This statutory interpleader brought pursuant to 28 U.S.C. Sec. 1335 was filed by the Small Business Administration (SBA) to determine the proper distribution of proceeds from a foreclosure sale. The fund represents the remaining assets of Texas Electronics Mart, Inc. (TEMI). In distributing the fund, the District Court determined that Westside Bank of San Antonio (Westside) held the only priority claim. The Court thus denied the priority status asserted by O'Sullivan Industries, Inc. (O'Sullivan) based on its right to reclaim the proceeds from the sale of goods it delivered to TEMI just prior to the foreclosure. O'Sullivan duly perfected this appeal. We hold that a seller of goods (here, O'Sullivan) retains a priority status to the extent of traceable proceeds from the sale of those goods where he has complied with all the requirements of Texas Business and Commerce Code Annotated Sec. 2.702 (Vernon 1968) (the Texas UCC), and diligently pursued the right of reclamation created under that section. We therefore affirm in part, reverse in part, and remand for a determination of whether O'Sullivan diligently pursued its right to reclamation.

In April of 1976 TEMI executed a promissory note and security agreement in favor of Westside for the sum of $99,500. The note was guaranteed by the SBA. TEMI granted Westside a security interest in "all machinery, and equipment, fixtures, inventory and accounts receivable now owned, to be purchased with loan proceeds and hereafter acquired." The agreement included a future advance clause, a clause securing any legal fees incurred in enforcing the agreement, and a clause securing the interest due. Westside duly perfected its security interest.1

In September of 1979, TEMI executed a second promissory note to Westside for the sum of $16,000. The note was collateralized with the 1976 security agreement through the future advance clause.2 At the time of trial, Westside asserted an outstanding claim on this note in the amount of $12,471.52.

Pursuant to the SBA guarantee, Westside assigned its rights under the first note to the SBA sometime in December, 1979.3 The SBA declared the note delinquent and accelerated its maturity on December 14, 1979. In accordance with the security agreement, the SBA conducted a foreclosure sale of all TEMI's assets on January 21, 1980. After deducting the loan balance and expenses of the sale, the SBA deposited the remaining proceeds ($50,750.95) with the District Court for proper distribution among TEMI's creditors.

The District Court awarded Westside the sum of $17,666.60, representing its claim on the second note plus interest and attorney's fees. The Court, however, denied the priority right of reclamation asserted by O'Sullivan under Texas UCC Sec. 2.702. The Court reasoned that any right of reclamation would be cut short by a prior secured lender's foreclosure. Because in this case the SBA had foreclosed, the Court found that O'Sullivan had no right to the proceeds from the sale of the goods. In disposing of the case on this basis, the District Court deemed it unnecessary to reach the issue whether O'Sullivan had complied with the statutory requirements for reclamation under Sec. 2.702. The Court therefore distributed the remaining funds pro rata among O'Sullivan and TEMI's other general unsecured creditors.

The right of reclamation is specifically created in favor of a credit seller by Texas UCC Sec. 2.702.4 This right exists only in "specific and limited circumstances; it can be asserted only if an exacting procedure is followed; and the right can never be asserted to defeat the interest of certain third parties who have dealt with the defaulting buyer." Matter of Samuels & Co., Inc., 526 F.2d 1238 (5th Cir.1976) (en banc), cert. denied, 429 U.S. 834, 97 S. Ct. 98, 50 L. Ed. 2d 99 (1976).

