They say that “timing is everything,” and for sellers of goods who experience the misfortune of shipping goods to a customer which then quickly files for bankruptcy, the determination of when “receipt” takes place, can make or break whether the seller is more likely than not to get paid for the goods. The Bankruptcy Code provides generally that if a debtor receives goods within 20 days of filing for bankruptcy, then the creditor may move up the pecking order of priorities and treat its otherwise general unsecured claim as a preferential administrative claim.
The Third Circuit has become the first Circuit Court to squarely address whether receipt means the date of shipment or the date of physical possession by the buyer. The Third Circuit has clarified that “receipt” occurs at the end of a transaction; that is, when the buyer acquires actual possession of the goods. This ruling tends to help creditors as physical possession is more likely than the date of initial shipment to occur within the 20-day window.
Under 11 U.S.C. §503(b)(9), a creditor may recover as a priority administrative expense, the value of goods “received” by the debtor within the 20-day window preceding the bankruptcy filing. The meaning of “received” is important to creditors who ship goods via common carrier because there may be a significant lag between; (1) the date when goods are shipped, for example, free on board (FOB) at the port of origin, where title or risk transfers from the seller to the buyer at the shipper’s port; and (2) the date that the debtor actually receives the goods. If “receipt” means the date risk of loss transfers at the shipper’s port, then it is less likely that there would be sellers in a position to take advantage of the priority designation under 11 U.S.C. §503(b)(9), as the shipping process itself often takes days, if not weeks.
In In re World Imports, 862 F.3d 338 (3d Cir. 2017), the Third Circuit answered the question as to whether “received” meant the date of shipment or physical acceptance. There, two creditors shipped furniture to the debtor from China, “free on board” at the point of origin, which meant that risk of loss passed from the creditors to the debtor upon transfer at the shipping port. The shipments left China outside of the 20-day window, but the debtor took physical possession of the goods within the 20-day window. The creditors filed motions to allow payment for the goods as an administrative expense under 11 U.S.C. §503(b)(9). The Bankruptcy Court and District Court on appeal, denied the application, on the basis that under international commercial terms incorporated into the Convention on Contracts for the International Sale of Goods (which those courts found governed the dispute), because the risk of loss under the FOB contract transferred at the port, the goods had been “constructively received” on the date shipped from China. In re World Imports, 862 F.3d at 341. The Third Circuit disagreed.
Payment for shipped goods may be deemed to be an administrative expense under 11 U.S.C. §503(b)(9) where: “’(1) the vendor sold “goods” to the debtor; (2) the goods were received by the debtor within twenty days [before the bankruptcy] filing; and (3) the goods were sold … in the ordinary course of business.’” In re World Imports, 862 F.3d at 341 (quoting In re Goody’s Family Clothing, 401 B.R. 131, 133 (Bankr. D. Del. 2009)). The Third Circuit held that goods are “received” when the debtor or its agent physically takes possession of the goods, based on its determination that the Uniform Commercial Code (UCC) definition applied. Id. at 342. The Third Circuit’s analysis began with the recognition that because “received” was not defined by the Bankruptcy Code, the “ordinary or natural meaning” of the word was to be used. Id.
Dictionary definitions of “receive” required “physical possession.” Id. Likewise, the UCC defines “receipt” as “taking physical possession” of goods. Section 2-103(1)(d). Moreover, Article 2 of the UCC, which governs sales of goods, had been adopted in 49 states when 11 U.S.C. §503(b)(9) was adopted in 2005. The Third Circuit proffered “ample evidence” that Congress relied on the UCC definition of the word when drafting Section 503(b)(9). Id.
For example, Section 503(b)(9) was drafted along with Section 546(c) which deals with “reclamation” (return of goods), if the debtor “received” goods while insolvent. Section 546(c)(2) offers Section 503(b)(9) as an alternative to a seller’s remedy of reclamation. The Third Circuit previously ruled that “receipt” under Section 546(c) meant taking physical possession of goods, reasoning that Congress borrowed the bankruptcy reclamation provision from the UCC and thus, also borrowed the definition of “receipt.” Id. at 343. Examining the practicalities, the Third Circuit observed that since notice for reclamation under Section 546(c) must be made within 45 days after goods are received, and since Section 503(b)(9) provides an exemption for goods received within the 20-day window before bankruptcy, it would be “implausible” to think that Congress intended the date of receipt to be different in the two provisions. Id. at 344.
The Third Circuit quickly shut down the debtor’s argument that the goods had been “constructively received” much earlier, since contractually they had been delivered “FOB” to a common carrier. The Third Circuit held that “[d]elivery, or transfer of title or risk of loss, has been treated as distinct from actual receipt of goods by the buyer.” Id. Under the UCC, a seller can stop delivery while the goods are in possession of the common carrier, and that right does not end until the buyer is in physical possession of the goods. Thus, receipt does not occur until the seller can no longer stop delivery, that is, when the buyer obtains physical possession. Finally, a common carrier cannot at any point be in “constructive” receipt of the goods, as it is well settled that “intermediaries in the transport” are not agents of the buyer. Id. at 345-46.
A Delaware Bankruptcy Court has followed suit, ruling that in a “drop shipment case” (where the seller by-passes the debtor and ships directly to the end-user), there was no actual possession or receipt of the goods by the debtor as only UPS, a non-agent common carrier, was in physical possession of the goods during the 20-day window. In re SRC Liquidation, 573 B.R. 537 (Bankr. D. Del. 2017). Similarly, a Bankruptcy Court in the Eastern District of Michigan has held that “receipt” includes receipt by a debtor’s agent. There, the debtor’s staff, to whom goods were delivered, was paid by another entity and not the debtor itself. In re VPH Pharmacy, __ B.R. __, 2017 WL 6347807 at *3 (Bankr. E.D. Mich. 2017). The Bankruptcy Court noted that Section 503(b)(9) could not be read so narrowly as to require “the seller” to deliver to “the buyer”: “[t]hese types of transactions are few and far between in American commerce today because many different people or companies are involved in the sale, delivery and receipt of goods.” Id. at *4.
As with many judicial determinations, the resolution of one issue opens the door to other issues. Although the Third Circuit has provided firm guidance as to what constitutes “received” vis-à-vis the date of shipment versus the date of a buyer’s physical possession, left open are other issues, such as whether a third party that receives goods within the 20-day period may be deemed an agent of the debtor, as is the typical drop shipment transaction, where goods bypass the debtor and are shipped directly to a third party. This may very well require a case-by-case analysis.
Perkins is a partner with McElroy, Deutsch, Mulvaney & Carpenter, in Ridgewood. He serves on the Panel of Chapter 7 Trustees for the U.S. Bankruptcy Court, District of New Jersey, Newark Vicinage. Shea is a senior associate in the firm’s bankruptcy and restructuring practice group, also working out of the Ridgewood office.