C Credit providers may be shocked to learn that the courts - - PDF document

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Electricity as a Good or a Service: Some “Shocking” Developments

Credit providers may be shocked to learn that the courts have reached confmicting decisions over whether elec- tricity is a “good,” entitled to Bankruptcy Code Section 503(b)(9) priority status1, or a service that is not entitled to any priority protection. Tie United States Bankrupt- cy Court for the District of Puerto Rico in In re PMC Marketing Corporation, and the United States District Court for the Southern District of New York in Hudson Energy Services, LLC v. Tie Great Atlantic & Pacifjc Tea Company, Inc. (A&P) both recently considered whether electricity is a “good” or a “service.” Tie PMC Court held that electricity is a “service” and not a “good,” because it was provided by a government

• wned utility. On the other hand, the A&P District

Court vacated and remanded the order of the United States Bankruptcy Court for the Southern District of New York, rejecting the A&P Bankruptcy Court’s hold- ing that electricity is a “service” and not a “good” and directing that an evidentiary hearing be conducted on this issue. In re Erving Industries, Inc. Tie PMC Court and the A&P District Court focused on the District of Massachusetts Bankruptcy Court’s hold- ing in In re Erving Industries. In Erving, Constellation NewEnergy, Inc., an electricity reseller, timely asserted a Section 503(b)(9) priority claim in the amount of $281,667.88 on account of electricity delivered to the debtors Erving Industries, Inc. and two affjliates (col- lectively, Erving) within 20 days of Erving’s bankruptcy

• fjling. Erving objected to Constellation’s Section 503(b)

(9) claim and argued that electricity was a “service” and not a “good.” Tie Erving Court held that the electricity Constellation had resold to Erving was a “good.” First, applying the defjnition of “goods” contained in Section 2-105(1) of the Uniform Commercial Code (UCC), the Erving Court held that electricity is movable and identifjable because it can be measured at the point it passes through a customer’s meter. Section 2-105(1) defjnes goods as “all things...which are movable at the time of identifjca- tion to the contract for sale.” Tie Erving Court rejected Erving’s argument that electricity ceases to be movable when it is measured by the meter because identifjcation and consumption occur simultaneously. Instead, elec- tricity does not simply cease to exist when it reaches a customer’s meter, but moves through the meter and continues to move throughout the customer’s electrical wiring until the customer ultimately uses it. Tie Erving Court also focused on Constellation’s role as a wholesale energy supplier and the relevant terms of the parties’ contract. Constellation had purchased elec- tricity from third parties and resold that electricity to Erving and other consumers. Moreover, Constellation was not a “utility” because it was not subject to govern- mental regulation, did not possess a monopoly as the sole source of electricity available to Erving, and was not included in the list of utilities maintained by the rel- evant state agencies. Tie Erving Court also relied on the terms of the parties’ contract that described a purchase/ sale relationship, and not the provision of a “service.” The PMC Marketing Corporation Case PMC Marketing Corporation fjled a Chapter 11 peti- tion on March 18, 2009. PMC’s case was converted to a Chapter 7 case on May 21, 2010. P.R. Electric Power Authority (PREPA) fjled a motion seeking payment of a Section 503(b)(9) claim in the amount of $89,336.42. PREPA argued that it was entitled to Section 503(b)(9) priority status because its claim was based on its sale of, and PMC’s receipt of, electricity during the 20-day peri-

• d (February 26, 2009 and March 17, 2009) before

PMC’s bankruptcy fjling. S e l e c t e d t o p i c

BruCe NaThaN, esq. aNd eriC ChafeTZ, esq.

1

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the united states Bankruptcy Court for the district of Puerto rico and the united states district Court for the southern district of new York both recently considered whether electricity is a “good” or a “service.”

