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Electricity As a Good Or a Service: Some “Shocking” Developments

Electricity As a Good Or a Service: Some “Shocking” Developments

Selected topic Bruce Nathan, Esq. and Eric Chafetz, Esq.

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

Credit providers may be shocked to learn that the courts have reached conflicting decisions over whether elec- N a t i o n a l A s s o c i a t i o n o f C r e d i t M a n a g e m e n t 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. The United States Bankrupt- Ccy 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 Services, LLC v. The Great Atlantic & Pacific Tea NOVEMBER/DECEMBER 2013

Company, Inc. (A&P) both recently considered whether The Publication For Credit & Finance Professionals $7.00 electricity is a “good” or a “service.”

The PMC Court held that electricity is a “service” and Court held that electricity is movable and identifiable not a “good,” because it was provided by a government because it can be measured at the point it passes through owned utility. On the other hand, the A&P District a customer’s meter. Section 2-105(1) defines goods as Court vacated and remanded the order of the United “all things...which are movable at the time of identifica- States Bankruptcy Court for the Southern District of tion to the contract for sale.” The Erving Court rejected New York, rejecting the A&P Bankruptcy Court’s hold- Erving’s argument that electricity ceases to be movable ing that electricity is a “service” and not a “good” and when it is measured by the meter because identification directing that an evidentiary hearing be conducted on and consumption occur simultaneously. Instead, elec- this issue. tricity does not simply cease to exist when it reaches a customer’s meter, but moves through the meter and The United States Bankruptcy Court for continues to move throughout the customer’s electrical the District of Puerto Rico and the United wiring until the customer ultimately uses it. States District Court for the Southern TheErving Court also focused on Constellation’s role as a wholesale energy supplier and the relevant terms of District of New York both recently the parties’ contract. Constellation had purchased elec- considered whether electricity is a tricity from third parties and resold that electricity to Erving and other consumers. Moreover, Constellation “good” or a “service.” was not a “utility” because it was not subject to govern- mental regulation, did not possess a monopoly as the In re Erving Industries, Inc. sole source of electricity available to Erving, and was ThePMC Court and the A&P District Court focused on not included in the list of utilities maintained by the rel- the District of Massachusetts Bankruptcy Court’s hold- evant state agencies. TheErving Court also relied on the ing in In re Erving Industries. In Erving, Constellation terms of the parties’ contract that described a purchase/ NewEnergy, Inc., an electricity reseller, timely asserted a sale relationship, and not the provision of a “service.” Section 503(b)(9) priority claim in the amount of $281,667.88 on account of electricity delivered to the The PMC Marketing Corporation Case debtors Erving Industries, Inc. and two affiliates (col- PMC Marketing Corporation filed a Chapter 11 peti- lectively, Erving) within 20 days of Erving’s bankruptcy tion on March 18, 2009. PMC’s case was converted to a filing. Erving objected to Constellation’s Section 503(b) Chapter 7 case on May 21, 2010. P.R. Electric (9) claim and argued that electricity was a “service” and Authority (PREPA) filed a seeking payment of a not a “good.” Section 503(b)(9) claim in the amount of $89,336.42. PREPA argued that it was entitled to Section 503(b)(9) The Erving Court held that the electricity Constellation priority status because its claim was based on its sale of, had resold to Erving was a “good.” First, applying the and PMC’s receipt of, electricity during the 20-day peri- definition of “goods” contained in Section 2-105(1) of od (February 26, 2009 and March 17, 2009) before the Uniform Commercial Code (UCC), the Erving PMC’s bankruptcy filing.

