In re World Imports: Court Denies Section 503(b)(9) Claims of Sellers Who Did Not Ship Goods Directly to the Debtor | Practical Law

In re World Imports: Court Denies Section 503(b)(9) Claims of Sellers Who Did Not Ship Goods Directly to the Debtor | Practical Law

The US Bankruptcy Court for the Eastern District of Pennsylvania, in In re World Imports, denied administrative priority status under section 503(b)(9) of the Bankruptcy Code to sellers of goods who shipped their goods to the debtor's customers, rather than directly to the debtor, implying that a debtor must physically receive the goods for the claim to attain priority.

In re World Imports: Court Denies Section 503(b)(9) Claims of Sellers Who Did Not Ship Goods Directly to the Debtor

by Practical Law Finance
Published on 04 Nov 2014 • USA (National/Federal)
The US Bankruptcy Court for the Eastern District of Pennsylvania, in In re World Imports, denied administrative priority status under section 503(b)(9) of the Bankruptcy Code to sellers of goods who shipped their goods to the debtor's customers, rather than directly to the debtor, implying that a debtor must physically receive the goods for the claim to attain priority.
On September 10, 2014, the US Bankruptcy Court for the Eastern District of Pennsylvania, in In re World Imports, denied administrative priority status under section 503(b)(9) of the Bankruptcy Code to sellers of goods who shipped their goods to a debtor's customers rather than directly to the debtor, implying that a debtor must physically receive the goods for the claim to attain priority (516 B.R. 296 (Bankr. E.D. Pa. 2014)).

Background

Two creditors of World Imports (Debtor), Sunrise Furniture Co. Ltd. (Sunrise) and Weisheng Zhangzhou Industrial (Weisheng), asserted administrative expense claims under section 503(b)(9) (section 503(b)(9) claims) for goods purchased from them by the Debtor.
Sunrise based its section 503(b)(9) claims on two shipments of goods originating from China that were shipped from Shenzhen on June 19 and June 23, 2013 and delivered directly to customers of the Debtor (i.e., "drop-shipped") on July 13 and July 18, 2013. Weisheng based its section 503(b)(9) claims on three shipments of goods also originating from China that were shipped from Xiamen on June 13 and June 17, 2013. Two of the three Weisheng shipments were drop-shipped on July 13, 2013, and the third shipment was delivered directly to the Debtor on July 17, 2013.
Under section 503(b)(9) of the Bankruptcy Code, a seller is entitled to an administrative expense claim if it can establish that:
  • The claimant sold goods to the debtor.
  • The goods were sold to the debtor in the ordinary course of the debtor's business.
  • The debtor received the goods within 20 days before filing for bankruptcy.
The parties agreed on the first two elements required for priority under section 503(b)(9). However, they disagreed about whether the Debtor received the goods within 20 days before it filed for bankruptcy. The Debtor argued that a drop-shipment is not "received" by the retail merchant, and therefore it can never qualify for administrative expense priority treatment under section 503(b)(9). Sunrise and Weisheng (Sellers) argued that under the Uniform Commercial Code (UCC), receipt of goods by a buyer includes receipt by the buyer's representatives or sub-purchaser, and therefore, the goods were received by the Debtor within the 20-day period before bankruptcy.

Outcome

The Court:
  • Denied Sunrise's request for administrative priority in its entirety.
  • Granted Weisheng's request for administrative expenses to the extent it related to the shipment that was delivered directly to the Debtor.
The Court, noting that this case involved both a legal issue concerning the four drop-shipments to the Sellers' customers and a factual issue concerning the one direct shipment to the Debtor, held that, under section 503(b)(9) of the Bankruptcy Code:
  • A drop-shipment is not received by the retail merchant and therefore can never qualify for administrative priority status.
  • For a shipment that is delivered directly to the debtor to gain priority, the record must reflect that the debtor received it within 20 days before bankruptcy.

