Receipt under Section 503(b)(9) Means Physical Receipt: A Mixed Bag for Trade Creditors

On its face, Section 503(b)(9) of the Bankruptcy Code looks deceptively easy to apply. It grants a goods seller an administrative priority claim 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 its bankruptcy filing. However, there has been extensive litigation over various aspects of Section 503(b)(9), particularly over the meaning of the term “received.” Success or failure in these litigations has greatly impacted trade creditor recoveries because creditors have a greater likelihood of obtaining full payment of their Section 503(b) (9) priority claims in comparison to their far less valuable general unsecured claims, in which recovery prospects are oftentimes dim to nonexistent.

The United States Court of Appeals for the Third Circuit, in In re World Imports Ltd., recently became the first United States Court of Appeals to address the meaning of “received” in the context of Section 503(b) (9) administrative priority claims. The Third Circuit, which includes Delaware (the venue where many large Chapter 11 cases are filed), New Jersey and Pennsylvania, held that a debtor receives goods when the debtor or its agent takes physical possession of them, instead of when title or risk of loss passes to the debtor, which might occur earlier. This decision could lead to an increase in allowed Section 503(b)(9) priority claims, particularly for creditors manufacturing and then delivering goods from outside the United States.

Then, just a few days later, the United States Bankruptcy Court for the District of Delaware, in SRC Liquidation LLC, formerly known as Standard Register Company (“Standard Register”), relied on the World Imports decision to resolve another issue: whether a creditor’s claim for goods “drop-shipped” directly to a debtor’s customer is eligible for administrative priority status under Section 503(b)(9). The SRC Liquidation court denied Section 503(b)(9) administrative priority status to the claim of a goods seller that drop-shipped goods to the debtor’s customer based on the court’s determination that neither the debtor nor its agent took physical possession of the goods. This ruling could have devastating consequences to trade creditors that sell on drop-ship terms.

You win some and you lose some!