In re Wezbra Dairy, LLC, 493 B.R. 768 (Bankr. N.D. Ind. 2013) –

Crop farmers grew corn for use as feed for the debtor’s dairy herd and then stored the corn in bunkers on the debtor’s property under a license from the debtor.  Title to the corn did not transfer until the debtor removed the corn from the bunkers to feed it to its herd.  This opinion addresses when the debtor “received” the corn for purposes of determining whether the crop farmers could assert administrative expense priority claims.

Under a silage agreement the crop farmers grew a certain number of acres of corn for the debtor, and the debtor paid a formula price in 14 equal monthly installments.  After harvesting, the corn was stored in bunkers on the debtor’s property under a license agreement.  Under the license the debtor was responsible for corn stored on its property and determined when to withdraw it from the bunkers.  However, title to the corn remained with the crop farmers until the debtor removed corn from the bunkers to feed to its dairy herd.

Section 503(b)(9) of the Bankruptcy Code gives a creditor an administrative expense priority 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.”  This section was added to help address the perceived inadequacy of reclamation rights under Section 546(c) of the Bankruptcy Code.  Among other things, a plan of reorganization cannot be confirmed unless administrative expense claims are paid in full in cash on the effective date of the plan (except to the extent that a particular claimant agrees to other treatment of its claim).

The parties agreed that the corn was “goods” and that it was sold in the ordinary course of debtor’s business.  They also agreed on the value of the corn that was used by the debtor during the 20 days prior to bankruptcy.  The only dispute turned on when the corn was “received.”

The crop farmers argued that receipt by the debtor did not occur until title transferred – i.e. when it withdrew corn from the bunkers to use for feed – so that everything used during the 20 days prior to bankruptcy gave rise to a priority claim.  In contrast, the debtor’s lender argued that the corn was received as soon as it was placed in the bunkers on the debtor’s property following harvest – which had occurred months before the bankruptcy case – so that none of the corn sales were entitled to priority.

The court looked to treatment of reclamation claims under Section 546(c) of the Bankruptcy Code and the related Uniform Commercial Code (UCC) reclamation provisions for guidance.  Under the UCC “receipt” is defined as taking physical possession of the goods.  Case law says that physical possession can be either actual or constructive.

In this case, the corn was located on the debtor’s property, it was responsible for the care while on the property, it bore the risk of loss, and it decided when and how much to remove from the bunkers to feed its dairy herd.  Under these circumstances, the court concluded that “it is extremely difficult to see how all of this does not constitute actual physical possession, notwithstanding the locus of title.”

Thus, the debtor “received” the corn as soon as it was delivered to the bunkers, and not when the debtor removed the corn from the bunkers to feed to its livestock.  Consequently, the crop farmers were not entitled to administrative expense priority claims.

Clients often seem convinced that contract terms providing for retention of title (for example, until goods are paid for by the buyer) are important and provide significant protection.  However, as this case illustrates, the status of title is often irrelevant to the determination of rights.

Although not discussed in this case, Section 2-401 of the UCC itself limits the effectiveness of title retention provisions:

Title to goods cannot pass under a contract for sale prior to their identification to the contract (Section 2-501), and unless otherwise explicitly agreed the buyer acquires by their identification a special property as limited by this act.  Any retention or reservation by the seller of the title (property) in goods shipped or delivered to the buyer is limited in effect to a reservation of a security interest.  Subject to these provisions and to the provisions of the article on secured transactions (Article 9), title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed on by the parties.

So, even outside of bankruptcy attempts to protect a seller’s interest in goods by retaining title has somewhat limited effectiveness.

Vicki R. Harding, Esq.