In order for the right to arise, certain conditions must be met. First, the buyer must have received the goods on credit. There is no dispute that TEMI received the goods shipped by O'Sullivan on credit. Second, the buyer must receive the goods while insolvent. The District Court made no finding as to when TEMI became insolvent, but it did find that O'Sullivan did not know of TEMI's insolvency when it shipped the goods. Finally, the seller must learn of the buyer's insolvency and make demand for return of the goods within ten days from the date of delivery. The District Court found that O'Sullivan shipped furniture accessories valued at $36,756.94 on November 19 and 21, 1979, and that the shipments were received by TEMI on November 21 and 23, respectively. The Court determined that O'Sullivan learned of TEMI's insolvency sometime between November 21 and November 30. It also found that O'Sullivan made written demand for payment of the entire amount of TEMI's open account ($50,727.07) on November 30.5

In addition to the demand made upon TEMI, O'Sullivan also made written demand upon Westside6 through O'Sullivan's parent corporation, Conroy, Inc. The letter from Conroy also demanded payment for the full amount of TEMI's open account. This letter, however, also specified that it was a demand pursuant to Sec. 2.702 of the Texas UCC. The goods were not returned, nor was payment made to O'Sullivan.

O'Sullivan filed suit against TEMI in state court on January 18, 1980 to enforce its right of reclamation. However, on January 21 the SBA foreclosure sale was conducted, and TEMI ceased to exist for all practical purposes as a business entity. This effectively terminated the state court litigation.7 In order to further protect the reclamation right it was asserting, O'Sullivan repurchased 797 of the 1,000 pieces of furniture from the November shipment at the foreclosure sale for a price of $27,500. On appeal, O'Sullivan continues to urge its priority status as to the full sales proceeds of $36,756.94. Alternatively, it urges priority status as to $27,500--the traceable proceeds from the goods O'Sullivan has sought to reclaim.

In determining that O'Sullivan's right to reclaim was terminated by the SBA foreclosure and therefore could not attach to proceeds, the District Court relied on Matter of Samuels, supra. We believe the Court's reliance was misplaced.

In Samuels, a divided en banc Court adopted Judge Godbold's dissent from the panel opinion, which held that an unpaid cash seller's right of reclamation is subordinate to a preexisting perfected security interest in the buyer's after acquired property. Id. at 1245. In so holding, the Court emphasized several important factors which are not present in the case before us. At the outset, the Court recognized that the reclaiming seller was a cash seller.8 Id. at 1244. Furthermore, he had not made a demand under Sec. 2.702 until a full year after the delivery. The Court refused to find that his reclamation right had been timely exercised. Id. at 1245. Disturbed by the fact that in recognizing the cash seller's right to reclaim courts had extended the Sec. 2.702 remedy, the Court refused to further extend the time within which the right could be exercised.9

While the Samuels opinion expressed doubt as to whether a reclamation right would extend to proceeds,10 the issue was not outcome-determinative. Rather, the Court assumed for the purpose of analysis that the reclamation right could attach to proceeds, and disposed of the case on other grounds. Samuels involved a priority contest between an unpaid cash seller and a prior secured lender with a perfected Article Nine security interest. Significantly, in the present case the only prior secured lenders (the SBA and Westside) have been fully satisfied. Thus, Samuels dealt with the right to reclamation in an entirely different priority context than the one before us today. Furthermore, in reaching its conclusion the Samuels Court relied upon the seller's failure to make a timely demand. Even if he had made such a demand, reasoned the Court, he would have taken subject to the prior lender's perfected Article Nine security interest because the holder of such an interest qualifies under the Texas UCC as a good faith purchaser for value.11 Section 2.702 expressly mandates that a seller's reclamation right is "subject to" the rights of an Article Nine good faith purchaser for value.

Moreover, the meticulous analysis provided by Samuels regarding the interplay between Articles Two and Nine of the UCC is fully consistent with a finding in favor of O'Sullivan in the instant case. Turning first to the Texas UCC, Sec. 2.401(a), the Samuels Court determined that the seller's interest was in the nature of a security interest. Samuels, supra, 526 F.2d at 1246. The Court went on to recognize that the UCC makes security interests that arise by operation of law under Article Two (such as the right of reclamation) subject to Article Nine. Samuels, supra, 526 F.2d at 1247. The Court found this crucial to the final outcome.12 It is not inconsistent with this reasoning for us to hold now that the express language of Sec. 9.504, which makes the power of foreclosure "subject to Article Two," creates a duty in the foreclosing creditor to recognize and protect any Article Two interest of which the creditor is aware. Rather, such a holding reemphasizes the internal consistency of the UCC.

