Ningbo Chenglu Paper v . Momenta 11-CV-479-SM 8/29/12 UNITED STATES DISTRICT COURT

DISTRICT OF NEW HAMPSHIRE

Ningbo Chenglu Paper Products Manufacturing Co., Ltd., Appellant

v. Case N o . 11-cv-479-SM Opinion N o .

Momenta, Inc., Appellee

O R D E R

This is an appeal from a decision of the United States

Bankruptcy Court for the District of New Hampshire. In the

proceedings below, a creditor, Ningbo Chenglu Paper Products

(“Ningbo”), sought payment under Section 503(b)(9) of the

Bankruptcy Code for the value of goods it sold to the debtor,

Momenta, Inc. (“Momenta”) within twenty days before bankruptcy

protection was sought. See

(b)(9). Section

503(b)(9) entitles a limited class of sellers to priority payment

for goods sold to a debtor, so long as the goods were “received

by the debtor” during a twenty-day pre-petition period.

The

bankruptcy court granted Ningbo’s motion with respect to the

value of goods Ningbo shipped directly to Momenta, but denied

Ningbo’s request for payment of approximately $140,000 related to

goods it shipped, at Momenta’s direction, to third parties

(Momenta’s own customers). Ningbo appeals. At issue is the meaning of the phrase “received by the

debtor,” as it is used in Section 503(b)(9). Ningbo contends

that, where goods are delivered under a drop-shipment arrangement

to a debtor/buyer’s customer,1 commercial reality requires that

the phrase “received by the debtor” be broadly construed to

include goods “received by the debtor’s customer.” For obvious

reasons, Ningbo urges a broad construction — one that would

extend Section 503(b)(9)’s priority provision to all sellers who

delivered goods within twenty days before the debtor’s petition —

i.e., including sellers who do not otherwise possess traditional

reclamation rights. Appellant Br., Doc. N o . 1 9 , at 4 . Momenta,

on the other hand, presses for a narrow construction of the term

“received” — limiting Section 503(b)(9) as a supplemental remedy

to a seller’s right of reclamation under Section 546(c)(1). See

(c)(1).

Standard of Review

Jurisdiction over appeals from final judgments, orders, and

decrees issued by the bankruptcy court lies in this court.

(a). The bankruptcy court's legal determinations are

reviewed de novo. See, e.g., Dahar v . Jackson (In re Jackson),

1 A “drop shipment delivery” is defined as “a manufacturer’s shipment of goods directly to the consumer rather than initially to a wholesaler.” Black’s Law Dictionary (9th ed. 2009).

2

1 7 , 121 (1st Cir. 2006); Askenaizer v . Seacoast Redimix

Concrete, LLC,

, at *1 (D.N.H. March 2 9 , 2007).

But its findings of fact are accorded deference and will not be

disturbed unless clearly erroneous. Groman v . Watman (In re

Watman),

, 7 (1st Cir. 2002); Brown v . Reifler,

, at *1 (D.N.H. Oct. 2 3 , 2008). A factual finding “is

‘clearly erroneous' when although there is evidence to support

i t , the reviewing court on the entire evidence is left with the

definite and firm conviction that a mistake has been committed.”

Anderson v . Bessemer City,

6 4 , 573 (1985) (quoting

United States v . United States Gypsum Co.,

6 4 , 395

(1948)).

The Bankruptcy Court’s Decision

Momenta filed its bankruptcy petition on October 2 3 , 2010.

During the twenty days preceding that event, seven shipments of

goods purchased by Momenta were delivered by Ningbo. At

Momenta’s direction, three shipments, valued at about $23,000,

were delivered to Momenta. Four other shipments (the “drop-

shipped goods”), valued at over $140,000, were delivered to

Momenta’s customers in the United Kingdom and Canada.

On December 6, 2010, Ningbo petitioned the bankruptcy court

to allow its “administrative expense” payment claims under

3 Section 503(b)(9) of the Bankruptcy Code,

(b)(9).

It sought payment for the full value of all goods shipped during

the twenty-day pre-petition period. See

(a)(9)(A) (the holder of an administrative expense claim

“will receive . . . cash equal to the allowed amount”). Section

503(b)(9) provides in pertinent part:

[T]here shall be allowed administrative expenses . . . 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.

