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Decisions by Third Circuit and Delaware Bankruptcy Court Clarify that “Receipt” under Section 503(b)(9) Requires Physical Possession

Haining Wansheng Sofa Co., Ltd. v. World Imports Ltd. (In re World Imports, Ltd. et al.), No. 16-1357, 2017 WL 2925429 (3d Cir. Mar. 8, 2017) and In re SRC Liquidation, LLC, No. 15-10541 (BLS), 2017 WL 2992718 (Bankr. D. Del. July 13, 2017)

In two recent Opinions, the Third Circuit Court of Appeals and the Delaware Bankruptcy Court clarified that the word “received” in section 503(b)(9) of the Bankruptcy Code requires a showing that goods were delivered into the physical possession of a debtor or its agent within the 20 days before a debtor’s petition date (the “20-Day Period”).  Under the Third Circuit’s holding in Haining Wansheng Sofa Co., Ltd. v. World Imports Ltd. (In re World Imports, Ltd. et al.) and the Bankruptcy Court’s holding in In reSRC Liquidation, LLC, neither receipt of goods by a common carrier nor receipt by a debtor’s customer as the result of a drop shipment within the 20-Day Period satisfy the standard required to render a claim eligible for administrative priority.   The decisions reinforce courts’ strict construction of section 503(b)(9).

In World Imports, vendors turned goods over to a common carrier in China prior to the timeframe set forth in section 503(b)(9), and the goods were ultimately received by the debtors in the United States within the 20-Day Period.   The debtors argued that the vendors’ claims were not entitled to priority as 503(b)(9) claims based on  the earlier and alleged “constructive receipt” of the goods by the common carrier.  Both the Bankruptcy Court and the District Court for the Eastern District of Pennsylvania agreed with the debtors, and denied 503(b)(9) priority status to the vendors’ claims. World Imports, 2017 WL 2925429 at *1.

However, the Third Circuit reversed and remanded on appeal, holding goods are “received” only “when the debtor or its agent takes physical possession of them.”  Id.  at *2.  The Third Circuit’s holding followed precedent in In re Marin Motor Oil, Inc., 740 F.2d 220 (3d. Cir. 1984), in which it held that “receipt” – in accordance with the definition set forth in § 2-103(1)(c) of the Uniform Commercial Code (“UCC”) –  requires “taking physical possession” of goods.   2017 WL 2925429 at *3.  Although Marinwas decided in the context of reclamation under section 546(c) of the Bankruptcy Code, the Third Circuit found canons of statutory construction required it to give the same meaning to the word under section 503(b)(9).  The Court found that doing so harmonizes creditors’ rights under the Bankruptcy Code related to receipt of goods with state law rights of reclamation and stopping delivery under the UCC, as was intended by the Code’s drafters.  Id. at *3-4.

The issue of receipt before the Delaware Bankruptcy Court in SRC Liquidation arose in the context of a vendor that drop-shipped goods to the debtor’s customers during the 20-Day Period.  The debtor argued the resulting claims did not qualify for priority status under section 503(b)(9) because the relevant goods never came into its physical possession, and thus were not “received” under the UCC definition.  In response, the vendor argued that commercial realities such as drop shipment — where the debtor receives the value of the goods but not actual possession — require a different interpretation of receipt.  The vendor argued that it would be more appropriate for receipt under section 503(b)(9) to be determined based on the passing of title. Op. at 7-8.

Consistent with the Third Circuit’s holding in World Imports, the Bankruptcy Court rejected the vendor’s argument, noting “the UCC does not rely on the concept of title for purposes of establishing the rights of buyers and sellers: possession is the key.”  Op. at 7-8.  Since the debtor never physically possessed the goods, the Bankruptcy Court ruled that the drop-shipped goods only gave rise to a general unsecured claim.  In a footnote, the Bankruptcy Court further ruled, to the extent the vendor had directly shipped goods to the debtor, it was only entitled to 503(b)(9) status for the goods themselves and not ancillary costs such as shipping.  Op. at 9.