Reclamation claimants have long enjoyed special protections under Bankruptcy Code section 546(c), which recognizes that “the rights and powers of a trustee... are subject to the right of a seller of goods,” including reclamation rights under Section 2-702 of the Uniform Commercial Code. At a minimum, Section 2-702 clearly requires that a reclamation claimant must make demand upon its buyer in order to reclaim its goods and protect its rights. However, Paramount Home Entertainment Inc. v. Circuit City Stores, Inc., 2010 WL 3522089 (ED Va., Sept. 3, 2010) highlights the importance of diligence in enforcing reclamation rights.

Circuit City filed for chapter 11 protection on November 10, 2008. The next day, Paramount Home Entertainment, the home video arm of Paramount Pictures Corp., served Circuit City with a demand for the return of approximately $11.6 million in goods shipped to Circuit City within the 45 days before the commencement of the case. Circuit City later sought, and obtained, a protective “reclamation procedures order” from the bankruptcy court in order to alleviate the need to otherwise spend substantial time and limited resources contesting or litigating reclamation demands. The reclamation procedures order provided, among other things, that reclamation demands would have to be filed no later than 20 days after commencement of the case. Having already delivered its reclamation demand to Circuit City, Paramount did nothing further. Notably, Paramount’s actions (or inaction) are typical of those of many other reclamation claimants in bankruptcy cases across the country.

More than eight months later, however, in June of 2009, Circuit City filed an objection seeking to reclassify Paramount’s reclamation claim as a general unsecured claim. The bankruptcy court upheld the objection and reclassified the claim. The US District Court for the Eastern District of Virginia affirmed on appeal, holding that Paramount had lost the right to its reclamation claim as a matter of law on account of its inaction. How did this happen?

The district court cited to numerous published decisions to support its holding that notwithstanding the Bankruptcy Court’s own reclamation procedures order, it was incumbent upon Paramount to diligently seek the recovery of its goods. Specifically, the district court found the following inaction to be fatal to Paramount’s claim:

• Paramount sat on the sidelines and did not object to the debtor’s motion for post-petition financing, which provided its lender with a priority lien over all the estate’s assets, including the goods supplied by Paramount.
• Paramount did not at any time file a complaint against Circuit City or seek relief from stay to pursue the return of its goods.
• Paramount did nothing even as all of Circuit City’s inventory, including the goods in question, was sold at going out of business sales.

The Circuit City decision underscores the need to actively pursue reclamation rights during a bankruptcy case. Reclamation rights are an important weapon in a trade vendor’s arsenal and, if asserted properly, can result in significantly enhanced recoveries. Paramount, however, learned the hard way that $11.2 million in goods can easily turn into an unsecured claim worth pennies on the dollar if a creditor becomes overly complacent.