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Blissfully unaware that its customer, a merchant, is on the brink of filing a bankruptcy petition, your client has delivered goods on credit. The likely unhappy result: when the customer files, your client is left holding a general unsecured claim, with little chance to be paid until the conclusion of the proceeding. That may be years down the road, and when it finally takes place may amount to no more than pennies on the dollar. But all may not be lost.

 

This article focuses on section 503(b)(9) of the Bankruptcy Code, a specific bankruptcy provision that was enacted with the intent of addressing this situation, and provides a primer for business lawyers that are called upon to counsel clients who have delivered goods to a bankrupt company during the twenty-day period prior to the date of the bankruptcy filing.

 

The Enactment of Section 503(b)(9)

 

The enactment of the 2005 Bankruptcy Prevention and Consumer Protection Act amended Title 11 of the United States Code, §§ 101-1532 (as amended, the “Bankruptcy

Code”) in many ways to enhance the rights of trade creditors in commercial bankruptcies, including section 503(b)(9) of the Bankruptcy Code. Section 503(b)(9) provides that a creditor has an administrative expense claim for the “value of any goods received by the debtor within 20 days before the date of commencement of a case under [the Bankruptcy Code] in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.”1 A creditor’s right to assert a section 503(b)(9) claim is not linked or conditioned upon the creditor’s separate, potential right to assert a reclamation claim against the debtor pursuant to section 546(c) of the Bankruptcy Code.2

 

Prior to section 503(b)(9), prepetition obligations of a debtor to a trade creditor were classified as general unsecured claims for all purpose—often resulting in distributions of pennies on the dollar, or nothing. Now such claims, if they satisfy section 503(b)(9), are transformed into administrative expense claims which are given priority of treatment over general unsecured claims, and which must be paid in full in order for a chapter 11 debtor to emerge from bankruptcy.3 A second benefit of the statute to trade creditors is the possibility of more prompt payment of the section 503(b)(9) claim.4 Since the liability is an administrative expense and not a prepetition claim, a chapter 11 debtor with adequate resources can pay the allowed administrative expense prior to confirmation of a plan. In sum, trade creditors that successfully assert a section 503(b)(9) claim for goods delivered within twenty days of the petition date have an increased likelihood of a full and quicker recovery of this claim. A downside from the debtor’s perspective is that the cash needed to successfully reorganize and emerge from chapter 11 will be significantly increased by the amount necessary to pay the section 503(b)(9) claims in full, and the payment of the section 503(b)(9) claims may deprive the debtor of much needed liquidity.5 However, debtors—even after allowance and payment of the section 503(b)(9) claims for the value of the goods—may continue to realize the mark-up profit on the re-sale of the goods or use of the goods incorporated into a finished product for sale.

 

In enacting this provision, it is believed that Congress intended to address the situation in which a supplier would withhold credit and goods during a customer’s liquidity crisis out of a concern that it would be paid little or nothing for goods delivered to a debtor on the eve of its bankruptcy.6 (And as prior cases and experience have made clear to trade creditors, traditional reclamation rights under section 546(c) of the Bankruptcy Code could easily be defeated in a bankruptcy.) This would often turn liquidity problems into full-blown liquidity crises, as debtors would increasingly be unable to buy goods on credit that were vital for continued operations. Anecdotes also abounded of less ethical companies placing unusually large orders for goods to be delivered just days before a planned bankruptcy fi ling from vendors who were unaware of the severity of the debtor’s liquidity problems. By filing for bankruptcy right after receiving the goods, a retailer (for instance) would have products on its shelves to allay customer concerns and generate cash for post filing expenses—coupled with a debt to be paid, if at all, under a confirmed chapter 11 plan months or years down the road.

 

With little legislative history behind section 503(b)(9), practitioners and courts recognize there are many questions about the interpretation and application of this statute. Just two years after its enactment, Judge Burton R. Lifl and of the United States Bankruptcy Court for the Southern District of New York was already writing that “[t]his new provision presents other issues concerning, inter alia, the valuing of the subject goods; what constitutes the actual receipt of the goods; how is the claim asserted; when is it to be paid; is it subject to the claims processing and omnibus bar date orders, etc.”7 Now that the statute has operated for more than five years and there has been an increased number of retail bankruptcies during the recent economic downtown, case law is beginning to address the issues raised by section 503(b)(9).

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