Section 503(b)(9) Priority Claim Developments

T h e P u b l ic ation Fo r C r edit & Fin a nce P ro f ession a l s
june 2010
N a tion a l Associ a tion o f C r edit M a n a gement
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Bruce Nathan, Esq.
t o p i c
Section 503(b)(9) Priority Claim
Developments: The Beat Goes On!
B
s e l e c t e d
ankruptcy Code Section 503(b)(9) has seen more
than its fair share of litigations just over the past
several months, as reflected in the articles on Section
503(b)(9) that have appeared in recent issues of Business Credit. And, if you’ll allow a writer to throw in a
pun here and there, the litigations have recently even
yielded “shocking” results.
Section 503(b)(9) grants goods sellers an administrative
priority claim 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
such debtor’s business.”
In the Erving Industries, Inc. case, the United
States Bankruptcy Court in Massachusetts
recently characterized a creditor’s sales of
electricity as goods that are entitled to
priority status under Section 503(b)(9).
While Section 503(b)(9)’s requirements sound rather
simple, that has not stopped debtors and trade creditors
from litigating many of its seemingly straightforward
terms. And the stakes for goods sellers could not be
higher. This “20-day goods” priority claim has increased
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the likelihood of the debtor’s payment for these goods,
which has been the primary motivation behind much
of the opposition to these claims.
This article discusses two very recent decisions dealing
with the extent of goods suppliers’ Section 503(b)(9)
priority claims. In the Erving Industries, Inc. case, the
United States Bankruptcy Court in Massachusetts
recently characterized a creditor’s sales of electricity (yes,
the shocking kind, not susceptible to touch, pardon the
pun) as goods that are entitled to priority status under
Section 503(b)(9). And in yet another decision from the
Circuit City Stores Chapter 11, pending in the United
States Bankruptcy Court for the Eastern District of Virginia, the court ruled that a debtor receives goods in a
consignment transaction when the debtor takes actual
physical possession of the goods, rather than when title
to the goods actually passes to the debtor at a later date.
The Erving Industries Case
Erving Industries, Inc. (“Erving”) filed Chapter 11 on
April 20, 2009. On July 2, 2009, the Massachusetts bankruptcy court approved an order that set August 7, 2009
as the last day for creditors to file their Section 503(b)
(9) “20-day goods” administrative priority claims. Constellation NewEnergy Inc. (“Constellation”) had timely
filed a Section 503(b)(9) priority claim in the amount
of $281,667.08 against Erving.
Erving objected to Constellation’s Section 503(b)(9)
priority claim, asserting that electricity is a service for
which there is no Section 503(b)(9) priority status. Erving
invoked several references to services in its contract with
Constellation. Erving also raised the predominant factor
test, which deals with mixed goods and services transactions, to show that Constellation was providing primarily
services to Erving and, therefore, was not entitled to any Section 503(b)(9) priority.1 Erving also invoked Constellation’s
status as a utility as an automatic bar to obtaining the Section 503(b)(9) priority.
Constellation argued that it was a seller of electricity and was
not providing any service to customers. Constellation was not
a utility because it did not have a monopoly or exclusive service or franchise area, was not regulated by the government
and was subject to competition from a number of available
alternative sources of electricity. Constellation also disclaimed
any responsibility, in its contract with Erving, for the transmission and distribution of electricity to Erving.2 Finally,
Constellation rejected the applicability of the predominant
factor test to Section 503(b)(9) priority claims. Section 503(b)
(9) confers priority status upon goods sellers for the value of
all goods the debtor had received within 20 days of bankruptcy, even if the sale were part of a larger predominantly serviceoriented transaction.
The Erving court allowed Constellation’s Section 503(b)(9)
priority claim. The court was called upon to decide the meaning of “goods” in deciding whether electricity is a good. Neither Section 503(b)(9) nor any other Bankruptcy Code provision defines the term “goods.” The court relied on the
definition of goods contained in UCC Section 2-105, which
states as follows:
“(1) ‘Goods’ means 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, investment
securities (Article 8) and things in action. ...”