1 B u s i n e s s C r e d i t n o v e m b e r / d e c e m b e r 2 0 1 3 PREPA argued that its aforementioned claim for the electric- bulk of fungible goods” because it is “simply a stream of elec- ity provided to PMC was entitled to Section 503(b)(9) priority trical energy… identified… at the point of delivery.”4 As such, treatment because the electricity was a “good” within the “it is hard to see that [electricity] is actually moveable at the UCC’s definition of that term. According to PREPA, the elec- time of identification…[and] in essence disappears at that tricity was both moveable (from when it was metered and moment.” afterwards) and identifiable (to a customer’s contract at the time it was metered at the consumer’s place of business).2 Significantly, the A&P Bankruptcy Court disagreed with the Erving Court’s holding that electricity is a “good,” despite the The PMC Court recognized the division among the courts fact that both Hudson and Constellation (the claimant in Erv- over whether electricity is a “good” or a “service.” The court ing) were non-utility suppliers of electricity that did not per- held that the electricity supplied by PREPA, a utility,3 was a form a delivery service. The A&P Bankruptcy Court disre- service, not a good. The court defined the term “utility” as a garded Hudson’s status as a seller of electricity as reflective of provider of a service, such as light, power or water. The court industry deregulation and not determinative of whether the also observed that a utility refers to a “business organization UCC’s definition of “goods” includes electricity. Hudson ([such] as an electric company) performing a public service appealed the A&P Bankruptcy Court’s order to the A&P and subject to special governmental regulations,” that has District Court. “some special position with respect to the debtor,” and has “a monopoly in the area so that the debtor cannot easily obtain PREPA argued that its aforementioned comparable service from another.” claim for the electricity provided to Applying these various definitions and concepts, the PMC PMC was entitled to Section 503(b)(9) Court concluded that PREPA was a utility provider because: (i) like other traditional utilities, it is subject to governmental priority treatment because the regulation, (ii) enjoys a “special relationship” with PMC as electricity was a “good” within the PREPA is the only electricity provider in Puerto Rico, (iii) has a monopoly, and (iv) is owned by the government and direct- UCC’s definition of that term. ed by a government board. Accordingly, the PMC Court held that electricity in this specific context was a “service” and Hudson argued that the A&P Bankruptcy Court erred in PREPA was not entitled to an administrative priority claim holding, without any evidentiary support, that electricity is under Bankruptcy Code Section 503(b)(9). not a good. Hudson asserted that the electricity it had pro- vided A&P was movable when it was identified to the contract ThePMC Court distinguished the Erving Court’s holding that at the following two discrete points: (i) when Hudson pur- electricity is a good eligible for Section 503(b)(9) priority sta- chased the electricity and it was subsequently released into tus. The court noted that the claimant in Erving, Constella- the grid5, and (ii) when the electricity exited the grid, was tion, was a private alternative energy provider that sold elec- measured, and passed through a customer’s meter.6 Hudson tricity as a “competitive supplier” and was not a also argued that electricity qualified as “an identified bulk of provider, like PREPA, that was responsible for the ultimate fungible goods” like “oil in a pipeline or grain in an elevator,” delivery of electricity to a customer as a “service.” because any unit of electricity is identical to any other unit and the electricity that Hudson had purchased on behalf of its The A&P District Court Decision customers (including A&P) was an undivided share of all the On April 27, 2011, Hudson Energy Services, LLC filed a electricity included in the entire . motion seeking the allowance of a Section 503(b)(9) claim in the amount of $875,943.90 on account of electricity Hudson A&P countered that the electricity it had purchased from had sold to Great Atlantic & Pacific Tea Company, Inc. and its Hudson could not have been identified to a contract of sale as affiliates (collectively, A&P). A&P objected to Hudson’s soon as it entered the power grid. In addition, A&P had motion, arguing that the electricity provided to A&P was not already consumed the electricity when it was identified to its a “good” under Section 503(b)(9). contract with Hudson at the time it was measured at the meter. As such, A&P could not return the electricity to Hud- The A&P Bankruptcy Court had ruled that electricity is a son after it was measured at the meter. Moreover, just because service, and not a good, and, therefore, is not entitled to Sec- A&P could store a de minimis amount of electricity did not tion 503(b)(9) priority status. The court noted that electricity mean that the A&P Bankruptcy Court erred in holding that does not fall within the UCC’s definition of “goods” even the electricity was not “moveable at the time of identification though electricity is a commodity that can be bought and to the contract.” A&P also countered Hudson’s argument that sold. The electricity at issue was not “movable at the time of electricity is “an identified bulk of fungible goods” by ques- identification to the contract” and was “not identifiable until tioning the plausibility of Hudson’s argument that the entire the moment it reaches [the customer’s] meter, and at that power grid is a “bulk” of goods, especially as electricity is con- point it is used.” The court also relied on UCC Section stantly being “generated, transmitted and consumed” and was 2-105(4) in concluding that electricity is not an “identified not capable of identification.

