Third Circuit Defines 'Received' for Section 503 (B)(9) Claims

Be careful what you wish for. An appellate tribunal has now reversed the decision (and, effectively, this writer). In Haining Wansheng Sofa Co., Ltd. v. World Imports, Ltd. (In re World Imports, Ltd.), ___ F.3d ___ (3d Cir. July 10, 2017), the venerable U.S. Court of Appeals for the Third Circuit firmly declared that “received” in Section 503(b)(9) connotes actual physical custody of the goods by the debtor. As it was undisputed at the trial level that the goods were not handed over to the debtor until well within the 20 days prior to its bankruptcy filing, the tribunal ruled that the creditors were, in fact, entitled to a 503(b)(9) administrative expense priority.

This turnabout in the interpretation of the meaning of “received” in Section 503(b)(9) is a significant development, given that such claims frequently arise in business bankruptcies. The fact that it comes from such an august tribunal as the Third Circuit adds gravitas to the reversal of the courts discussed herein. For those reasons, we now analyze the decision, all the while feasting on a healthy serving of humble pie, well deserved in this instance.

Statutory Background

Before turning to the opinion per se, a further explanation of the statute — or, better said, statutes — in question is warranted. From its inception in 1978, the modern Bankruptcy Code has consistently recognized a creditor's remedy of reclamation. This is, simply put, a creditor's right to retake goods shipped to the debtor on the eve of the latter succumbing to insolvency. See 11 U.S.C. § 546. The right of reclamation has long been recognized in the common law, as well as in the Uniform Commercial Code.

Congress decided to refine Section 546 as part of the lawmakers' broader reforms promulgated by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). BAPCPA appended a new subparagraph to Section 503 of the Code, the administrative expense statute. 11 U.S.C. § 503. Recognition as an administrative expense is much coveted by creditors in bankruptcy cases, as such a claim is eligible for a priority of payment. 11 U.S.C. § 507.

This 2005 addition provides that a creditor is entitled to administrative expense status, and, ergo, a right to priority of payment, for a claim rooted in goods received by the debtor within the 20 days before the debtor files for bankruptcy. 11 U.S.C. § 503(b)(9). Given that the Section 546 right to reclamation sometimes proved to be a hollow one, Congress implicitly sought to better balance the scales for afflicted creditors.

World Imports

But now the question evolved into: What is the meaning of “received” in this context? When we first reviewed the subject months ago, the trial court iteration of World Imports informed us of the following: The creditors, based in China, had sold furniture and similar goods to World Imports. The goods were shipped “F.O.B.” from the Far East, meaning that legal title passed to the buyer on that side of the Pacific. While that all transpired well before Section 503(b)(9)'s 20-day period had even commenced, physical receipt in the U.S. by World Imports readily fell within the statutory interval. None of these essential facts was in dispute.

In that initial determination, the district court made much of the terminology found in relevant international trade treaties. Relying mainly upon the F.O.B. shipping term, the lower court deemed that the debtor “received” the goods when legal title passed. Accordingly, the judge below ruled that the creditors were not entitled to a priority claim, since the debtor had “received” the goods on a date well before the obligatory 20-day period had commenced.

It was against this backdrop that the Third Circuit made its intriguing reversal. And it did so understanding the gravity of the question at the bar. Writing for the panel, Circuit Judge Thomas Michael Hardiman commenced with the notation that this appeal “has important ramifications for a creditor that sells goods to a debtor soon before the debtor files a … bankruptcy petition.”

The tribunal's decision was, effectively, a triad of reasoning. For the first pillar of its rationale, the appellate court invoked a hallowed axiom of statutory construction. Words in a statute should be given their everyday meaning, opined Judge Hardiman, particularly so in matters of interpreting the Bankruptcy Code.

Accordingly, the panel first consulted the leading dictionaries, both legal and general, to divine the ordinary meaning of the word “received.” The court found the relevant authorities generally agreed that “received” means actual custody, a physical taking of possession by the recipient.

Certainly, the appeals court admitted that the reference works it consulted did not provide identical definitions of the term in question; nevertheless, the panel lauded their consistency with each other, and the fact that they all ended in essentially the same place. In addition, by a process of elimination, the Third Circuit eschewed the notion that “received” was satisfied by the mere legalism of a transfer of title or risk of loss alone.

In further support, the tribunal noted that the referenced dictionary meanings were consistent with the definition of “receive” as found in the Uniform Commercial Code. See U.C.C. § 2-103(1)(c). Reminding that the commercial codification is very nearly universal among the American states, the panel deemed this “ample evidence” that “Congress relied on the UCC definition” when it inserted Section 509(b)(9) into the Bankruptcy Code in 2005.

