Fed Raises Interest Rates (Again): A Christmas Gift for Bankruptcy Professionals?

The Federal Reserve voted Wednesday to raise short-term interest rates for the third time this year. That means the federal funds rate, which helps determine rates for other borrowing, will now hover in a range of 1.25% to 1.5%. Overall, still in historically low territory.

This is the fifth time the Fed has lifted rates since the 2008 financial crisis. And it has signaled it will stay on course next year, with three rate hikes planned in 2018 and two in 2019. Expect a slow climb towards more normal levels of around 3%.

Implications for the Economy… and Restructuring Professionals

Widely hailed as a show of continued optimism about the U.S. economy, interest rate hikes are uniquely celebrated among one group of people.  Bankruptcy and restructuring professionals! Why? Because, although the rate hikes have thus far not caused noticeable pain in the economy, rate hikes tend to moderate economic growth.

That leads me to wonder, how strong is our economy and what impact are the continuing rate hikes likely to have? The Fed cast its decision as a positive sign of worldwide economic momentum as employers keep hiring, consumers keep spending, and inflation remains (oddly) low.  And it noted that the imminent tax bill is a key driver of its own rosy forecast. Although the Fed stopped well short of forecasting the 4% growth Republicans have promised, it expects a more modest, albeit uncertain, 2.5% increase in growth from the tax plan.

“At the moment,” Fed Chair Janet L. Yellen said, “There’s less to lose sleep about now than has been true for quite some time.”


Coming Next: Ask an Economist!

“I think economics is a terrific field,” Yellen said.  Well, so do I!  So when Yellen stated that the Fed’s growth expectations “are in line with the general expectation among most economists that the type of tax changes that are likely to be enacted would tend to provide some modest lift to GDP growth in the coming years,” I decided to run this by the smartest economist I know. Stay tuned for an upcoming blog post on interest rates, the tax bill, and you….

Janet Yellen: Another Crack in the Glass Ceiling

57848617_SI end this post with a fond farewell to Janet Yellen, our outgoing chairperson of the Federal Reserve — the first woman to hold the top spot in the 100-year history of the U.S. central bank, or any major central bank. Asked for any thoughts for women and minorities who see her as a role model, Yellen said she would love to bring in more women and minorities at the central bank and lamented that their numbers in the field of economics is disproportionately and disturbingly low.

In response to her call to action, I volunteer to mentor any young woman (or anyone else!) interested in pursuing an economics degree.  Little known fact: I hold a B.A. in Economics from Trinity University.  A degree with many uses, at the Fed and beyond.

If there is a job that you feel passionate about, do what you can to pursue that job; if there is a purpose about which you are passionate, dedicate yourself to that purpose.

–Janet Yellen

Mette K.

Reclamation Claims, Bankruptcy Financing, and You.

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Reclamation rights are an important, but often confusing, tool in a credit manager’s arsenal.  Adding to the confusion, New York and Delaware courts have recently diverged in their treatment of certain aspects of reclamation claims.

Reclamation Rights: The General Rule

In the bankruptcy context, reclamation rights are based on Bankruptcy Code section 546(c). This code section does not create new reclamation rights, but it does recognize otherwise valid state law reclamation claims.

Subject to the prior rights of a holder of a security interest in such goods or the proceeds thereof . . . a seller of goods that has sold goods to the debtor in the ordinary course of such seller’s business [has the right] to reclaim such goods if the debtor has received [them] while insolvent within 45 days before the commencement of a case under this title. 11 U.S.C. § 546(c)

In plain English, the concept is straightforward enough.  Let’s say you manufacture fuzzy eggbeaters.  If you deliver your eggbeaters to a customer as usual but it turns out the company was insolvent, and this all happened in the 45 days before the customer goes bankrupt, you may be able to get your eggbeaters back or assert an administrative claim for the amounts you are owed.  (There are a quite a lot of legal nuances to this.)

Adding Some Complexity: The Pre-Existing Secured Lender

Your reclamation rights, however, are subject to prior rights of a senior secured lender, e.g., the bank that finances your customer’s fuzzy eggbeater and furry teacup retail business. Think about a typical scenario where a bank extends a credit line to a company and takes a security interest in all of its assets. That security interest typically extends to existing and future assets. So when the retailer then goes out and buys your fuzzy eggbeaters, they become part of the bank’s collateral.  When you try to get them back, you may find your reclamation rights trumped by the lender’s pre-existing security interests. If the bank is underwater—often the case in a bankruptcy—your reclamation rights may have no  real value.

