Section 503(b)(9) of the Bankruptcy Code provides creditors with an administrative expense priority claim for value of goods that were received by the debtor in the ordinary course within the 20 days prior to the bankruptcy filing Because section 503(b)(9) affords administrative priority status to an otherwise unsecured prepetition claim, it is strictly construed by courts.  Nowhere was this more apparent than in the bankruptcy court’s recent decision in In re World Imports, Ltd.,  

In World Imports, the court denied the 503(b)(9) claims of two Chinese companies, notwithstanding the fact that the debtor admitted to having taken physical possession of the goods within the 20-day pre-bankruptcy filing period, because the Chinese vendors had loaded their goods onto ships for delivery to the debtor outside of the 20-day period.  The court concluded that the key factor in determining whether an international shipment of goods is entitled to 503(b)(9) claim status is the date on which title passed from the vendor to the debtor, not the date on which the debtor took physical possession of the shipment.

The court first noted that it was obliged to look to non-bankruptcy law to determine when the goods were “received” by the debtor because the Bankruptcy Code does not define that term in section 503(b)(9). The court then determined that the standard trade definitions used in international sales contracts under the United Nations Convention on Contracts for the International Sale of Goods (the “CISG”) (which the court determined was applicable in lieu of the Uniform Commercial Code by operation of the US Constitution’s supremacy clause and the failure of the parties to opt out of the CISG in their contract) controlled when the subject goods were received.  Under the CISG, goods shipped “FOB from port of origin” (like the goods in this case) are delivered by the seller (and “perforce constructively received” by the buyer) when the seller places the goods on the ship and the “risk of loss or damage passes to the buyer.”  Because the goods were placed by the Chinese vendors on the ship prior to the 20-day period, they were not eligible for 503(b)(9) treatment.

The holding in World Imports, which is currently under appeal, applies in only limited circumstances.  Purely domestic transactions are governed by the UCC (which defines “receipt” as the taking of physical possession). Moreover, international suppliers can circumvent the result in World Imports by specifically writing into their purchase and sale agreements that the UCC, and not the CISG, applies with respect to the definition of “receipt” in connection with the sale and shipment of goods.  It is important to note that, in order to opt out of the CISG, it is not enough to simply reference the applicable state law. Parties must explicitly state that the CISG does not apply.

Of course, suppliers with the requisite bargaining power can avoid the bankruptcy claims process altogether and be insulated from the risk of a clawback of any payments made by a debtor on the eve of bankruptcy by demanding payment in advance for all goods shipped or by requiring the purchaser to obtain a letter of credit from its bank against which the supplier can draw down at the same time it delivers the goods “FOB from point of origin.”