), i.e., an administrative expense priority claim or a secured claim. In this case, however, the administrative expense priority claim or the secured claim may only be paid from the residual value of the goods after payment of all secured claims collateralized by the goods. If, in satisfying their claims, secured creditors take the entire value of the goods, the seller’s administrative expense claim or lien is worthless and may not be satisfied from other assets of the estate.”

The Appellate Panel further noted that Congress did not intend to grant additional rights to sellers when it drafted § 546(c). Pursuant to state law, a seller’s reclamation right would be valueless if the goods were worth less than the value of the floating lien. If the remedy under state law has no value, then the substitute remedy afforded by the Bankruptcy Code would, likewise, have no value.

After deciding that this second line of cases controls, the Appellate Panel applied this reasoning to the Vendors’ reclamation claims. The Appellate Panel held that the Vendors were not entitled to a lien or administrative expense status with respect to their reclamation claims because the individual vendors’ claims were insufficient to satisfy either the Pre-Petition Lenders or the DIP Lenders. The Appellate Panel noted that this is a harsh remedy, but stated that the Post-Petition Financing Order granted the DIP Lenders a superpriority lien on the Debtors’ assets and that order was final and had not been appealed by the Vendors. Furthermore, the Vendors could have more adequately protected their interests by retaining and perfecting a purchase money security interest in the goods sold. Accordingly, the Appellate Panel affirmed the decision of the bankruptcy court granting the Debtor’s Reclamation Motion and declaring the Vendors’ claims to be unsecured.

Comments: As this cases reveals, Bankruptcy Code § 546(c) does not grant reclaiming creditors any rights that said creditors do not have under applicable state law. Therefore, because the UCC’s provision on reclamation expressly limits reclamation claims as being subject to lien creditors and good faith purchasers for value in the ordinary course of business, unless each reclaiming creditor’s goods exceed in value the amount of the secured claim that they collateralize, the reclaiming creditors do not have a valid reclamation claim under state law and thus are not entitled to the protections afforded to such creditors under § 546(c). This ruling may ultimately resolve, but for now only further solidifies, the split among the courts as discussed above. Any vendor concerned with its potential reclamation rights can protect itself by negotiating for a purchase money security interest with its customers.

Michael P. DiLaura
Jaffe, Raitt, Heuer, & Weiss, P.C.
27777 Franklin Road, Suite 2500
Southfield, MI 48034
248.351.3000
mdilaura@jaffelaw.com

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Case Law Update

Eleventh Hour Fax of Proof of Claim Is Not a Timely Proof of Claim When Notice of Bar Date Requires Mailing. Notice of Claims Bar Date required creditors to mail their proofs of claim to a designated post office and to be received by the claims agent by November 15, 2002. However, the creditor in this case faxed its proof of claim to counsel for the trustee on November 15, 2002. The court upheld the bankruptcy court finding that faxing the proof of claim was unacceptable since the notice of the claims bar date specifically stated that claims must be mailed to the post office. Thus, the proof of claim was not timely. In re Outboard Marine Inc., 2004 U.S. App. LEXIS 21580 (7th Cir. Oct. 18, 2004).

Chapter 11 Filing Does Not Change the Tax Relationship Between a Debtor Corporation and its Shareholders. Court rejected appellant’s argument that the company’s S corporation status ended when the company entered bankruptcy because it no longer met the requirements of a “small business corporation.” Appellant argued that because the trustee took control of the company for the benefit of its creditors, appellant no longer was its real owner. He maintained that the transfer of power left the company with new shareholders – the corporate creditors – who were not individuals and also generated more than one class of stock. Rejecting appellant’s argument, the Court held that a Chapter 11 bankruptcy filing does not change the tax relationship between a debtor corporation and its shareholders. Mourad v. Commissioner of Internal Revenue, 2004 U.S. App. LEXIS 21790 (1st Cir. Oct. 20, 2004).

Court Does Not Have Authority to Determine Dischargeability of a Sanction in a Future Bankruptcy. The Ninth Circuit, agreeing with the Fifth Circuit, ruled that a bankruptcy court may not finally adjudicate the subsequent dischargeability of a sanction properly imposed on a non-party participant in a bankruptcy proceeding. A bankruptcy court may adjudicate only the dischargeability of debts owed by the debtor seeking protection under the bankruptcy laws. Hansbrough v. Birdsell (In re Hercules Enterprises, Inc.), 2004 U.S. App. LEXIS 22532 (9th Cir. Oct. 29, 2004).

