Legal proceedings where courts have been required to determine the classification of electricity as either a “good” or a “service” under § 503(b)(9) of the Bankruptcy Code have been the subject of recent “charged” debates. Under § 503(b)(9), a seller of goods receives “administrative expense” priority status 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.” Sellers of “services” do not enjoy this benefit.
As the Bankruptcy Code does not define “goods,” parties have turned to the courts for clarification. Although civil courts have consistently used Uniform Commercial Code § 2-105(1) to define “goods,” the interpretation among bankruptcy courts has been inconsistent.
Unlike other subsections of § 503, which create administrative priority for post-petition debt, subsection (b)(9) applies to prepetition debt. Some explain this apparent discrepancy by arguing that § 503(b)(9) was intended for goods that are in the debtor’s possession prior to filing, but that are generally used by the debtor in possession post-petition in order to continue operations.
Indeed, courts have used parallel reasoning to determine that prepetition contracts can nevertheless give rise to post-petition administrative expenses if the events giving rise to the post-petition claim provided some benefit to the estate. Under this premise, electricity should not be considered a good covered under § 503(b)(9) as all electricity in the company’s possession prepetition would be used prepetition.
At least one commentator has argued that § 503(b)(9) must stand for something beyond this narrow proposition of post-petition consumption or use by the estate. Prior to the existence of § 503(b)(9), § 503(b)(1)(A) provided administrative expense claim rights to the debtors, allowing the debtors to recover “actual, necessary costs and expenses of preserving the estate.” A plain reading of § 503(b)(9) distinctively contemplates something beyond the consumption of goods by the debtor’s post-petition estate, because § 503(b)(9) covers claims for goods that are both received and disposed of by the debtor within 20 days prior to bankruptcy.
As a consequence of § 503(b)(9)’s relatively recent enactment, its limited legislative context, and the nuanced differences between (b)(9) and other subsections of 503, it has been difficult for the courts to reach a consensus when considering whether certain “goods” or “services” are within § 503(b)(9)’s scope. Specifically, electricity has generated a significant split in the courts. Courts have seemed to struggle with how to define electricity — is it a good, or is it a service? The answer will determine whether the electricity-providing creditor receives administrative priority.
In this article we look at several perspectives in an effort to better understand the nature of electricity and how the determination of whether it is a good or service is informed by the goals of the Bankruptcy Code.
Courts are divided over whether electricity constitutes a good or a service for purposes of § 503(b)(9). In re Pilgrim’s Pride Corp. is a prominent early case that considered this issue. In Pilgrim’s Pride, the court was tasked with determining whether electricity and natural gas were goods for purposes of § 503(b)(9). The court held that although natural gas is a good, electricity is not. Specifically, the court rejected arguments that because electricity was “property” and a “product,” it had to be a good.
The court noted that things such as intellectual property rights and television shows might well be classified as “property” and “products,” respectively, while neither could be classified as a good. Nor was the court convinced that electricity was a good simply because it was metered. Looking to the plain language of the UCC, the court concluded that the drafters did not intend things like electricity or radio waves to constitute goods. The court also found that a narrow definition of the word “good” was consistent with the bankruptcy policy that Bankruptcy Code provisions granting claims priority are to be narrowly construed.
Just a year later, however, two courts reached the opposite conclusion as to electricity. In In re Erving Industries Inc., the court took a more scientific approach to examining electricity and concluded that electricity possessed both tangible and moveable properties. Furthermore, the court found that electricity was identifiable because it could be measured on a meter upon its delivery to a customer, reaching the opposite conclusion from the court in Pilgrim’s Pride.
Finally, the court held that electricity meets the UCC’s requirement that goods be moveable at the time of identification to the contract because electricity does not cease to exist once it hits the meter; instead, it passes through the meter to its ultimate use.
In contrast to Erving Industries, the court in GFI Wisconsin Inc. v. Reedsburg Utility Commission relied on logic rather than science to reach the same conclusion. The GFI court noted that the meaning of “goods” should not depend on science but rather should be a “straightforward assessment” of what the item is, as well as its similarities to goods that clearly fall within the UCC’s definition. Upon examining electricity, the court found that both the identification and movability requirements were satisfied due to electricity’s movement during and after it hit the meter. Although the GFI court attempted to distinguish its reasoning from one grounded in science, it also reached the same conclusion based on the same reasoning as the Erving Industries court.