More Complexity: Bankruptcy Financing

Still with me?  Now let’s introduce some typical bankruptcy financing terms. Companies are often financed with revolving credit lines. When a company seeks bankruptcy protection, it typically needs to establish new financing. Very often, its existing lender will provide that new financing on terms that include a rollup of pre-petition debt. In other words, as new post-petition credit is extended, payments are applied first to the old, pre-petition debt.  The result is that, over time, the old pre-petition loan is rolled up into a new post-petition loan. (Post-petition loans are treated more favorably in bankruptcy, so there are a lot of advantages to a lender in doing this.)

This is where things get interesting for reclamation claimants and where New York and Delaware bankruptcy courts recently parted ways.

New York’s “Integrated Transaction” Approach: The Lender Wins

In two New York cases decided in 2003 and 2007, the bankruptcy courts considered the relative rights of: (a) a post-petition lender where the post-petition loan proceeds had been used to rollup the debtor’s pre-petition loan; and (b) reclamation claimants.  The new post-petition loans were made after the reclamation rights arose. Since Section 546(c) states that reclamation rights are subject to prior rights of a secured lender, the reclamation claimants argued that their rights trumped those of the new post-petition lender. The bankruptcy courts disagreed, however.  They held that the security interests under the post-petition loans “related back” to the lender’s prepetition rights because of the rollup feature.  Viewing the two loans and resulting liens as an “integrated transaction,” the courts sided with the secured lenders.

You can view the New York opinions here: In re Dana Corp., 367 B.R. 409 (Bankr. S.D.N.Y. 2007); and In re Dairy Mart Convenience Stores, Inc., 302 B.R. 128 (Bankr. S.D.N.Y. 2003).

Delaware’s Approach: Questioning the Integrated Transaction

In a recent opinion, In re Reichhold Holdings US, Inc., Judge Mary Walrath parted ways with the New York decisions. She held that a post-petition lender’s security interest – perfected after the reclamation rights arose – does not trump those reclamation rights even if the loan proceeds were used to payoff a pre-petition loan that would have.

In this case, the debtor’s prepetition lender had a lien on all of the debtor’s inventory.  Shortly after the debtor filed for bankruptcy, the court approved post-petition financing from a new lender.  That new financing was used to payoff the debtor’s old, pre-petition loan. And the new loan was secured by a first priority lien on all of the debtor’s assets, subject to valid, non-avoidable liens in existence as of the petition date.

After the bankruptcy filing, a vendor delivered a reclamation demand to the debtor and filed an administrative claim based on its reclamation rights. The trustee objected, stating that the reclamation claim was rendered valueless when the pre-petition loan was repaid. The vendor fought back, arguing that the new lender had not assumed the old, pre-petition lender’s liens but rather had obtained entirely new, post-petition liens. Since only prior liens defeat a reclamation claim, the vendor asserted that its reclamation claims trumped those of the new, post-petition lender.

The Delaware bankruptcy court rejected the logic of the New York bankruptcy courts, following a Six Circuit case, In re Phar-Mor, instead. Finding that the two loans, which were made by different lenders at different times, were not an integrated transaction, the bankruptcy court overruled the trustee’s clam objection.

“[W]hen the Prepetition Loan was paid from the DIP Loan, the Prepetition Lender’s lien was satisfied but [the vendor’s] reclamation rights remained in force.  The fact that funds obtained from the DIP Loan were used to satisfy the Prepetition Loan, or that the Debtor granted the DIP Lenders a lien in inventory to obtain such funds, is irrelevant.  [The vendor’s] reclamation rights arose before the DIP Lenders’ security interest attached, and the DIP Lenders’ lien was expressly subject to reclamation rights under section 546. . . .  Nor can the Court find that the DIP Loan and the Prepetition Loan are an ‘integrated transaction.’  They were two different loans by two different lenders at two different times.  Because [the vendor’s] rights arose before the DIP Lenders had any rights in the goods, the Court concludes that the DIP Lenders do not have prior rights in the goods under section 546(c).”

You can view the Delaware opinion here: In re Reichhold Holdings US, Inc., 2016 WL 4479286 (Bankr. D. Del. Aug. 24, 2016); see also In re Phar–Mor, 301 B.R. 482 (Bankr. N.D. Ohio 2003), aff’d, 534 F.3d 502 (6th Cir. 2008).

Some Concluding Thoughts

This is certainly good news for vendors with reclamation claims.  It is worth noting, though, that most post-petition loans are made by existing, pre-petition lenders.  This loan was made by a new and different lender group, which was a factor that the court noted when it held that the two loans should not be viewed as an integrated transaction. The result could be different if the pre-petition and post-petition loans were made by the same lender.

Mette H. Kurth