Recent Bankruptcy Court Decision May Illuminate Whether Electricity Will Be Considered a Good Entitled to Priority Status in Future Cases
I give the experimentalist’s answer to the very fundamental but very familiar query: “What is electricity?” His answer is naïve, but simple and definite. He admits at once that as to the ultimate nature of electricity he knows nothing.
– Robert Millikan, American Nobel Laureate in Physics
Courts are sometimes required to ponder difficult questions. One such question is: “What is electricity?” And, as a corollary, “Is electricity a good or service?” The questions seem simple enough on their surface, but the answers have major ramifications for a variety of reasons under commercial law. One such reason at the heart of some recent litigation revolves around whether a creditor can seek a priority claim for electricity sold to a debtor within days preceding the filing of the bankruptcy petition.
Section 503(b)(9), added to the United States Bankruptcy Code under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, provides sellers of goods a priority administrative expense claim for “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.” Since such claims need to be paid in full before any payments can be made to general unsecured claims, priority administrative claim status is clearly preferable from a creditor’s point of view.
In an enlightening case of first impression in the First Circuit, a bankruptcy court recently held that a creditor’s supply of electricity to a debtor within the 20 day window does constitute a sale of “goods,” entitling the creditor to a priority administrative expense claim under Section 503(b)(9). In re Erving Industries, Inc., 2010 Bankr. LEXIS 1069 (Bankr. D. Mass. Apr. 7, 2010).
The implications of this ruling are significant because it sets a precedent for an electricity provider to invoke the Section 503(b)(9) priority claim to elevate some or potentially all of what may otherwise be an unsecured claim to a claim with administrative expense priority. However, rather than simply consider Erving as a guaranteed boon for such creditors, future courts may likely distill the unique factors of the Erving case in terms of the creditor’s role in the electric industry (e.g., creditor operated in the partially deregulated electric industry in Massachusetts where it was able to exclusively sell electricity without having to deliver it) and the terms of the electricity supply agreement between the parties (e.g., contract expressly disclaimed responsibility for transmission/distribution of electricity, and invoices reflected only charges for sale of electricity itself and not the delivery). Therefore, it is important to understand some of the case’s basic factual aspects and legal applications.
In Erving, Constellation NewEnergy, Inc., the creditor, timely filed a priority administrative claim with respect to the electricity it delivered to Erving Industries, Inc., the debtor. However, Erving objected that NewEnergy’s claim was not entitled to priority status because NewEnergy did not sell a good, but merely provided a service. After the Erving court determined that the creditor’s claim solely arose from the sale of electricity and not from services provided to the debtor, it held that electricity constitutes a good under Section 503(b)(9).
The debtor asserted, inter alia, that (i) New Energy did not “sell” anything, but merely provided a “service,” (ii) New Energy is a “utility provider” which status it claimed is an automatic bar to obtaining Section 503(b)(9) priority, (iii) the electricity contract with NewEnergy refers in several places to service or services, and (iv) even if the court decides to apply the definition of goods under Article 2 of the Uniform Commercial Code (UCC), the court should apply the “predominant factor test” to determine that the transaction between the parties relate primarily to the rendering of services.
The Erving court dismissed all of debtor’s above claims holding that (i) NewEnergy is a “competitive supplier” that is in the business of selling electricity that had been independently generated since it contracts with electricity generators to purchase electricity and then separately sells it to its customers who contract with local utilities to have it delivered, (ii) NewEnergy is not a utility in the traditional sense because it does not have a monopoly or exclusive service or franchise area, is not subject to governmental regulation, and is subject to competition from a number of available alternative sources of electricity; also, even if it were a utility, no Bankruptcy Code provision precludes a utility from asserting a Section 503(b)(9) priority claim, (iii) while the electricity contract does refer to service or services, the usage is loose and generic when read in context, and such language cannot trump two better pieces of evidence supporting the creditor: the contract’s very title, “Master Electricity Supply Agreement,” indicates it is a contract governing the sale of electricity (not the rendition of a service), and the contract consistently refers to the debtor’s “purchase” and creditor’s “sale” of electricity, and (iv) the predominant factor test does not apply to Section 503(b)(9) because the language of that provision grants priority status for any claim arising from the “value of goods” sold to a debtor, regardless of whether the transaction as a whole could be characterized as primarily the provision of services.
