Important Delaware Decision on “20-Day Administrative Claim” Remedy for Creditors
by: David Conaway
Shumaker, Loop & Kendrick LLP; Charlotte, N.C.
The most significant potential benefit to vendors from the 2005 Bankruptcy Code Amendments is the creation of the 20-day administrative claim. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) added a new category of administrative claims in §503(b)(9) of the Code for vendors that shipped goods to a debtor 20-days prior to the filing. A recent case in Delaware, Global Home Products LLC, provides vendors guidance on the use and potential limitations on this remedy.
To provide some context, most vendors are aware that reclamation has been their standard bearer for its “shipment of goods”-based remedy. Under applicable reclamation provisions, a vendor could “reclaim” goods recently shipped to an insolvent debtor if written demand for reclamation was sent to the debtor within 10 days of the debtor’s receipt of the goods. The real goal of the creditor was to obtain administrative priority status for the vendor’s invoices that fall within the 10-day reclamation period. The basis of that goal was the Bankruptcy Code provision that allowed a court to deny reclamation to a seller with a right of reclamation if the court alternatively granted the seller a lien or an administrative expense priority claim.
This remedy was considered low-hanging fruit for vendors because at least a portion of its unsecured claim would, in essence, be converted to an administrative expense priority claim. Unsecured claims usually receive dismal treatment in bankruptcy cases while administrative claims, on parity with professional fees, usually are paid in full.
The 2005 Bankruptcy Code amendments made some dramatic changes to vendors’ reclamation remedy. On the plus side, the 10-day period was expanded to 45 days. On the negative side, denial of a reclamation no longer automatically results in providing the vendor a lien or administrative expense priority claim. The clear implication of such deletion is that reclamation will no longer result in an administrative expense priority claim for a vendor.
However, the drafters of BAPCPA added the new 20-day administrative claim, presumably in lieu of the prior remedy. On its face, the 20-day administrative claim is a much better remedy for vendors than reclamation. Note that a reclamation claim is subject to elimination, or at least subordination, if there is no equity in the inventory above the secured lender’s claim. In addition, a vendor seeking reclamation has the burden of proving that its goods were in the debtor’s possession at the time of the reclamation demand and not consumed by the debtor or converted to an unidentifiable component part of another product. This can be a challenge for a vendor to prove, particularly if a vendor waited several months to determine if the debtor will voluntarily do the right thing and recognize and pay the reclamation claim.
By contrast, the 20-day administrative claim does not have all the baggage of a reclamation claim. Under new §503(b)(9), to establish a 20-day administrative claim a vendor must:
- file a motion seeking the remedy;
- prove that the debtor received the vendor’s goods within 20 days before the filing
- prove the value of the goods; and
- prove the goods were sold to the debtor in the ordinary course of the debtor’s business.
These requirements appear to be relatively easy to meet. Note that a vendor does NOT need to prove there is equity in the inventory, and does NOT need to prove the vendor’s goods were present and pristine at the time of the demand. Although a written demand is not required (but advisable), a written motion with the court seeking approval and payment of the 20-day administrative claim is required.
This is exactly what a creditor in Global Home Products did. The Delaware court’s ruling illustrates the adage that nothing is as easy as it seems and, more importantly, provides vendors guidance on exactly how this new vendor remedy for payment may play out.
In Global Home Products, the vendor Industria Mexicana del Aluminio S.A. de C.V. (IMASA), was owed approximately $200,000 arising from the sale of about 123,000 lbs. of aluminum to the debtor in the ordinary course of business. IMASA filed its motion for allowance and immediate payment of its §503(b)(9) “20-day administrative claim.” The debtor objected on two grounds: (1) IMASA had not met its burden of proof on the value of the goods, and (2) IMASA is not entitled to payment of its claim. The lender, Wachovia Bank, also filed a limited objection asserting that the DIP financing agreement prohibited Global Home Products from paying any debts not in the post-petition budget.
