In an issue the court notes is one of first impression, a Bankruptcy Appellate Panel for the U.S. Court of Appeals for the Ninth Circuit has held that a bankruptcy court could grant an administrative priority to a claim which also may be secured. Brown & Cole Stores, LLC v. Associated Grocers, Inc., 375 B.R. 873 (9th Cir. BAP, Aug. 17, 2007).

“We expect that the issue is of great importance to many sellers of goods to troubled companies,” the court wrote, noting that the case involved the new section 503(b)(9) of the Bankruptcy Code. That section, as amended in 2005, gives administrative priority to a claim for the value of goods, received by a debtor within 20 days before the commencement of a case, which were sold to the debtor in the ordinary course of the debtor’s business.

While affirming the grant of administrative priority, the court reversed the denial of the debtor’s attempt to setoff pre-petition claims against allowed administrative claims.

The debtor, Brown and Cole Stores, LLC (B&C), is a large grocery store chain operating in Washington. Associated Grocers Incorporated (AGI), a cooperative of which B&C is the largest shareholder, is B&C’s primary supplier and wholesaler. The parties operated under a supply agreement that provided that AGI would sell goods to B&C on terms no less favorable than any of its other customers or shareholders. As security for B&C’s indebtedness, AGI held a security interest in B&C’s stock. Shortly after B&C filed its bankruptcy case, AGI filed a motion seeking allowance and payment of its claim for goods delivered in the 20 days pre-petition.

B&C opposed the motion and argued that AGI’s claim was not entitled to administrative priority because of AGI’s claimed security interest in B&C’s stock. B&C also argued that, prior to B&C’s bankruptcy, AGI breached their supply agreement by charging B&C higher prices than its other customers; thus, B&C was entitled to a setoff.

The bankruptcy court granted AGI’s motion and denied B&C’s request for setoff. The court concluded that B&C was precluded from exercising its setoff right as a matter of law and equity because AGI’s claim was an administrative priority claim.

Ninth Cir. BAP

On appeal, the Ninth Circuit BAP affirmed the allowance of AGI’s administrative claim, but rejected the bankruptcy court’s analysis of B&C’s asserted right to setoff.

In considering whether a claim that is secured is entitled to administrative priority, the court noted that because section 503(b)(9) does not specifically exclude secured claims, the statute must be interpreted as including any conforming claims, whether secured or unsecured.

The court also addressed whether B&C’s claim against AGI for overcharges in violation of their agreement could be setoff against AGI’s claim for goods delivered in the 20 days pre-petition. The BAP found that administrative priority status does not change the character of the underlying claim. Although AGI’s claim was afforded administrative priority status, the claim nonetheless arose pre-petition. Thus, since B&C’s claim and AGI’s claim both arose pre-petition, the claims are mutual and setoff was possible, the BAP concluded.

This case clarifies that under the Bankruptcy Code, a creditor’s security for a claim for goods delivered within the 20 days pre-petition does not impact the claim’s eligibility for administrative priority status. While a claim of this type is afforded administrative priority status, this does not, however, change the character of the claim. Therefore, traditional defenses available to claims which arise pre-petition remain available.