For suppliers Section 503(b)(9) can mean the difference between receiving nothing and being paid 100% of the value of the goods delivered in the 20 day period before a customer’s bankruptcy. This is a result of the priority scheme of the Bankruptcy Code. This priority scheme places the holders of administrative expenses before the holders of general unsecured trade claims in receiving distributions. In addition to increasing distributions, Section 503(b)(9) potentially offers some suppliers an opportunity to reduce exposure to bankruptcy preference claims.
The benefits of Section 503(b)(9) to suppliers are matched by the damage it does to debtors. The impact of movement of substantial dollars from the unsecured trade creditor bucket to the administrative expense bucket can end (or preclude any effort to start) debtor’s plans to reorganize. Debtors have responded with increasingly aggressive attacks on suppliers’ attempts to obtain the benefits of Section 503(b)(9). We have included an article on this site that describes one debtor’s all out assault on 503(b)(9) claims.
Simply, suppliers should take the process of making a Section 503(b)(9) expense request very seriously for at least 3 major reasons:
- there is a chance for recovery where otherwise there would be none;
- strategies might be available to use administrative expenses to lessen bankruptcy preference exposure; and
- the potential for aggressive debtor attacks on a Section 503(b)(9) request.
Background of Section 503(b)(9)
Section 503 is entitled “Allowance of Administrative Expenses”. Subsection 503(b) details nine types of expenses which are to be allowed as administrative expenses and therefore are entitled to priority under Section 507(a)(2). Section 503(b)(9) provides administrative expense status 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 business.”
Section 503(b)(9) was added to the Bankruptcy Code as part of Section 1227 of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”). Unfortunately, the legislative history surrounding the adoption of Section 503(b)(9) is limited. Scholars discussing Section 503(b)(9) generally make two observations: Congress’ intent was to encourage suppliers to continue the flow of goods to a customer even when a customer’s bankruptcy was immanent; and Congress recognized that the continued flow of goods immediately before a bankruptcy preserved the value of the debtor’s business just as much as goods sold to a debtor after the bankruptcy filing.
What are the requirements of Section 503(b)(9)?
To be entitled to a 503(b)(9) claim, a supplier must show four things:
(1) that it sold goods to the bankrupt customer;
(2) that these goods were received by debtor within 20 days prior to its bankruptcy filing;
(3) that goods were sold to debtor in ordinary course of the debtor’s business; and
(4) the value of the goods that were sold to the debtor.
The Sale of Goods (Not Services) to the Customer
Section 503(b)(9) only applies to the sale of “goods”. The courts have been uniform in excluding services. However, the term “goods” is not defined in the Bankruptcy Code. Those courts that have addressed the definition of goods in interpreting Section 503(b)(9) generally have looked to the definition of “goods” in Section 2-105(1) of the Uniform Commercial Code (“UCC”) and the dictionary definition of “goods”.
The UCC defines “goods” as “all things (including specially manufactured goods) which are movable at the time of identification to the contract for sale other than the money in which the price is to be paid . . . and things in action . . . .” Neither this UCC definition nor the common dictionary definition provide practical guidance. The decisions of the Bankruptcy Courts have done little to establish objective standards.
What happens when Goods and Services are Provided Together?
It also is possible that both goods and services were provided by the same supplier, and in this hybrid situation, the Bankruptcy Courts also have not been uniform in their decisions. Some courts will determine the value of the goods by themselves and allow an administrative expense for just that value. In one case a snow removal contractor was granted an administrative expense priority for value of goods, consisting of salt and chloride de-icer, provided to debtor.
Other courts apply a “predominant purpose test” and decide if the supplier was predominantly providing goods or services. Under this test the supplier is allowed the entire expense, including the value of any services, if the transaction is found to be predominantly the provision of goods. The converse is also true. The supplier will not get any allowed claim where the court finds the transaction was predominantly the provision of services.
A supplier may have a hard time with the “goods or services” question and that is to be expected. This is an area where there is a lot of confusion among bankruptcy professionals as well. If the things delivered to the customer entail value addition that might be viewed as services or if the invoice is for a goods and services transaction, suppliers should involve bankruptcy creditor counsel well versed in Section 503(b)(9) issues before reaching any conclusions.
