The Supreme Court declined on Monday to consider whether retailer Kmart Corp. should have been allowed to pay more than $300 million to about 2,500 “key vendors” immediately after filing its chapter 11 case in January, 2002.
The Kmart case stemmed from Kmart’s decision immediately after the filing of its chapter 11 case to request that the Bankruptcy Court approve emergency payments to its key vendors (including over 1,000 newspapers) on the grounds that such payments were essential to preserving Kmart’s going concern value for the ultimate benefit of all of its creditors.
Absent such payments, key vendors of bankrupt companies often refuse to do business and provide trade credit with a debtor even though their post-bankruptcy claims receive a higher priority of payment than pre-petition unsecured claims. Bankruptcy Courts often authorize such payments to key vendors, and the Bankruptcy Court in Kmart’s case elected to do so.
However, the District Court and the the 7th U.S. Circuit Court of Appeals reversed the Bankruptcy Court’s key vendor ruling and held that Kmart had failed to establish that business from its designated key vendors was any more necessary to the survival of Kmart than business from certain companies that were excluded from key vendor status.
The effect of the Supreme Court’s refusal to review the 7th Circuit’s decision is that the lower courts remain split on the issue of key vendor payments. Some courts deny such payments on the grounds that the Bankruptcy Code contemplates that any such payments to the debtor’s creditors should only be made under a confirmed plan of reorganization. However, the better view is that, under appropriate circumstances, a debtor should be allowed to pay key vendors at the outset of a case to hedge the risk that the debtor would otherwise meltdown into liquidation to the detriment of creditors before a reorganization plan can even be proposed.
Kmart’s “key vendor” motion was unusally aggressive and neither the 7th Circuit’s decision nor the Supreme Court’s refusal to review that decision prevents a Bankruptcy Court from approving key vendor payments under appropriate circumstances. But it is clear that from these rulings that debtors will be required to tailor such key vendor programs more carefully than Kmart did.