Phar-Mor, Inc. v. McKesson Corp.

• Decision Date: 17 July 2008
• Docket Number: No. 05-4525.,No. 05-4526.,05-4525.,05-4526.
• Citation: 534 F.3d 502
• Parties: PHAR-MOR, INC., Appellant, v. McKESSON CORPORATION, Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

534 F.3d 502

PHAR-MOR, INC., Appellant, v. McKESSON CORPORATION, Appellee.

No. 05-4525.

No. 05-4526.

United States Court of Appeals, Sixth Circuit.

Argued: December 7, 2007.

Decided and Filed: July 17, 2008.

ARGUED: Timothy M. Reardon, Nadler, Nadler & Burdman Co., Youngstown, Ohio, for Appellant. Jeffrey K. Garfinkle, Buchalter Nemer, Irvine, California, for Appellee. ON BRIEF: Timothy M. Reardon, Michael A. Gallo, Nadler, Nadler & Burdman Co., Youngstown, Ohio, for Appellant. Jeffrey K. Garfinkle, Buchalter Nemer, Irvine, California, for Appellee.

Before: BATCHELDER, Circuit Judge;^* BUNNING, District Judge.^**

OPINION

ALICE M. BATCHELDER, Circuit Judge.

At issue in this bankruptcy case is whether a vendor's administrative-expense priority on its reclamation claim is effectively extinguished when the goods subject to reclamation are sold and the proceeds used to satisfy a secured creditor's superior claim. Because we hold that it is not, we AFFIRM the district court's decision.

I.

Phar-Mor, Inc. filed Chapter 11 bankruptcy on September 24, 2001, but continued to operate as a debtor in possession (DIP). In response, several vendors, including McKesson Corporation, filed timely "reclamation claims," pursuant to 11 U.S.C. § 546(c) and Ohio Rev.Code § 1302.76 (UCC § 2-702), seeking to recover goods they had delivered to Phar-Mor on credit. On October 5, 2001, Phar-Mor proposed "that each Vendor be granted an administrative expense priority claim under Section 503(b) in the amount (if any) of its allowed reclamation claim," and reported reclamation claims from 141 vendors totaling $18 million. All but McKesson have since settled.

On the petition date, Phar-Mor owed its secured creditors $103 million. The bankruptcy court authorized Phar-Mor to borrow up to $135 million to repay these pre-petition secured creditors.¹ Phar-Mor did so and those security interests were extinguished. Phar-Mor gave the new creditors (i.e., "DIP Lenders") super-priority status over the remaining security interests, which also meant that their claims had priority over any administrative expense claims, such as McKesson's.

Upon entering bankruptcy, Phar-Mor closed 65 stores and held going-out-of-business sales, which generated $30 million. Phar-Mor continued to lose money, continued to close stores, and eventually had a final going-out-of-business-liquidation sale, which generated $103 million. Phar-Mor was able to pay off the $135 million post-petition loan from the DIP Lenders and was left with $64.5 million. After expenses, fees, and the money allotted to payment of the reclamation claims, $30 million was left towards payment of $185.5 million in general unsecured claims.

On February 13, 2003, Phar-Mor moved the bankruptcy court to reclassify the reclamation claims as general unsecured claims. Phar-Mor argued that the vendors' administrative-expense priority was extinguished when the goods subject to reclamation were sold and the proceeds used to pay off the DIP Lenders. The court denied the motion and held that, even though the reclamation claims were rendered "subject to" the DIP Lenders' super-priority, the vendors' properly filed reclamation claims still had administrative-expense priority over the general claims.

Phar-Mor moved the bankruptcy court for reconsideration (twice), and was denied (twice); appealed to the district court, which affirmed the bankruptcy court; and now appeals to this court — each time asserting the same arguments that it had asserted to the bankruptcy court in the first instance. Because we find that the bankruptcy court properly granted McKesson an administrative expense priority in lieu of its reclamation claim, we affirm the bankruptcy court's decision.

II.

"We review the bankruptcy court's decision directly, according no deference to the district court. The bankruptcy court's findings of fact are reviewed for clear error, and questions of law are reviewed de novo." In re S. Air Transp., Inc., 511 F.3d 526, 530 (6th Cir.2007) (citation omitted). This case presents a question of law or an application of the law to the given circumstances, and the bankruptcy court's factual findings are immaterial to the disposition of this appeal.

