Since it burst onto the Bankruptcy Code scene in 2005 with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), section 503(b)(9) of the Bankruptcy Code, which affords a creditor administrative priority for the value of goods the debtor received within 20 days prior to its bankruptcy filing, has been the subject of many bankruptcy decisions. The express language of section 503(b)(9) has come under heavy scrutiny, with much of the litigation surrounding section 503(b)(9) focusing on what constitutes a “good.” You can read about whether electricity, for example, is a “good” here,herehere and here.

In re World Imports, issued by the United States Bankruptcy Court for the Eastern District of Pennsylvania last week, again examines the express language of section 503(b)(9) but, this time, from an entirely different context. In re World Imports discusses, among other things, what it means, under section 503(b)(9), for a debtor to have “received” goods.

Background

In In re World Imports, creditor Sunrise Furniture Co. Ltd. souganalysht payment of administrative expenses relating to goods it sold to the debtor within 20 days prior to the debtor’s bankruptcy filing. Specifically, section 503(b)(9) provides, “After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502(f) of this title, including – (9) 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 the debtor’s business.” To establish entitlement to administrative priority, the claimant must show that: (1) it sold goods to the debtor, (2) the goods were sold in the ordinary course of the debtor’s business, and (3) the goods were received by the debtor within 20 days prior to the bankruptcy filing.

Though the debtor and Sunrise agreed that the goods at issue were sold in the ordinary course of business and were, in fact, “goods” under the meaning of section 503(b)(9), they disagreed as to whether the debtor had “received” the goods as contemplated by the statute. This is because Sunrise had “drop-shipped” (i.e., delivered directly) the items at issue to the debtor’s customers. The debtor contended that a drop-shipment is not “received” by the retail merchant, so Sunrise’s drop-shipments to the debtor’s customers could not qualify for administrative priority treatment under section 503(b)(9).

To support its position, the debtor argued that every case to consider the issue had held that section 503(b)(9) applies only when the debtor has physically received the goods. By contrast, Sunrise argued that, under the Uniform Commercial Code, receipt of goods by a buyer includes receipt of such goods by the buyer’s representative or subpurchaser.  Sunrise also cited to a trade journal article espousing the opinion that drop-shipped goods should be deemed received by the debtor for purposes of section 503(b)(9).

Analysis

Apparently unconvinced by the characterizations in the Uniform Commercial Code and the opinion piece in the trade journal, the court concluded, without expressly stating it, that the term “received,” essentially, implies physical receipt. Justifying its conclusion, the court relied upon two of the four cases cited by the debtor in its pleadings. The court noted that the Bankruptcy Court for the Eastern District of Michigan had considered a similar issue and rejected the seller’s argument that, where goods are delivered to the debtor’s customer, the debtor need not actually receive the goods in order for the creditor to claim administrative priority. The Michigan court had relied on the express language of section 503(b)(9) requiring receipt and did not expand the definition beyond the more traditional meaning of the word.

The court next cited to a decision issued by the United States District Court for the District of New Hampshire. There, the New Hampshire district court had undertaken a more thorough analysis of the term “receipt.” Observing that the word “received,” as it is used in section 503(b)(9), is not defined in the statute or elsewhere in the Bankruptcy Code, the New Hampshire court stated that Congress added section 503(b)(9) to supplement the remedies available to reclamation sellers under section 546(c) and that Congress had not actually intended to “create a new and expansive creditor class entitled to a unique priority.” TheWorld Imports court quoted the New Hampshire decision in noting that reading section 503(b)(9) narrowly “would likely enhance prospects for successful reorganization, while respecting creditor equality principles” and “the larger the potential cash reserve needed,…the less likely a debtor will reorganize.” In this context, the New Hampshire district court concluded that the phrase “received by the debtor” in section 503(b)(9) necessarily meant “possessed by the debtor, either actually or constructively” and concluded that a drop-shipment does not constitute “even constructive possession” for purposes of section 503(b)(9). Persuaded by the reasoning of the New Hampshire District Court, the court in World Imports held that the goods delivered by Sunrise via drop-shipment were not actually received by the Debtor and could not qualify for administrative priority.

Conclusion

It’s probably true that, in commercial trade, bankruptcy is not always at the forefront of merchants’ minds. The efficient scenario in which a purchaser requests that the seller deliver the items directly to the purchaser’s customers and “eliminate the middle man” is likely a common one. But, as the World Imports decision suggests, a seller’s agreement to deliver goods directly to the ultimate purchaser may have economic consequences for the seller if the purchaser files for bankruptcy protection within the 20-day period in which the goods are delivered and the court finds the customer’s receipt of the goods directly from the seller necessarily means the debtor did not receive the goods under section 503(b)(9).

This article was originally posted on Weil’s Bankruptcy Blog. For more information, please visit the blog at: http://business-finance-restructuring.weil.com/