Collect Your Material Costs in Bankruptcy Using 503(b)(9) Claims

For many contractors and suppliers, the typical reaction when a customer files bankruptcy is to (1) get angry, (2) avoid involvement in the bankruptcy as much as possible, and (3) chase down whatever money you can via mechanic’s lien and bond claims. While pursuing mechanic’s liens and bonds is almost always one of the correct moves, there are some often ignored or forgotten steps that you can take in the bankruptcy court that can improve your position significantly. In situations where mechanic’s liens or bond claims may not provide complete relief, it is important to know what options exist in the world of bankruptcy law. In particular—whether you are a contractor or supplier—it is important to consider whether you may have what is generally called a 503(b)(9) claim.

WHAT IS A 503(b)(9) CLAIM?

In 2005, Congress amended the Bankruptcy Code via a bill named the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 [1]. This bill created a new type of administrative claim as a part of 11 U.S.C. § 503 that applied to “goods” supplied shortly before the debtor filed bankruptcy. An administrative claim has higher priority than general unsecured claims (like a typical breach of contract claim) in bankruptcy. Importantly this means that administrative claims will be paid in full before any amount is paid on the general unsecured claims. While not a guarantee of payment, an administrative claim is certainly a significant improvement over a general unsecured claim.

Specifically, 11 U.S.C. § 503(b)(9) creates an administrative claim for:

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.

This new administrative claim, of course, is very favorable to materials suppliers and—except in situations where the debtor is completely without assets—it almost always makes sense for a supplier to pursue such a claim. Even if it appears that the debtor may not be able to pay the claim in full, having such a claim improves your priority and gives you another bargaining chip when negotiating preference claims.

There is little question that a supplier who supplies, for example, windows to a debtor in the twenty days prior to a bankruptcy is entitled to seek an administrative claim for the value of those windows. The more complicated question is whether a contractor who, for example, supplies and installs windows for a debtor in the twenty days prior to a bankruptcy has that same administrative claim. The answer is not totally clear at this point and requires some detours through state commercial law, but the indications are positive that a contractor is allowed to make such a claim.

WHAT ARE “GOODS” UNDER 503(b)(9)?

The first question in determining whether a contractor has a potential 503(b)(9) claim is whether what was supplied to the debtor are “goods” within the meaning of the statute. Essentially every court to consider this question has determined that the word “goods” as used in 503(b)(9) has the same meaning as “goods” under Article 2 of the Uniform Commercial Code (“UCC”) [2]. With some minor variation, the UCC has been adopted nationwide [3]. Speaking broadly, this means that there should not be much variation as to the meaning of goods for 503(b)(9) purposes across the various bankruptcy courts.

The UCC defines "goods" as "all things . . . which are movable at the time of identification to a contract for sale." [4] This definition of goods seems to include most construction materials. Using Virginia as an example, Virginia courts have specifically held that asphalt is a good under the UCC [5]. So are air conditioning units [6] , exterior cladding [7] , and plumbing and heating materials [8]. While each factual situation will require its own analysis, there is a strong initial basis to conclude that most construction “materials” fit the UCC definition of goods and therefore the definition of goods for 503(b)(9) claims.

WHO CAN MAKE A 503(b)(9) CLAIM FOR GOODS SUPPLIED?

Here is where things really start to get interesting. The entirety of the statutory language of 503(b)(9) is:

After notice and hearing, there shall be allowed, administrative expenses, other than claims allowed under section 502(f) of this title, including . . . 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 [9].

This language seems to say that anyone who supplied “goods” to the debtor within the relevant time frame and the ordinary course of such debtor’s business is entitled to a 503(b)(9) claim. However, because of the broad acceptance of the UCC definition of “goods” for the purposes of this statute, a number of trustees and debtors have argued that to have a 503(b)(9) claim the “goods” must have been sold to the debtor pursuant to acontract controlled by the UCC. Because the UCC does not apply to many contracts that include both goods and services, this would potentially exclude many construction contracts.

The test that courts apply to determine whether a contract is covered by the UCC is generally referred to as the “predominant purpose test” or the “predominant factor test.” For this test, courts must decide “whether the contract primarily concerns the furnishing of goods or the rendering of services.” [10] Courts look at factors such as 1) the language of the contract, (2) the nature of the business of the supplier, and (3) the intrinsic worth of the materials [11].

