s e l e c t e d
t o p i c
Bruce Nathan, Esq.
Section 503(b)(9) Goods
Supplier Priority—Beware of
the Debtor’s Setoff Rights
ection 503(b)(9) of the Bankruptcy Code was added by
the 2005 Bankruptcy Code amendments to grant an
administrative priority claim in favor of trade creditors
that sell goods to the debtor in the ordinary course of
the debtor’s business, which the debtor had received
within 20 days of its bankruptcy filing (the “20-Day
Goods”). Section 503(b)(9) enables a trade creditor to
step up the priority of its pre-petition claim for 20-Day
Goods and thereby increase the likelihood of a larger
and faster payment of this claim. A trade creditor’s Section 503(b)(9) priority claim is also not saddled with
all of the issues and defenses that have made reclamation rights a nearly meaningless remedy. By way of
example, the Section 503(b)(9) priority is not lost
where the 20-Day Goods are no longer in the debtor’s
possession, are not identifiable and/or are subject to a
prior perfected security interest in the debtor’s inventory when the debtor files bankruptcy.
Debtors and secured lenders have more frequently
sought to limit the amount of trade creditors’ 20-Day
Goods priority claims by litigating many questions left
unanswered by Section 503(b)(9). Among the litigated
issues is the debtor’s invocation of its setoff rights
This ruling could severely limit trade
creditors’ recovery on their Section
503(b)(9) Association of Business where has
“National priority claims in cases Credit
debtors havefor over 100 years.” against
been around pre-petition claims
the creditors.
against the creditor to disallow or reduce the creditor’s
Section 503(b)(9) priority claim. That is precisely what
recently happened in Circuit City’s Chapter 11 case
pending in the United States Bankruptcy Court for the
Eastern District of Virginia. The Circuit City court
ruled that Circuit City could setoff its pre-petition
chargeback, returns, credits, rebates, deductions, allowances and other similar claims (the “Pre-petition Credits Claims”) in reduction of trade creditors’ Section
503(b)(9) priority claims, instead of first reducing
trade creditors’ lower priority pre-petition general
unsecured claims. This ruling could severely limit trade
creditors’ recovery on their Section 503(b)(9) priority
claims in cases where debtors have pre-petition claims
against the creditors.
48
Business Credit february 2010
Catch Bruce in sessions:
18021. Bankruptcy
18042. Creditors’ Committees
18054. Hot & Emerging Legal Issues
18079. The Legal Clinic: Ask an Attorney
Prior Court Decision Where Debtor
Invoked Setoff Rights to Defeat Creditor’s
Section 503(b)(9) Claim
Circuit City is not the first case to deal with a debtor’s
attempt to assert its setoff rights in opposition to a Section 503(b)(9) priority claim. In Brown & Cole Stores,
LLC, the United States Ninth Circuit Bankruptcy Appellate Panel, the equivalent of a United States District
Court, ruled that a debtor could exercise its setoff rights
arising from its pre-petition breach of contract claim
against the creditor to reduce a Section 503(b)(9) priority claim. The debtor, Brown & Cole Stores, LLC
(“Brown & Cole”), was a large privately held grocery
store chain that operated 27 stores in the state of Washington. Associated Grocers, Inc. (“Associated”) was
Brown & Cole’s principal supplier. Associated’s claim
against Brown & Cole included a claim of $6,379,879.51
for 20-Day Goods that Associated had sold to Brown &
Cole prior to the latter’s bankruptcy filing.
Brown & Cole and Associated were also parties to a supply agreement. The agreement contained a “most
favored nations” pricing clause that required Associated
to sell goods to Brown & Cole on no less favorable terms
than the terms offered to Associated’s other customers.
Brown & Cole claimed that prior to its Chapter 11 filing, Associated had breached the agreement by selling
goods to Brown & Cole at higher prices than Associated
had charged its other customers. Brown & Cole sought
recovery of a “seven figure” damage claim from Associated based upon Associated’s improper pre-bankruptcy
termination of a rebate program.