A Seller’s Remedy, But With Limitations

Nearly a decade ago, Congress amended the U.S. Bankruptcy Code to add a new section that was intended to benefit sellers of goods to failing or financially distressed companies. Under this new provision, Bankruptcy Code Section 503(b)(9), a seller of goods is entitled to an “administrative expense claim,” for the goods sold and received by the buyer in the 20 days before the buyer’s bankruptcy.  This administrative expense claim gives the seller priority over other general, unsecured creditors.  Although the specific statutory section is quite brief, there are a number of important issues that sellers must keep in mind to be able to rely on Section 503(b)(9) – and a number of important questions involving Section 503(b)(9) that still bedevil the courts.

The Statute

Bankruptcy Code Section 503, which is entitled “Allowance of Administrative Expenses,” lists nine kinds of expenses that bankruptcy courts must allow as “administrative expenses,” which entitles the creditor holding such an administrative expense claim to priority of payment.  One of those expenses is described in Section 503(b)(9), which was added to the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

The text of Section 503(b)(9) seems quite clear. It provides that:

“[a]fter notice and a hearing, there shall be allowed administrative expenses . . . [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.”

Thus, the statute authorizes an “administrative expense” priority claim for a seller of “goods” that are “received” by a debtor within “20 days” before the debtor’s bankruptcy filing in the “ordinary

Certainly, much of this section – for example, the “20 days” and “ordinary course” requirements – seems rather clear. A surprising amount of litigation, however, has arisen over other provisions of this section.  In particular, courts continue to struggle with the question of whether a seller has been selling “goods” within the meaning of Section 503(b)(9) and whether the goods that were sold were “received” by the debtor. Neither “goods” nor “received” are terms that are defined in the Bankruptcy Code.

What are Goods?

In many cases, it is clear whether or not a seller is selling “goods” to a buyer.  For example, “services” are not goods and, therefore, the provision of “services” does not qualify a creditor for a Section 503(b)(9) administrative priority.
Although the Bankruptcy Code does not define “goods,” the Uniform Commercial Code does. It states that, generally speaking, goods are “all things . . . which are movable at the time of identification to the contract for sale.”

This definition, however, can still present difficult issues.  For example, recently, the U.S. District Court for the Southern District of New York directed the Bankruptcy Court to further consider whether electricity sold by a vendor to a debtor qualified as “goods” for purposes of Section 503(b)(9). In its decision, the District Court noted that in the Section 503(b)(9) context, courts are in essence evenly split on whether or not electricity is actually a “good”.

Rulings such as this make it clear that creditors seeking to rely on Section 503(b)(9) may do so only where they have in fact supplied “goods” to the debtor.

When Does the Debtor “Receive” Goods?

Another issue involving Section 503(b)(9) that continues to arise in the bankruptcy courts with some frequency is whether a debtor has “received” the goods sold by the vendor.  Where goods are shipped and delivered to the debtor’s warehouse or other facility, the goods certainly are “received.” But the debtor’s receipt is not as clear where a supplier “drop ships” goods purchased by a debtor directly to the debtor’s customers.

In one case, decided last August, the District Court of New Hampshire granted an administrative expense claim to a paper company that sold and shipped goods to the debtor purchaser itself. However, the Court denied the seller an administrative expense claim for goods that it drop shipped directly to the purchaser’s customers.

Given these and similar rulings, vendors that are aware of a purchaser’s financial extremis but willing to continue dealing with the purchaser might consider avoiding drop-shipping goods directly to the purchaser’s customers so that it could get the benefits of Section 503(b)(9) protection.

Questions of Timing

In addition to the 20 day requirement contained in Section 503(b)(9), sellers seeking to assert a 503(b)(9) claim must keep all filing deadlines in mind.  Some bankruptcy courts may impose specific deadlines for creditors to file Section 503(b)(9) claims; in other instances, a claim under Section 503(b)(9) may have to be filed with all other claims before the claims “bar date” (i.e. the deadline to file claims against the debtor). 

Whatever the case, meeting the deadline is a crucial requirement to be able to assert a Section 503(b)(9) claim. Several years ago, one court denied a Section 503(b)(9) claim to the Goodyear Tire & Rubber Company when it determined that Goodyear had filed its Section 503(b)(9) claim too late. 

The important message is that each case – and each court – may have different unique circumstances and requirements, and these deadlines should be assessed and followed so that 503(b)(9) creditors do not waive their rights.

Conclusion

Trade creditors with a claim against a bankrupt company may find more success by asserting a Section 503(b)(9) claim than by trying to “reclaim” the goods they have sold, especially where those goods have been resold or cannot be identified (because, for example, they have been co-mingled or fabricated.) It is important to keep in mind, however, that even where a creditor is able to meet all of the requirements of Section 503(b)(9), the creditor only will have an administrative priority claim that the bankrupt debtor may – or may not – be able to pay. Where a bankruptcy estate is “administratively insolvent,” or where the bankruptcy court authorizes a “super priority” administrative priority claim that trumps a Section 503(b)(9) claim, the vendor may find that it is in the same position as the debtor’s other unsecured creditors. Still, it is clear that Section 503(b)(9) offers vendors certain advantages, and a supplier that invokes Section 503(b)(9) may be able to put itself in a more favorable position than general unsecured creditors.