Are Utility Providers Entitled to Section 503(b)(9) Claims?

Under § 503(b)(9) of the Bankruptcy Code, trade creditors are granted an administrative-priority claim for the value of goods that they had sold and delivered to the debtor in the ordinary course of the debtor’s business, and the debtor had received within 20 days of its bankruptcy filing. Although § 503(b)(9) appears to be a simple, rather uncomplicated provision, it has nevertheless been the subject of litigation over some of its seemingly simple terms. One such area of litigation is over the meaning of the term “goods” and whether it is broad enough to encompass certain things such as electricity, water and natural gas provided by utility companies. This article addresses the growing number of decisions to touch on these issues.

General Considerations.
Section 503(b)(9) provides as follows:

(b) After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502(f) of this title 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. [1]

The Bankruptcy Code does not define the term “goods.” As a result, every bankruptcy court to address the issues has applied the Uniform Commercial Code’s (UCC) definition of goods, reasoning that using the UCC definition will support uniformity inasmuch as 49 states have adopted some version of the UCC. [2] Additionally, these courts dismiss the idea that they should craft a new definition of goods because “where words are employed in a statute which had at the time a well-known meaning at common law or in the law of this country, they are presumed to have been used in that sense.” [3] Although courts are divided on what constitutes “goods” under § 503(b)(9), the statute’s plain language does not allow creditor claims arising from the provision of services to a debtor. [4]

For contracts of mixed goods and services, the majority of courts, outside of bankruptcy, apply the predominant-factor test, which states that “[t]he test for inclusion or exclusion is not whether [the contracts] are mixed, but, granting that they are mixed, whether their predominant factor, their thrust, their purpose, reasonably stated, is the rendition of service, with goods incidentally involve[d]…or is a transaction of sale, with labor incidentally involved.” [5] Under this test, if services “predominate,” then the item in question is not a “good.” In most cases, debtors will urge application of this test in an effort to defeat the entire § 503(b)(9) claim. However, as discussed below, most bankruptcy courts reject this test and instead separate the goods (treated as an administrative claim) from the services (treated as a general unsecured claim).

Finally, in addition to arguing that utilities such as electricity, natural gas and water are not “goods” for purposes of the UCC definition, debtors will also typically argue that utility providers are not entitled to a § 503(b)(9) claim because (1) section 503(b)(9) must be read in conjunction with § 546(c)(2) of the Code (governing reclamation of goods) and certain utilities (such as electricity and natural gas) can not be reclaimed, they are not “goods” for purposes of § 503(b)(9); and (2) a utility can not invoke both the protections of § 366 (governing adequate assurance for utility providers) of the Code and also assert a § 503(b)(9) claim.

Cases Addressing Natural Gas and the Applicability of § 503(b)(9)
In In re Plastech Engineered Products Inc., [6] the bankruptcy court held that a provider of natural gas was entitled to a § 503(b)(9) administrative-expense claim by making a number of important findings. As with all other courts to address the issues, the court began its analysis by adopting the definition of “goods” provided for in Article 2 of the UCC. [7] Importantly, the court rejected the “predominant factor” test reasoning that there is “nothing in section 503(b)(9) that dictates the use of a ‘winner take all approach.’” [8] The court held that if both goods and services are provided and the value of each of them can be readily ascertained, the value of the goods will be given § 503(b)(9) administrative claim status and the value of the services will be a general unsecured claim. [9]

In arguing that natural gas was not a “good” and thus not entitled to administrative-claim treatment under § 503(b)(9), the debtor argued that § 503(b)(9) must be read in conjunction with § 546(c)(2) of the Code (governing reclamation of goods) and because natural gas can not be reclaimed, it is not a “good” for purposes of § 503(b)(9). [10] The court rejected this argument and held that §§ 503(b)(9) and 546(c)(2) need not be read together: “There is nothing in section 503(b)(9) that requires a claimant to also be entitled to a reclamation right under section 546. Section 546 does not limit or control in any way the rights that a claimant has under section 503(b)(9).” [11]

The debtor also argued that a utility cannot invoke both the protections of § 366 of the Code and assert a § 503(b)(9) claim. The court rejected this argument. [12] According to the court, § 366 addressed post-petition utility services and § 503(b)(9) addressed pre-petition goods sold to a debtor, and are therefore not mutually exclusive. [13]

The court in In re Pilgrim’s Pride Corp. [14] reached a similar conclusion and addressed whether electricity, natural gas and water were entitled to § 503(b)(9) status. Similar to the court in Plastech, the Pilgrim’s Pride court adopted the definition of “goods” under Article 2 of the UCC. [15] Likewise, the court rejected the “predominant factor” test and concluded that the better approach was to separate the goods from the services (goods constitute an administrative claim and services constitute a general unsecured claim). [16]

The court concluded that natural gas was a good under the plain definition of the term in the UCC. [17] However, the court limited the § 503(b)(9) claim to the gas provided and excluded any fees for the use of the utility’s infrastructure in delivering the gas. [18]

Cases Addressing Water and the Applicability of § 503(b)(9) of the Bankruptcy Code
As discussed, the Pilgrim’s Pride court considered, among other things, whether water constituted a “good” for purposes of § 503(b)(9) administrative treatment. The court concluded that water meets the definition of “mineral” and is thus a good under the UCC. [19] Again, the court held that the § 503(b)(9) claim would be limited solely to the value of the water provided and would not include fees for the service of delivering the water. [20]

Cases Addressing Electricity and the Applicability of § 503(b)(9) of the Bankruptcy Code
Outside of the bankruptcy context, the majority of courts to consider the issue have held that electricity is a “good” under § 2-105 of the UCC, reasoning that once the electricity passes to the customer’s meter, it can be measured and is in the stream of commerce. [21] The bankruptcy courts to address the issue have been almost equally divided with three holding that electricity is a good and thus not entitled to administrative claim treatment under § 503(b)(9), and two courts reaching the opposite conclusion.

