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Federal Courts Conflict Whether Electricity is a Goods Under Section 503(b)(9) of the Bankruptcy Code

I. OVERVIEW

Shakespeare stated that “beauty is in the eye of the beholder”. Similarly, it probably will require a ruling from the U.S. Supreme Court to resolve the conflicting decisions now appearing in U.S. District and Bankruptcy Courts over the issue whether the sale of electricity is a goods or service under Section 503(b )(9) of the U.S. Bankruptcy Code.

Enacted in 2005, Section 503(b )(9) provides:

After notice and a hearing, there shall be allowed, administrative expenses, other than claims allowed under section 502(f ) of this title, including –

(9 ) 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 thedebtor in the ordinary course of such debtor’s business.

Qualification under this statute elevates the claim from a general unsecured claim (frequently, allowed general unsecured claims are paid less than $1.00 for $1.00) to an administrative expense. To confirm a Chapter 11 plan, administrative expenses have to be paid in full on or before the effective date of the plan.

The Bankruptcy Code does not define goods. Bankruptcy courts defer to state law for the definition of goods, and specifically, U.C.C. Section 2-105. State law is the substantive law applied to determine the origin, existence, and allowance of a claim – if the Bankruptcy Code otherwise does not define a term. Murguillo v. Cal. State Bd. Of Equalization (In re Murgillo), 176 B.R. 524, 529 (B.A.P. 9th Cir. 1994); state law controls the definition of property and interests in property; Barnhill v. Johnson, 503 U.S. 393, 398 (1992).

Under U.C.C. Section 2-105, goods is defined:

(1 ) Goods means all things (including specially manufactured goods) which are movable at the time of identification to the contract for sale other than money in which the price is to be paid . . . .

(2 ) Goods must be both existing and identified before any interest in them can pass. . . .

Factually, the basis for an electric utility’s Section 503(b)(9) follows. Once electricity passes through a flow meter ( measures the amount sold), then it travels through a network of electrical wires throughout the customer’s premises, where the electricity is used as an energy and power source to generate heat, air conditioning, power, and light and for equipment. Once measured, any one (1) kilowatt-hour of electrical energy is the same as any other kilowatt-hour of electrical energy, and any one (1) kilowatt of electrical power is the same as any other kilowatt of electrical power. Upon passing through the meter, electricity is a movable thing, which has been existing and identified (in terms of the number of kilowatts sold). At the meter, an interest in the number of kilowatts sold passes to the customer, who is responsible to pay the amount in an invoice. Once the number of kilowatt-hours and kilowatts are measured at the meter, then the utility multiplies same by the tariff price per kilowatt-hour or per kilowatt to calculate the amount due. These factors should qualify electricity to be a goods under U.C.C. Section 2-105.

Section 503(b)(9) permits a creditor to seek administrative expense priority for goods received by the debtor within twenty days of the petition date. At the early stages of a case, it is unknown what will be the distribution rate on allowed, general unsecured claims. The distribution rate generally is known when a Chapter 11 plan is confirmed. Under a confirmed plan, if the distribution rate on allowed general unsecured claims is 100%, then that would moot seeking recovery under Section 503(b )(9). Accordingly, prior to issuance of an order confirming a plan of reorganization, the challenge to an electric utility is whether to file a claim for Section 503(b )(9) recovery for the unpaid electric charges.

II. ANALYSIS

A.Bankruptcy and District Court Cases: Whether Electricity is a Goods

1.It Is.

