Bankruptcy and Commercial Transactions with Foreign Entities: What Law Governs?

July 8, 2014

As most astute manufacturers know, there is a statutory right under Bankruptcy Code section 503(b)(9) to assert an administrative priority claim (one with the highest priority in payment after secured creditors) for goods delivered to a debtor within 20 days before the debtor commences a bankruptcy case. There are, however, other laws that should be considered when dealing with foreign commercial transactions as illustrated in a recent decision by the Bankruptcy Court in the Eastern District of Pennsylvania in the case of In re World Imports, Ltd. (No. 13-15929 SR). There, the Bankruptcy Court tackled the issue of what law applies to calculate the commencement of the 20 days for purposes of determining whether creditors had the right to assert an administrative priority claim.

In World Imports, two creditors sought allowance and payment of their claims for goods they shipped to the debtor. At issue was when the debtor received the goods for purposes of determining whether they fell within the 20 day period giving rise to an administrative claim. Both creditors shipped the goods from China well outside the 20 day period. The debtor (or its customers) received the goods within the 20 day period. The debtor argued that it received the goods once they were placed on board the shipping vessel destined for the United States, which was outside the 20 days. The creditors countered that the date the debtor took physical possession in the U.S. controlled which would be within the 20 day period. At issue was what law controlled to determine when the debtor received the goods.

The claimants argued that since the Bankruptcy Code was silent as to the definition of the word “receive,” the court should follow accepted practice and look to state law – here, the Uniform Commercial Code – to fill in this gap in the federal statute. Under the UCC “receipt” is defined as taking actual possession of goods – which would have been within 20 days of the debtor’s bankruptcy filing.

The debtor responded that a treaty existed which acted as an exception to application of the UCC in this instance, specifically, the Convention on Contracts for the International Sale of Goods (CISG) which was signed by China and the U.S., among others. As signatories of the convention, the parties were to be held to the standards widely known and regularly observed by parties to contracts typical of the type involved in the trade. Although the CISG also did not define the term “receipt,” it did provide that terms recognized by the International Commerce Commission were incorporated into the CISG. One of these terms was “Free on Board” or FOB which places the risk of loss or damage to goods to the buyer once the goods were placed on a vessel for delivery. Since the contracts at issue stated the shipments were to be FOB China, the debtor argued that under the CISG the goods were transferred to the debtor (or its customers) once they were put on the ship in China, which would make the receipt of the goods outside of the 20 days period.

After conducting an analysis of whether the existence of a treaty would preempt application of state law, Judge Raslavich concluded that “state law must yield when it is inconsistent with or impairs the policy or provision of a treaty.” Since the treaty trumped application of state law, he ruled in favor of the debtor and did not allow the creditors an administrative claim.

Since the parties in World Imports were dealing in international trade, they were subject to application of the CISG as opposed to the UCC, which resulted in the creditors losing an administrative claim. To achieve a different result, the creditors could have negotiated to exclude the application of the CISG by stating so in their contracts. Given the volume of trade conducted with foreign entities, those entities need to be aware of this potential pitfall in the bankruptcy context and they should adjust the terms of their contracts to protect themselves so as to take advantage of the narrow statutory 20 day window for administrative priority status.