The parties quickly agreed on the allowance of IMASA’s claim so the case came down to whether IMASA was entitled to receive immediate payment of its 20-day administrative claim. The court ruled that IMASA was NOT entitled to immediate payment and left IMASA’s administrative claim to be paid pursuant to an eventual reorganization plan.
It is not news that a bankruptcy court has discretion on the timing of payment of administrative claims. The Bankruptcy Code does not specify when an administrative claim must be paid, only that administrative expenses must be paid in full on the effective date of a reorganization plan. On the other hand, a fundamental tenet of bankruptcy is that while a debtor may be able to postpone dealing with the pre-petition liabilities it accumulated, to avail itself of the privilege of bankruptcy, it must at least be able to pay as it goes, or pay its post-petition bills in a timely fashion. If not, then the case should be converted or dismissed. A §503(b)(9) administrative expense priority claim is a hybrid since it arose as a pre-petition debt.
The court prohibited immediate payment based on three grounds: (1) the debtor testified it could not afford to pay the claim, especially if it triggered a race to the debtor’s assets; (2) the Wachovia Bank DIP-lending facility prohibited it; and (3) IMASA did not produce any evidence of its business need to receive the payment.
The good news here is IMASA was granted an administrative expense priority claim for a portion of its pre-petition claim. This is significant because, as stated above, general unsecured claims usually fare poorly in chapter 11 cases while administrative expense priority claims are generally (but not always) paid in full. Imagine a vendor whose customer is on strict, net 30-day terms. In theory, an administrative claim for 20 days of shipments would mean two-thirds of the vendor’s claim would be reclassified from unsecured to administrative expense priority. Not a bad outcome, all things considered.
The bad news from Global Home Products is:
- The court allowed a contract between the debtor and the lenders, the post-petition DIP facility, to impact the vendor’s remedy; and
- The court was not apparently troubled by the fact that Global Home Products could not pay the bill, i.e., the debtor was administratively insolvent.
In denying IMASA’s request for immediate payment, the bankruptcy court cited that the Wachovia Bank DIP facility prohibited payments of items not specifically provided for in the DIP budget. Has the court effectively added a new requirement for the remedy – specifically that the DIP facility must allow for payment of §503(b)(9) claims? In reaction, vendors will need to be present at the outset of a chapter 11 case to object to any provision of the DIP facility that limits the debtor’s ability to pay such claims. Perhaps vendors should insist on carve-outs for 20-day administrative claims, similar to the carve-outs professionals receive.
It is striking that the bankruptcy court was apparently not concerned about the debtor’s clear admission that it did not have sufficient capital or liquidity to pay the claim. In effect, that is an admission that the debtor is administratively insolvent, meaning it cannot pay its post-petition bills. If a debtor cannot pay its administrative claims now, what are the realistic chances it will be able to pay at plan confirmation?
What are the takeaway points of this case? Vendors should be buoyed by the relative ease in which the vendor’s 20-day administrative claim was recognized and allowed by the court. This is a net gain for vendors as it allows vendors to convert 20 days of its pre-petition shipments from general unsecured status to administrative expense priority status. While payment of administrative claims may not be immediate, the probability of ultimate payment is much greater than an unsecured claim. Under prior reclamation law, a vendor was limited to 10 days worth of shipments, and subject to proving equity in the inventory and that the goods had not been consumed.
On the other hand, the Delaware Bankruptcy Court was clearly struggling with how to temper the §503(b)(9) remedy given its potential adverse impact on liquidity and cash flow of the debtor. It seems that the court was grasping for ways to buoy the debtor’s liquidity and enhance the prospects for a successful chapter 11. This translates into more hurdles for the creditor, at least to achieve immediate payment of the 20-day administrative claim.
Even though bankruptcy courts, as in Global Home Products, may be concerned about the impact on liquidity, there is no doubt the 20-day administrative claim of §503(b)(9) is a powerful remedy for vendors and should be aggressively pursued when the opportunity arises.