Finally, we find the fact that Samuels was a bankruptcy proceeding to be an important distinction.13 This is crucial because the Samuels Court treated the reclamation right there as an unperfected security interest. Under bankruptcy law, an unperfected security interest is cut short by the trustee's status as a hypothetical lien creditor against all assets in the debtor's estate from the date the petition is filed. In the instant case, bankruptcy was not pending; therefore, there is no hypothetical lien creditor to cut short O'Sullivan's interest, and none of TEMI's general creditors have attained that status.

The issue whether a right of reclamation extends to proceeds has not been squarely addressed in Texas. For the reasons set out below, we hold that a seller's right of reclamation under Sec. 2.702, if properly exercised, extends to traceable proceeds from the sale of goods where all prior interests in those goods have been fully satisfied. To hold otherwise would in many instances render the statutory remedy a nullity. In most instances, a buyer such as TEMI has granted a security interest in his after acquired property to at least one of his financing creditors. The seller is already second in priority to that lender. Furthermore, the right to reclaim goods does not arise unless the buyer is insolvent, a condition that makes foreclosure by the prior lender more than likely. Often there will be very little, if any, money left after the priority debts are paid. To hold that such a foreclosure terminates a reclaiming seller's rights to any remaining proceeds would in most cases emasculate the reclamation remedy. We recognize that Article Nine provides a means by which a seller can defeat prior liens,14 however, we are not faced with such a situation here. In enacting Sec. 2.702 we believe that the Texas Legislature intended to provide an entirely separate remedy, outside the complexities of Article Nine. It is a remedy which enables a seller to maintain a priority status against the buyer's unsecured creditors in a situation such as this. We find support for this position in many contexts.

Turning first to the language of the statute, the seller's right is made subject to the rights of "a buyer in the ordinary course or other good faith purchaser or lien creditor under this chapter (Section 2.403)." Texas UCC Sec. 2.702(c). Comment 3 to that section lists precisely those interests to which the seller's rights are made subject. Conspicuously missing are the buyer's general unsecured creditors. Quite the contrary, the comment expressly states that "this section constitutes preferential treatment as against the buyer's other creditors."

The Ninth Circuit has held that the Texas right of reclamation survives bankruptcy; thus the right of the trustee as a hypothetical lien creditor cannot supercede the right of the seller to reclaim despite the words of the statute. Matter of Daylin, 596 F.2d 853, 855-56 (9th Cir.1979). Citing In re Telemart Enterprises, Inc., 524 F.2d 761 (9th Cir.1975), as authority, the Daylin Court further held that:

Section 2.702 authorizes the exact equivalent of the common law remedy of rescission, and therefore sales described by that section result in a transfer of only voidable title. Consequently, the seller's right can only be cut off by a good faith purchaser for value.

Daylin, supra, 596 F.2d at 856 (citation omitted).

The District Court reasoned that O'Sullivan's right of reclamation was completely terminated when the SBA, as a prior lienholder, foreclosed. However, under the UCC system, the prior lienholder has several duties upon foreclosure of its lien that are designed to protect both the interests of the buyer and those of the buyer's other creditors. Texas UCC Sec. 9.501 et seq. The SBA was charged with these duties when it became subrogated to Westside's position. Texas UCC Sec. 9.504(e).

For example, a secured party's right to dispose of collateral is "subject to the chapter on sales (Chapter 2)," therefore, a seller's reclamation right, which is created under Chapter Two, is implicitly recognized as a limitation on the seller's ability to dispose of a debtor's assets. Texas UCC Sec. 9.504(a). Furthermore, Sec. 9.504(a) provides that after the lienholder satisfies its own claim, the proceeds of the sale must be applied to the satisfaction of any junior security interests if written demand is received. The record here clearly reveals that O'Sullivan made written demand on Westside, advising Westside of its Sec. 2.702 claim prior to the foreclosure on TEMI's assets.