(b)(9) (emphasis added).

Momenta conceded that all seven shipments consisted of goods

Ningbo sold to Momenta “in the ordinary course of business.”

Momenta also conceded that goods delivered directly to it were

“received” for purposes of Section 503(b)(9). But it objected to

Ningbo’s request for payment of the value of the drop-shipped

goods, arguing that those goods were not “received by the

debtor,” but by the debtor’s customers. Accordingly, Momenta

argued, the statutory language did not literally apply, and

should not be construed to apply, given the relationship between

Section 503(b)(9) and the development of reclamation seller

protection under the Code, as well as the Code’s general policy

of construing preferences narrowly. The bankruptcy court agreed

4 that the provision protects only sales of goods subject to

reclamation rights, that i s , goods delivered to the debtor within

the twenty days preceding a buyer’s filing for bankruptcy

protection.

The bankruptcy court first considered whether the term

“received” as used in Section 503(b)(9) should be given the same

meaning as “received” as found in the reclamation provision of

the Bankruptcy Code, Section 546(c). Bankr. C t . Mem. Op., Doc.

N o . 7-3, at 8 . Section 546(c) addresses the rights of sellers to

reclaim goods which “the debtor . . . received . . . while

insolvent.”

(c). 2 It provides that, with some

exceptions, a seller’s state-created right of reclamation is

protected from the bankruptcy trustee’s avoiding powers, so long

as the seller’s demand for reclamation is filed within a

specified time.

The section provides, moreover, that “[i]f

a seller of goods fails to provide notice in the manner described

. . . [it] still may assert the rights contained in section

503(b)(9).”

(c)(2).

Given the “language of the Bankruptcy Code, its legislative

history, and pre-BAPCPA practice,” the bankruptcy court held that

2 “Reclamation is the right of a seller to recover possession of goods delivered to an insolvent buyer.” In re Dana Corp.,

(Bankr. S.D.N.Y. 2007).

5 Sections 503(b)(9) and 546(c) “are related provisions that should

be read together,” such that the term “received” should be given

the same meaning in both sections. Bankr. C t . Mem. Op., Doc. N o .

7-3, at 6-8 (citing In Re Circuit City Stores, Inc.,

(Bankr. E.D. V a . 2010)). The court found that Congress

intended the sections to operate in tandem to provide enhanced

remedies for reclamation sellers: “[Section] 503(b)(9) provides a

seller, who did not comply with the notice requirements of §

546(c)(1), an alternative remedy to reclamation.” Id. at 6. See

also id. at 12 (Section 503(b)(9) “is related t o , and a part of

the remedies provided under the provisions of § 546(c)”).

Construing “received,” as it is used in Section 546(c), the

bankruptcy court concluded that the term “is the equivalent of

‘receipt’ in the UCC.” Id. at 8 . “‘[R]eceipt of goods’” under

UCC Section 2-103(c) means “‘taking physical possession of

them.’” Id. (quoting UCC § 2-103(c)). The bankruptcy court

found, however, that “possession” for purposes of reclamation can

mean actual physical possession or constructive possession, as

outlined in U.C.C. § 2-705(2), but that the debtor/buyer in a

reclamation situation does not have constructive possession of

goods delivered to a third-party good faith purchaser. Id. at

10-12. Such goods, the court held, are not amendable to

reclamation, and do not qualify for alternative relief under

6 Section 503(b)(9). In other words, Section 503(b)(9) was enacted

to protect reclamation sellers from minor impediments to Section

546(c) relief. It was not meant to create a new class of sellers

entitled to a priority remedy at the expense of other creditors.

Applying that definition of “received” to Ningbo’s claim

under Section 503(b)(9), the bankruptcy court held that the goods

Ningbo drop-shipped directly to Momenta’s customers were not

“received” by Momenta. Because Momenta did not have possession

of those goods, either actual or constructive, id. at 1 2 , no

reclamation rights arose and no alternative remedy under Section

503(b)(9) was available.

The bankruptcy court allowed an administrative expense in

the amount of $23,079.95, representing the value of goods shipped

by Ningbo directly to and received by Momenta, but otherwise

denied the claim. Ningbo appealed the bankruptcy court’s

disallowance of its administrative expense claims for the drop-

shipped goods.