Three more recent cases have only muddied the waters when it comes to electricity and § 503(b)(9). In In re Great Atlantic & Pacific Tea Co. Inc., the court held that the determinative factor for characterizing electricity was whether it was metered and consumed at the same time, or whether there was a delay in between. Based on the record of the proceedings below, the court could not determine whether a delay in fact existed; however, the court seemed to indicate that if a delay could be shown, it would treat electricity as a good.
Just a few days earlier, another bankruptcy court released a decision concluding that electricity was not a good, at least in the context of the case. In In re PMC Marketing Corp., the court stated that an analysis of electricity depended on the unique facts of each case. Because the court determined that the utility provider in the case before it was providing a “utility service” to the debtor, the court held that it was not providing a good under either the UCC or § 503(b)(9).
Finally, in In re NE Opco, the court scoured the opinions of previous cases and assessed all of the factors examined by the prior courts. The NE Opco court ultimately determined that the key to characterizing electricity for purposes of the UCC (and hence § 503(b)(9)) was that the period between electricity’s identification at the meter and ultimate consumption must be meaningful. Concluding that there was no meaningful delay between identification and consumption, the court held that electricity failed to meet the UCC’s movability requirement, thus placing it outside the realm of “goods” under § 503(b)(9)’s plain meaning.
Courts have recognized two primary policy goals behind § 503(b)(9). First, it seeks to encourage trade creditors to continue to extend credit to a debtor potentially headed for bankruptcy. Second, it discourages abuse by debtors who seek to acquire goods at a time when they know that bankruptcy is imminent and that, therefore, they will not have to pay for those goods.
Note that there is not a policy goal to ensure that all creditors are reasonably compensated for prepetition debts, and notably not those that are provided in the 20 days prior to the bankruptcy petition. While there may be certain portions of the code that provide for such protections, it is not one of the primary policy goals of the code.
Regarding the first goal, other provisions of the Bankruptcy Code already encourage utility providers to continue to supply debtors during their bankruptcies. Indeed, § 366 requires a utility provider to continue service to the debtor if the debtor meets § 366(b)’s adequate assurance requirements. As such, giving the utility provider an administrative expense claim should not alter the service provided immediately before or after the debtor has filed.
However, the Bankruptcy Code fails to specify a standard for “adequate assurance,” but states that “administrative expense priority shall not constitute an assurance of payment.” As such, even though § 366(b) requires a utility to provide electricity when the debtor has provided adequate assurance, this does not ensure that the utility will be paid or will have administrative priority.
Although § 366 provides post-petition protection to utility providers, it does not discuss the priority status granted to prepetition utility debts. Electricity is critical to a debtor’s ability to continue operations. One could argue that the impact of suspending electricity due to the accumulation of debts could destroy or significantly impair a struggling company before it even has a chance to file for bankruptcy. This suggests that allowing utility providers protection under § 503(b)(9), in order to encourage them to continue providing electricity leading up to the bankruptcy filing, may be consistent with the Bankruptcy Code’s fundamental goal to provide debtors an opportunity for a “fresh start.”
The second policy goal is essentially inapplicable in the electricity setting: there is little to no potential for abuse by debtors when it comes to electricity. Most businesses require electricity on a continuing basis, and it seems unlikely that a debtor would dramatically increase its electricity consumption just prior to filing for bankruptcy, on the theory that it will not have to pay for the service once it files. Even if a debtor were to engage in this type of behavior, § 366 still works to protect the utility by requiring the debtor in bankruptcy to provide adequate assurance of payment if the debtor wants to maintain its electricity supply while in bankruptcy.
Some have stated that without § 503(b)(9), creditors would constrain both the amount and the terms of credit agreements with distressed firms on the brink of bankruptcy. These limited terms serve to protect the creditor if the debtor does file for bankruptcy. Without the protection of § 503(b)(9), debtors would be unable to continue relationships with suppliers, limiting their ability to continue operations.
Section 503(b)(9) provides a substitute means of protection to the creditor and encourages them to continue extending credit when they otherwise would have retreated, to the detriment of the debtor. A limitation to this theory is the timing of repayment and legal costs associated with recovering assets from the debtor. The timing of repayment is not defined and, therefore, may be discounted in the perspective of the creditor.