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PREPA argued that its aforementioned claim for the electric- ity provided to PMC was entitled to Section 503(b)(9) priority treatment because the electricity was a “good” within the UCC’s defjnition of that term. According to PREPA, the elec- tricity was both moveable (from when it was metered and afuerwards) and identifjable (to a customer’s contract at the time it was metered at the consumer’s place of business).2 Tie PMC Court recognized the division among the courts

• ver whether electricity is a “good” or a “service.” Tie court

held that the electricity supplied by PREPA, a utility,3 was a service, not a good. Tie court defjned the term “utility” as a provider of a service, such as light, power or water. Tie court also observed that a utility refers to a “business organization ([such] as an electric company) performing a public service and subject to special governmental regulations,” that has “some special position with respect to the debtor,” and has “a monopoly in the area so that the debtor cannot easily obtain comparable service from another.” Applying these various defjnitions and concepts, the PMC Court concluded that PREPA was a utility provider because: (i) like other traditional utilities, it is subject to governmental regulation, (ii) enjoys a “special relationship” with PMC as PREPA is the only electricity provider in Puerto Rico, (iii) has a monopoly, and (iv) is owned by the government and direct- ed by a government board. Accordingly, the PMC Court held that electricity in this specifjc context was a “service” and PREPA was not entitled to an administrative priority claim under Bankruptcy Code Section 503(b)(9). Tie PMC Court distinguished the Erving Court’s holding that electricity is a good eligible for Section 503(b)(9) priority sta-

• tus. Tie court noted that the claimant in Erving, Constella-

tion, was a private alternative energy provider that sold elec- tricity as a “competitive supplier” and was not a public utility provider, like PREPA, that was responsible for the ultimate delivery of electricity to a customer as a “service.” The a&P district Court decision On April 27, 2011, Hudson Energy Services, LLC fjled a motion seeking the allowance of a Section 503(b)(9) claim in the amount of $875,943.90 on account of electricity Hudson had sold to Great Atlantic & Pacifjc Tea Company, Inc. and its affjliates (collectively, A&P). A&P objected to Hudson’s motion, arguing that the electricity provided to A&P was not a “good” under Section 503(b)(9). Tie A&P Bankruptcy Court had ruled that electricity is a service, and not a good, and, therefore, is not entitled to Sec- tion 503(b)(9) priority status. Tie court noted that electricity does not fall within the UCC’s defjnition of “goods” even though electricity is a commodity that can be bought and

• sold. Tie electricity at issue was not “movable at the time of

identifjcation to the contract” and was “not identifjable until the moment it reaches [the customer’s] meter, and at that point it is used.” Tie court also relied on UCC Section 2-105(4) in concluding that electricity is not an “identifjed bulk of fungible goods” because it is “simply a stream of elec- trical energy… identifjed… at the point of delivery.”4 As such, “it is hard to see that [electricity] is actually moveable at the time of identifjcation…[and] in essence disappears at that moment.” Signifjcantly, the A&P Bankruptcy Court disagreed with the Erving Court’s holding that electricity is a “good,” despite the fact that both Hudson and Constellation (the claimant in Erv- ing) were non-utility suppliers of electricity that did not per- form a delivery service. Tie A&P Bankruptcy Court disre- garded Hudson’s status as a seller of electricity as refmective of industry deregulation and not determinative of whether the UCC’s defjnition of “goods” includes electricity. Hudson appealed the A&P Bankruptcy Court’s order to the A&P District Court. Hudson argued that the A&P Bankruptcy Court erred in holding, without any evidentiary support, that electricity is not a good. Hudson asserted that the electricity it had pro- vided A&P was movable when it was identifjed to the contract at the following two discrete points: (i) when Hudson pur- chased the electricity and it was subsequently released into the grid5, and (ii) when the electricity exited the grid, was measured, and passed through a customer’s meter.6 Hudson also argued that electricity qualifjed as “an identifjed bulk of fungible goods” like “oil in a pipeline or grain in an elevator,” because any unit of electricity is identical to any other unit and the electricity that Hudson had purchased on behalf of its customers (including A&P) was an undivided share of all the electricity included in the entire power grid. A&P countered that the electricity it had purchased from Hudson could not have been identifjed to a contract of sale as soon as it entered the power grid. In addition, A&P had already consumed the electricity when it was identifjed to its contract with Hudson at the time it was measured at the

• meter. As such, A&P could not return the electricity to Hud-

son afuer it was measured at the meter. Moreover, just because A&P could store a de minimis amount of electricity did not mean that the A&P Bankruptcy Court erred in holding that the electricity was not “moveable at the time of identifjcation to the contract.” A&P also countered Hudson’s argument that electricity is “an identifjed bulk of fungible goods” by ques- tioning the plausibility of Hudson’s argument that the entire power grid is a “bulk” of goods, especially as electricity is con- stantly being “generated, transmitted and consumed” and was not capable of identifjcation. 2

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PrePA argued that its aforementioned claim for the electricity provided to PmC was entitled to section 503(b)(9) priority treatment because the electricity was a “good” within the uCC’s definition of that term.