The court next turned to the question of whether electricity is a “good” under Section 503(b)(9). Since a good is not defined anywhere in the Bankruptcy Code, the debtor contended that the “ordinary or natural” meaning of the term should be utilized and that Black’s Law Dictionary defines a good as “tangible or movable personal property.” In that vein, the debtor insisted that electricity is not a good because “it is an intangible phenomena, the movement of electrical charges, and is devoid of physical form or attributes.” However, the court rebuffed the debtor’s urged approach and reasoned that given the “wide usage and acceptance of the definition of goods found in the UCC at § 2-105(1), it is hardly plausible that Congress expected bankruptcy judges to roll up their sleeves and set to work re-inventing the proverbial wheel and divining a more amorphous ‘common understanding’ of the term.” Thus, the court applied the UCC § 2-105(1) definition of goods as “all things . . . which are movable at the time of identification to the contract for sale” and found electricity to easily satisfy it since after electricity is generated, it moves through a huge network of transmission distribution systems and when it reaches the customer’s location, it moves through the electric meter where it can be measured and identified. In a humorous judicial moment, the court quipped that even if the debtor’s preferred definition of good as something that is “tangible” were to be applied, the outcome would be the same since someone can get electrocuted when touching electricity.
The Erving decision clearly diverges from the recent Texas bankruptcy court holding in Pilgrim’s Pride, where that court contended that “UCC Section 2-105 does not suggest that the provision’s drafters had intended that ‘goods’ would include things which cannot be packaged and handled. . . things that, like manufactured goods, clearly occupy space and can be moved about. . .” In re Pilgrim’s Pride Corp., 421 B.R. 231 (Bankr. N.D. Tex 2009). The Pilgrim’s Pride court analogized electricity to the transmission of TV or radio waves which are not considered goods under the UCC and held that electricity also should not be characterized as a good under the UCC and Section 503(b)(9). In marked contrast, the Erving court held that electricity is not similar to telecommunication signals (e.g., internet, radio or TV) which are services because they were simply means of transmitting non-good intellectual property such as ideas, sounds, images, music and other content while electricity “is the thing the customer seeks to purchase.”
Given that this area of bankruptcy law is controversial and unsettled, it is uncertain how the Erving decision will impact other trade creditors in future Section 503(b)(9) litigation. Much of the impact could hinge upon whether Erving involved special facts which favored NewEnergy’s outcome – e.g., Massachusetts’ apparently unique regulatory structure which preempted NewEnergy from being pegged by the debtor as a traditional utility, the electric supply contract’s very title and consistent reference to the “purchase” and “sale” of electricity, and the debtor’s “bifurcated” bill (the debtor received one bill from NewEnergy for the sale of electricity and a separate bill from a local utility for the delivery of electricity). Ultimately, however, the decision does give more credence to UCC application when defining “goods” in Section 503(b)(9), and can likely be persuasive authority in other jurisdictions for the position that electricity, however mystifying its ultimate nature is, may in fact be a good for purposes of asserting an administrative priority claim in a bankruptcy case.
Daniel Abram is a member of the derivatives and energy practice groups at Schwell Wimpfheimer & Associates LLP. He negotiates sophisticated agreements for a Fortune 100 energy company, including: commodities derivatives; currency exchange swap agreements; agreements for the purchase and sale of energy commodities, including oil, natural gas, and electricity; and guarantees and letters of credit securing the aforementioned transactions. Daniel can be reached at dabram@swalegal.com or 646 328 0793.
This SWA publication is intended for informational purposes and should not be regarded as legal advice. For more information about the issues included in this publication, please contact Daniel Abram . The invitation to contact is not to be construed as a solicitation for legal work. Any new attorney/client relationship will be confirmed in writing.
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