The 2005 amendments to the Bankruptcy Code included the addition of an administrative expense claim for the value of goods received by the debtor in the 20 days prior to the bankruptcy filing. The allowance of an administrative expense priority—which generally garners payment in full—for a prepetition claim was a break from tradition and a significant boon to suppliers of goods. For that same reason, however, debtors have had an incentive to fight against the magnitude of such claims in any way possible. One tool for debtors has often been the ambiguity surrounding the meaning of the word “received.”
On July 10, 2017, the US Court of Appeals for the Third Circuit issued a precedential opinion that is likely to be highly influential on that issue. Reversing two lower courts, the Third Circuit held that the word “received” requires actual physical possession of the goods. That holding is a victory for suppliers, because a debtor will often take physical possession later than it might have been deemed to take constructive possession—allowing deliveries of more goods to qualify for the administrative expense claim.
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The Third Circuit opinion arises out of the bankruptcy case, In re World Imports, Ltd. In that case, Haining Wangsheng Sofa Company and Fujian Zhangzhou Foreign Trade Company (the Creditors) supplied furniture and other goods to the debtor, World Imports. On May 26, 2013, Haining sent a shipment from Shanghai, free on board (FOB) at the port of origin, meaning that the risk of loss or damage passed to World Imports upon transfer at the Shanghai port. On May 17, May 31 and June 7, Fujian sent goods under similar terms from Xiamen, China. All of the goods were accepted by World Imports in the US within the 20 days preceding July 3, 2013, the date on which World Imports filed a petition for relief under chapter 11 of the Bankruptcy Code.
Section 503 of the Bankruptcy Code addresses administrative expenses, which are generally the highest priority in the Code’s scheme. Subsection (b)(9) provides for the allowance of an administrative expense for “the value of any goods received by the debtor within 20 days before the date of commencement of a [bankruptcy] case... in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.”
The issue in World Imports centers on when the debtor received the goods. If receipt occurred when the goods were transferred at the port of origin, then the delivery would fall outside of the 20-day period and the Creditors would not be entitled to an administrative expense claim. On the other hand, if World Imports received the goods when it took physical possession in the US, then the Creditors would qualify for the section 503(b)(9) administrative expense.
The bankruptcy court ruled in favor of the debtor. It emphasized that the Bankruptcy Code does not define the word “received,” and therefore the court first looked to the Convention on Contracts for the International Sale of Goods (CISG). The CISG also does not define the term, however, and therefore the court looked to the international commercial terms (Incoterms) that are incorporated into the CISG. Even under the Incoterms, there is no definition of “received,” but the bankruptcy court underscored that the Incoterm governing FOB contracts governs when the risk of damage or loss transfers to the buyer. Based on the operation of the FOB provisions in the contract and the effect of the Incoterms, the bankruptcy court concluded that the goods were “constructively received” by the debtor when the goods shipped from China. On appeal, the district court affirmed the bankruptcy court’s ruling.
The Third Circuit rejected the bankruptcy court’s analysis. In a footnote, the court emphasized that the Bankruptcy Code provides the relevant substantive law, and that courts should not “assume that Congress intended to adopt a definition from another source of federal law in the absence of any explicit connector between the Bankruptcy Code and a definition” contained elsewhere. Further, it underscored that the CISG and the Incoterms were relevant for contractual disputes between the parties, but not necessarily for disputes related to rights under the Bankruptcy Code.
Instead, the Third Circuit provided an analysis that began with the text and context of the relevant statute. It agreed that the Bankruptcy Code does not define the word “received.” In such circumstances, it noted that if a given word has “a well-known meaning at common law or in the law of this country, it is presumed to have been used in that sense unless the context compels to the contrary.”
Therefore, the court surveyed two different editions of Black’s Law Dictionary and the Oxford English Dictionary for their definitions of “receive.” Those definitions varied somewhat, but the court highlighted that they all required physical possession. It concluded: “Applying those definitions to § 503(b)(9), a debtor must take goods into its possession, custody or hands in order to receive them.” The court noted that such a definition is consistent with the definition of “receipt” found in the Uniform Commercial Code.
As secondary support, the Third Circuit also traced the legislative history of the 2005 amendments to the Bankruptcy Code. The relevant amendments were said to create section 503(b)(9) “as an exemption” from the existing bankruptcy treatment of reclamation rights. The Third Circuit has existing case law, In re Marin Motor Oil Inc., in which it holds that receipt requires physical possession for reclamation purposes. Because of the interrelated nature of section 503(b)(9) and the reclamation statute, the court concluded that the two statutes must be interpreted together. “It strikes us as quite implausible that Congress meant for the date of receipt to be different between these two provisions. Indeed, for this general-rule-and-exemption scheme to make sense, the date of receipt must be fixed.”
Based on those factors, the court concluded that “there is no support for the idea that a buyer constructively receives goods when they are delivered to a common carrier, even if title and risk of loss pass at that time.” It therefore reversed the order of the district court and remanded for further proceedings.
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The World Imports opinion is a striking victory for suppliers of goods, generally at the expense of debtors’ reorganization efforts and other types of creditors in bankruptcy. The decision provides some needed certainty to the markets, and it will likely have some small effects of encouraging trade with a troubled buyer. For some industry segments, such as commodity traders or other importers, the benefit may be significant. Still, debtors will continue to try to push back against asserted section 503(b)(9) claims on a variety of other issues, such as the meaning of “goods.”