Electricity was found to be tangible, capable of being felt and
something that could be created, measured and stored. It
could be purchased and is not a medium of delivery. It can be
differentiated from telecommunication signals, such as television, radio, telephone and Internet signals, which the court
characterized as services because they are the means of transmitting other non-goods intellectual property, ideas, sounds,
music, images and words from one location to another.
The court also concluded that electricity satisfies the moveability requirement of UCC Section 2-105(1) because, following its generation, electricity moves through a huge network of transmission distribution systems before ultimately
reaching the customer’s location. Electricity is still moving
when it is identified to the sale contract, and continues to
move for some time thereafter. Electricity is also identifiable
because it can be measured at the point it passes through a
meter. Electricity does not reach a customer’s meter and then
cease to exist. Instead, it passes through a meter and then
continues to move through the customer’s electrical wiring
until it is ultimately used.
The Erving court also noted that Constellation had provided
goods, rather than services, to Erving because Constellation
had first purchased electricity and then resold it to Erving.
Constellation was responsible for transmitting electricity
from the generating facility to the transmission grid. Erving
was then responsible for having its local utility deliver the
electricity from the transmission grid to Erving’s location.
The Erving court also rejected Erving’s argument that Constellation was providing a service because it was a utility. The
court defined a utility as:
“...a business organization (as an electric company)
performing a public service and subject to special
governmental regulations, [that has] some special
position with respect to the debtor, [and has] a monopoly
in the area so that the debtor cannot easily obtain comparable service from another.”
Constellation was not a utility because Constellation was not
subject to governmental regulation, as are traditional utilities
and the local utilities that continue to provide transmission,
distribution and maintenance of customer services in Massachusetts. In addition, Constellation did not have a special
relationship with Erving that would otherwise justify utility
status because of the availability of alternative sources of electricity to Erving.
The Erving court also recognized that Constellation could
have asserted a Section 503(b)(9) “20-day goods” priority
claim even if it were a utility. No Bankruptcy Code provision,
Section 503(b)(9) or otherwise, precludes a utility from
asserting a Section 503(b)(9) 20-day goods priority claim.
The United States Bankruptcy Court for the Northern District of Texas, in Pilgrim’s Pride, and the United States Bankruptcy Court for the Eastern District of Michigan, in Plastech
Engineered Products, have also ruled that utilities could assert
a Section 503(b)(9) priority claim.
The court also found nothing in Constellation’s agreement
with Erving supporting Constellation’s provision of services
to Erving. The title of the agreement, “Master Electricity
Supply Agreement,” showed that the contract dealt with the
sale of electricity, and not the provision of services. The contract also consistently referred to Constellation’s sale and
Erving’s purchase of electricity, hardly the indicia of a provision of services.
Finally, the Erving court ruled that the predominant factor
test, with respect to mixed goods and services transactions,
does not apply to Section 503(b)(9) priority claims. Section
503(b)(9) grants priority status for the “value of goods” sold
to the debtor in the ordinary course of its business that the
debtor had received within 20 days of bankruptcy, regardless
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of whether the transaction as a whole can be characterized as
primarily for the provision of services.3
goods had passed to Circuit City within 20 days of its bankruptcy filing.
The Circuit City Stores Case
Circuit City argued in opposition to Panasonic’s Section
503(b)(9) claim that Circuit City had received the consigned
goods when Circuit City had taken physical possession of
them. If Circuit City prevailed on its view of when it had
received the consigned goods, based on its physical possession
of the goods, most of Panasonic’s asserted Section 503(b)(9)
claim would have been denied priority status because Circuit
City had taken actual physical possession of most of the goods
more than 20 days before its Chapter 11 filing.
Circuit City Stores was this country’s second largest retailer of
consumer electronic products. When it filed Chapter 11 on
November 8, 2008, Circuit City employed approximately
39,600 employees and operated approximately 712 retail and
9 outlet stores throughout the United States and Puerto Rico.
Circuit City’s fate was sealed on January 16, 2009 when the
court approved going-out-of-business sales at Circuit City’s
remaining 567 stores. Circuit City is currently seeking court
approval of its Chapter 11 liquidation plan.
Debtors are more frequently litigating
the meaning of many of Section 503(b)
(9)’s rather simple terms to limit trade
creditors’ recoveries.
