Section 503(b)(9) of the Bankruptcy Code (11 U.S.C.
§503(b)(9)) provides a special administrative priority claim
for someone that supplies goods to a debtor in the 20 day period
before the bankruptcy filing, but is unpaid as of the date of the
filing. This is a meaningful priority. Administrative priority
claims, which are on par with the claims of other post-petition
service providers, like the debtor's professionals, must be
paid in full at the time of the confirmation of a plan, in order
for a plan to be confirmed. Reliance on the priority provided by
Section 503(b)(9) of the Bankruptcy Code can serve as an important
alternative to suppliers who might otherwise be forced to seek to
exercise state law rights of reclamation under the Uniform
Commercial Code after a customer receives their goods—claims
which can clash, often unsuccessfully for the supplier, with the
rights of secured lenders.
Claims arising under Section 503(b)(9), are, at their essence,
relatively uncomplicated on first blush. An unpaid claim for
"the value of any goods received by the debtor within 20 days
before the date of commencement of a case under this title in which
the goods have been sold to the debtor in the ordinary course of
such debtor's business" is entitled to the priority.
Notwithstanding what looks to be pretty straightforward language,
however, a recent set of decisions from the Third Circuit Court of
Appeals, and from the Bankruptcy Court for the District of Delaware
provide some detail on what it means for goods to be "received
by the debtor" for purposes of Section 503(b)(9).
In In re World Imports, Ltd., 16-1357 (3rd.
Circuit, July 10, 2017), two Chinese suppliers sold goods to the
debtor which were loaded onto ships in China, "FOB at the port
of origin". As a result, the risk of loss with respect to the
goods passed to the debtor at the time the goods were transferred
to the shipper for carriage to the United States. Although the
debtor accepted the goods in the United States within 20 days of
the date it filed its chapter 11 petition, the date the goods were
transferred to the shipper in China was more than 20 days prior to
the filing date. The debtor objected to the suppliers'
subsequent 503(b)(9) claim, arguing that the goods were
"received" when the risk of loss
transferred—outside the 20 day period. The Bankruptcy Court
agreed with the debtor and denied 503(b)(9) priority to the
suppliers' claims. On appeal, the District Court affirmed.
However, on appeal to the Third Circuit Court of Appeals the lower
courts were reversed, as the Court of Appeals determined that the
term "received by the debtor" as used in Section
503(b)(9) meant the time "the debtor or its agent takes
physical possession of [the goods]." Because the goods were
actually in the possession of the debtor within the 20 day period
preceding the filing date, the suppliers were entitled to 503(b)(9)
priority.
Shortly after the decision in World Imports,
the Bankruptcy Court for the District of Delaware was faced with a
slightly different problem in a Section 503(b)(9) context. In
In re SRC Liquidation, LLC, No. 15-10541 (Bankr.
D. Del. July 13, 2017), the debtor had arranged for one of its
suppliers to "drop ship" certain goods ordered by the
debtor so that they would be shipped by the supplier directly to
the debtor's customers, with the debtor never taking actual
physical possession of the goods. The supplier claimed that it was
entitled to an administrative expense claim under Section 503(b)(9)
for the value of the goods shipped directly to the debtor's
customers, but in ruling on an objection to that claim the
Bankruptcy Court disagreed. Relying in significant measure on the
Third Circuit's determination in World
Imports, the Court found that under the drop shipment
arrangement, the goods were never "received by the
debtor" because neither the debtor nor its agent (and, as the
Court pointed out, a common carrier/shipper does not qualify as an
"agent" of a debtor for these purposes) ever had physical
possession of them. As a result, the supplier was not entitled to a
priority claim under Section 503(b)(9).
In reaching their respective decisions, both courts above made
specific reference to the provisions of Section 2-705 of the UCC to
support the conclusion that goods are "received" by the
buyer's physical possession of the goods or the buyer's
"constructive receipt" of the goods, in each case as
outlined in 2-705. Thus, the phrase "received by the
debtor" in Section 503(b)(9) turns out to mean pretty much
exactly what common sense would suggest it means—the goods
must have been physically received by the debtor or its agent (such
as a bailee who holds the goods for the debtor) within the 20 day
period.
Finally, one other recent case suggests vitality for a supplier
remedy under the UCC that has been somewhat overshadowed by
503(b)(9) and post-delivery reclamation demands—the right to
seek to stop delivery of goods in transit.
In O2Cool, LLC v. TSA Stores, Inc., No. 16-10527
(Bankr. D. Del. March 1, 2017) a supplier found itself in a fight
with a debtor's secured lenders over the value of goods that
were shipped to the debtor pre-petition. Here, there was no dispute
about the debtor's receipt of the goods. However, in this case,
the supplier alleged that prior to the time the goods had been
received by the debtor it had served a timely notice to stop
delivery under Section 2-705 of the UCC upon the carrier of the
goods. According to the supplier's complaint, that notice had
been actually received by the carrier before the debtor took
possession of the goods, but the debtors had instructed the carrier
to disregard the notice. The debtor subsequently sold the goods,
and turned over the proceeds of the sale to the secured lenders.
The supplier sought a judicial determination that its rights to the
value of the goods and their proceeds were senior to those of the
secured lenders.
The lenders sought to dismiss the complaint, arguing that there was
no timely reclamation demand made by the supplier, and that even if
there had been, the supplier's claim would be junior to the
lenders' liens. The supplier admittedly never made a
reclamation demand of the debtor, and never filed a timely claim
under 503(b)(9), notwithstanding the debtor's receipt of the
goods. Instead, the supplier asserted that the effect of the
stoppage notice was that the debtor never acquired any rights in
the goods whatsoever—hence there was no need for any such
claims. Rather, it argued, because the debtor never acquired rights
in the goods, the debtor never had any right to sell the goods, and
the liens of the secured lenders never attached to them at all. As
a result, the supplier contended it was entitled to the full value
of the goods.
This claim survived the lenders' motion to dismiss as the
Bankruptcy Court found that if the allegations of the complaint
were in fact true, no reclamation claim would have been required of
the supplier, and the disputed goods would never have become
property of the bankruptcy estate. Thus, the supplier had a
colorable argument that any subsequent sale of the goods after the
notice to stop delivery would have required full payment in cash to
the supplier—which never occurred, as the proceeds were
instead paid to the lenders.
While clearly at a preliminary stage of the proceeding, this case
suggests an alternative for suppliers other than simply taking
action after delivery of the goods to the debtor—the giving
of notice to a carrier to stop delivery before
delivery to the debtor, when permitted to do so under Section 2-705
of the UCC. Clearly, there are a great number of details associated
with taking this sort of action in any particular case (for
example, the supplier in O2Cool had utilized a
freight forwarder, and initially gave the stop shipment order to
the wrong entity), but if done timely, and correctly, and in
compliance with 2-705 of the UCC, another arrow may reside in the
quiver of the supplier.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.