In GFI Wisconsin, Inc. v. Reedsburg Utility Commission, [22] the court considered whether electricity was a “good” for purposes of § 503(b)(9), and concluded that the UCC definition of “goods” should guide the court’s analysis under § 503(b)(9). [23] The only disputed issue was whether electricity is “movable,” [24] and the debtor argued that it required an analysis of the physical nature of electricity, stating that electricity cannot be moving when metered because it is consumed as it is simultaneously measured. The district court rejected this argument opining:

I conclude that the bankruptcy court ruled correctly that electricity is a ‘good’ within the meaning of § 503(b)(9)... Determining the physical nature of electricity is complex. It requires an understanding of the nature of electrons and a grasp of quantum physics and special relativity. For the purpose of determining administrative priority under the Bankruptcy Code, the meaning of “goods” under the UCC should not depend on quantum physics, how fast electrons are moving at a particular time or even where a debtor’s meter is located on an electrical circuit. Rather, determining whether a particular thing qualifies as a good and deserves administrative priority should be a straightforward assessment, taking into consideration the nature and common understanding of the thing, but also considering its similarities to goods that fall undisputedly under the UCC and would receive administrative priority under § 503(b)(9). [25]

The debtor also argued that a definition of “goods” that included “utility services” is inconsistent with § 366, which addresses the post-petition provision of utility services. Again, the court rejected the debtor’s argument. The court observed:

Just because a seller of goods may also be a utility that is entitled to the protection of § 366 for the sale of utility services post-petition to a debtor does not mean it is prohibited from allowance of a § 503(b)(9) administrative-expense claim to the extent that it has sold goods to the debtor that qualify under § 503(b)(9). Section 503(b)(9) addresses the sale of goods pre-petition and § 366 addresses the provision of utility services post-petition. The sections are not mutually exclusive. A utility provider may provide both goods and services within the meaning of each section. In sum, the rights afforded by § 503(b)(9) to a seller of goods are not dependent either explicitly or implicitly upon the availability of other remedies under the Code for the seller. [26]

On similar grounds, two other bankruptcy courts have concluded that electricity is a "good" for purposes of § 503(b)(9) of the Bankruptcy Code. See In re Grede Foundries, Inc., 435 B.R. 593, 596 (Bankr. W.D. Wis. 2010); In re Erving Industries, Inc., 432 B.R. 354, 370 (Bankr. D. Mas. 2010).

As discussed, the Pilgrim’s Pride court concluded that both natural gas and water were “goods” for purposes of § 503(b)(9) and thus entitled to administrative expense treatment. With respect to electricity, the court concluded that electricity was not a good inasmuch it cannot be packaged and handled. [27] Moreover, once it is capable of measurement at the meter, it has already been consumed by the end user and cannot be returned to the electricity provider:

While it is true that electricity is metered, this does not mean that it is within the UCC definition of “goods.” Telecom companies meter phone calls and internet bandwidth usage. However, the entities providing the medium for phone calls and the internet are clearly providing to their customers not “goods” but services. Further, the UCC requires that goods be movable at the time of identification. This is simply not true of electricity. Once electricity has been “identified” by measurement at the meter, it has already been consumed by the end user. It is impossible for the consumer to return electricity to the provider after it has passed the meter point. The mere fact that electricity is sold in metered quantities does not bring it within UCC § 2-105 or Code § 503(b)(9). [28]

As a result, the court concluded that electricity was not a good for purposes of § 503(b)(9). Likewise, in In re Samaritan Alliance, [29] the court, with little analysis, held that electricity is not a “good[30],” and thus, the electricity provider was not entitled to a § 503(b)(9) claim. [30]

Conclusion

Although the subject of utility providers and their right to § 503(b)(9) status has been the subject of much litigation, there does appear to be some consensus developing on certain key issues: (1) the UCC’s definition of the term “goods” will almost certainly be employed by bankruptcy courts considering these issues, and (2) the “predominate factor” test is unlikely to be adopted by a bankruptcy court. Instead, bankruptcy courts are more likely to separate the goods from the services and afford administrative status to the value of the goods provided while affording general unsecured claim status to the value of the services provided. Moreover, it seems unlikely that bankruptcy courts will limit § 503(b)(9)’s application based on either § 366 or 546(c). Nevertheless, there will almost certainly be continued debate on whether things such as water, natural gas and electricity, constitute “goods” within the meaning of § 503(b)(9) of the Bankruptcy Code.