Prior to and after commencement of Circuit City’s Chapter
11 case, Panasonic Corporation of North America (“Panasonic”) had delivered consumer electronic products on a consignment basis (the “consigned goods”) to Circuit City based
on a consignment agreement between Circuit City and Panasonic. Circuit City sold Panasonic’s consigned goods at its
stores. The consignment agreement, like most other consignment arrangements, stated that Panasonic had retained title
to the consigned goods until Circuit City had sold them to its
customers. Title to the consigned goods remained with Panasonic despite Panasonic’s delivery of the goods to Circuit
City’s warehouses and stores and Circuit City’s possession of
the goods from delivery through their sale. When Circuit City
sold the consigned goods, title to the goods simultaneously
passed first to Circuit City and then to Circuit City’s customer.
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Overview of Consignment Arrangements
A consignor of goods in a consignment transaction typically
retains title to the goods delivered to the consignee. Title passes
to the consignee when it uses or sells the goods. The written
consignment agreement between the consignor and consignee frequently sets the consignment terms. The agreement
should contain all of the necessary terms and conditions to
protect the consignor’s interest in the consigned goods. Consignments are also generally governed by each state’s UCC,
specifically, UCC Article 9. UCC Section 9-102(a)(20) defines
a consignment as a transaction in which a person delivers
goods to a merchant for purposes of sale and (a) the merchant
deals in goods of that kind under a name other than the name
of the person making delivery, is not an auctioneer and is not
generally known by its creditors to be substantially engaged in
selling the goods of others; (b) the goods must be worth at
least $1,000.00 at the time of delivery; (c) the goods are not
consumer goods immediately before delivery; and (d) the
transaction does not create a security interest.
Shortly after its Chapter 11 filing, Circuit City obtained court
approval of an order setting December 18, 2008 as the bar
date for filing Section 503(b)(9) priority claims. Panasonic
timely filed its Section 503(b)(9) priority claim in the amount
of approximately $9.3 million for consigned goods sold to
Circuit City during the 20-day period prior to the commencement of the bankruptcy. However, Panasonic delivered these
goods to Circuit City more than 20 days before Circuit City’s
bankruptcy filing.
The consignor should make it a practice to file a UCC financing statement describing the consigned goods in the correct
jurisdiction in order to maintain a protected perfected interest in the goods. Otherwise, the consignee’s creditors can
obtain liens and security interests in the goods with priority
over the consignor’s unperfected consignment interest. A
bankruptcy trustee or debtor-in-possession also has priority
over an unperfected consignor. UCC Article 9 allows a consignor to file a UCC financing statement on its own, without
the consignee’s signature, as long as there is an agreement
executed or otherwise authenticated by the consignee that
describes the consigned goods. The consignor uses the same
UCC form that a secured creditor uses in perfecting a security
interest in personal property collateral.
Circuit City and Panasonic disagreed on when the consigned
goods were “received” as required by Section 503(b)(9). Panasonic asserted, in support of its Section 503(b)(9) priority
claim, that Circuit City “received” the consigned goods when
Circuit City had sold the consigned goods to its customers
because that was when title to the goods passed to Circuit
City. If Panasonic prevailed on its view of when the consigned
goods were “received” by Circuit City, based on passage of title
to the goods, most of Panasonic’s claim would have been subject to Section 503(b)(9) priority status because title to the
The consignor must satisfy additional requirements to obtain
priority over the rights of the consignee’s preexisting secured
lender, or other creditor, with a prior perfected blanket security interest in the consignee’s inventory, including the consigned goods. According to UCC Section 9-103(d), a consignor has a purchase money security interest in its consigned
goods. The consignor, therefore, has priority over other creditors with a prior security interest in the consigned goods if the
consignor satisfies all of the requirements of a purchase
money security interest contained in UCC Section 9-324.
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These requirements include (a) filing a UCC financing statement describing the goods prior to the consignee’s receipt of
the goods; (b) sending an authenticated notification to the
holders of conflicting prior perfected security interests in the
consigned goods that the consignor has, or expects to, acquire
a consignment interest in the goods and describes the goods;
and (c) receipt of such notice by the holders of conflicting
inventory security interests in the consigned goods within five
years before the consignee’s receipt of the goods.
