Banking and Finance Law Daily Seller’s reclamation claim subordinate to DIP financing lenders’ claims
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Thursday, February 13, 2020

Seller’s reclamation claim subordinate to DIP financing lenders’ claims

By Nicole D. Prysby, J.D.

A seller’s reclamation claim is not superior to the claims of secured lenders that extended the debtor-in-possession financing in exchange for a priming, first-priority floating lien on existing and after-acquired inventory.

A home appliance seller’s reclamation claim against a buyer is subordinate to the claims of a lender that extended debtor-in-possession (DIP) financing to the buyer in exchange for a priming, first-priority floating lien on existing and after-acquired inventory, held the federal Seventh Circuit Court of Appeals. The lender had an operating agreement with the debtor that granted the lender a first-priority floating lien on nearly all of the debtor’s assets, including existing and after-acquired inventory and its proceeds. In the first 24 hours of the debtor’s bankruptcy proceedings, the lender extended DIP financing in exchange for a priming, first-priority floating lien on substantially all of the debtor’s assets, including existing and after-acquired inventory and its proceeds. Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) modifications to section 546(c) of the Bankruptcy Reform Act, it is clear that a seller’s reclamation claim is subordinate to the prior rights of a holder of a security interest. Therefore, when the appliance seller made its reclamation demand three days after the DIP was approved by the court, the reclaimed goods were subject to the lender’s pre-petition and DIP financing liens. While the pre-petition lien was later lifted, the reclaimed goods remained subject to the DIP financing lien, and at all times, the seller’s reclamation claim was subordinate to the DIP financing lien (In re: hhgregg, Inc.; Whirlpool Corp. v. Wells Fargo Bank, N.A., Feb. 11, 2020, Sykes, D.).

Backdrop. Wells Fargo Bank extended operating financing to appliance retailer hhgregg. Under the credit agreement, Wells Fargo’s advances were secured by a first-priority floating lien on nearly all of hhgregg’s assets, including existing and after-acquired inventory and its proceeds. Whirlpool Corp. delivered appliances to hhgregg during the period leading up to hhgregg’s bankruptcy filing. In the first 24 hours of the Chapter 11 proceeding, hhgregg sought the court’s approval for $80 million in DIP financing, with Wells Fargo acting as administrative agent for a group of post-petition lenders. The DIP financing agreement authorized a "creeping roll-up" of the secured lenders’ prepetition debt and gave Wells Fargo a priming, first-priority floating lien on substantially all of hhgregg’s assets, including existing and after-acquired inventory and its proceeds.

The bankruptcy judge approved the DIP financing that same day. Three days later Whirlpool sent a reclamation demand to hhgregg seeking the return of $16.3 million in appliances it had delivered in the 45-day period before the bankruptcy petition. Meanwhile, the reorganization plan called for hhgregg to sell existing inventory—including the Whirlpool reclaimed goods—and apply the proceeds to the prepetition debt owed to Wells Fargo. Whirlpool filed an adversary action against Wells Fargo seeking a declaration that its reclamation claim is first in priority as to the reclaimed goods. The bankruptcy judge entered final judgment for Wells Fargo. The district court affirmed, and Whirlpool appealed.

Reclamation claim. Whirlpool argued that its reclamation claim was first in priority as to the reclaimed goods, ahead of Wells Fargo’s DIP financing lien. Alternatively, Whirlpool sought a remand to establish that Wells Fargo did not act in good faith and thus did not have prior rights as a good-faith purchaser. The court rejected both arguments. BAPCPA modified section 546(c) of the Bankruptcy Reform Act, and, among other changes, added new language making explicit that a seller’s reclamation claim is subordinate to the prior rights of a holder of a security interest. Under the terms of the DIP financing agreement, Wells Fargo obtained a priming, first-priority security interest in all hhgregg assets, including the Whirlpool inventory. Whirlpool’s reclamation demand came later, on March 10, and was therefore "subject to" Wells Fargo’s prior rights as the holder of a perfected, first-priority security interest in the reclaimed goods.

Whirlpool countered that its reclamation claim was "in effect" as of the March 6 petition date and that its reclamation claim jumped ahead of Wells Fargo’s DIP financing lien when the prepetition lien was extinguished in the final roll-up of the collateralized pre-petition debt. There were two problems with this argument. A reclamation right is not a security interest; nor is the reclamation remedy self-executing. Whirlpool served its written reclamation demand on March 10, three days after Wells Fargo’s post-petition lien attached. Therefore, there was no support for Whirlpool’s assertion that its reclamation claim was actually "in effect" on the petition date, four days before the demand was made. And there was no gap in the Wells Fargo lien chain. Before and as of the March 6 petition date, Wells Fargo held a first-priority, perfected lien on hhgregg’s assets, including the Whirlpool inventory. Effective March 7, Wells Fargo obtained a court-approved, priming, first-priority, perfected lien on hhgregg’s assets, including the Whirlpool inventory. The Whirlpool goods were continuously encumbered by one or both of Wells Fargo’s liens.

Whirlpool’s fallback argument was that Wells Fargo could not be considered a good-faith purchaser based on its conduct as agent for the DIP lenders. But whatever force this argument might have had under the old version of section 546(c), the post-BAPCPA text of section 546(c) expressly subordinates a seller’s reclamation claim to the prior rights of a lienholder; there is neither need nor any reason to import a state-law good-faith purchaser inquiry. Whirlpool’s allegations of bad faith were irrelevant to the priority determination under section 546(c).

The case is No. 18-3363.

Attorneys: Michael David Bess (Michael Best & Friedrich LLP) for Whirlpool Corp. Mark Cahill (Choate Hall & Stewart LLP) for Wells Fargo Bank, N.A.

Companies: hhgregg, Inc.; Wells Fargo Bank, N.A.; Whirlpool Corp.

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