Sellers Must Show “Physical Possession” by a Debtor to Qualify for a 20-Day Administrative Expense Claims Under Bankruptcy Code Section 503(b)(9)


The Business Advisor

Summer 2017

A seller of goods may recover as a priority administrative expense the value of goods received by a debtor within 20 days before the filing of a chapter 11 case. Administrative expense claims receive priority treatment over unsecured claims in bankruptcy and must be paid in full, in cash on the effective date of any confirmed chapter 11 plan. Therefore, 503(b)(9) claims (for the value of goods received by the debtor within 20 days before the filing of a chapter 11 case) are valuable claims for creditors—and burdensome claims for debtors hoping to confirm a plan. Three recent court decisions make clear that the “received by the debtor” language in section 503(b)(9) means that the debtor must actually take physical possession of the goods.

1. ADI Liquidation, Inc.

In In re ADI Liquidation, Inc., Case. No. 14-12092 (KJC), 2017 WL 2712287, the debtor (AWI) was a cooperative grocery distributor that provided distribution and retail services to its members who operated retail grocery stores (AWI Members). It is common for grocery cooperative wholesaler/distributors to provide certain “back-office” services for their members, including centralized accounting, billing, and payment services.

Bimbo Bakeries USA, Inc. (Bimbo) is a manufacturer and distributor of well-known brands of fresh baked goods. Although AWI Members ordered baked goods directly from Bimbo, and Bimbo delivered those goods directly to those members, the payments for those goods were made by AWI to Bimbo. In turn, AWI Members paid AWI for the value of those goods.

Bimbo filed an administrative priority claim against the AWI debtors seeking to recover the amount of $962,538 (Bimbo 503(b)(9) Claim), representing the value of goods delivered to and received by the non-debtor AWI Members within 20 days before the AWI debtors’ bankruptcy filing.

Bimbo asserted that the integral role that AWI played in connection with the AWI Members’ operations meant the AWI debtors “constructively received” the goods. The AWI debtors objected to the Bimbo 503(b)(9) Claim, asserting that the AWI debtors never received—physically or constructively—the goods delivered by Bimbo to AWI Members.

There was no dispute about the fact that the goods were never physically received by the AWI debtors. Thus, in resolving the parties’ competing motions for summary judgment, the only issue for the court to decide was whether the goods were “constructively received” by the AWI debtors.

The ADI Liquidation court noted that the word “received” is not defined in the Bankruptcy Code, but that other courts have found that the term “received” has the same meaning as “received” in Bankruptcy Code section 546(c), governing reclamation claims. The court also looked to the Uniform Commercial Code’s (UCC) definition of “receipt” in interpreting the term “received” in section 503(b)(9). UCC section 2-103 defines “receipt” as taking physical possession of goods, which, in the context of reclamation claims, can be actual or constructive possession. Under the UCC, however, constructive possession can occur only where the receiving party is a bailee1 of the debtor, which the court determined was not the relationship between AWI and the AWI Members.

Analogizing the case to “drop-ship” cases where a debtor orders goods to be delivered directly to its customers, courts have consistently denied 503(b)(9) claims because “drop-shipped” goods are never physically “received by” the debtor. The ADI Liquidation court found the connection between AWI and Bimbo was even more remote than the typical “drop-ship” case, because the third-party AWI Members ordered the goods directly from Bimbo, not the AWI debtors.

The court denied the Bimbo 503(b)(9) Claim because constructive receipt does not extend to non-bailee third parties like the AWI Members, and also because the court found that the goods were sold to the AWI Members—not the AWI debtors.2

2. World Imports, Ltd.

In Haining Washeng Sofa Co., Ltd, Fujian Zhangtzhou Foreign Trade Co., Ltd v. World Imports, Ltd (In re World Imports, Ltd., et al.), Case No. 16-1357, 2017 WL 2925429 (3d Cir. July 10, 2017), two China-based sellers sold furniture and similar goods to World Imports prior to the commencement of its chapter 11 case. The goods were delivered to common carriers for shipment to the United States FOB (“free on board,” meaning that the risk of loss passed to World Imports upon delivery at the China ports). Although the goods were delivered to the common carriers in China more than 20 days before the commencement of World Imports’ chapter 11 case, World Imports actually took physical possession of the goods in the United States within the applicable 20-day window.

