Do Hybrid Claims Qualify for Section 503(b)(9) Administrative Expense Treatment

By: Brendan Gage

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

Courts are increasingly divided over whether so-called “hybrid” claims – those involving both goods and services transactions – can qualify as an administrative expense under section 503(b)(9) and, if so, to what extent. Claims characterized as administrative expenses are paid off first whereas claims that fail to meet section 503(b)(9)’s requirements will be deemed unsecured claims which are paid at a lower priority level and rarely in full.[1] A product of BAPCA, section 503(b)(9)[2] creates a specific type of 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.”[3] Yet despite this seemingly straightforward language, courts battle over whether goods transactions within hybrid claims can be allocated as individual section 503(b)(9) expenses or whether hybrid claims should be considered indivisible and analyzed wholesale for qualification under section 503(b)(9).[4]

 

Recently in In re Circuit City Stores, Inc.,[5] the Bankruptcy Court for the Eastern District of Virginia Bankruptcy Court took the wholesale approach by requiring that hybrid claims be analyzed using the “predominant purpose” test.[6] The test asks whether a hybrid claim is based on a transaction motivated to buy goods, and if not, the entire claim is classified an unsecured claim.[7] Conversely, where services are only incidentally involved the entire claim will qualify as a section 503(b)(9) expense.[8] The test may yield harsh results because even where claims include expense goods or significant quantities of goods, the claim as a whole might still be considered predominantly for services, making section 503(b)(9) inapplicable.[9] Ultimately, in In re Circuit City the court reserved applying the test to the claims at issue which stemmed mainly from utility bills and lease obligations[10] pending the outcome of a previously scheduled evidentiary hearing.[11] However, the court qualified hybrid claims by holding that section 503(b)(9) did not cover materials “provided to the debtor [were] incident to the performance” of services rendered.[12]

 

Using the predominant purpose test may at times significantly restrict creditor protection. The Bankruptcy Court for the Eastern District of Michigan in In re Plastech Engineered Prod., Inc.,[13] recognized the test’s ability to “eliminate fact intensive evidentiary hearings”[14] but ultimately found it to be an “unnecessary . . . winner take all approach” at least where the value of goods could be “ascertained.”[15] Instead, the court adopted an allocation approach where individual goods transactions within hybrid claims could be deemed section 503(b)(9) administrative expenses.[16] For instance, in analyzing a snow removal claim, the court held that costs associated with de-icing products constituted valid section 503(b)(9) expenses whereas the shoveling charges did not.[17] But the court arguably did not have a “fact intensive” situation because it had creditor invoices clearly delineating the value of goods sold from the cost of the services provided.[18]

 

Notwithstanding the current jurisdictional split, in both the Circuit City and Plastech decisions the courts recognized protracted litigation as a legitimate reason for disqualifying predominantly hybrid claims, but each was presented with a very different evidentiary reality. In Circuit City the court feared the protracted litigation that would result from determining the value of goods within all hybrid claims where a national Chapter 11 debtor was involved. Conversely, in Plastech the court had invoices from which it could determine the extent of the goods sold and it ultimately classified those goods as administrative expenses. Thus, with available evidence on hand, the well-documented showing may ultimately sway the court to adopt the creditor friendly allocation approach.

---