Drop Shipments and Receipt

The Sellers argued that the UCC recognizes that receipt of goods by a buyer includes receipt by the buyer's representative or subpurchaser. The Sellers also relied on an article in a trade journal which stated that drop-shipped goods should be deemed to have been received by the debtor for purposes of section 503(b)(9) of the Bankruptcy Code. However, the Court rejected these arguments, holding that a drop-shipment does not constitute actual or constructive possession for purposes of section 503(b)(9). In implying that receipt of goods under section 503(b)(9) requires direct physical receipt, the Court relied on two cases cited by the Debtor in its pleadings.
First, the Court considered a similar case in which the seller argued that the debtor's receipt of the value of the goods should suffice for purposes of section 503(b)(9) (see In re Plastech Engineered Products, Inc., 397 B.R. 828 (Bankr. E.D. Mich. 2008)). The court in that case rejected this reasoning based on the express language of section 503(b)(9).
Next, the Court considered Ningbo Chenglu Paper Products Manufacturing Co., Ltd. v. Momenta, Inc. (In re Momenta, Inc.), in which the US District Court for the District of New Hampshire analyzed the history of section 503(b)(9) and concluded that:
  • The addition of the section 503(b)(9) provisions in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 suggests that Congress intended to create a priority administrative expense to supplement remedies available to reclamation sellers, and not to "quietly create a new and expansive creditor class entitled to a unique priority." Therefore, Congress intended that the term "receipt" to be construed consistently with the reclamation provisions of section 546(c) of the Bankruptcy Code. Further, a narrow reading of section 503(b)(9) would enhance the prospects for a successful reorganization because that would require less cash to be set aside by the debtor to pay these potential claims.
  • The phrase "received by the debtor" should be defined in this context to mean "possessed by the debtor, either actually or constructively," and therefore, a drop-shipment to a debtor's customer does not constitute even constructive possession for purposes of section 503(b)(9).
(see No. 11-cv-479, (D.N.H. Aug. 29, 2012)).

Direct Shipment

The Sellers then argued that the Court should grant Weisheng's request as to the shipment of goods that it shipped directly to the Debtor. The Sellers argued that the Court should reconsider its previous holding that receipt for purposes of international sales of goods takes place when goods are placed on the ship for transport (see World Imports, Ltd., 511 B.R. 738 (Bankr. E.D. Pa. 2014)). The Court declined to reconsider its prior ruling on the grounds that it saw no basis to depart from the legal conclusions in that ruling. However the Court still addressed the Sellers' arguments, despite finding this request a bit puzzling given that its prior ruling supported Weisheng's claim.
First, the Sellers agreed that, although the contract was governed by an international treaty (the UN Convention on Contracts for the International Sale of Goods) (CISG)) which incorporates international trade terms (Incoterms), the Incoterms 2010 failed to define the term "receipt," which they argued requires the Court to look elsewhere for a definition. Second, the Sellers argued, in the alternative, that the Incoterms 2010 provided a definition from which the meaning of the term "receipt" could be found. The Court rejected these arguments because:
  • The Incoterms 2010 did in fact include shipping terms, including "FOB," (free on board) which was the term under which the shipment in the Court's prior opinion was shipped. In the previous ruling, the Court held the definition of FOB to mean that the buyer took delivery of the goods when they were placed on board the ship in China, and that, in turn, was when "receipt" occurred. Therefore, there was no reason to look to other sources for a definition of "receipt."
  • The Court rejected the assumption that the Court had previously failed to properly note in the Incoterms 2010 Introduction an explanation of the term "FOB" that would indicate that "receipt" occurred after the goods were physically delivered to the buyer. The Court found that the Sellers misconstrued the terms of the Incoterms 2010 Introduction, which it stated was "akin to dicta," and taken out of context.
Therefore, the Court held that receipt of the goods occurred in China, when they were placed on board. Because the Debtor "received" a direct shipment of goods from Weisheng, Weisheng was entitled to administrative priority for this portion of its claim.

Practical Implications

This case serves as a warning to sellers that delivering goods directly to a purchaser's customers, while an efficient business arrangement, can result in the loss of the seller's section 503(b)(9) claim if the purchaser files for bankruptcy within the 20-day period in which the goods are delivered.
For more information on section 503(b)(9) claims, see Practice Note, Reclamation Rights in Bankruptcy: Section 503(b)(9) Claim as Alternative Remedy and Standard Document, Request for Allowance and Payment of Section 503(b)(9) Administrative Claim.
For more information on the practice of drop-shipping, see Practice Note, Drop Shipments.