Critical Vendors in a Retail Bankruptcy – Part II

In Part I of this post, we discussed the rationale for paying critical vendors in a bankruptcy and the Court’s ruling in the Kmart bankruptcy.  This blog will discuss how the Kmart verdict has impacted how debtors and bankruptcy courts determine when a vendor is truly “critical” as well as examples of recent critical vendor motions in retail bankruptcy cases.

The Kmart ruling has made it more difficult for suppliers to obtain critical vendor status in retail bankruptcies. There are heightened procedural and evidentiary standards that must be met before any payment is deemed critical. For example, debtors must prove that critical vendors are essential to their survival.  They also must show that:
  • Discriminating among vendors by treating some vendors as critical is the only way to facilitate a bankruptcy plan,
  • The vendors not receiving critical vendor payments are at least as well off as they would be if the critical vendor payments don’t occur, and
  • Vendors receiving critical vendor payments will not continue to do business with the Debtor without the critical vendor payments.
Because of the Kmart ruling, all bankruptcy courts have had more to consider, thereby making critical vendor motions anything but routine these days. Critical vendor motions are now largely driven by the following factors:
  • Jurisdiction in which the bankruptcy was filed, as some courts continue to scrutinize critical vendor motions more than others,
  • Willingness of pre- and post-petition secured lenders to permit payments to critical vendors,
  • Availability of cash in the debtor’s cash flow budget, and
  • Debtor’s plan for the bankruptcy (reorganization, sale or liquidation of the business).
As a result of these stringent standards, both the number of critical vendors and amount to be paid to critical vendors has decreased, as evidenced in recent critical vendor motions. 

For example, in the Ultimate Electronics bankruptcy case in Delaware, a bankruptcy judge last Friday refused to approve the Debtor’s request to pay $10 million to critical vendors since the Judge was concerned that the Debtor did not have the cash available to make the payments and did not yet have the support of its secured lender.

What do you think of the stringent standards around critical vendors?