The parties do not dispute the meaning or effect of the bankruptcy code provision in this case — a provision that has since been amended. The prior (applicable) version states, in pertinent part:

[T]he rights and powers of a trustee ... are subject to any statutory or common-law right of a seller of goods that has sold goods to the debtor, in the ordinary course of such seller's business, to reclaim such goods if the debtor has received such goods while insolvent, but — ... the court may deny reclamation to a seller with such a right of reclamation that has made such a demand only if the court —

(A) grants the claim of such a seller priority as a claim of a kind specified in section 503(b) of this title [i.e., an administrative expense]; or

(B) secures such claim by a lien.

11 U.S.C. § 546(c)(2) (1998) (amended in 2005 by Pub.L. 109-8, § 1227(a)). There is no question that McKesson sold goods to Phar-Mor in the ordinary course of its business, that Phar-Mor received the goods while insolvent, or that McKesson, upon discovering Phar-Mor's insolvency, made a timely, written demand for reclamation. The immediate question is whether McKesson had a statutory or common-law right, pursuant to Ohio law, to reclaim those goods. If so, then the court, having denied reclamation, was obligated to grant McKesson either an administrative-expense priority in the amount of the goods (as it did) or a lien on the proceeds resulting from the use of those goods by the debtor. But if not, then the court was not so obliged and McKesson's claim for the value of those goods may be properly regarded as merely a general unsecured claim.

Ohio statute provides an aggrieved seller with a right to reclaim its goods, and that right stems from "the proposition that any receipt of goods on credit by an insolvent buyer amounts to a tacit business misrepresentation of solvency and therefore is fraudulent as against the particular seller." Ohio Rev.Code § 1302.76 (Official Comment 2 (1961)). This particular provision states:

Where the seller discovers that the buyer has received goods on credit while insolvent he may reclaim the goods upon demand made within ten days after the receipt, but if misrepresentation of solvency has been made to the particular seller in writing within three months before delivery the ten day limitation does not apply. Except as provided in this division the seller may not base a right to reclaim goods on the buyer's fraudulent or innocent misrepresentation of solvency or of intent to pay.

Ohio Rev.Code § 1302.76(B). In addition to creating (or codifying) this right to reclaim, this same statute also governs the aggrieved seller's ability to reclaim the goods in question, stating:

The seller's right to reclaim under division (B) of this section is subject to the rights of a buyer in ordinary course or other good faith purchaser or lien creditor under section 1302.44[²] of the Revised Code. Successful reclamation of goods excludes all other remedies with respect to them.

Id. at § 1302.76(C). The statute's accompanying commentary explains that "[b]ecause the right of the seller to reclaim goods under this section constitutes preferential treatment as against the buyer's other creditors," successful reclamation bars the seller from pursuing any other remedies from the buyer, id. at Official Comment 3 (1966) — that is, the buyer is not treated as having breached the contract (by failing to pay), but rather, the contract is rescinded and the reclaimed goods are returned to the seller as though the contract had never been entered and the goods never delivered.

It appears clear from the plain language of this statute that McKesson had the right to reclaim the goods delivered to Phar-Mor. See id. at § 1302.76(B). This finding — that McKesson had a right to reclaim the goods — would seem to answer the pending question and end our analysis; the court, having denied reclamation, was indeed obligated to grant McKesson a priority on its claim, which it did by granting the administrative-expense priority in the amount of the goods

Phar-Mor argues, however, that McKesson did not have a right to reclaim the goods because McKesson did not have the ability to reclaim those goods, inasmuch as § 1302.76(C) renders a seller's right to reclaim "subject to the rights of a buyer in ordinary course or other good faith purchaser or lien creditor." Phar-Mor contends that the DIP Lenders, who held a security interest in all of Phar-Mor's inventory, via an after-acquired-property clause in their security agreement, see Ohio Rev.Code § 1309.204, were "good faith purchasers." See In re Pester Ref. Co., 964 F.2d 842, 844 (8th Cir.1992) (stating that "most secured creditors are good faith purchasers under the UCC"). Thus, Phar-Mor surmises that, because McKesson's reclamation rights are "subject to" the DIP Lenders' security interest and because Phar-Mor sold McKesson's "reclamation goods" to satisfy the DIP Lenders' claim, McKesson is unable to reclaim the goods and, hence, is left without any right to reclaim the goods. But see id. at 846 (holding that an aggrieved seller's "right to reclaim was not extinguished because [the debtor] had secured creditors with perfected security interests").

In the case of In re Mel Golde Shoes, Inc., 403 F.2d 658, 661 (6th Cir.1968), we held that, under Kentucky law, a defrauded seller's right to reclaim his goods is superior to any right of attaching creditors, despite UCC 2-702's "subject to" provision. In finding that the secured creditor was not the type of good faith purchaser that would overcome the vendor's right to reclamation, we adopted some reasoning from a Kentucky Court of Appeals decision and said:

[N]o reason exists why, as between...