Seventh Circuit Upholds Chapter 11 Secured Lenders’ Priority over Reclamation Claimants

Trade creditors of financially distressed customers that filed for bankruptcy relief can assert reclamation rights as part of their recovery toolkit. However, the Bankruptcy Code restricts reclamation rights by explicitly subjecting them to the prior rights of a secured creditor with a blanket security interest in the debtor’s inventory (which includes goods subject to reclamation).

Courts have issued conflicting opinions as to whether a lender providing Chapter 11 financing with a blanket lien in the debtor’s inventory has priority over a reclamation creditor where the post-petition loan is used to pay off a prepetition loan secured by a blanket security interest in the debtor’s inventory. In the Chapter 11 cases of In re hhgregg, Inc., the United States Court of Appeals for the Seventh Circuit (the “Seventh Circuit”) recently concurred with other courts in ruling in favor of the post-petition lenders where the debtors had obtained the bankruptcy court’s approval of Chapter 11 financing granting the post-petition lenders a prior security interest in all of the debtors’ inventory. The Seventh Circuit concluded the post-petition secured lenders had retained a prior interest in the goods subject to reclamation rights because the “lien chain” between the prepetition and post-petition secured lenders had not been broken.