Discussion

On appeal, Ningbo does not seriously contest the bankruptcy

court’s construction of the term “received” under Section 546(c).

It says, rather, that the bankruptcy court erred in holding that

7 Section 546(c)’s definition dictates the meaning of “received” as

the term as used in Section 503(b)(9). It argues that the

commercial reality of drop-shipment arrangements (and the plain

language of Section 503(b)(9)) necessarily leads to the

conclusion that when goods are delivered, at the debtor’s

direction, to the debtor’s customer, during the twenty-day pre-

petition period, those goods are “received” (at least

constructively) when the debtor’s customer takes possession.

Unsecured creditors who supply goods or services to a debtor

pre-petition are generally treated the same. See In re Nichols,

0 7 , 311 (Bkrtcy. D. Mass. 2011) (bankruptcy creditors

of the same class are generally entitled to an “equal and ratable

distribution” from the estate), citing Florida Dept. of Revenue

v . Piccadilly Cafeterias, Inc.,

(2008). A

preferential exception exists, however, under Section 546(c), for

sellers who have valid reclamation claims.

(c); Marin Motor, 740 F.2d at 223 (Congress adopted Section

546(c) in 1978 to recognize state law reclamation rights). See

also United States v . Westside Bank,

(5th

Cir. 1984) (allowing “a reclaiming seller a priority claim” under

Section 546(c) “[c]learly . . . constitutes preferential

treatment against the buyer’s general unsecured creditors.”)

(quotation omitted).

8 Momenta contends that Section 503(b)(9) does not, and was

not intended t o , create a new and broad class of preferred

claimants. Instead, that section provides a supplemental remedy

for those sellers who would be preferred reclamation sellers, but

for a minor disqualification under Section 546(a).

Ningbo, on the other hand, says Section 503(b)(9), by its

terms, extends priority status to a new and broad class of pre-

petition sellers. It argues that goods drop-shipped directly to

a debtor’s customer are goods “received by the debtor,” without

regard to the context-specific meaning ascribed to the term

“received” under Section 546(c). It points out that, while

U.C.C. Section 2-103 defines “receipt of goods” as “taking

physical possession of them,” the preface to that section

cautions that the definition will not apply if “the context

otherwise requires.” U.C.C. § 2-103(1). In common drop-shipment

scenarios, Ningbo says, “received” should be defined in context —

in a way that accounts for the commercial reality of drop-

shipment arrangements. It points to the fact that drop-shipment

arrangements are not only common, but often call for flexibility,

and that a buyer’s decision to direct delivery to a third-party

should not permit the buyer to later deny receipt of the goods.

See Appellant’s Br., Doc. N o . 1 0 , at 11-13, citing U.C.C § 2-

310(a) (where there are “open” payment terms, “payment is due at

9 the time and place at which the buyer is to receive the goods”)

and U.C.C § 2-705(2)(a) and official comments (“seller may stop

delivery until . . . receipt of the goods by the buyer,” which

includes receipt “by the buyer’s . . . subpurchaser”).

As a general matter, Ningbo’s point is well-taken. That i s ,

in some contexts commercial reality might well counsel

application of an expansive definition of “received.” But the

statutory construction it proposes here does not fit the context.

Priorities in bankruptcy, such as the administrative expenses

listed in Section 503(b),

(b)(1)-(9), stand as

discrete exceptions to the general equality principle. As such,

they must be strictly construed and be “clearly authorized by

Congress.” Howard Delivery Serv., Inc. v . Zurich Am. Ins. Co.,

5 1 , 655 (2006). Therefore, Ningbo’s claim to priority

turns not on “commercial reality” with respect to the delivery of

purchased goods, but on whether Congress “clearly authorized” the

specific priority Ningbo seeks.3

3 In any event, “commercial reality” might not support Ningbo’s position. Under familiar rules of the marketplace relating to the relative priorities of creditors, Ningbo could not, at the time it agreed to deliver goods directly to Momenta’s customers, have had any expectation that it could reclaim them. Reclamation is generally available only while delivered goods remain in the buyer’s possession. Ningbo’s suggestion that it would be unfair to exclude those transactions from priority treatment runs counter to “commercial reality” of creditor’s rights.

