In re Arlco, Inc.

• Decision Date: 21 September 1999
• Docket Number: Bankruptcy No. 97-B-43789,97-B-43790(AJG). Adversary No. 97-8536.
• Citation: 239 BR 261
• Parties: In re ARLCO, INC. and HFO, Inc. f/k/a Arley Corporation and Home Fashions Outlet, Inc., respectively, Debtors. Galey & Lord Inc., Plaintiff, v. Arley Corporation, Defendant.
• Court: U.S. Bankruptcy Court — Southern District of New York

239 B.R. 261 (1999)

In re ARLCO, INC. and HFO, Inc. f/k/a Arley Corporation and Home Fashions Outlet, Inc., respectively, Debtors Galey & Lord Inc., Plaintiff, v. Arley Corporation, Defendant.

Bankruptcy Nos. 97-B-43789, 97-B-43790(AJG). Adversary No. 97-8536.

United States Bankruptcy Court, S.D. New York.

September 21, 1999.

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Kreindler & Relkin, P.C., New York City, Bruce S. Nathan, David P. Lennon, of counsel, for Galey & Lord, Inc.

Angel & Frankel, P.C., New York City, John H. Drucker, Laurence May, Carlos J. Cuevas, of counsel, for the debtor.

MEMORANDUM DECISION DENYING PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AND GRANTING DEFENDANT'S MOTION FOR SUMMARY JUDGMENT

ARTHUR J. GONZALEZ, Bankruptcy Judge.

On June 6, 1997, Arley Corporation ("Arley") and Home Fashions Outlet, Inc. ("Home Fashions" and together with Arley, the "Debtors") each filed a petition under chapter 11 of title 11 of the United States Code (the "Bankruptcy Code"). Arley was engaged in the business of manufacturing, importing, and wholesaling home furnishings, window coverings, bed-coverings, and linens which were sold to retailers, one of which was Home Fashions, Arley's wholly-owned subsidiary. Home Fashions operated retail outlet stores in Massachusetts and California. In addition, the Debtors maintained business and corporate offices, a showroom, and a design facility in New York. They also maintained business offices in Massachusetts and manufacturing facilities in Massachusetts, North Carolina, South Carolina, and California.

On September 15, 1997, pursuant to 11 U.S.C. § 363, the Court approved an asset purchase agreement for the sale of substantially all of the Debtors' assets as a going concern. The asset purchase agreement included a requirement that the Debtors change their corporate names contemporaneously with the closing of the sale transaction. Thus, Arley changed its name to Arlco, Inc. and Home Fashions changed its name to HFO, Inc. On August 6, 1998, the Debtors chapter 11 cases were converted to chapter 7. Thereafter, Robert Fisher, Esq. was appointed as chapter 7 trustee (the "Trustee").

Galey & Lord, Inc. ("Galey") is a fabric manufacturer. Prior to the filing of the Debtors' petitions, Galey, in its ordinary course of business, sold textile goods on credit to Arley. On May 16, 1997, Galey sent a letter to Arley by fax, overnight courier, and certified mail (the "May 16th Letter") demanding that Arley return the merchandise it "received during the applicable periods referred to in § 2-702 of the Uniform Commercial Code" and notifying Arley that "all goods subject to Galey's right of reclamation should be protected and segregated by Arley and are not to be used for any purpose whatsoever." Subsequently, on May 21, 1997, Galey sent the Debtor an additional notice detailing each invoice issued to Arley within the 10-day period prior to May 16, 1997 for the goods allegedly subject to reclamation. Since early 1995, CIT Group/Business Credit Inc. ("CIT") has held a perfected security interest in substantially all Arley's assets, including accounts receivable and inventory.

On June 9, 1997, prior to the sale of the Debtors' assets, Galey commenced an adversary proceeding against Arley seeking reclamation of the textile goods referred to in the May 16th Letter. On June 11, 1997 Galey filed an Amended Complaint. Currently before the Court are motions for summary judgment filed by Galey and by the Trustee, respectively.

In its summary judgment motion, Galey maintains that it has complied with all the statutory requirements for establishing a valid claim for reclamation. The Trustee refutes Galey's contention and opposes entry of summary judgment in favor of Galey. Rather, the Trustee maintains that his arguments support entry of summary judgment in Arley's favor. The three principal reasons advanced by the Trustee in opposition to Galey's motion and in support of his own motion are that 1) the reclamation notice was legally deficient, 2) Galey failed to prove what goods Arley still had on hand when Galey made its demand, and 3) Galey's right to reclamation is subject to CIT's perfected security interest. In addition, Arley contends that there are factual disputes that preclude entry of summary judgment in favor of Galey.

DISCUSSION

The purpose of 11 U.S.C. § 546(c)¹ is to recognize any right to reclamation that a seller may have under applicable nonbankruptcy law. In re Victory Markets Inc., 212 B.R. 738, 741 (Bankr.N.D.N.Y.1997). Section 546(c) does not create a new, independent right to reclamation but merely affords the seller an opportunity, with certain limitations, to avail itself of any reclamation right it may have under nonbankruptcy law. Id.; Toshiba America, Inc. v. Video King of Illinois, Inc. (In re Video King of Illinois, Inc.), 100 B.R. 1008, 1013 (Bankr.N.D.Ill. 1989). Pursuant to § 546(c), a seller may reclaim goods it has sold to an insolvent debtor if it establishes:

(1) that it has a statutory or common law right to reclaim the goods;

(2) that the goods were sold in the ordinary course of the seller\'s business;

(3) that the debtor was insolvent at the time the goods were received; and

(4) that it made a written demand for reclamation within the statutory time limit after the debtor received the goods.

