Chapter 5 Protecting Trade Creditors' Rights in Bankruptcy

• Jurisdiction: United States

5. Protecting Trade Creditors' Rights in Bankruptcy

Written by:

Aaron G. York

Sacks Tierney PA; Scottsdale, Ariz.

Thomas M. Horan

Womble Carlyle Sandridge & Rice PLLC

Wilmington, Del.

The Bankruptcy Code provides several protections for parties that have supplied goods or services to a debtor on credit prior to the debtor's bankruptcy petition date. A trade creditor that timely invokes these protections can elevate what might otherwise be an unsecured claim to a claim that is either secured or has administrative expense priority, thereby greatly increasing the likelihood that it will receive a meaningful distribution from the debtor's bankruptcy estate.

For a practitioner new to bankruptcy, ready familiarity with these protections is essential to counsel suppliers who find themselves creditors in a bankruptcy case. This article surveys some of the most important protections for suppliers and recent significant case law developments.

A. Section 503(b)(9) Request for Administrative Expense¹

Those who sell goods to a debtor in the 20 days before a bankruptcy case is filed are entitled, upon application to the bankruptcy court, to elevate their claims for the value of such goods to an administrative expense priority. Section 503(a) of the Code provides, in relevant part, that "[a]n entity may file a request for payment of an administrative expense." In turn, § 503(b)(9) states, in relevant part,

(b) After notice and a hearing, there shall be allowed administrative expenses...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 goods have been sold to the debtor in the ordinary course of such debtor's business.

Section 503(b)(9) grants such an administrative expense only for "goods" (as opposed to services).

Bankruptcy courts generally employ the definition of "goods" found in the Uniform Commercial Code (UCC).² Section 2-105(1) of the UCC defines goods as:

[A]ll things (including specially manufactured goods) which are moveable 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. "Goods" also includes the unborn young of animals and growing crops and other identified things attached to realty as described in the section on goods to be severed from realty.

However, each state that has enacted the UCC has developed its own case law interpreting it. Therefore, it is possible that what might be a good in one state might not be a good in another, which could lead to surprising results. For instance, there is a split of authority over whether electricity is a good or a service.³ A bankruptcy court could find that one supplier of electricity in a state where electricity is a good under the UCC may properly have a § 503(b)(9) claim (or reclamation rights under § 546(c)), while another supplier of electricity in a state where electricity is a service would not have the same rights.

When a transaction involves a combination of goods and services, some courts have applied a "predominant purpose" test and will deny a § 503(b)(9) claim where the predominant purpose of the transaction was the delivery of services.⁴ Other courts have rejected this approach for transactions involving the sale of both goods and services holding that the value of the goods is entitled to § 503(b)(9) priority.⁵

Administrative expenses allowed under § 503(b)(9) are afforded priority of payment under § 507(a) (2). Importantly, § 1129(a)(9)(A) provides that a plan may not be confirmed in a chapter 11 case unless the plan provides for full payment of "a claim of a kind specified in section 507(a)(2)...on the effective date of the plan." This requirement that administrative expenses be paid in full for a plan to be confirmed gives trade creditors who qualify under § 503(b)(9) a substantial advantage. Accordingly, if a supplier has sold "goods" to a debtor within 20 days before the debtor filed its petition, the supplier should file a request for administrative expense under § 503(b)(9) for the value of those goods. The value typically is presumed to be the invoice or purchase price; however, that presumption may be rebutted if there is evidence showing that the invoice or purchase price is not an appropriate measure of value.⁶ If the claim is allowed, whether the debtor must make payment prior to the effective date of a plan will be in the bankruptcy court's discretion.⁷

However, an emerging issue that suppliers must confront is whether, notwithstanding that it holds an allowed administrative expense under § 503(b)(9), the court may disallow that administrative claim under § 502(d), which provides that certain claims may be disallowed where the claimant received an...