International Shipments Deemed “Received” by Debtor When Delivered to Common Carrier “FOB Port of Origin” – Rather Than Physically Received – for Purposes of Granting an Administrative Expense Claim Under Section 503(B)(9) of the Bankruptcy Code

August 18, 2014

Suppliers selling goods to a purchaser on credit have often experienced the frustration of a purchaser filing for bankruptcy protection shortly thereafter and leaving the supplier with nothing except a general unsecured claim.  The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 included Bankruptcy Code section 503(b)(9)[1] — along with expanded reclamation rights in section 546(c)[2] — to provide some protection to suppliers of goods by allowing such suppliers an administrative expense claim for the value of goods supplied in the ordinary course of business and received by the purchaser within 20 days prior to the purchaser’s bankruptcy filing.  As a result, the claims of vendors who supply goods to a debtor within this time period (and who have not received payment) have a higher priority, and are paid before, those of general unsecured creditors.  Unlike reclamation claims, this priority is available whether or not the supplier can prove that the debtor still had possession of the goods and without the need for a formal reclamation demand.

However, where the Convention on Contracts for the International Sale of Goods (the “CISG”)[3] applies, non-U.S. suppliers who ship goods “Free On Board port of origin” (“FOB”)[4] from a country that has ratified the CISG to the United States may be precluded from asserting an administrative expense claim under section 503(b)(9) if the purchaser files a petition under the Bankruptcy Code more than 20 days after the FOB date.  In In re World Imports, Ltd., 511 B.R. 738 (Bankr. E.D. Pa. 2014), the bankruptcy court found that Chinese suppliers who sold goods to a U.S. purchaser that later filed a chapter 11 petition were not entitled to administrative expense claims under section 503(b)(9) notwithstanding the fact that the purchaser took physical possession of the goods within 20 days prior to its bankruptcy filing.  The court reasoned that the CISG, an international treaty, preempted application of state law — in this case, the Uniform Commercial Code (the “UCC”) — so the shipments of goods were deemed “received” by the purchaser on the FOB date at the ports in China, not upon the purchaser’s “physical receipt” as suggested by the UCC.  See UCC § 2-103.[5]  This decision appears to apply primarily to shipments of goods between suppliers in foreign countries that have ratified the CISG (including China, France, Germany, Belgium, Brazil, and Singapore)[6] and purchasers in the United States or in any other signatory country that later file for relief under the United States Bankruptcy Code.[7]  The World Imports court noted that had the UCC definition of “receipt” applied, as it does in domestic sales of goods between U.S. suppliers and purchasers, the Chinese suppliers’ claims may have been entitled to priority for the price of all goods physically received by the purchaser within the 20 days prior to its bankruptcy filing.

Analysis of In re World Imports, Ltd.

In World Imports, Chinese suppliers shipped goods to the debtor FOB from ports in China.  Although the purchaser took physical possession of the goods in the United States within 20 days prior to the purchaser’s bankruptcy filing, the goods were actually loaded on vessels and shipped from China more than 20 days before the purchaser filed for bankruptcy.  Thus, the court had to determine when the goods were deemed “received” by the purchaser for purposes of section 503(b)(9).  The Chinese suppliers argued that their claims were entitled to administrative priority because although the Bankruptcy Code does not define the term “received,” the UCC defines the term “receipt” as taking “physical possession” of the goods, which, in this case, occurred within the 20-day period.  Conversely, the purchaser argued that the transaction was not governed by the UCC, but rather the CISG.  The purchaser argued that, under the CISG, it “received” the goods when they were “put on the ship” and the risk of loss was transferred, which, in this case, occurred outside the 20 day period.  In re World Imports, Ltd., 511 B.R. at 741.  Ultimately, the court agreed with the purchaser and denied the Chinese suppliers’ motions for administrative expense claims.  Id. at 746.  The court found that the sale transactions were governed by the CISG, which, being a federal treaty, preempted application of the UCC (i.e., state law).  Id. at 743-44 (citing treatises for the proposition that the CISG broadly displaces Article 2 of the UCC in the context of international sales transactions).  Moreover, there was no evidence that the parties agreed to opt out of the CISG’s application or intended for the UCC to govern.  Id.  Accordingly, for purposes of section 503(b)(9), the court concluded that the purchaser “received” the goods when they were put on the ship FOB because, under the CISG, the risk of loss transferred to the purchaser at that time.  The decision is currently on appeal.