B u s i n e s s C r e d i t n o v e m b e r / d e c e m b e r 2 0 1 3 2 The A&P District Court’s Decision and Observations Finally, the A&P District Court discounted A&P’s argument The A&P District Court concluded that insufficient evidence that electricity is static and does not change from case to case. was presented to determine whether the electricity that Hud- In rejecting this argument, the court focused on the conflict- son had sold to A&P was a good, and, therefore, entitled to ing court holdings over whether electricity is a “good” or a Section 503(b)(9) priority status. Accordingly, the A&P Dis- “service.” Based on those conflicting decisions, the court trict Court vacated and remanded the A&P Bankruptcy determined that it needed to conduct an evidentiary hearing Court’s decision and ordered that an evidentiary hearing be on whether the electricity Hudson had sold to A&P was a held on whether the electricity that was subject to the parties’ good or a service. contract satisfied the UCC’s definition of a good, moveable at the time of identification to the contract, or identified asa Conclusion bulk of fungible goods. The most important lesson for electricity providers can be summed up by the A&P District Court9 as follows: Although the A&P District Court did not I recognize that the possibility of individualized fact-find- decide whether the electricity that ing regarding the nature of the claimant’s business, how it physically provides the electricity, its arrangements with Hudson had sold to A&P was a “good” generators, etc.—is less desirable than a bright-line rule or a “service,” the court made several that electricity always or never is a “good.” But individual- interesting observations regarding ized analysis may be what the statute requires. whether and when electricity can be While the ideal result for electricity providers would be for electricity to always be considered a “good,” the A&P District considered a “good.” Court’s and PMC Court’s holdings make clear that many courts will likely not adopt such a straightforward approach. Although the A&P District Court did not decide whether the Accordingly, there will likely continue to be significant litiga- electricity that Hudson had sold to A&P was a “good” or a tion concerning whether electricity is a “good” or a “service,” “service,” the court made several interesting observations since the issue arises in many factual scenarios. regarding whether and when electricity can be considered a “good.” First, the court relied on the UCC’s definition of Because individualized “goods” for determining whether electricity is a good that is entitled to Section 503(b)(9) priority status. assessments of the electricity being provided will have to be , the A&P District Court observed that it would likely agree with Hudson’s argument and conclude that the electric- undertaken, the courts and ity Hudson had sold to A&P is a “good” if Hudson can prove litigants will be forced to engage that the “electricity passes through the meter at the customer’s location and is at that moment identified and thereafter con- in case-by-case analyses of each sumed.” The court also observed that if Hudson’s theory about electricity does not hold up, the court would need to under- electricity provider’s interaction take an “individual assessment” of the exact arrangement with a debtor. between A&P and Hudson to determine whether the electric- ity that Hudson had sold to A&P is a “good.” The court further Complicating further, this litigation will not just focus observed that the terms “purchase” and “sale” in the parties’ on the physical attributes of electricity, but will also focus on contract could be relied upon as further support for charac- each claimant’s unique interaction with electricity in a specific terizing electricity as a “good” and not a “service.” debtor’s bankruptcy case. Illustrating this point, the PMC Court was able to conclude that PREPA was a “service” pro- Third, theA&P District Court considered the economics sur- vider because it was a government owned and operated utility rounding the sale and delivery of electricity. Electricity can be that had a monopoly on electricity sales in Puerto Rico. Based “provided by integrated utilities that generate, sell, deliver and on these facts, the PMC Court distinguished the Erving service [electricity],” or by entities like Hudson, that make Court’s decision, where the claimant was not a utility. How- “money simply by buying electricity from generators at a ever, the decisions by the A&P District Court and Erving lower price than that at which it sells to customers, but is oth- Court demonstrate that utilities, like PREPA, occupy only one erwise hands off.” Complicating matters further, companies end of the spectrum related to dispositions of electricity and can fall between traditional utilities on one far end of the there are numerous other points on the spectrum. Because spectrum and companies on the other end, like Hudson, that individualized assessments of the electricity being provided solely buy electricity and sell it to their customers. Complicat- will have to be undertaken, the courts and litigants will be ing matters even further is that not all courts disqualify utili- forced to engage in case-by-case analyses of each electricity ties from enjoying Section 503(b)(9) priority status.8 provider’s interaction with a debtor (including those instances

3 B u s i n e s s C r e d i t n o v e m b e r / d e c e m b e r 2 0 1 3 where the electricity provider interacts with the debtor in Bruce S. Nathan, Esq. is a partner in the Bankruptcy, Financial more than one way). Reorganization and Creditors’ Rights Group in the New York office of the law firm of Lowenstein Sandler LLP. He is a member of NACM and is Accordingly, electricity providers could be in for a shocking a former member of the Board of Directors of the American Bankruptcy and unpredictable ride as it does not appear that the courts 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 will be establishing a bright line test for determining whether Committee working with ABI’s Commission to Study the Reform of electricity is a good that is entitled to Section 503(b)(9) prior- Chapter 11. He can be reached via email at [email protected]. ity status or a service that does not enjoy such protection. Eric S. Chafetz, Esq. is counsel at the law firm of Lowenstein Sandler LLP. He can be reached at [email protected]. 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 *This is reprinted from Business Credit magazine, a publication of the before the date of commencement of a case under this title in which the National Association of Credit Management. This article may not be goods have been sold to the debtor in the ordinary course of such forwarded electronically or reproduced in any way without written debtor’s business.” permission from the Editor of Business Credit magazine. 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 file 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 filed three years after the claims bar date set by the PMC Court. However, the PMC Court held that PREPA preserved the right to obtain priority status by filing a general unsecured claim that included invoices paid within 20 days before PMC’s bankruptcy filing, 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. The 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- tified bulk of fungible goods is sufficiently identified 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 specifically identified to Hudson’s contract with A&P. 6. Hudson disagreed with the A&P Bankruptcy Court’s holding that once 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 after passing through the customer’s meter. 7. The 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. The 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 satisfied the UCC’s definition of “goods” and was subject to Section 503(b)(9) priority status. 9. The 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 out 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.”

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