On April 20, 2005, President George W. Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Bankruptcy Abuse Act” hereafter referred to as the BAA), making sweeping changes to the United States Bankruptcy Code. The majority of the Act is composed of reforms designed to prevent perceived abuses by consumers. There are, however, a few changes that will likely have significant impact on commercial creditors whose customers file for bankruptcy protection.

 Rights of Reclamation

 The Bankruptcy Code previously recognized the right of sellers of goods to reclaim their goods in certain circumstances. Prior to the BAA, the Bankruptcy Code, permitted the seller, under the seller’s state reclamation law, to make written demand for goods received by the buyer within 10 days prior to the buyer’s bankruptcy filing. The demand had to be made within that 10day period. However, if the bankruptcy was filed before the 10day period expired the demand could be made up to 20 days after the bankrupt buyer’s receipt of the goods.

 The debtor than had the option to: A) return the goods; B) grant the seller a lien on other property to secure the value of the goods; or C) grant the seller an administrative priority claim. The seller’s rights, however, were subordinate to the rights of any secured creditor with a valid lien on the goods. Accordingly, many reclamation demands were of no benefit to the seller.

 The BAA now provides seller’s specific Federal rights of reclamation eliminating the seller’s, who sell in multiple jurisdictions, need to be aware of individual state law.

 Under the BAA, a seller may reclaim goods received by the buyer within 45 days of the buyer’s receipt. If the 45-day period expires after the buyer’s bankruptcy filing, the seller must make a written demand for the goods within 20 days from the petition date (found on the 341, 1^st meeting of creditors, notice). The BAA eliminates the buyer’s option of retaining the goods in return for granting the seller either a lien or an administrative claim. The buyer must return any goods still in their possession on the date of the written demand. The seller’s reclamation rights, however, remain subject to any rights of a buyer’s secured creditors.

 Additionally, any seller that ships goods to the buyer in the ordinary course of business in the 20 days prior to the buyer’s bankruptcy filing is entitled to an administrative expense claim for any portion of the purchase price that remains unpaid. An administrative expense claim is senior in priority to a general unsecured claim and, generally, must be paid in full in order for the bankrupt to confirm a plan of reorganization. This administrative claim right is independent of the seller’s reclamation rights, and is not subject to the requirement of a written demand within 20 days of the bankruptcy filing.

 Although it is too early to know for certain, the language of the Act makes it appear that the seller would be entitled to assert an administrative claim even when the goods sold is covered under a lien by a secured creditor.

 Preferences

 The BAA unlike the old Act favors creditors who receive pre-bankruptcy payments. Under the Bankruptcy Code, “preferences” are generally defined as payments made:  (1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt; and (3) made while the debtor was insolvent either within 90 days of the petition date (to a general creditor) or within 12 months of the petition date (to an insider). The debtor or bankruptcy trustee can avoid such transfers on the grounds that the creditor received preferential treatment to the detriment of the debtor’s other creditors who did not receive a payment during the “preference period”.

 The BAA makes it easier for the creditor to defend itself against a preference action. Under the old law, a preference defendant could avoid preference liability by proving (among other defenses) that the challenged payment was made in payment of a debt incurred in the “ordinary course of business” of the debtor and creditor, provided that the transfer was actually made in the ordinary course of business of the parties (the so-called “subjective test”) AND made according to ordinary business terms (the “objective test”). The latter often times requires costly expert testimony regarding general industry practice, which is impractical except in large cases.

 Under the BAA, the creditor only needs to show that the payment was either made in the ordinary course of business of the parties or according to ordinary business terms, making the ordinary course of business defense much easier to prove.

 The BAA also bars pursuit of a preference action by debtor or trustee where the aggregate value of payments to the creditor is less than $5000.00. Also, a debtor or trustee seeking to recover alleged preference payments totaling less than $10,000.00 for any one creditor must bring suit in the District Court in the defendant creditor’s jurisdiction instead of the in the Bankruptcy Court where the case is pending.

 These changes to the preference rules should significantly aid creditors in avoiding and defending against costly preference actions.

 Small Business Bankruptcy

 The BAA streamlines the procedure for a small business debtor seeking to confirm a plan of organization. A qualifying “small business” debtor generally is one whose aggregate non-contingent liquidated debts do not exceed $2 million.

 Under the old Act, a debtor had to prepare a disclosure statement tailored to the specific case; submit the disclosure statement for formal court approval; and, upon obtaining court approval, solicit creditor votes in favor of a proposed plan of reorganization.

 The BAA makes the process for small business easier and less expensive. For example, if the court finds that a plan of reorganization provides creditors with “adequate information” then it may not require the filing of a disclosure statement. The small business debtor may also solicit acceptance of its plan prior to the final approval of the plan, so long as the court has “conditionally” approved the disclosure statement.

In addition to the above there are several additional changes that will have a positive effect on commercial credit grantors. Those who sell on a "purchase money" basis now have 30 days to perfect their filing an increase of 20 days. Also, small business creditors may request to be added to the creditor committee whereas under the old law it was limited to the 7 largest creditors.

I wish you well.  

The information provided above is for educational purposes only and not provided as legal advice. Legal advice should be obtained from a licensed attorney in good standing with the Bar Association and preferably Board Certified in either Creditor Rights or Bankruptcy.