World Imports does not appear to apply to wholly domestic transactions between parties with places of business within the U.S.; rather, it appears to apply only to international transactions between parties with places of business in different countries that have ratified the CISG.  For example, had the contracting parties’ places of business been in San Francisco and New York, it appears the court in World Imports would have applied the UCC definition of “receipt” because the transactions would have been entirely domestic in nature.  However, in World Imports, the contracting parties’ places of business were China and the U.S.  Because both countries have ratified the CISG, the court found that the CISG (equivalent to federal law) preempted the application of the UCC (state law) and ultimately governed the transactions.  Accordingly, assuming it is affirmed on appeal, the holding in World Imports would be limited to international sales transactions and would not impact wholly domestic sales transactions (or the body of law[8] governing them).

Practical Takeaways:

For suppliers located outside the United States, the outcome in World Imports is likely preventable.

  • Although the CISG applies to certain international commercial transactions by default, it expressly allows parties to contract around its application if they so desire.  See CISG Art. 6 (“The parties may exclude the application of this Convention or, subject to article 12, derogate from or vary the effect of any of its provisions.”).  Hence, after World Imports, suppliers located outside the U.S. may wish to expressly write into their agreements that Article 2 of the UCC, and not the CISG, governs the meaning of the term “receipt” in connection with their international sales transactions.  Travelers Prop. Cas. Co. of Am. v. St.-Gobain Tech. Fabrics Can., Ltd., 474 F. Supp. 2d 1075, 1081-82 (D. Minn. 2007) (“A majority of courts . . . conclude that a reference to a particular state’s law does not constitute an opt out of the CISG; instead, the parties must expressly state that the CISG does not apply.”).  Doing so should increase the probability that a non-U.S. supplier’s claim would receive administrative priority if the purchaser files for bankruptcy protection in the U.S.
  • A supplier that has sufficient leverage with its purchasers can avoid the risks of dealing with claims in a U.S. bankruptcy case by requiring “payment in advance” for all products shipped.  Demanding payment in advance also insulates suppliers from the risk of a lawsuit to avoid payments received during the ninety (90) days prior to a bankruptcy filing as preferential transfers because there is no “antecedent debt” with an advance payment.
  • A supplier could also require a purchaser to cause its bank to issue a documentary letter of credit which would be drawn when goods shipped under FOB terms in the supplier’s jurisdiction are loaded.  This insures that payment is made to the supplier at the point in time the “risk of loss” is shifted to the purchaser.  This is precisely the setting in which letters of credit first arose as a means to assure payment to suppliers of goods based in remote locations.  Obtaining a letter of credit also insulates the supplier from preference litigation risk because there is no “transfer by the debtor” if payment is received from a bank pursuant to a letter of credit.

Finally, more and more non-U.S. entities are seeking the protection of U.S. bankruptcy laws by filing chapter 11 (or chapter 15) cases in the U.S.  As such, U.S. suppliers who ship goods to non-U.S. purchasers that subsequently file a bankruptcy petition in the U.S. should heed the lessons of World Imports.  If a court finds that a non-U.S. purchaser who files for bankruptcy protection in the U.S. has a “place of business” outside the U.S. for purposes of a sales contract, the CISG may apply and the U.S. supplier’s ability to obtain an administrative expense claim under section 503(b)(9) could be adversely impacted.

   [1]   Bankruptcy Code section 503(b)(9) provides in relevant part:

(b)  After notice and a hearing, there shall be allowed, administrative expenses . . . including —

(9)  the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.