After junior interests are satisfied, the secured party must account to the debtor. "[W]here the secured party knows the collateral is owned by a person who is not the debtor, the owner of the collateral and not the debtor is entitled to any surplus." Texas UCC Sec. 9.504(b), Comment 2.

If the nature of a seller's right of reclamation in Texas is that of an unperfected security interest, see Matter of Samuels, supra, 526 F.2d at 1244-46, then it seems clear that O'Sullivan was entitled to second priority status with regard to the proceeds after making demand. See also Peerless Equipment Co. v. Azle State Bank, 559 S.W.2d 114, 115-16 (Tex.Civ.App.1977).15

However, if O'Sullivan's interest is classified as the "equivalent" of a right to rescind, thereby enabling it to void the buyer's title, Daylin, supra, 596 F.2d at 856,16 then Westside was on notice that the goods in fact were owned by someone other than the debtor, and should have accounted to O'Sullivan for the proceeds. Finally, both the SBA and Westside implicitly recognized that O'Sullivan had retained an interest in the goods by giving O'Sullivan notice of the time and place of the foreclosure sale.17

While no bankruptcy petition was filed in the instant case, the treatment of a seller's right of reclamation under the new bankruptcy code provides a useful analogy.18 It is generally recognized that the UCC and the bankruptcy code were intended to provide a comprehensive and interrelated scheme for recognizing different property rights. Hence, the priority scheme of the UCC is incorporated into the bankruptcy code. The new code contains an express provision for dealing with the state UCC created right of reclamation in 11 U.S.C. Sec. 546(c). The legislative history of that section makes clear that "the purpose of the provision is to recognize, in part, the validity of Sec. 2-702 of the Uniform Commercial Code, which has generated much litigation, confusion, and divergent decisions in different circuits." House Judiciary Report No. 95-595 to accompany House Report 8200, 95th Cong., 1st Sess. (1977) p. 371-72, U.S.Code Cong. & Admin.News 1978, pp. 5787, 6328.

While Sec. 546(c) does not reverse the holding of Samuels, it does provide that the trustee's status as a hypothetical lien creditor is subordinate to the seller's right of reclamation. Furthermore, if the Court utilizes its power to deny the seller's right of reclamation, it must adequately protect the seller's interest by granting the seller's claim priority as an administrative expense or securing the claim with a lien. 11 U.S.C. Sec. 546(c)(2). Thus, the post-Samuels, new bankruptcy code deals with a seller's right of reclamation as equivalent to a perfected security interest under Article Nine.19 See 11 U.S.C. Sec. 363. Finally, the House Report indicates that Congress intended to extend the right of reclamation to proceeds:

The right is subject however, to the power of the court to deny reclamation and protect the seller by granting him a priority as an administrative expense for his claim arising out of the sale of the goods.

House Report, supra, at 372, U.S.Code Cong. & Admin.News 1978, p. 6328. (emphasis added). Hence, we see that Sec. 546(c) was intended to allow the reclaiming seller a priority claim20 against the proceeds from the sale of the goods when the Court chooses not to return the goods themselves. Clearly this constitutes "preferential treatment against the buyer's general unsecured creditors." See Texas UCC Sec. 2.702 comment 3.

On the basis of all the foregoing, we hold that where a seller of goods has diligently asserted its right of reclamation and otherwise met the requirements of Sec. 2.702, and where all prior lienholders have been fully satisfied, that seller's claim will be afforded priority status as against the buyer's general unsecured creditors. Furthermore, we hold that such a seller's priority will extend to proceeds that are traceable to the goods. We therefore reverse the District Court's holding as to this last point. We remand, however, for a factual finding as to whether O'Sullivan diligently exercised its right of reclamation. That finding is essential to a determination of this case.21 However, the District Court was clearly correct in granting Westside first priority to the interpleaded fund.

AFFIRMED IN PART, REVERSED IN PART AND REMANDED.