A At long last, yet another court has issued a decision N AT I O N - PDF document

S e l e c t e d t o p i c Critical Vendor Treatment? No Sure Thing! Bruce NathaN, esq. A At long last, yet another court has issued a decision N AT I O N A L A S S O C I AT I O N O F C R E D I T M A N A G E M E N T JUNE 2013 addressing a debtor’s motion to approve the payment of the pre-petition claims of alleged “critical vendors” during the debtor’s Chapter 11 case and prior to the approval of a Chapter 11 plan. Tiis time, the United States Bankruptcy Court for the Northern District of Georgia, in In re News Publishing Company , denied a debtor’s motion to approve the payment of all but one of the pre-petition claims of these so-called “critical vendors.” Tie debtor could not satisfy the following THE PUBLICATION FOR CREDIT & FINANCE PROFESSIONALS $7.00 stringent three-part test that the News Publishing court had laid down as a pre-condition for its approval of the “critical vendors.” Tiese favored creditors fell within the critical vendor motion: (1) the necessity of the critical following three groups: (1) supply companies that pro- vendor payments for the debtor’s reorganization; (2) vided supplies and equipment for the debtor’s printing the critical vendors’ refusal to do business with and press and related equipment; (2) service companies that supply necessary goods and/or services to the debtor maintained and repaired the debtor’s printing press; unless their pre-petition claims were paid; and (3) the and (3) a temporary employment agency that provided lack of prejudice to other disfavored creditors by the temporary critical employees to the debtor. critical vendor payments. Tie debtor argued that its non-payment of these criti- Tie takeaway from the News Publishing Company deci- cal vendor claims would materially interfere with the sion is that critical vendor relief is no sure thing in many debtor’s business operations. For instance, the debtor jurisdictions around the country. asserted that the “critical vendors” were the only rea- sonable alternative source of certain necessary goods and services. Unless the debtor paid their pre-petition At the inception of its Chapter 11, the debtor claims, the “critical vendors” would likely either refuse moved for authority to pay the pre- to continue providing their goods and services to the debtor or provide them on unreasonable credit terms. petition claims of 16 creditors the debtor Tie debtor’s estate and its other creditors would also benefjt since the “critical vendors’” had to agree to con- had characterized as “critical vendors.” tinue doing business with the debtor according to the trade terms in efgect prior to the Chapter 11 fjling date Background as a condition for receiving payment of their pre-peti- Tie debtor, News Publishing Company, publishes one tion claims. paid daily newspaper, fjve paid weekly newspapers, seven free newspapers, shoppers and niche publica- Tie debtor also justifjed the critical vendor payments tions, and six newspaper and niche websites located in because most of the vendors were entitled to adminis- urban, suburban and rural markets. Tie debtor’s wholly trative priority status under Section 503(b)(9) of the owned subsidiary, Cherokee Publishers Company, also Bankruptcy Code based on the debtor’s receipt of their publishes one paid daily newspaper. Tie debtor also goods within 20 days of the petition date. Finally, the operates a substantial commercial printing business. debtor proposed to cap its total critical vendor pay- ments at not more than $200,000. On January 1, 2013 (the petition date), the debtor fjled its Chapter 11 case. At the inception of its Chapter 11, Tie debtor also submitted a supplemental declaration in the debtor moved for authority to pay the pre-petition support of its critical vendor motion. Tie supplemental claims of 16 creditors the debtor had characterized as declaration contained a chart that listed the 16 critical 1 B u s i n e s s C r e d i t j u n e 2 0 1 3

vendors, the nature and amount of their claims and the reason eral unsecured claims to higher priority Chapter 11 adminis- for critical vendor treatment. An abstract of the chart is pro- trative priority claims with enhanced prospects for recovery. vided on page 15 (page 3 of this document). Other courts imposed stringent One of the debtor’s largest unsecured creditors, United Com- requirements as a condition for munity Bank (UCB), with an unsecured claim totaling $885,988.86, objected to the debtor’s critical vendor motion. approving the payment of critical UCB argued that the debtor had failed to satisfy the stringent vendor claims. requirements for critical vendor relief that the United States Court of Appeals for the Seventh Circuit in the K-Mart case, and other courts had adopted. Specifjcally, the debtor did not However, the