Victory Markets, 212 B.R. at 741. The reclaiming seller has the burden of establishing each element of § 546(c) by a preponderance of the evidence. Victory Markets, 212 B.R. at 741. Thus, in addition to establishing the requirements necessary to obtain reclamation under common law or any statutory right for such relief, the seller seeking reclamation under § 546(c) must prove that it sold the goods in the ordinary course of business and it made a written demand within ten days of the receipt of the goods. Pester Refining Co. v. Ethyl Corp. (In re Pester Refining Co.), 964 F.2d 842, 845 (8th Cir.1992). Moreover, Bankruptcy Code § 546(c) limits the definition of insolvency to that found in 11 U.S.C. § 101(31). Video King, 100 B.R. at 1013.

In addition, to be subject to reclamation, goods must be identifiable and cannot have been processed into other products. Party Packing Corporation v. Rosenberg (In re Landy Beef Co., Inc.), 30 B.R. 19, 21 (Bankr.D.Mass.1983). It has also been noted that "an implicit requirement of a § 546(c) reclamation claim is that the debtor must possess the goods when the reclamation demand is made." Flav-O-Rich, Inc. v. Rawson Food Service, Inc. (In re Rawson Food Service, Inc.), 846 F.2d 1343, 1344 (11th Cir.1988). See In re Adventist Living Centers, Inc., 52 F.3d 159, 163 (7th Cir.1995); Eighty-Eight Oil Co. v. Charter Crude Oil Co. (In re Charter Co.), 54 B.R. 91, 92 (Bankr. M.D.Fla.1985). However, it is not clear "whether possession is an element under § 546(c) of the Bankruptcy Code or in establishing an independent right of reclamation under nonbankruptcy law to be recognized under § 546(c)." Video King, 100 B.R. at 1014. Logic dictates that, if not possession, the debtor should at least have control over the goods if it is to be required to return them. For the same reason, if the goods are not identifiable, the debtor could not identify or extract the goods to return them to the reclaiming seller. The issue concerning control of the goods or the identifiable nature of the goods would be relevant whether or not the reclaiming seller is seeking the goods in a bankruptcy context. Thus, it appears that these elements are requirements under the "independent right of reclamation under nonbankruptcy law." Video King, 100 B.R. at 1014.

Section 546(c) also affords the bankruptcy court broad discretion to substitute an administrative claim or lien in place of the right to reclaim. Pester, 964 F.2d at 845. This discretion gives the court needed flexibility and permits it to recognize the reclaiming creditor's rights while allowing the debtor the opportunity to retain the goods in order to facilitate the reorganization effort. Id.

Uniform Commercial Code ("U.C.C.") § 2-702,² as enacted in various jurisdictions, ordinarily forms the statutory right upon which sellers base their reclamation demand. Thus, as previously noted, the reclaiming seller must establish the requirements of the relevant U.C.C. section³ and remains subject to its limitations. Pursuant to U.C.C. § 2-702(3),⁴ the seller's right to reclamation is "subject to" the rights of a good faith purchaser from the buyer. Pester, 964 F.2d at 844; In re Leeds Building Products, Inc., 141 B.R. 265, 268 (Bankr.N.D.Ga.1992); Video King, 100 B.R. at 1016; Sandoz Pharmaceuticals Corp. v. Blinn Wholesale Drug Co., Inc. (In re Blinn Wholesale Drug Co., Inc.), 164 B.R. 440, 443 (Bankr.E.D.N.Y. 1994); Victory Markets, 212 B.R. at 742. That the right of a reclaiming creditor is subordinate to that of a good faith purchaser does not automatically extinguish the reclamation right. Pester, 964 F.2d at 846. Rather, the reclaiming creditor is "relegated to some less commanding station." Leeds, 141 B.R. at 268.

Most courts have treated "a holder of a prior perfected, floating lien on inventory . . . as a good faith purchaser with rights superior to those of a reclaiming seller." See Victory Markets, 212 B.R. at 742 (citing, Stowers v. Mahon (In re Samuels & Co.), 526 F.2d 1238, 1242-43 (5th Cir.1976)); In re Child World, Inc., 145 B.R. 5, 7 (Bankr.S.D.N.Y.1992); Blinn Wholesale Drug, 164 B.R. at 443; Isaly Klondike Co. v. Sunstate Dairy & Food Products Co. (In re Sunstate Dairy & Food Products Co.), 145 B.R. 341, 344 (Bankr.M.D.Fla.1992); Leeds, 141 B.R. at 268. See also House of Stainless, Inc. v. Marshall & Ilsley Bank, 75 Wis.2d 264, 273, 249 N.W.2d 561, 567 (1977) (citing, In re Hayward Woolen Co., 3 U.C.C.Rep. Serv. 1107, 1111-12 (Bankr.D.Mass.1967); First-Citizens Bank & Trust Co. v. Academic Archives, 10 N.C.App. 619, 624, 179 S.E.2d 850, 853 ...