Goods “Sold” not Leased, Licensed or Consigned
Keep in mind that 503(b)(9) applies only to goods “sold” by the creditor to the debtor. The Bankruptcy Code does not define “sale” but the Uniform Commercial Code includes the following definition: “the passing of title from the seller to the buyer for a price” UCC § 2-106(1). This “passing of title” standard increasingly is being used by debtors to object to 503(b)(9) claims in cases where the supplier did not have title or where the supplier did not pass title. For example, if the supplier leased the goods, the debtor will claim that 503(b)(9) does not apply.
There is no requirement that the “sale” occur within 20 days of the bankruptcy filing … that timing requirement only applies to “receipt”. While the “sale” must occur before the bankruptcy filing, it can occur at any time before the bankruptcy filing. Don’t make the mistake of thinking that 503(b)(9) does not apply just because the invoice date precedes the 20th day before the bankruptcy filing. The date of “sale” and the date of “receipt” can be, and often are, different days. You have to determine the date of “receipt”.
The Question of Receipt
“Received” is not defined in the Bankruptcy Code. Bankruptcy Courts generally have looked to the definition of “receipt” in the UCC. “Receipt”, in the UCC, is defined to mean “taking physical possession.” This physical possess may be by the debtor itself (actual possession) or by the debtor’s agent (constructive possession). In the case of goods in transit, many Bankruptcy Courts have focused on the point where the supplier could no longer stop delivery of goods to the debtor.
For most suppliers, a strict application of the “physical possession” standard for determining “receipt” will prove beneficial. Unfortunately, many suppliers misunderstand the practical impact of a delay in “receipt” and miss a golden opportunity to improve their positions.
Consider a simple example. A supplier makes two shipments by common carrier to its customer. The supplier can call the shipment back at any time before offloading at the debtor’s plant. The first shipment is made on the 21st day before and the other on the last day before the customer’s bankruptcy. The first shipment is offloaded at the customer’s dock on the 19th day prior to the bankruptcy and the second shipment is offloaded at the customer’s dock on the day after the bankruptcy filing.
In the above example, if physical possession is the standard for “receipt”, the first shipment will qualify as an administrative expense under Section 503(b)(9) as goods received by the customer in the 20 day pre-petition period. The second shipment will qualify for a post-petition administrative expense under Section 503(b)(1)(A) and might even be paid by the debtor in the ordinary course pursuant to Bankruptcy Court order (i.e. under pre-petition terms).
Using the same facts as above, if shipment were used to define “receipt” the result is much worse for the supplier. The first shipment would have been “received” by the customer on the 21st day before the petition filing and therefore would create only a general, unsecured claim. The second shipment would have been received one day before the filing and will qualify as and administrative under Section 503(b)(9), which the customer likely will wait to pay until an order directing payment is entered or a plan of reorganization is confirmed.
Although mostly helpful to suppliers, using the “physical possession” standard can cause trouble. One common trouble situation is where the supplier delivers goods on behalf of the bankrupt customer to someone other than the bankrupt customer – e.g. to another supplier, directly to the end customer (i.e. drop shipments) or to some intermediate holding facility. In this situation, the bankrupt customer may argue that it never received the goods since they went directly to someone else. This situation can get very complicated and an evaluation by bankruptcy creditor counsel is imperative.
Another problem situation arises when goods are delivered to the customer under an arrangement where the customer does not own the goods until pulled from stock. Under these “bulk delivery” arrangements, the customer often receives the goods well outside the 20 days before bankruptcy even though they are “sold” within that period.
There may be other cases where the “physical possession” standard of receipt does not allow the supplier to preserve a 503(b)(9) claim. Those situations also require involvement of bankruptcy creditor counsel.
The Value of the Goods.