Implied Authorization To Accept Service of Process Extended. An attorney who was extensively involved in the underlying bankruptcy proceeding and on several occasions acted on the defendant’s behalf was found to have the implied authorization to accept service of process for the defendant in an adversary proceeding. The court also found that the totality of the surrounding circumstances demonstrated the intent of the client to convey such authority. Rubin v. Pringle (In re Focus Media, Inc.), 2004 U.S. App. LEXIS 22713 (9 th Cir. Nov. 2, 2004).

Attorney Ordered to Bear Burden of Fees for Frivolous Appeals. A Pennsylvania attorney was ordered to pay $45,000 in fees for bringing frivolous appeals that extended a case for eight years. During the case’s pendency, there were eight appeals to the Third Circuit Court of Appeals, seven petitions for rehearing, and five petitions to the United States Supreme Court. The attorney also refused to comply with case management schedules, provide or request discovery, and made no response to appellees’ motions for summary judgment. Thus, the court awarded the appellees Rule 38 damages. The attorney was also found to solely bear the burden of paying these fees since it should have been evident to a reasonable attorney that the appeals were frivolous. Grine v. Coombs, 2004 U.S. App. LEXIS 21855 (3d Cir. Oct. 21, 2004) (unpublished).

Paige E. Barr
Kenneth B. Moll & Associates
Three First National Plaza, 50th Floor
Chicago, Illinois 60602

Phone: (312) 558-6444
Fax: (312) 558-1112
peb@kbmoll.com

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Washington Hot News

November 16, 2004: Sen. Schumer (D-NY), the senior Senator from the State of New York is staying in the Senate.

Sen. Schumer announced yesterday he will not run for the Governor of New York, but will instead head up the Democratic Senatorial Campaign Committee. Sen. Schumer, a member of the Senate Judiciary Committee, has in past Congresses been an active participant in the debate over bankruptcy reform legislation. Presumptive Minority Leader Reid (D-NV) has agreed to waive existing rules to allow Sen. Schumer to serve on the Senate Finance Committee without giving up his seats on the Judiciary and Banking Committees.

November 16, 2004: Supreme Court Denies Request for Certiorari in Kmart Case.

The United States Supreme Court has declined to review the Seventh Circuit’s decision on critical vendor orders, In re Kmart Corp., 359 F.3d 866 (7th Cir. 2004). In the Kmart case, the bankruptcy judge allowed Kmart to pay over $300 million to satisfy the pre-petition debts of some 2,330 "critical vendors." The District Court reversed, concluding that the Bankruptcy Code did not authorize these so-called critical vendor orders.

On appeal, the Court of Appeals for the Seventh Circuit affirmed, but notably did not foreclose the possibility that critical vendor orders may be entered in appropriate cases. Such authority, if it exists, likely would come from § 363(b)(1) of the Code, which permits the trustee to use, sell or lease property of the estate other than in the ordinary course of business. This question was left for another day, however, because the Seventh Circuit held that the Kmart critical vendor order "was unsound no matter how one reads § 363(b)(1)."

More Washington Hot News can be found by clicking here.

David Goch
Washington Legislative Counsel
Commercial Law League of America

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First Day Orders Survey Results

Earlier in the summer we conducted a poll of the Bankruptcy Section's members to determine if practitioners thought that their local bankruptcy rules adequately provide for First Day Orders in Chapter 11 cases and whether they would be in favor of development of a set of national Bankruptcy Rules covering these types of matters (i.e. cash collateral, prepetition wages or DIP loans). Here are the results.

Only 52% of respondents agreed that their jurisdictions adequately provide for First Day Orders. By an overwhelming majority, 75% of those who responded indicated that they were favor of developing a uniform set of rules covering First Day Orders. Approximately 11% of the Section's total membership completed our First Day Orders poll.

In response to the poll, the Executive Board of the Bankruptcy Section recently commissioned Lou Robin (last year's Chair of the Section) to conduct preliminary research and analysis on a possible amendment to the Bankruptcy Rules covering First Day Orders. If you have any comments or are interested in working on such a project, please contact Lou Robin at louis.robin@prodigy.net to discuss further. Thank you for your input on the poll.

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