Section 503(b)(9) can also be considered an additional weight on debtors, severely restricting, if not stifling completely, their ability to emerge successfully from a bankruptcy reorganization. As a result of § 503(b)(9), debtors now have a sizably larger administrative expense burden, as more creditors now qualify for this priority repayment status and are now given significant power over the debtor in obtaining reorganization plan approval under Chapter 11. As such, these creditors most likely will be fully repaid, reducing the remaining assets available to continue operations and repay unsecured creditors.
As the available asset base shrinks, the probability of emergence from bankruptcy shrinks as well. Lenders, who play a crucial role in the debtor’s ability to reorganize, are less likely to extend credit to an entity with little or no collateral and questionable ability to repay. Without appropriate financing, debtors often find themselves in a situation where liquidation is the only option. It could be argued that a company unable to pay its administrative expenses should not be allowed to emerge from bankruptcy as, even after reorganization, the company’s business model is not one that can succeed, but the additional administrative expenses resulting from § 503(b)(9) claims may also prevent a firm of value from successfully emerging from bankruptcy.
As previously mentioned, the Bankruptcy Code does not define the word “good”; however, the term is used in both § 546(c), the reclamation provision discussed below, and in § 503(b)(9). Electricity is clearly not a “good” that can be reclaimed under § 546(c); however, many courts have nevertheless held that electricity is a good under § 503(b)(9).
Is this inconsistent reading of the word “good” throughout the Bankruptcy Code problematic? When interpreting the Bankruptcy Code, the U.S. Supreme Court generally looks at the plain meaning of the code provision first and examines the code’s object and policy second. One canon of statutory interpretation tells us that words in a statute are presumed to have the same meaning in all subsections of that same statute, so courts following this canon should interpret the same language in a statute in the same fashion throughout the statute.
Applying these interpretation rules to the Bankruptcy Code, any interpretation of § 503(b)(9) should begin by an examination of the statute’s plain meaning. When that meaning is ambiguous, as in the case of the statute’s application to electricity, a court should next turn to broader questions of the Bankruptcy Code’s underlying goals and policies, while keeping in mind that words should be interpreted consistently throughout the Bankruptcy Code. This may suggest that, if electricity is not a “good” that can be reclaimed under § 546(c), it should not be interpreted as a “good” for purposes of § 503(b)(9).
Unfortunately, the legislative history of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which added § 503(b)(9) to the Bankruptcy Code, provides little insight on this matter. Although it appears that Congress enacted BAPCPA in part to provide better protection to creditors, bankruptcy judges have found BAPCPA’s sparse legislative history to be of little help in determining Congress’ intent for specific statutory provisions such as § 503(b)(9).
Making matters worse, no legislative history exists to tell us why § 503(b)(9) was needed or what specifically it was intended to accomplish or rectify. The complete lack of legislative history specific to § 503(b)(9) makes it difficult to determine the scope of that section’s application with any certainty.
Legislative history need not provide all of the answers, however, because we can also try to construe § 503(b)(9) in accordance with other principles underlying the Bankruptcy Code. For example, one key tenet of the Bankruptcy Code is the policy of construing administrative expense claims narrowly. This might lead us to conclude that for § 503(b)(9) purposes, electricity, which exhibits characteristics of both a good and a service, ought to be considered a service.
Although § 503(b)(9) may be seen as an additional effort by Congress to give creditors more of an advantage over debtors, should this advantage be pressed to the point where debtors are no longer able to reorganize? In short, the policies of narrowly construing administrative expense claims and striking a balance between debtors and creditors would seem to point us in the direction of construing things like electricity as services when there is some doubt as to whether the item being sold is actually a good or a service.
Others have argued that § 503(b)(9)’s legislative history suggests it was intended to provide relief to sellers who failed to give the required notice under the reclamation section of the Bankruptcy Code, § 546(c). This would suggest electricity ought not to be interpreted as a “good” as it is typically not considered reclaimable.
Other courts, however, have expressly stated that a creditor’s claim under § 503(b)(9) is not linked to or conditioned upon the creditor’s rights of reclamation under § 546(c). Section 503(b)(9) applies even when goods are not identifiable and it does not matter whether the goods were sold, consumed or even in the buyer’s possession prior to the seller giving notice of its claim. Because sellers have a much broader range of rights under § 503(b)(9) than they do under reclamation, it does not seem correct to limit application of § 503(b)(9) to only those goods that can be reclaimed.