preferred treatment that “critical vendors” had prove that the “critical vendors” would not otherwise do busi- enjoyed clashed with the bankruptcy claims priority rules. Tie ness with the debtor during its Chapter 11 case, or the debtor’s priority rules required the payment of claims based on where Chapter 11 reorganization would fail and its unsecured credi- they are situated on the claims priority ladder. Secured credi- tors would receive nothing in the event the debtor had failed tors sit at the top of the priority ladder and are entitled to pay- to pay the critical vendors’ pre-petition claims. Nor did the ment of the proceeds of their collateral. Creditors providing debtor submit any evidence of the pre-petition relationship goods and services to a debtor in bankruptcy have administra- between the debtor and the so-called “critical vendors” to tive priority claims that sit on the next lower rung of the prior- show that the critical vendor payments were a continuation of ity ladder. Creditors at the next lower priority level include the debtor’s ordinary course relationship with these creditors. wage, salary, benefjt and tax claimants. Pre-petition general Bottom line, the debtor was unjustifjably seeking payment of unsecured claims occupy the lowest creditor rung of the prior- the unsecured claims of some inappropriately favored “critical ity ladder and are not entitled to receive any distribution from vendors” while neglecting to pay other similarly situated the debtor until the higher priority creditors are paid in full. unsecured claims, such as UCB’s claim. While some courts had granted a debtor’s motion to approve critical vendor treatment with virtually no analysis, other it did not take long for bankruptcy courts subjected a debtor’s critical vendor motion to far more courts outside of the seventh scrutiny. Some courts denied a debtor’s post-petition pre-plan payment of critical vendors’ pre-petition unsecured claims Circuit to approve a debtor’s based on the absence of any Bankruptcy Code provision per- payment of critical vendors’ mitting such payment and the violation of the claims priority rules that did not permit the payment of lower priority pre- pre-petition claims based on petition unsecured creditors prior to the payment of higher priority claims. much less onerous requirements. Other courts imposed stringent requirements as a condition the historical Grounds for critical Vendor treatment for approving the payment of critical vendor claims. For Prior to the passage of the Bankruptcy Code, the courts had instance, the United States Bankruptcy Court for the North- approved a debtor’s post-petition pre-plan payment of a cred- ern District of Texas, in In re Coserv, L.L.C. , conditioned a itor’s pre-petition claim based on the “necessity of payment” debtor’s payment of critical vendors’ pre-petition claims on doctrine laid out by the United States Supreme Court in its the debtor’s proof that (1) the vendor was indispensable to 1882 decision in Miltenberger v. Logansport Railway. Tie the debtor’s business because the vendor was a major cus- Supreme Court had approved a debtor’s post-petition pre- tomer of the debtor, the sole supplier of a particular product plan payment of the pre-petition claims of those creditors the debtor needed, or controlled a valuable property the who were found to be necessary for the reorganization and debtor needed; (2) the debtor would realize economic gain, rehabilitation of the debtor’s business. or avoid serious economic harm, that materially exceeded the amount of the payment, and (3) the debtor had no practi- Following enactment of the Bankruptcy Code, the courts cal or legal alternative to dealing with the vendor, except by granted critical vendor relief based on the “necessity of pay- paying the vendor’s pre-petition unsecured claim. Bottom ment” doctrine and/or Bankruptcy Code Section 105(a). Sec- line, critical vendor relief would not be granted if there were tion 105(a) recognizes the bankruptcy court’s equitable power other vendors willing to sell to the debtor on cash terms or to “issue any order, process or judgment that is necessary or other assurances of payment. appropriate to carry out the provisions of this title.” Tie United States Court of Appeals for the Seventh Circuit, in Tiose courts usually conditioned granting critical vendor its watershed 2004 K-Mart ruling, rejected the debtor’s request relief on the vendors’ agreement to continue extending post- to pay the pre-petition unsecured claims asserted by 2,330 of petition credit to the debtor. Tie “critical vendors” benefjtted its trade creditors, in the aggregate amount of approximately through the elevation of their lower priority pre-petition gen- $300 million. Tie Seventh Circuit had held that the “necessity 2 B u s i n e s s C r e d i t j u n e 2 0 1 3