The Circuit City Decision
The Circuit City court was called upon to decide the meaning
of “received” under Section 503(b)(9) in connection with a
consignment transaction. The court, lacking any guidance in
Section 503(b)(9) or other provisions of the Bankruptcy
Code (which do not define “receipt” or “received”), relied
upon Article 2 of the UCC, Black’s Law Dictionary and Webster’s Ninth New Collegiate Dictionary, and the parties’ consignment agreement for guidance.
The Circuit City court relied upon court decisions that have
interpreted “received” in connection with the Bankruptcy
Code’s Section 546(c) reclamation of goods provision. These
courts relied upon UCC Section 2-103(c)’s definition of
“receipt,” based on the debtor’s taking “physical possession” of
the goods. The Circuit City court concluded that “receipt” and
“received” are similar words that should be interpreted the
same way. The use of the word “received” in Section 503(b)(9)
meant the debtor must have taken physical possession of the
goods, just as the courts that interpreted Section 546(c) in
connection with trade creditors’ reclamation rights have
defined “receipt” as the debtor’s taking “physical possession”
of the goods subject to reclamation.
The court also relied upon Black’s Law Dictionary’s definition
of “receipt” as the “[a]ct of receiving; also the fact of receiving
or being received;” and its definition of “receive” as “[t]o take
into possession and control; to accept custody of.” The court
also considered Webster’s Ninth New Collegiate Dictionary’s
definition of receipt as “[having] come into possession of...”
it took possession of the goods more than 20 days before the
bankruptcy. Trade creditors should be prepared to continue
to litigate these and other Section 503(b)(9) issues if they
wish to obtain allowance of, and enhanced recovery on, their
priority claims. ●
1. State and federal courts have applied the “predominant factor test”
or “predominant purpose test” to determine whether Article 2 of the
Uniform Commercial Code (“UCC”), dealing with the sale of goods,
applies to a particular transaction. Courts applying this test have
considered whether the predominant purpose of the contract is the sale
of goods or rendition of services. To the extent the contract is primarily
focused on the sale of goods, the contract in its entirety (both the goods
and services components), is considered a sale of goods to which UCC
Article 2 applies. Alternatively, a contract that is primarily geared toward
providing services is not considered a sale of goods and UCC Article 2
does not apply to the transaction.
2. It was the regulated local utility that Erving dealt with, not
Constellation, that was responsible for transmitting and delivering
electricity to Erving.
3. The court agreed with the holdings of the Pilgrim’s Pride and
Plastech Engineered Products courts that the predominant purpose test
does not apply to Section 503(b)(9) priority claims.
4. The United States Bankruptcy Court for the Eastern District of
North Carolina, in In re Pridgeon, had also previously ruled that a
debtor/consignee received consigned goods based on possession of the
goods, rather than passage of title to the goods.
Bruce Nathan, Esq. is a partner in the New York City office of the law
firm of Lowenstein Sandler PC. He is a member of NACM and is on
the Board of Directors of the American Bankruptcy Institute and is a
former co-chair of ABI’s Unsecured Trade Creditors Committee. He
can be reached via email at [email protected].
*This is reprinted from Business Credit magazine, a publication of the
National Association of Credit Management. This article may not be
forwarded electronically or reproduced in any way without written
permission from the Editor of Business Credit magazine.
The Circuit City court also relied upon the consignment
agreement between Circuit City and Panasonic in holding
that “received” is based on when Circuit City took physical
possession of the goods. The agreement distinguishes between
consigned goods that Circuit City had “received” and “sold.” 4
Conclusion
As is becoming apparent from the Erving Industries and Circuit City decisions, and all the other recent court decisions
dealing with Section 503(b)(9)’s 20-day goods priority
claims, debtors are more frequently litigating the meaning of
many of Section 503(b)(9)’s rather simple terms to limit
trade creditors’ recoveries under Section 503(b)(9). These
cases illustrate that debtors are seeking to defeat or limit trade
creditors’ Section 503(b)(9) priority claims by characterizing
a transaction as a provision of services and not as a sale of
goods and asserting that the debtor received the goods when
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