10 Congress did not define the term “received” as it is used in

Section 503(b)(9). Nor is that term defined elsewhere in the

Bankruptcy Code.4 But it appears that Congress intended that the

term, as used in Section 503(b)(9), should be construed

consistently with the reclamation section of the Code, Section

546(c). As the bankruptcy court correctly noted, changes made to

the Bankruptcy Code in 2005 suggest an intent to create a

priority administrative expense as a supplemental remedy for

reclamation sellers, and not, as Ningbo argues, a priority remedy

for all sellers who deliver goods pursuant to a contract with the

debtor and within twenty days preceding bankruptcy.

Before the Bankruptcy Abuse Prevention and Consumer

Protection Act of 2005 (“BAPCPA”), Section 546(c)(2) allowed a

“‘court [to] deny reclamation to a seller with such right of

reclamation that has made such a demand,” but “only if the

court’” awarded an administrative expense claim or secured the

seller’s “‘claim by a lien.’” Dana Corp.,

(quoting

(c)(2) prior to BAPCPA). In other

words, before BAPCPA, an administrative expense priority served

4 Without definitional guidance, the word “received” is ambiguous, since commercial practices and the larger statutory context may suggest different plausible meanings. See Bankr. C t . Mem. Op., Doc. N o . 7-3, at 8 (goods may be “received” when “the risk of loss passes, when title passes, . . . or when a party takes possession of [the goods].”)

11 as an alternative remedy to reclamation, but only if the seller

met Section 546(c)’s notice requirement. See In re Microwave

Prods. of Am., Inc.,

6 7 , 970 (Bankr. W.D. Tenn. 1989)

(“Copyfax failed to comply with the demand requirements,

therefore, it is not to be protected by the Court pursuant to

Section 546(c) once reclamation is denied.”).

In 2005, BAPCPA modified the reclamation rules under an

amendatory provision titled “Reclamation.” See Sec. 1227

“Reclamation,” Bankruptcy Abuse Prevention and Consumer

Protection Act of 2005, Pub. L . N o . 109-8, § 1227(b),

3 , 119-200. The provision deleted language in Section 546(c)(2)

authorizing courts to allow an administrative expense claim

(i.e., allow a cash payment in lieu of reclamation) where a

seller had otherwise made a proper reclamation demand. See In re

TI Acquisition, LLC,

4 2 , 745-46 (Bankr. N.D. G a . 2009)

(detailing legislative changes). It also added new language to

Section 546(c) specifying that, even if “a seller of goods fails

to provide notice in the manner described [in Section 546(c)(1),

it] still may assert the rights contained in Section 503(b)(9).”

(c)(2). Finally, it added Section 503(b)(9),

providing an administrative priority claim for goods the debtor

received within twenty days before bankruptcy. See In re TI

Acquisition,

.

12 As noted, the provision that made these changes was titled

“Reclamation.” Outside of the provision, BAPCPA made no other

reference to Section 503(b)(9)’s new administrative expense

remedy. See Frederick J. Glasgow, I I I , Comment, Reclaiming the

Defenses to Reclamation, 26 EMORY BANK. DEV. J. 3 0 1 , 315 (2010).

It seems likely, then, that in creating Section 503(b)(9),

Congress meant to expand and clarify the rights of reclamation

sellers, but did not intend to quietly create a new and expansive

creditor class entitled to a unique priority.

Other courts have reached the same conclusion. See e.g., In

re Circuit City,

(“Both § 503(b)(9) and the

amendments to § 546(c) were enacted as part of [BAPCPA] to

enhance certain types of reclamation claims.”) (quotation

omitted); In re Deer,

, at *2 (Bankr. S.D. Miss.

June 1 4 , 2007) (Section 503(b)(9) “was adopted to operate[] in

conjunction with

(c)(2) to provide

administrative expense treatment to a creditor with reclamation

rights even if the seller fails to make a demand.”) (quotation

omitted); In re TI Acquisition, LLC,

4 2 , 745 (Bankr.