What about the “value” of goods delivered? Bankruptcy courts usually will give suppliers the presumption that the invoice price represents the value of the goods. However, the presumption can be overcome. The most common case where the invoice amount does not determine value is where the invoiced amount includes an ancillary service charge (e.g. a charge for delivery of the goods) or when services and goods are provided together. For example, if you have an expedited freight charge or overtime charge that the customer agreed to reimburse, then you might have to argue about whether that amount is part of the “value” of the goods to your customer.
When does your company need to determine if it qualifies for a Section 503(b)(9) expense?
This determination must be made as soon as possible after the bankruptcy filing. The timing for asserting 503(b)(9) claims is not set by the Bankruptcy Code. The deadlines for these claims are set by court order. Increasingly, bankruptcy courts are setting these deadlines very early in the bankruptcy proceedings. If you do not know if the bankruptcy court has set a deadline and what that deadline is, you are at risk of loosing the right to assert the 503(b)(9) claim. For an example of a deadline being set for a 503(b)(9) claim see our article on the Contech bankruptcy.
A terrible example of a creditor missing a bar date came in the Dana Corp bankruptcy. In that case, Goodyear lost a 503(b)(9) claim for $1,401,053.85 for goods delivered to the customer within three weeks of the customer’s’ bankruptcy filing. Goodyear filed their claim after the bar date had past.
For a more detailed, practical discussion of the need to timely file Section 503(b)(9) claims, go to the article “Debtor Onslaught to Disallow Supplier 503(b)(9) Administrative Expenses.”
How does my company make a 503(b)(9) claim?
In each bankruptcy case the rules may be different. That is because the judge can set the procedures for filing of a 503(b)(9) claim. In some cases, the court will require a filing by a lawyer asserting the 503(b)(9) claim. Click the immediately preceding link to see an example of that type of filing. In other cases, the judge may require that the 503(b)(9) claims be asserted with the general unsecured creditor claims. Finally, in still other cases, the court may establish special, and sometimes complicated, procedures that have to be strictly followed to assert a 503(b)(9) claim.
To find out how a 503(b)(9) claim must be filed, you are going to have to look that the court’s orders. If the court did not enter any orders establishing procedures for filing of 503(b)(9) claims, then in most bankruptcy courts you will have to get a lawyer to file the 503(b)(9) claim for your company.
An experienced bankruptcy creditor lawyer should assist in the preparation of any Section 503(b)(9) administrative expense request. Certain aspects of the request can get complicated and the interaction of a request with potential bankruptcy preference claims must be considered. There may be both a real opportunity for supplier bankruptcy strategic planning and some risks.
What does making a 503(b)(9) administrative expense mean in terms of payment?
If your company’s 503(b)(9) claim is allowed, it will get an “administrative expense priority” for the amount of the claim. This status requires that your 503(b)(9) claim get paid before general unsecured creditor claims. It does not mean that there will be money to pay your claim.
Secured creditors and creditors who have provided debtor in possession financing (“DIP Financing”) must get paid before the administrative expense claims. Also, there can be other administrative expense claims that have to be paid along with yours. In these hard times, we are seeing more and more often cases in which there is either no money to pay any administrative expense claims or there in not enough money to pay all the claims. This situation is called “administrative insolvency.”
A Section 503(b)(9) claim can have value greater than its face dollar amount, even where there is administrative insolvency, in negotiating the resolution of potential preference claims. The way the strategy works is described in detail in our post “Best, Worst Examples of Using 503(b)(9) Claims to Settle Bankruptcy Preference Claims.“
When will a 503(b)(9) administrative expense get paid?
The answer to that questions depends on the decision of the bankruptcy judge. The judge’s decision is going to be heavily influenced by the position of the customer, the unsecured creditors committee, the secured lenders and DIP Financing provider.
The latest that it must be paid is at the time of confirmation of the plan of reorganization. That can be months or even years after the bankruptcy filing. You can request to be paid sooner, but if that request is opposed by the customer, the creditors’ committee or the secured lenders, the chances of that request being granted are slim.
One ray of hope has recently emerged. In recent cases in the automotive sector, we increasing have seen requests being made by the customer itself for authority from the bankruptcy court for the customer to go ahead an pay all or some of the 503(b)(9) claims. The bankruptcy courts, when requested by the debtor, are often giving this authority. These requests are only to give the customer the authority to pay the claims early. The customer is not required to make the payments before they have to be paid.