The majority of courts addressing the issue held that the predominant purpose test has no application to 503(b)(9) claims. The first published opinion to consider the issue directly is In re Plastech Engineered Products, Inc. from the United States Bankruptcy Court for the Eastern District of Michigan [12]. There the debtor urged the court to determine that the predominant purpose test must be satisfied for a § 503(b)(9) to be valid. The court rejected that argument on the basis that there is nothing in 503(b)(9) that “disqualifies a § 503(b)(9) claim just because the contract pursuant to which the goods were sold also provides for the sale of services.” Subsequently, the United States Bankruptcy Court for the Northern District of Texas reached the same conclusion in In re Pilgrim's Pride Corp., 421 B.R. 231 (Bankr. N.D. Tex. 2009). These cases say that a contractor who has a contract that includes labor and materials, should have a 503(b)(9) claim for the value of the materials that it supplied to the debtor in the relevant twenty-day time window.

Of course, there is almost always an exception. The one published opinion where a court has decided that the predominant purpose test must be used is from the United States Bankruptcy Court for the Eastern District of Virginia in In re Circuit City Stores, Inc., 416 B.R. 531 (Bankr. E.D. Va. 2009). There the court relied upon the latter portion of 503(b)(9) which limits 503 (b)(9)’s reach to claims when “goods have been sold to the debtor in the ordinary course of business.” From this language the court reached its determination that Congress intended 503(b) (9) to be limited not only to the value of the goods sold but also only to contracts for the “sale of goods” subject to the UCC.

Notably, one of the claimants in the Circuit City case appealed the bankruptcy court’s decision to the United States District Court for the Eastern District of Virginia. Before that appeal could be decided, the debtor and the claimant reached a settlement whereby the claimant received a 503(b)(9) claim with a value of fifty percent of what was initially claimed.

Following the Circuit City decision, three more courts have weighed in on this issue in published opinions. All of these courts joined the reasoning from Plastech and rejected the bankruptcy court’s decision in Circuit City [13]. As of now, Circuit City stands alone among published decisions for the proposition that 503(b)(9) claims are barred if the predominant purpose test cannot be satisfied.

503(b)(9) IS (PROBABLY) FOR CONTRACTORS AND SUPPLIERS!

Despite the decision in Circuit City, there seems to be a burgeoning consensus that contractors who supply materials as a part of their work are entitled to a 503(b)(9) administrative claim for the value of the materials supplied to the debtor in the twenty days prior to the bankruptcy filing. A 503(b)(9) claim can be an important remedy where bond or mechanic’s lien remedies may not be available or even as a supplement to those remedies. When your customer files bankruptcy, make sure to consult your counsel regarding this and other tools that may be available to protect your interests.

[1]  109 P.L. 8, 119 Stat. 23, 109 P.L. 8, 2005 Enacted S. 256, 109 Enacted S. 256.

[2]  P.R. Elec. Power Auth. v. Rentas (In re PMC Mktg. Corp.),517 B.R. 386(B.A.P. 1st Cir. 2014).

[3]  Osborne v. Subaru of America, Inc., 198 Cal. App. 3d 646, 662 (Cal. App. 3d. Dist. 1988).

[4]  GFI Wis., Inc. v. Reedsburg Util. Comm'n, 440 B.R. 791, 798 (Bankr. W.D. Wisc. 2010).

[5]  Harrison's Moving and Storage Co. v. Princess Anne Paving Corp., 60 Va. Cir. 303 (Va. Cir. Ct. 2002).

[6]  French v. York Int'l Corp., 72 Va. Cir. 538, 542 (Va. Cir. Ct. 2007).

[7]  Bay Point Condo. Ass'n v. RML Corp., 57 Va. Cir. 295 (Va. Cir. Ct. 2002).

[8]  W. E. Brown, Inc. v. Pederson Constr. & Tile Co. , 20 Va. Cir. 280 (Va. Cir. Ct. 1990).

[9]  11 U.S.C. § 503 (2016).

[10]  Princess Cruises v. GE, 143 F.3d 828, 833 (4th Cir. 1998); see also Long Island Lighting Co. v. IMO Indus., 6 F.3d 876 (2d Cir. 1993).

[11]  Princess Cruises, 143 F.3d at 833.

[12]  397 B.R. 828 (Bankr. E.D. Mich. 2008)

[13]  In re Erving Indus., Inc., 432 B.R. 354 (Bankr. D. Mass. 2010), In re NE OPCO, Inc., 501 B.R. 233 (Bankr. D. Del. 2013), GFI Wis., Inc. v. Reedsburg Util. Comm'n, 440 B.R. 791 (W.D. Wis. 2010).