Battle for the Bulge: The Reclaiming Seller vs. the Floating Lien Creditor

Monday, January 1st, 2001 at 12:00 am by William Louis Tabac
William Louis Tabac, Battle for the Bulge: The Reclaiming Seller vs. the Floating Lien Creditor, 2001 Colum. Bus. L. Rev. 509

Trade credit is a very big business and an important source of financing. Its low costs make it attractive to small businesses with limited resources. Unlike secured creditors, who insist on cushions to support their longer- term debts, trade creditors who sell goods, like the small businesses they support, are risk-takers. They deliver their goods on cheap, short-term, unsecured credit, trusting their debtors to pay up.

A trade creditor is more likely to lend, and to lend more than a secured creditor. The service they perform for the economy is so valuable that these entrepreneurs are subsidized under federal and state law. Bankruptcy-bound debtors can prefer them and the Uniform Commercial Code gives them a lien even when they have not asked for one.

The lien arises under Article 2. Trade creditors may reclaim the sold goods if they learn that their buyer has received them while insolvent. This is the only security that the Code gives them, and it is lost if the goods are resold to unknowing buyers. But the protection extends beyond their immediate buyer to other kinds of purchasers who claim through that buyer. The defaulting buyer might, for example, serve merely as a middleman by channeling the goods to a lessee under a prearranged lease contract. If so, the lessee’s position is no stronger than his defaulting lessor’s. Only ‘subsequent‘ lessees, those who commit themselves after the goods have been sold to their lessor, will prevail. The Uniform Commercial Code so provides.

Secured creditors also feed off of a buyer’s ownership. The priority contest with the secured creditor, however, may have a different ending than it does with the lessee. The floating lien creditor, for example, prevails even though his debtor would be forced to yield to the seller. This, even though no advances were made against the sold good and no foreclosure occurred. Because of a failure to file, the seller may have been unaware that the floating lienor existed, and the floating lien creditor may have been equally ignorant about the existence of the sold goods.

Under the prevailing view, the secured creditor’s lack of reliance on the sold goods is of no consequence: the unpaid seller still loses. However, the Code does not provide for this outcome. It exists because of a misreading of the Code’s text. This view is also at odds with the other Code articles that regulate goods. It clashes, for example, with the rule that explicitly provides that only subsequent lessees can defeat the reclaiming seller. Finally, it contradicts what the Code drafters foresaw for reclamation; namely, that it ‘constitutes preferential treatment as against the buyer’s other creditors.‘

How did this happen? This construction was lobbied for by some venerable commercial law scholars who concluded that certain market principles were more powerful than the language penned by the Code’s drafters. Respectfully, I submit that this view repudiates Code language and policy, commercial history, and basic restitution principles, not to mention good sense.

I am not alone in taking this position. Under pressure from secured creditor interests, the Article 2 Drafting Committee, which is struggling to win approval of a revised Article 2, has gone back and forth, unable to settle on whether or not the floating lien creditor should triumph over the reclaiming seller. The equivocation by the Committee is hardly surprising given the Balkanized way in which Code revision occurs. Because separate drafting groups are hired to redo each of the Code articles the big picture that the Code has in place tends to be lost. It is for precisely that reason that the Code has been misread.

Is it unfair to allow the floating lienor, who gave up nothing in reliance on the sold goods, to trump the unpaid seller? I believe that it is. I hope to illustrate that, as the Code stands, only buyers, lessees and secured creditors who rely to their detriment on the sold goods should win this priority contest.

Part I of this article will discuss ‘title‘ holders under the Uniform Commercial Code and the powers and rights that they have to defeat reclaiming sellers. Part II will describe the Code ‘lessees‘ and ‘secured creditors‘ as well as the powers and rights that they have to defeat reclaiming sellers. Part III will explain how a misreading of the Code has subordinated the reclaiming seller of goods to the Article 9 floating lien creditor. Finally, Part IV will argue that, as the Code drafters intended, the reclaiming seller of goods should prevail over the floating lien creditor.

Author Information

Professor of Law, Cleveland State University