These decisions have concluded that under the U.S. Bankruptcy Code, electricity either is a goods under Section 2-105 or a commodity (and therefore not a service):

a.Electricity is a Goods under Section 503(b )(9)

GFI Wis., Inc. v. Reedsburg Util. Comm’n. (In re Grede Foundaries), 440 B.R. 791 (W.D. Wis. 2010), aff’g 435 B.R. 593 (Bankr. W.D. Wis. 2010); In re S. Montana Elec. Gen. & Transmission Coop., Inc., 2013 Bankr. LEXIS 62 (Bankr. D. MT Jan. 8, 2013); and In re Erving Indus., Inc., 432 B.R. 354 (Bankr. D. Mass. 2010). In Grede Foundaries, the District Court distinguished or rejected the arguments raised in the contra, earlier Bankruptcy Court cases, and sided with the court in Erving Industries to conclude in the affirmative. The District Court saw no reason to delve into quantum physics on the issue and affirmed the Bankruptcy Court, who ruled that goods are all things that are movable at the time of identification to a contract for sale; electricity is identified at the moment it is metered; and something is a good if movable at the time of identification. S. Montana followed the rulings in Grede Foundaries and Erving Industries. Erving Industries ruled that electricity is identifiable, because it can be metered at the point it passes through the meter, and afterwards, it still is identifiable and movable for some time as it moves through the customer’s wiring until it is ultimately put to use. Electricity is movable at the time it is identified to the contract, and therefore is a goods under U.C.C. Section 2-105(1).

One only need to touch a live electric connection; e.g., place one’s finger in an electric socket, to feel and sense the sub-particles of electricity which have passed through the meter at the customer’s premises; thus, electricity can be measured and identified. This is true both at the meter and afterwards, inside the customer’s premises.

In In re Great Atlantic & Pacific Tea Co., Inc., 498 B.R. 19 (S.D. N.Y. 2013), the District Court vacated and remanded the decision of the Bankruptcy Court ruling that under Section 503(b )(9), electricity is a service and not a goods. The District Court remanded to have an evidentiary hearing on the issue whether electricity is identified to the contract at the customer’s meter. This case still is pending before the Bankruptcy Court.

b. Other Bankruptcy Decisions

In bankruptcy cases in contexts other than Section 503(b )(9), federal courts have held that electricity either is a goods or not a service. Enron Power Mktg. v. Nev. Power Co. (In re Enron Corp.), 2004 U.S. Dist. LEXIS 20351, at 7 (S.D.N.Y. Oct. 12, 2004) (under U.C.C. Section 2-105, electricity is a goods); Puget Sound Energy, Inc. v. Pac. Gas & Elec. Co. (In re Pac. Gas & Elec. Co.), 271 B.R. 626, 638-40 (N.D. Cal. 2002) (interpreted U.C.C. Section 2-105 to be that once electricity is metered, it becomes a product or a goods, a thing movable at time of identification to contract for sale, because once the amount is metered, it becomes identifiable); and Lightfoot v. MXEnergy Elec. Inc (In re MBS Mgmt. Serv., Inc.), 430 B.R. 751, 753 (Bankr. E.D. La. 2010) (electricity is a commodity under Section 761(8) of the Bankruptcy Code).

2.It Is Not

Several bankruptcy courts have ruled that under Section 503( b )(9), electricity is a service and not goods.

In re NE Opco, Inc., 2013 Bankr. LEXIS 4569 (Bankr. D. Del. Nov. 1, 2013) (appeal pending); In re PMC Marketing Co., 2013 Bankr. LEXIS 3690 (Bankr. D. P.R. Sept. 4, 2013); In re Pilgrim’s Pride Corp., 421 B.R. 231 (Bankr. N.D. Tex. 2009); In re Plastech Engin. Prods., Inc., 397 B.R. 828, 839 (Bankr. W.D. Mich. 2008); and In re Samaritan Alliance, LLC, 2008 WL 2520107, 2008 Bankr. LEXIS 1830 (Bankr. E.D. Ky. June 20, 2008).

NE Opco disagreed with A&P, GFI Wisconsin, and Erving Industries. It held that once electricity passes the meter, it constitutes a service under U.C.C. Section 2-105, because there is not a meaningful delay between identification and consumption. Id. at 12. This is based upon the Judge’s own analysis (there was no citation to testimony of an engineer or any other witness; there was no citation of any court case as precedent, even the cases holding that electricity which passes the meter is a service) that electricity moves at the speed of light, and therefore, there is no separation between identification and consumption. Something that is performed and consumed simultaneously; e.g., washing a car, is a service and not a good. Electricity is the same thing. Due to it traveling so fast, there is no meaningful delay; therefore, it is a service. Id. at 12-13, and 17.

