The Continuing Conflict Between Secured Lender and Reclamation Rights

The courts have reached conflicting decisions over whether a debtor’s Chapter 11 lender trumps a trade creditor’s reclamation rights where the lender is secured by the debtor’s inventory and its loan is used to pay off a pre-petition loan also secured by the debtor’s inventory. The United States Bankruptcy Court for the Southern District of Indiana, in In re hhgregg, Inc., recently denied relief on a reclamation claim based on it being subordinate to, and rendered valueless by, the debtors’ Chapter 11 loan secured by the debtors’ inventory. The hhgregg court relied on the rulings of the United States Bankruptcy Court for the Southern District of New York, in the Dairy Mart and Dana Corporation cases, that denied relief on reclamation claims because the debtors’ Chapter 11 lenders’ security interest in the goods subject to reclamation trumped the rights of the reclaiming creditors in the goods. Both courts relied on the debtors’ use of the proceeds of the Chapter 11 loans secured by the debtors’ inventory to repay the debtors’ pre-petition loans also secured by the debtors’ inventory. The courts regarded the debtors’ pre-petition and Chapter 11 secured loans as one transaction that related back to the inception of the pre-petition secured loan when there were no reclamation claims.