Although drawing a black and white line between goods and services may seem simple, review of several information sources has not yielded any clarity on the matter. As shown by the sliding scale graphic below, goods and services often overlap and can have many similar characteristics, making them difficult to clearly define. If electricity were to be considered a good, it would follow that electricity could not, under any circumstances, be considered a service.
Certain sources define services as “the supplying or supplier of utilities or commodities, as water, electricity, or gas, required or demanded by the public,” which would lead one to believe that these three items should be considered services, but this conflicts with U.S. courts’ findings that water and gas are definitively a good under § 503(b)(9). Below are supplemental definitions of goods and services according to commonly referenced sources:
A Good or Goods:
A traditional electricity bill apportions total electricity charges between “supply charges” and “delivery charges.” Supply charges include a flat cost per kilowatt hour, as well as “merchant function charges,” which are associated with procuring the electricity and covering uncollectable accounts, and taxes on “gross receipts from sales of utility services and other tax surcharges.
Delivery charges include a “basic service charge” for system infrastructure, accounting, customer-related services, and meter reading and maintenance, in addition to a delivery charge per kilowatt hour to maintain the system through which electricity is delivered to the customer and additional taxes.
Although electricity providers may procure energy from multiple sources, a general procurement and distribution cost is what customers see on an electricity utility bill. It appears that utilities define certain of the costs as “services” while others are charged per kilowatt hour, meaning, the customer is charged based on consumption of electricity. As such, it appears as if electricity may be partially a good and partially a service.
Courts have developed and applied a method, the “predominant purpose test,” which is applicable to hybrid contracts calling for the delivery of both goods and services. Although most courts follow the predominant purpose test in applying the UCC, only one bankruptcy court has adopted that test for § 503(b)(9). This approach had been explicitly rejected for § 503(b)(9) purposes in an earlier decision, however, when the court concluded that the only relevant determination for § 503(b)(9) purposes was the value of the goods delivered, regardless of whether the contract also called for the provision of services. This rejection of the predominant purpose test for § 503(b)(9) was echoed in a recent decision from the Delaware bankruptcy court.
If we are to accept the premise that electricity should not be considered a “good” for purposes of § 503(b)(9) on the grounds that electricity provides no benefit to the post-petition estate, what should we think about natural gas? Natural gas seems similar to electricity in many ways: it is generally consumed at the same time as it is provided, and gas suppliers are awarded utility privileges under § 366. Yet, case law definitively recognizes natural gas as a good for purposes of § 503(b)(9). Courts agree that natural gas meets the definition of a “good” as it is movable at the time it is identified for sale.
The ability to store natural gas for future use is frequently used to differentiate its status as a “good.” Although electricity can be stored in batteries for future use (including, more recently, in electric vehicles), this is not typically considered relevant when determining whether electricity should be considered a good. Perhaps this is because electricity stored in a battery has markedly different qualities from electricity provided as part of standard electric service.
For example, electricity provided by utilities is not typically stored by the company and therefore cannot be rationed for later use. Even in cases where electricity service fails, most businesses rely on generators, machines that create electricity rather than store it, as a backup, instead of batteries.
Furthermore, it seems evident that a battery containing electricity would undoubtedly be considered a “good” that could be subject to a § 503(b)(9) claim if delivered to the debtor in the 20 days prior to the bankruptcy. But in that case, the good would be the battery as opposed to the electricity itself. Thus, the ability to store natural gas may make it differentiable from electricity in the § 503(b)(9) context. Notably, although courts have concluded that natural gas is clearly a good under the UCC, provision of natural gas is identified as a service under § 366 of the Bankruptcy Code, illustrating a possible separation between §§ 366 and 503(b)(9).
U.S. bankruptcy courts are not alone in their struggle to characterize electricity as a good or service. International trade rules and regulations differ between goods and services, resulting in different treatment and considerations in international transactions involving goods versus services. Neither the General Agreement on Tariffs and Trade (GATT), which explicitly covers goods, nor the General Agreement on Trade in Services (GATS), which explicitly covers services, clearly define electricity, nor do they explicitly decide on its inclusion or exclusion. The GATS comes nearest, as it includes a sector titled “Services Incidental to Energy Distribution,” which is included in the sector, “Other Business Services.”