Tie A&P District Court’s Decision and Observations Tie A&P District Court concluded that insuffjcient evidence was presented to determine whether the electricity that Hud- son had sold to A&P was a good, and, therefore, entitled to Section 503(b)(9) priority status. Accordingly, the A&P Dis- trict Court vacated and remanded the A&P Bankruptcy Court’s decision and ordered that an evidentiary hearing be held on whether the electricity that was subject to the parties’ contract satisfjed the UCC’s defjnition of a good, moveable at the time of identifjcation to the contract, or identifjed as a bulk of fungible goods. Although the A&P District Court did not decide whether the electricity that Hudson had sold to A&P was a “good” or a “service,” the court made several interesting observations regarding whether and when electricity can be considered a “good.” First, the court relied on the UCC’s defjnition of “goods” for determining whether electricity is a good that is entitled to Section 503(b)(9) priority status. Second, the A&P District Court observed that it would likely agree with Hudson’s argument and conclude that the electric- ity Hudson had sold to A&P is a “good” if Hudson can prove that the “electricity passes through the meter at the customer’s location and is at that moment identifjed and thereafuer con- sumed.” Tie court also observed that if Hudson’s theory about electricity does not hold up, the court would need to under- take an “individual assessment” of the exact arrangement between A&P and Hudson to determine whether the electric- ity that Hudson had sold to A&P is a “good.” Tie court further

• bserved that the terms “purchase” and “sale” in the parties’

contract could be relied upon as further support for charac- terizing electricity as a “good” and not a “service.” Tiird, the A&P District Court considered the economics sur- rounding the sale and delivery of electricity. Electricity can be “provided by integrated utilities that generate, sell, deliver and service [electricity],” or by entities like Hudson, that make “money simply by buying electricity from generators at a lower price than that at which it sells to customers, but is oth- erwise hands ofg.” Complicating matters further, companies can fall between traditional utilities on one far end of the spectrum and companies on the other end, like Hudson, that solely buy electricity and sell it to their customers. Complicat- ing matters even further is that not all courts disqualify utili- ties from enjoying Section 503(b)(9) priority status.8 Finally, the A&P District Court discounted A&P’s argument that electricity is static and does not change from case to case. In rejecting this argument, the court focused on the confmict- ing court holdings over whether electricity is a “good” or a “service.” Based on those confmicting decisions, the court determined that it needed to conduct an evidentiary hearing

• n whether the electricity Hudson had sold to A&P was a

good or a service. Conclusion Tie most important lesson for electricity providers can be summed up by the A&P District Court9 as follows: I recognize that the possibility of individualized fact-fjnd- ing regarding the nature of the claimant’s business, how it physically provides the electricity, its arrangements with generators, etc.—is less desirable than a bright-line rule that electricity always or never is a “good.” But individual- ized analysis may be what the statute requires. While the ideal result for electricity providers would be for electricity to always be considered a “good,” the A&P District Court’s and PMC Court’s holdings make clear that many courts will likely not adopt such a straightforward approach. Accordingly, there will likely continue to be signifjcant litiga- tion concerning whether electricity is a “good” or a “service,” since the issue arises in many factual scenarios. Complicating matters further, this litigation will not just focus

• n the physical attributes of electricity, but will also focus on

each claimant’s unique interaction with electricity in a specifjc debtor’s bankruptcy case. Illustrating this point, the PMC Court was able to conclude that PREPA was a “service” pro- vider because it was a government owned and operated utility that had a monopoly on electricity sales in Puerto Rico. Based

• n these facts, the PMC Court distinguished the Erving

Court’s decision, where the claimant was not a utility. How- ever, the decisions by the A&P District Court and Erving Court demonstrate that utilities, like PREPA, occupy only one end of the spectrum related to dispositions of electricity and there are numerous other points on the spectrum. Because individualized assessments of the electricity being provided will have to be undertaken, the courts and litigants will be forced to engage in case-by-case analyses of each electricity provider’s interaction with a debtor (including those instances 3

