March 20, 2006Client Alert

Trade Creditors' Rights Expanded Under New Bankruptcy Provisions

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA") includes a number of provisions that increase the rights of vendors in a customer bankruptcy.

Administrative Expense Status for Certain Vendors. Creditors are paid in an order of priority determined by the federal Bankruptcy Code. Secured creditors are paid first for the value of their collateral; next in line are administrative expenses and other priority claims. Only after these claims are paid did the Bankruptcy Code permit payment of vendors' claims arising from delivery of goods pre-bankruptcy. At least, that's the way it was before a new provision effective in 2005. Now, trade creditors have administrative expense claim status for the value of goods received by the debtor in the ordinary course of business within 20 days before the bankruptcy filing. Vendors' claims for such deliveries are now much more likely to be paid in full, in contrast to the minimal percentage often paid on pre-bankruptcy unsecured claims.

Reclamation Rights Expanded. Under both state and federal law, a creditor has the right to reclaim goods delivered to an insolvent debtor. Under state law, that right is typically limited to goods for which a notice of reclamation is sent by the creditor to the customer within 10 days of delivery. Under new bankruptcy provisions, the right to reclaim goods is extended to cover goods delivered within 45 days prior to the bankruptcy filing. To exercise the expanded reclamation right, a creditor must demand reclamation of the goods from the debtor in writing (a) not later than 45 days after the date of receipt of the goods by the debtor; or (b) not later than 20 days after the date of the commencement of the case, if the 45-day period expires after the commencement of the case.

Preferences. Trade creditors are often outraged when a customer with an account balance files bankruptcy, doesn't pay and sometime later demands that the creditor return past payments as alleged "preferential transfers" or "preferences." BAPCPA provisions reduce the likelihood that such payments will have to be surrendered by the creditor or set aside by the court.

Small Preferences. In business cases, the debtor and trustee are now precluded from avoiding preferences of less than $5,000.

Venue Protections. Under the old law, trade creditors often found themselves defendants in lawsuits filed in the court where the bankruptcy was filed - often in a different state. Now, for avoidance actions involving consumer debts less than $15,000 or non-consumer debts less than $10,000, the general rule is that the preference recovery lawsuit can only be filed where the creditor resides. This increases costs for the bankruptcy estate, and may reduce lawsuits to recover these smaller preferences.

Ordinary Course of Business Defense. One defense commonly used to avoid liability for a preferential transfer is that the transfer was made in the ordinary course of business. This defense used to require proof that the transfer was ordinary both between the debtor and vendor, and in the industry. Now, a creditor who can show that the transfer was ordinary EITHER between the debtor and creditor, OR in the industry generally, can avoid repayment of pre-bankruptcy transfers.

Purchase Money Loan Safe Harbor. Purchase money loans, those where the creditor takes as security the property purchased with the proceeds of the loan, have been given priority where those loans have been properly perfected within a short grace period. The grace period for perfecting the security interest in those loans has been expanded for Bankruptcy Code purposes from 20 to 30 days after the debtor receives possession of the property.

More Lien Protection. Non-purchase money security interests can also be set aside as preferential transfers, turning a creditor who intended to make a secured loan into an unsecured creditor. Before BAPCPA, to avoid this result, a secured creditor had to perfect its security interest within 10 days of the transfer. Now, perfection within 30 days of the transfer is sufficient to avoid having the lien set aside as preferential.

For more information, contact Ann Ustad Smith at 608.283.2251, or, or Paul A. Lucey at 414.270.2719, or

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