The Continuing Evolution of a Seller's Right to Reclamation and Administrative Expenses for Goods Sold Prepetition under the Bankruptcy Code

By Gregg, John | Business Credit, January 2009 | Go to article overview

The Continuing Evolution of a Seller's Right to Reclamation and Administrative Expenses for Goods Sold Prepetition under the Bankruptcy Code


Gregg, John, Business Credit


As the manufacturing and retail sectors continue to decline, creditors, especially those involved in just-in-time relationships, are increasingly at risk for goods delivered to a debtor just prior to the debtor's bankruptcy filing. Unfortunately, it is not uncommon for a debtor to create, but not pay for, a reserve of goods or a parts bank for use during the initial stages of its bankruptcy. However, as discussed in a myriad of recent articles, creditors, after the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) are provided with certain protections for the goods that they sell to a debtor on credit just prior to a debtor's bankruptcy filing. Recent issues of Business Credit have focused on a creditor's right not only to reclaim goods sold to the debtor within 45 days of the bankruptcy filing, but also a creditor's right to an administrative expense claim for the goods it sells to the debtor within the 20 days prior to the petition date under Section 503(b)(9) of the Bankruptcy Code.

This article attempts to supplement earlier discussions by alerting creditors to a debtor's potential objection to administrative expense claims arising under Section 503(b)(9) where the creditor has drop-shipped goods pursuant to the express terms of its contract with the debtor. The article also briefly discusses a recent decision from the Sixth Circuit Court of Appeals holding that, despite a secured lender's lien on all of a debtor's personal property, sellers of goods within the requisite reclamation period may nonetheless be entitled to an administrative expense under the pre-BAPCPA reclamation statute.

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Section 503(b)(9) Administrative Expenses: Actual Physical Possession v. Drop-ship Relationships

As many readers are undoubtedly now aware, Section 503(b)(9) provides, in pertinent part, that there shall be an allowed administrative expense 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." 11 U.S.C. [section] 503(b)(9); see In re Dana Corp., 367 B.R. 409, 415 (Bankr. S.D.N.Y. 2007).

The legislative history of Section 503(b)(9) "suggests that it was aimed at providing relief to sellers of goods who fail to give the required notice under the reclamation provision of Section 546(c)." In re Brown & Cole Stores, LLC, 375 B.R. 873, 875 n. 3 (B.A.P. 9th Cir. 2007) (citing Shirley S. Cho, The Intersection of Critical Vendor Orders and Bankruptcy Code [section] 503(b)(9), 29 Cal. Bankr. J. 7, 11 (2007)).

Upon review of the express terms of Section 503(b)(9), creditors typically assumed that they are entitled to an administrative expense if they sell goods to a debtor in the ordinary course of the debtor's business within the 20 days prior to the date of the bankruptcy filing. However, recently a new and admittedly creative argument has been raised by debtors and trustees seeking to disallow administrative expense claims under Section 503(b)(9). According to these trustees and debtors, it is not enough for a creditor to simply have sold goods to the debtor. Rather, the goods that were sold to the debtor allegedly must also have been "received" by the debtor.

The Bankruptcy Code does not provide a definition of the word "received" in Section 503(b)(9) or anywhere else in its text. However, the Uniform Commercial Code (the UCC) does contain a definition of the word "receipt." The UCC defines "receipt" as "actual physical possession." UCC [section] 2-103(c)(1). As such, it has been asserted that in order for a creditor to hold an allowed administrative expense under Section 503(b)(9), the debtor must have taken physical possession of the goods.

Such a scenario is extremely problematic in a situation, for example, where a debtor has issued a purchase order to the creditor for the purchase of goods and provided payment directly to the creditor for such goods, but instructed the creditor on the purchase order itself to ship the goods to a third party unrelated to the debtor. …

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