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Although the A&P district Court did not decide whether the electricity that Hudson had sold to A&P was a “good”

• r a “service,” the court made several

interesting observations regarding whether and when electricity can be considered a “good.” Because individualized assessments of the electricity being provided will have to be undertaken, the courts and litigants will be forced to engage in case-by-case analyses of each electricity provider’s interaction with a debtor.

where the electricity provider interacts with the debtor in more than one way). Accordingly, electricity providers could be in for a shocking and unpredictable ride as it does not appear that the courts will be establishing a bright line test for determining whether electricity is a good that is entitled to Section 503(b)(9) prior- ity status or a service that does not enjoy such protection.

• 1. Section 503(b)(9) grants goods sellers an administrative 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.”

• 2. PMC’s trustee argued that the PMC Court should not have even

reached the question of whether electricity was a “good” or a “service” because PREPA did not timely fjle a Section 503(b)(9) claim, despite being provided notice of the relevant bar date. In addition, according to the trustee, PREPA’s motion was actually a belated proof of claim in “disguise,” which could not be fjled three years afuer the claims bar date set by the PMC Court. However, the PMC Court held that PREPA preserved the right to obtain priority status by fjling a general unsecured claim that included invoices paid within 20 days before PMC’s bankruptcy fjling, even though the general unsecured claim did not include any refer- ence to Section 503(b)(9). It is unclear whether other courts would reach the same conclusion.

• 3. Tie PMC Court also observed that PREPA was a utility that

Congress had sought to protect when it enacted Bankruptcy Code Section 366.

• 4. UCC Section 2-105(4) states that “[a]n undivided share in an iden-

tifjed bulk of fungible goods is suffjciently identifjed to be sold although the quantity of the bulk is not determined…”

• 5. Hudson argued that it had made wholesale purchases of electricity

from power plants/electricity generators and these purchases could be specifjcally identifjed to Hudson’s contract with A&P.

• 6. Hudson disagreed with the A&P Bankruptcy Court’s holding that
• nce electricity reaches a meter it disappears into use. Instead, Hudson

argued that electricity is used at the exact moment it passes into the de- vice that it was intended to power. Hudson also argued that, if batteries are used to store electricity, they can delay the interval between metering and use, meaning, electricity can still be moveable afuer passing through the customer’s meter.

• 7. Tie A&P District Court rejected the A&P Bankruptcy Court’s

conclusion that Congress did not intend for electricity to be considered a good under Section 503(b)(9) because electricity cannot be stockpiled.

• 8. Tie Western District of Wisconsin in GFI Wis., Inc. v. Reedsburg
• Util. Comm’n (In re Grede Foundries, Inc.), held that electricity provided

by a utility satisfjed the UCC’s defjnition of “goods” and was subject to Section 503(b)(9) priority status.

• 9. Tie PMC Court also made the following similar observation: “this

Court believes that in deciding the question of whether electricity is a “good” or a “service” under the Bankruptcy Code, a court must carry

• ut an inquiry into the unique facts of each case and thus this analysis

cannot be determined without taking into consideration the totality of circumstances of all the relevant facts.” Bruce S. Nathan, Esq. is a partner in the Bankruptcy, Financial Reorganization and Creditors’ Rights Group in the New York offjce of the law fjrm of Lowenstein Sandler LLP. He is a member of NACM and is a former member of the Board of Directors of the American Bankruptcy Institute and is a former co-chair of ABI’s Unsecured Trade Creditors

• Committee. Bruce is also the co-chair of the Avoiding Powers Advisory

Committee working with ABI’s Commission to Study the Reform of Chapter 11. He can be reached via email at bnathan@lowenstein.com. Eric S. Chafetz, Esq. is counsel at the law fjrm of Lowenstein Sandler

• LLP. He can be reached at echafetz@lowenstein.com.

*Tiis is reprinted from Business Credit magazine, a publication of the National Association of Credit Management. Tiis article may not be forwarded electronically or reproduced in any way without written permission from the Editor of Business Credit magazine. 4

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