The issue before the bankruptcy court was whether World Imports “received the goods within 20 days prior to the bankruptcy filing.” The bankruptcy court concluded that, because the risk of loss transferred from the sellers to World Imports upon delivery FOB at the China ports, the goods were “constructively received” by World Imports upon delivery to the common carrier’s vessel, which occurred more than 20 days before the bankruptcy filing. Accordingly, the bankruptcy court denied the sellers’ administrative expense claims. The district court affirmed, and the sellers appealed to the Third Circuit Court of Appeals.

The Third Circuit began its analysis by reviewing the text and context of section 503(b)(9), stating that, because the Bankruptcy Code does not define the word “received,” the word should be construed in accord with its ordinary and natural meaning. The court said that a word’s well-known meaning is especially salient for bankruptcy law because, in Dewsnap v. Timm, 502 U.S. 410, 419 (1992), the Supreme Court recognized that Congress does not write on a clean slate when amending bankruptcy laws. After reviewing the ordinary meaning of “received” in several dictionaries, and considering legislative context, the UCC and the Third Circuit’s prior interpretation of a related Bankruptcy Code provision, 11 U.S.C. § 546(c), in In re Marin Motor Oil, Inc., 740 F.2d 220, 224-25 (3d Cir. 1984), where the court held that “receipt” occurs when the buyer takes physical possession of the goods, the court held that section 503(b)(9) requires physical possession by the debtor or its agent.

The Third Circuit observed that:

While it is true that a buyer may be deemed to have received goods when his agent takes physical possession of them, common carriers are not agents. Constructive receipt thus does not include FOB delivery to a common carrier …

2017 WL 2925429, at *4. The Court of Appeals reasoned that, where the parties are using a common carrier, “the seller has the right to stop delivery of the goods while the common carrier remains in possession … Only upon the buyer’s physical possession does the seller’s remedy convert to the different right of reclamation.” Id. (internal citations and quotations omitted). The Court of Appeals therefore found that “receipt does not occur until after the seller’s ability to stop delivery ends—namely, upon the buyer’s physical possession.” Id. at 5.

Thus, because World Imports took physical possession of the goods within 20 days before the bankruptcy filing, the Court of Appeals held that the creditors were entitled to allowance of their administrative expenses claims under Bankruptcy Code section 503(b)(9).

3. SRC Liquidation

Three days after the decision in World Imports, in In re SRC Liquidation, LLC, Case No. 15-10541 (BLS), 2017 WL 2992718, (Bankr. D. Del. July 13, 2017), the Delaware Bankruptcy Court addressed the same issue, i.e., whether goods were “received by” a debtor within the meaning of section 503(b)(9), albeit in a different context and netting a different result for the claiming seller.

The issue in the SRC Liquidation case was whether goods delivered to UPS for shipment using the debtor’s account to a third party customer during the 20-day administrative claim period qualified for priority treatment under section 503(b)(9). The seller asserted that, by drop-shipping the goods to the debtor’s customer, the goods were “constructively” “received by” by the debtor within the meaning of section 503(b)(9), and, therefore, the seller was entitled to an administrative expense claim for the value of the goods.

In light of the Third Circuit’s recent World Imports decision, the bankruptcy court had no choice but to deny the seller’s administrative expense claim under 503(b)(9), leaving the seller with a general unsecured claim.

The SRC Liquidation court began its analysis by stating that the administrative expenses listed in section 503(b)(9) are “discrete exceptions to the general equity principle” and accordingly “must be strictly construed and be clearly authorized by Congress.” 2017 WL 2992718, at *2 (internal citations and quotations omitted). The Bankruptcy Court found that the claimant failed to carry its burden of proof because only UPS actually possessed the goods and, as a common carrier, it did not qualify as the debtor’s agent. Thus, the seller’s priority administrative expense claim was denied.

Although these three recent decisions had different contexts and results, one common thread runs through all of them—namely, in all three cases, the sellers had to show “physical possession” by a debtor to qualify for a 20-day administrative expense claim under Bankruptcy Code section 503(b)(9).

1 A person or party to whom goods are delivered for a purpose, such as custody or repair, without transfer of ownership.
2 On July 5, 2017, BBU appealed the bankruptcy court’s decision.