N.D. G a . 2009) (“The treatment of expenses in Section 503(b)(9)

appears to be an outgrowth of the policy that first appeared in

(c)”). But see In re Erving Indus. Inc.,

, 373 (Bankr. D. Mass. 2010) (“‘Section 546 does not limit or

13 control in any way the rights that claimant has under §

503(b)(9)’”) (quoting In re Plastech Engineered Prods., Inc.,

2 8 , 838 (Bankr. E.D. Mich. 2008)).

Ningbo insists that Congress could not have intended Section

503(b)(9) to protect only reclamation sellers because neither

that Section, by its terms, nor Section 546, require a seller to

qualify as a “reclamation” seller in order to invoke the Section

503(b)(9) remedy. That i s , Ningbo asserts that (1) under the

express terms of Section 546(c), sellers who have not filed a

timely reclamation demand can still pursue the Section 503(b)(9)

remedy; and (2) sellers who invoke Section 503(b)(9) need not

show that the debtor still possesses the delivered goods — a fact

essential to a traditional reclamation claim.

Ningbo’s argument is plausible, but the factors it relies

upon equally suggest a more focused congressional intent, i.e.,

to provide a supplemental remedy to sellers who, but for a minor

deficiency, otherwise would have qualified for reclamation under

Section 546(c). It is one thing to say that, for bankruptcy

purpose, Congress modified traditional U.C.C. prerequisites to

reclamation seller relief; it is quite another to say that it

meant to abandon them entirely. Of course, Congress can do

either, as it chooses, but there is no clear indication, as there

14 must b e , that Congress intended to create a new and potentially

very large class of priority sellers, a class that would likely

distort if not completely undermine the Code’s general equity

principles governing asset distribution.

Ningbo lastly argues that policy reasons support the

statutory construction it presses. But each party’s proffered

construction of “received” promotes some recognized objective of

the Bankruptcy Code. For example, were Section 503(b)(9) read

broadly to extend priority status to the claims of all sellers

who deliver to debtors or third-parties within twenty days before

bankruptcy, more trade creditors would likely be “encourage[d]

. . . to continue to extend credit to a debtor potentially

heading for bankruptcy.” In re Arts Dairy, LLC,

(Bankr. N.D. Ohio 2009). On the other hand, a narrow reading

of Section 503(b)(9), that reserves its remedy for would-be

reclamation sellers, would likely enhance prospects for

successful reorganization, while respecting creditor equality

principles. Because the debtor must set aside cash to pay

priority administrative expenses, the larger the class of

creditors entitled to 503(b)(9) relief, the larger the potential

cash reserve needed, and the less likely a debtor will

successfully reorganize. That is not an insignificant

consideration. See In re Plastech Engineered Prods., Inc., 394

4 7 , 151 (Bankr. E.D. Mich. 2008) (Section 503(b)(9)

“creat[es] a large and potentially insurmountable cash hurdle for

a debtor to confirm a plan”).

The bankruptcy court correctly concluded that Sections

503(b)(9) and 546 are related statutory provisions enacted for

the benefit of reclamation sellers. It also properly determined

that the word “received” should be given the same meaning in both

sections. See generally United States v . Delgado-Garcia,

(D.C. Cir. 2004) (courts should “construe related

statutory provisions in similar fashion.”). The phrase “received

by the debtor” as used in Section 503(b)(9) means: possessed by

the debtor, either actually or constructively. The bankruptcy

court also correctly held that, under Section 503(b)(9), delivery

t o , or possession by, a debtor’s customer under a drop-shipment

arrangement does not constitute constructive possession by the

debtor for Section 503(b)(9) purposes.

Because, in this case, Momenta never had actual or

constructive possession of the drop-shipped goods, those goods

were not “received by the debtor” for purposes of Ningbo’s

administrative expense claim under Section 503(b)(9), and that

claim fails.

16 Conclusion

The bankruptcy court’s decision denying Ningbo’s several

administrative expense claims is AFFIRMED in all respects.

SO ORDERED.

Steven J . McAuliffe Jnited States District Judge

August 2 9 , 2012

cc: David E . LeFevre, Esq. Charles R. Bennett, Jr., Esq. Ann M . Dirsa, Esq. John C . Elstad, Esq. Geraldine L . Karonis, Esq.

17