NE Opco did not address most of the non-Section 503(b )(9) cases discussed herein; e.g., Pacific Gas & Electric, 271 B.R. 626 (District Court held unequivocally that electricity which passes the meter is a goods); yet, there was not one word or attempt to distinguish this case. Consequently, it is distinguishable for any of the reasons cited in these cases. As an appeal is pending, NE Opco’s future is uncertain.

The other bankruptcy cases forming the contra view also are readily distinguishable.

PMC Marketing held that since the claimant was a utility, and Section 366 references a utility as providing a service, a utility is precluded from asserting a Section 503(b )( 9) claim. Many of the other cases to examine Section 503(b )(9), including NE Opco, id. at 16, and Plastech, id. at 839-40, have ruled to the contrary: relief under Section 503(b ) (9) is completely independent from relief under Section 366. Nothing in Section 503(b)(9) states that it is inapplicable to utilities.

Pilgrim’s Pride is distinguishable because: (a) it only was a memorandum opinion, without the issuance of a judgment, order or decree; therefore, it was not appealable and was not appealed by the utilities; and (b) no judgment, order or decree was issued, because by the time the memorandum opinion was issued, the dispute over whether the Section 503(b)(9) utility claims were to have administrative expense or general unsecured priority was moot. By then, the bankruptcy court had confirmed the plan of reorganization, which provided for payment of allowed, general unsecured claims $1.00 for $1.00 (plus interest). Thus, there was no reason to decide whether Section 503(b)(9) claims were to be administrative expenses.

Plastech involved a claim only for the sale of natural gas, and not the sale of electricity. The discussion about electricity merely was to note the conclusion in Samaritan Alliance, which lacked statements of fact and conclusions of law, and there was no rationale. The court’s reasoning in Samaritan Alliance is unknown.

B. Non -Bankruptcy Cases : Electricity is a Goods

Additional authorities support the proposition that once it passes the meter at the customer’s premises, electricity is a goods, product, or commodity, and not a service.

Non-bankruptcy courts have found electricity to be goods under U.C.C. Section 2-105. IN: Helvey v. Wabash County REMC, 278 N.E.2d 608, 609-610 (Ind. Ct. App. 1972) (electricity is a movable, because of the “monthly reminder from the electric company of how much current has passed through the meter. Logic would indicate that whatever can be measured in order to establish the price to be paid would be indicative of fulfilling both the existing and movable requirements of goods.”); KY: C.G. Bryant v. Tri-County Elec. Member. Co., 844 F. Supp. 347, 349-52 (W.D. Ky. 1994) (electricity is a product after it is sold when it passes through the meter; the majority of state courts agree; a producer of electricity is like “other sellers of goods”); and PA: Bellotti v. Duquesne Light Co., 4 UCC Rep. Serv. 2d 1393, 1394-1395 (Pa. Ct. Comm. Pleas 1987).

Non-bankruptcy courts have found electricity to be a product under the Restatement of Torts Sec. 402A. GA: Monroe v. Savannah Elec. & Power Co., 471 S.E.2d 854, 855-856 (Ga. 1996) (“electricity is a product. . . . [I]t can be produced, confirmed, transmitted . . . and distributed in the stream of commerce.”); NJ: Aversa v. Pub. Serv. Elec. & GasCo., 451 A.2d 976, 979-980 (NJ Super. Ct. 1982); PA: Schriner v. Pennsylvania Power & Light Co., 501 A.2d 1128, 1134 (Pa. Super. Ct. 1985) (electricity becomes a product “once it passes through the customer’s meter and into the stream of commerce.”); and WI: Ransome v. Wisconsin Elec. Power Co., 275 N.W.2d 641, 643 (Wis. 1979) (“electricity itelf, in the contemplation of the ordinary user, is a consumable product”).

A. L. Anderson, 2 Uniform Commercial Code (3rd ed. 2004 rev.) § 2-105:37, at 141 (“[w]hatever can be measured by a flow meter has ’movability’ as that term is used in connection with the definition of goods.”). To calculate the amount of electricity provided to a customer, an electric utility uses a meter, located at the customer’s premises.