Constructing the second leg of its ratio decendi, the World Imports court looked no further than its own long-standing precedents. Over 30 years earlier, in Montello Oil Corp. v. Marin Motor Oil, Inc. (In re Marin Motor Oil, Inc.), 740 F.2d 220 (3d Cir. 1984), the Third Circuit decreed that the word “receipt,” as found in Section 546 of the Bankruptcy Code, “means the same thing” as it does in the Uniform Commercial Code, to wit, “taking physical possession.” Stressing the strong bonds between the Code's reclamation statute and the new subsection of the administrative expense proviso, the panel prepared to extend the reach of Marin Oil's definition of “received” to the latter.

Distinguishing Sections 546 and 503(b)(9)

But first it was incumbent upon the court to firmly rule upon the explicit interrelationship it found between Sections 546 and 503(b)(9). Judge Hardiman opined that the BAPCPA amendments codified the latter as “exemption” from the former. The appeals court concluded that Section 503(b)(9) is “an alternative remedy to [the] reclamation” right previously exercised by eligible creditors.

That linkage now exposited, the Third Circuit extended Marin Oil's definition of “received” to Section 503(b)(9). To do so, the tribunal called upon another canon of statutory construction. Reminding that individual statutes cannot be viewed in isolation, but rather must be interpreted in the context of the overall legislation, the panel justified its expansion of Marin Oil definitions to companionable matters arising under Section 503(b)(9). Given that 503(b)(9) is but “an exemption to the general bankruptcy reclamation scheme,” the World Imports court decreed that the most natural reading of the administrative expense statute would superimpose the same meaning of “received” as found in Marin Oil.

Geography provided the third and final piece of the foundation for World Imports. Attaching great significance to the fact that Congress amended Sections 546 and 503 in the same subpart of the 2005 legislation, Judge Hardiman was further persuaded that those two reforms — and only those two — were found under that particular BAPCPA heading. Given the obvious symmetry in the parallel amendments, the Third Circuit concluded it was “quite implausible that Congress meant for the date of receipt to be different between the two provisions.”

Delivery vs. Receipt

While the above constituted the bulk of the court's reasoning, it had to dispose of one final point, as argued by the debtor herein. World Imports contended that the shipping company was effectively its agent; therefore, the debtor truthfully “received” the goods when title passed, a result further mandated by the F.O.B. terms of the transaction. Not so, held the panel.

Once more asserting the precedential value of Marin Oil, the Third Circuit reiterated that it had long ago decided that the delivery of goods and the receipt of goods “can occur at different times.” Therefore, noted Judge Hardiman, the day that the debtor takes physical possession of the goods is ultimately determinative for Section 503(b)(9) administrative expense status.

To be sure, in a telling parenthetical, World Imports refuted the lower court's view that F.O.B. terms are controlling in these matters. In this revealing footnote, the panel rejected any need for reliance upon international trade terms, asserting that the Bankruptcy Code was more than sufficient to answer the question at bar.

At the end of the day, the Third Circuit held that “received” in the Section 503(b)(9) context means actual physical possession of the goods by the debtor within the 20 days preceding the bankruptcy. If so, the creditor is entitled to administrative expense priority for its claim. In contradistinction, if title merely passes, without physical receipt, then the claim is relegated to a lower rank in the distribution hierarchy.

Case Impact

World Imports is already influencing bankruptcy jurisprudence. This is inevitable, given that the Third Circuit supervises the Delaware bankruptcy court, a forum long favored for corporate bankruptcy filings. Strictly adhering to the instructions of the parent tribunal, a Delaware bankruptcy judge, in In re SRC Liquidation, Inc., ___ B.R. ___ (No. 15-10541) (Bankr. D. Del.) (July 13, 2017), ruled that a creditor that had “drop-shipped” goods to the debtor's customers within the statutory 20 days was not entitled to an administrative expense priority, for reason that the debtor “never physically possessed the goods.” Surely, more such decisions shall follow from that popular vicinage.

In closing, we do not argue with the efficacy of the Third Circuit's ruling. That panel took the surest course, by predicating its holding upon the firmest of grounds; statutes must first and foremost be interpreted in accordance with their plain meaning. Notwithstanding the solidity of such reasoning, we nevertheless interject a word of caution pertaining to the reach of this new decision.

First, the Third Circuit is but one of over a dozen such federal tribunals. Will its peers adopt the reasoning of World Imports in toto or strike out on their own with varying or even conflicting rulings?

Second, while the panel's interpretation of “received” here was forthright enough, what of the impact upon other, equally auspicious maxims of commercial law? Specifically, it has long been held that legal title and insurable interest pass in accordance with the F.O.B. and similar contractual terms found in contemporary shipping documentation, regardless of subsequent physical receipt. We can speculate as to whether, in resolving this narrow question pertaining to Section 503(b)(9), World Imports opens the door to future conflicts in the many interactions between commercial and bankruptcy law. Only time will tell.

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Anthony Michael Sabino is a Professor of Law, Peter J. Tobin College of Business, St. John's University; and Adjunct Professor of Law, St. John's University School of Law. He is also a partner at Sabino & Sabino, P.C. in Mineola, NY.