There are current negotiations related to the inclusion of an energy sector under GATS, and the United States has explicitly requested its inclusion by the World Trade Organization as a service, but no energy sector exists at this time. In 2010, the Background Note by the Secretariat of the Council for Trade in Services (under which the GATS resides), stated, “While power generation would appear to entail the production of a good, a number of services are directly related to the construction, maintenance and operation of generation plants.” This comment, and its footnote, suggest that many parties within the WTO consider electricity to be a good, although it is discussed in great detail as also being a service.
This same document states that, “From a WTO point of view, it may not be easy to draw the line between goods production and services supply as far as certain of these activities are concerned,” in reference to the council’s description and analysis of nuclear energy as an electricity source. Seemingly in contrast to the GATS interpretation and inclusion of “services incidental to energy distribution,” and the body of the secretariat’s 2010 background note, the WTO included an article in its 2010 “World Trade Report,” which states, “Electricity energy is thus considered to qualify as a good and by that subject to the rules of the World Trade Organization (WTO).”
Analysis and interpretation by a nongovernmental party has concluded that the cause of the electricity as a good or service debate is due to the different and distinct stages that comprise the electricity sector, from raw material (or renewable resource) to consumed product. Under this interpretation of the WTO framework, the generation of electricity falls under the scope of the goods agreement (GATT) and the distribution and related services fall under the scope of the GATS.
As the precise definition of goods versus services as they pertain to electricity sector has yet to be determined, a key question is whether electric power generation constitutes a service or a manufacturing process. For example, most power plants materially transform energy in various sources, such as coal, gas or oil into electrical energy. Such material transformation is typical for the manufacturing process.
Additionally, Chapter 6 of the North American Free Trade Agreement, “energy and basic petrochemicals,” appears to consider energy a good, as classified under the harmonized system. Interestingly, electrical energy is an “optional heading,” meaning it is not always clearly identified as a good and countries can choose whether to exclude or include it as a commodity or good for trade purposes. As there has been no GATT/WTO or NAFTA case law surrounding the trade of electricity, there is no jurisprudence in any of these facets dealing with trade in electricity. The most closely related jurisprudence case law relates to gasoline or petrol.
The concept of electricity as a product of “manufactured goods” may not be consistent among different forms of energy, such as renewable resources. Although electricity is the end product, the production, or generation, methods differ when energy is sourced from hydroelectric, solar or wind power. This again calls into question the ability to universally classify electricity as a good based on its original source.
As renewable resources become a larger part of electricity generation, this factor must be considered and included in the determination of electricity as a good or service in the context of trade. As shown in the table above, the composition of electricity sources has changed over time, and the share of natural resources can be expected to grow as the world becomes more conscious of fossil fuels and many companies are encouraged by government tax breaks and subsidies to use renewable energy sources.
In the past, international trade of electricity was not common due to its inability to be stored and transported easily. The inherent production and distribution issues with trading electricity had resulted in regional markets, which often involved a natural monopoly. As technology has progressed, the ability and desire for international electricity trade will continue to increase and it will become critical to accurately classify electricity under trade agreements.
Although large banks have been trending away from trading in the utility power space, energy trading continues to be an active market between electricity generation and transmission companies. As the entities purchasing power on the wholesale market and then redistributing it to end users are not “using” the electricity themselves, this type of electricity exchange seems to fit the UCC definition of a good as it is “movable” at the time of “identification” to the contract.
In fact, in wholesale transactions like this, one court has found electricity to be a good, qualifying for priority status under § 503(b)(9). Although electricity serves a different purpose for transmission entities than it does for a typical business enterprise, it is still scientifically the same.
No one ever says, “If you don’t pay your electricity bill they will turn off your good.” Rather, the common vernacular is that “they will shut off your service.” However, as one learns more about the physical/scientific characteristics of electricity and its generation and supply, the ability to define it becomes more complex.
The scientific community, and certain bankruptcy court opinions, can provide a detailed analysis of the properties of electricity and electrical currents. However, similar to how light can be considered both a wave and a particle, electricity is considered either a good or a service in different circumstances. Perhaps, while the world continues to sort out the tricky question of how to classify electricity, bankruptcy courts should focus instead on interpreting § 503(b)(9) in light of the key principles underlying the Bankruptcy Code. Perhaps the question bankruptcy courts should ask is: if we define electricity in a particular way for purposes of § 503(b)(9), does that advance the goals of the bankruptcy process?