To find out when you might be paid your 503(b)(9) claims, check the first day orders of the bankruptcy court and any subsequent orders that address 503(b)(9) claims.
 Drop shipments are especially difficult to claim for 503(b)(9) treatment because of the challenges in proving that a delivery to a debtor’s customer was “constructive” delivery to the debtor. To date, the United States District Court for the District of New Hampshire has provided the most detailed analysis of the statutory interpretation aspects of the issue. Ningbo Chenglu Paper Prods. Mfg. Co. v. Momenta, Inc., 2012 U.S. Dist. LEXIS 122615 (D.N.H. 2012). That court held:
The bankruptcy court correctly concluded that Sections 503(b)(9) and 546 are related statutory provisions enacted for the benefit of reclamation sellers. It also properly determined that the word “received” should be given the same meaning in both sections. See generally United States v. Delgado-Garcia, 374 F.3d 1337, 1347, 362 U.S. App. D.C. 512 (D.C. Cir. 2004) (courts should “construe related statutory provisions in similar fashion.”). The phrase “received by the debtor” as used in Section 503(b)(9) means: possessed by the debtor, either actually or constructively. The bankruptcy court also correctly held that, under Section 503(b)(9), delivery to, or possession by, a debtor’s customer under a drop-shipment arrangement does not constitute constructive possession by the debtor for Section 503(b)(9) purposes.
Even if prior decisions under the reclamation section 546(c) are discounted, the task of establishing that a debtor’s customer is in possession of the drop shipped “goods as an agent, designee, bailee, or in some other representative capacity for the Debtor” may be daunting. See In re Plastech Engineered Prods., 2008 Bankr. LEXIS 3130 (Bankr. E.D. Mich. Oct. 7, 2008).
 The problem of “pre-sale” storage of goods with a debtor was painfully illustrated in the recent decision of the United States Bankruptcy Court for the Northern District of Indiana in In re Wezbra Dairy, LLC, 2013 Bankr. LEXIS 2585 (Bankr. N.D. Ind. 2013). The Bankruptcy Court summarized the facts as follows:
The debtor in this chapter 11 case operates a dairy farm in northwest Ohio. As part of that operation, it entered into agreements with five brothers – Louis, Dennis, Roger, John and Matt Niese – for silage… . The second agreement was derived from the first; in particular from the license to store the silage on the debtor’s property. This was a title retention agreement. It acknowledged that title to the silage remained with the producer and gave the debtor the first right to purchase it, from time to time, but only for consumption by its dairy herd. Until it did so, title remained with the Nieses. In the meantime, the debtor was responsible for the care and protection of the silage, bore the risk of any loss, and was to insure it.
The supplier sought administrative expense treatment under 503(b)(9) for the silage (cattle fodder) used by the debtor in the 20 days before the bankruptcy filing. The Bankruptcy Court denied the administrative expense claim because the silage used in the 20 day period had been delivered before that period. The court reasoned:
“A person who knowingly has direct physical control over a thing, at a given time, is . . . in actual possession of it.” Black’s Law Dictionary 1163 (6th ed. 1990). From the time the silage was delivered to and placed in the bunkers on its property the debtor had control over it. The silage was located on the debtor’s property; the debtor was responsible for its care and protection; the debtor bore the risk of any loss; and the debtor determined when and how much silage would be removed from the bunkers to feed its dairy herd. It is extremely difficult to see how all of this does not constitute actual physical possession, notwithstanding the locus of title. This reality is not changed by the license debtor granted the movants or attempts to characterize the arrangement as a bailment, with debtor acting as a bailee. The court concludes that the debtor received the silage when it was delivered to and placed in the bunkers on its property and not when it was removed and fed to the debtor’s livestock. Accord, In re Circuit City Stores, Inc., 432 B.R. 225 (Bankr. E.D. Va. 2010); In re Pridgen, 2008 Bankr. LEXIS 1274, 2008 WL 1836950 (Bankr. E.D. N.C. 2008).