11 U.S.C. § 503(b)(9) (emphasis added).

   [2]   Unlike section 503(b)(9), which provides an administrative expense claim to trade vendors, section 546(c) provides creditors the right to actually reclaim the goods that they sold to the debtor while the debtor was insolvent and within 45 days before the debtor filed for bankruptcy so long as the creditor provides timely, written notice to the debtor demanding reclamation.  Timely notice means no later than:  (a) 45 days after the date of receipt of the goods by the debtor; or (b) 20 days after the petition date if the prior 45 day period expires postpetition.  Reclamation rights are subordinate to properly perfected security interests and are limited to the goods still in the possession of the debtor when the reclamation demand is delivered.  A trade creditor who fails to send the debtor a timely reclamation demand is still entitled to priority under section 503(b)(9) for the price of goods delivered during the 20 days prior to the petition date without making a timely reclamation demand and regardless of the existence of a security interest.

   [3]   The purpose of the CISG is to provide a modern, uniform and fair regime for contracts for the international sale of goods.  The CISG applies to “contracts of sale of goods between parties whose places of business are in different States . . . [w]hen the States are Contracting States.”  CISG Art. 1(1)(a).  “For the purposes of [the CISG]: (a) if a party has more than one place of business, the place of business is that which has the closest relationship to the contract and its performance, having regard to the circumstances known to or contemplated by the parties at any time before or at the conclusion of the contract; (b) if a party does not have a place of business, reference is to be made to his habitual residence.”  CISG Art. 10.  Whether the CISG governs a given sales transaction hinges on the “places of business” of the contracting parties.

   [4]   Notwithstanding the fact that the CISG, as opposed to the UCC, governed the meaning of the term “received” in World Imports, the court’s conclusion that shipping goods “FOB port of origin” transfers the risk of loss from the seller to the buyer at the port of origin is consistent with Article 2 of the UCC.  Indeed, UCC § 2-319(1)(a) provides, in pertinent part that “[u]nless otherwise agreed the term F.O.B. (which means ‘free on board’) at a named place . . . is a delivery term under which when the term is F.O.B. the place of shipment, the seller must at that place ship the goods in the manner provided in this Article (Section 2-504) and bear the expense and risk of putting them into the possession of the carrier.”  UCC § 2-319(1)(a) (emphasis added).  Importantly, the result is different when the shipping terms are “FOB place of destination,” where title /risk of loss does not transfer until after transport when the goods are actually tendered to the purchaser.  See UCC § 2-319(1)(b).

   [5]   UCC § 2-103(1)(c) provides:  “In this Article unless the context otherwise requires ‘Receipt’ of goods means taking physical possession of them.”

   [6]   The CISG has been ratified by 80 countries, including:  Argentina, Australia, Bahrain, Belgium, Brazil, Canada, China, Colombia, France, Germany, Italy, Japan, Korea, Mexico, Netherlands, Russia, Singapore, Spain, Switzerland, Turkey, the United States, and Venezuela.

   [7]   Although not discussed in the opinion, the World Imports decision could conceivably apply in the U.S. bankruptcy case of a non-U.S. debtor where the debtor/purchaser and the supplier have “places of business” in different countries that have ratified the CISG.

   [8]   See, e.g., In re Circuit City Stores, Inc., 432 B.R. 225 (Bankr. E.D. Va. 2010) (holding that, consistent with the UCC’s definition of the word receipt, “the definition of ‘received’ means ‘having taken into physical possession,’ and [] this definition should be applied as the federal definition of the term ‘received’ for purposes of interpreting § 503(b)(9) of the Bankruptcy Code”); In re Momenta, Inc., 455 B.R. 353, 358 (Bankr. D.N.H. 2011) (“Since ‘received’ is not defined in the Bankruptcy Code, courts have uniformly looked to the definition of ‘receipt’ as stated in the UCC.”)

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