These legal authorities collectively support the conclusion that electricity past the meter at the customer’s premises is manufactured, movable at the time of identification to the contract, and existing – the key elements to be a goods under U.C.C. Sections 2-105(1), and not a service.

C. Natural Gas is a Goods Under Section 503(b)(9)

NE Opco, id. at 17 – 20, and Pilgrim’s Pride, id. at 240-45, also involved claims by utilities for administrative expense priority for the sale of natural gas to Chapter 11 debtors during the twenty days prior to the petition date. As U.C.C. Section 2-107(1 ) provides that “a contract for the sale of minerals or the like (including oil and gas) . . . is a contract for the sale of goods within this Article if they are severed by the seller.”, both electric contra cases held that the sale of natural gas is a goods. The express language of the U.C.C. provision so provides (as compared with U.C.C. 2-105, in which there is no reference to electricity or gas.)

They would have been hard-pressed to hold otherwise, in view of the many cases already having ruled that either the sale of natural gas is a goods under Section 503(b)(9); Plastech, 397 B.R. 828, 839 (Bankr. E.D. Mich. 2008); U.C.C. Section 2-107(1); or otherwise. CO: Ky Energy, Inc. v. Great West. Sugar Co., 698 P.2d 769, 778, n. 10 (Col. 1985), cert. den. 472 U.S. 1022 (1985); MS: So. Nat. Gas v. Pursue Energy, 781 F.2d 1079, 1081, n. 3 (5th Cir. 1986); and MT: In re MSR Explo., 147 B.R. 560, 569 (Bankr. D. Mt. 1992).

However, that did not mean that the utilities were entitled to recover under Section 503(b )(9) for the total amounts of their claims for unpaid gas during the twenty days prior to the petition date. Instead, NE Opco and Pilgrims Pride established further hoops for the gas utilities to jump through. Under a predominant purpose test, both Courts ruled that the utility was entitled to recover only the cost of the gas at the wellhead, which was the sole element of goods, and the costs in transporting the gas from the wellhead to the meter at the customer’s premises were services, not goods. Even if the invoice only provided for one charge; namely, a bundled rate, these Courts only would permit recovery for the wellhead price.

As an analogy, suppose a furniture manufacturer delivered ten sofas to a debtor furniture store during the twenty days before the store filed for bankruptcy. The price per sofa was $1,000, and the manufacturer made a Section 503(b )(9) claim for $10,000. Suppose the costs of material and wood per sofa was $10, and the remainder of the charge included labor (to assemble the fabric and wood into a finished product), overhead, transportation, and profit. Under these two cases, the manufacturer only would be entitled to a recovery of $100 ($10 x 10).

This result in NE Opco and Pilgrims Pride was opposed by other Courts. Grede Foundries and Irving Industries rejected the predominant purpose test. This test addresses whether a transaction is a goods or services under U.C.C. Section 2-105. Where an item is a mixture; namely, both goods and services, then a court has to analyze whether it is predominately a goods or a service. Grede Foundaries, id. at 802-593, ruled that the item still could qualify for recovery under Section 503(b )(9) – at least that portion attributable to the goods in the claim. And in Grede Foundaries, since the first time that the debtor raised the predominant purpose test was in its appellate brief, and previously, it had not contested the value of the utility’s claim (meaning, which part was a goods vs. a service) and only had contested whether the entire claim was a goods or a service, it waived this as an appealable issue.

Attempts by some courts to create a second set of hoops for a utility to jump through appear to be incongruous. To constitute a ‘goods’ under Section 503(b )(9), courts look only to the definition of ‘goods’ in U.C.C. Section 2-105. The non- Section 503(b)(9) cases addressing U.C.C. Section 2-105 examine the issue in one of two ways: (a ) whether electricity has past the metering point; the majority of cases which do, then find that electricity is a goods, and therefore, the utility can be held strictly liable in tort; as for electricity falling in a field prior to reaching a meter, electricity is a service; courts have created a legal fiction: prior to the meter, electricity is a service; after the meter, it is a goods; for the minority of cases, it does not matter, because even once electricity passes the meter, it still is a service; or (b ) in non-U.C.C. Section 2-105 cases, electricity is a product or commodity, and not a service. Once a court concludes that electricity is a goods, the analysis ends.

This probably is the result, because at the meter, the number of kilowatts is identified and measured (amount which enters the customer’s premises) to compute the monthly invoice. No analysis then is undertaken whether the number of kilowatts (sale of electricity) or the number of mcf (sale of natural gas) consists of generation, transmission, distribution, or any other component part. With some utilities, and years ago probably with all utilities (before deregulation), the typical monthly invoice consisted of or still may consist of just one total number. Short of undertaking a rate case and extensive discovery, there only was or still is one total, unbundled amount.

Which, in the humble opinion of the undersigned author, is the way it is supposed to be. It is extremely unlikely that Bankruptcy Judges, as did the one in NE Opco, will undertake an internet analysis of all parts of the sofa manufacturer’s invoice and financial statements to ascertain a Section 503(b )(9) claim to permit recovery of only the $10 for wood and fabric. Curiously, while advocating that a bankruptcy court can bifurcate an electric utility’s Section 503(b )(9) claim into a part for goods and a part for services; meaning, it need not be an all or nothing conclusion, as to a Section 503(b )(9) claim for $154,000 by a manufacturer of pellets (consisting of raw material and labor), Plastech, 397 B.R. 828, at 839, awarded the manufacturer recovery as an allowed claim for the entire invoice amount for $154,000. This was the only evidence in the record of value. Likewise, for a utility, the total kwh or total mcf usage times the tariff rate, as set forth in the monthly invoice, should be the end of the analysis.

III. CONCLUSION

Contrary to NE OPCO, the analysis of whether the sale of electricity is a goods under Section 503(b (9) of the Bankruptcy Code and U.C.C. Section 2-105 should be a straight forward one, as suggested by the many cases cited above, and in particular Grede Foundaries, Erving Industries, and Pacific Gas & Electric. None requires an analysis of the physics of electricity. Like the other many cases herein, the analysis is simple: once electricity moves through the meter, it is capable of being identified and measured, with precision.

Courts have held electric utilities liable as the seller of goods, not services, under a variety of circumstances. Imposing warranties available once an item either is a goods, as provided under the U.C.C., or a product, as provided under strict liability tort statutes, courts have found that once electricity enters the stream of commerce (after passing the metering point at the customer’s premises), then it constitutes either a goods (under the U.C.C.) or a product (under the strict liability tort statute). Either way, electric utilities find themselves liable for potential damages as a result of such classifications. With the enactment of Section 503(b)(9), it would be extremely incongruous to rule that while for purposes of negligence or contract actions, electricity is a goods or a product, and not a service; however, for purposes of the Bankruptcy Code, electricity is a service and not a goods.

Be aware of one major caveat: Prior to filing a Section 503(b )(9) claim for electricity, one should consult with management and counsel to evaluate whether doing so might increase inordinately a municipal utility’s exposure to negligence or product liability claims.

Gilbert L. Hamberg's picture

Thank Gilbert L. for the Post!

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Michael Keller's picture
Michael Keller on January 25, 2014
I, no doubt, have a naive view on the issue, but it strikes me that electricity is "stuff". Stick your finger in an electrical socket and you will not feel the intangible affect associated with a "service". Seems to me, then under a bankruptcy, the utility is due their costs, which is just a fraction of the bill, while also being subject to the court's adjustment of the bankruptcy debts that caused the distress in the first place.
Gilbert L. Hamberg's picture
Gilbert L. Hamberg on January 26, 2014
That certainly is how the majority of Courts have ruled: under Section 503(b )(9), other parts of the Bankruptcy Code, and non bankruptcy cases. II think that the judges reviewing under Section 503(b)(9) initially decide whether electricity is a goods or a service and then they construct an opinion to support that conclusion.

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