Critical Vendor Order Insufficient to Protect Critical Vendors Against Preference Claims
by | posted in: Avoidance, Bankruptcy Roundtable Updates, Chapter 11, Preference | 0

By Nicholas A. Koffroth (Fox Rothschild)

Nicholas A. Koffroth

In Insys Liquidation Trust v. MeKesson Corporation (In re Insys Therapeutics, Inc.), No. 21-50176 (JTD), No. 21-50176, 2021 WL 3083325 (Bankr. D. Del. July 21, 2021), the United States Bankruptcy Court for the District of Delaware reminded practitioners to exercise caution when analyzing the scope of protections offered by critical vendor orders.  The order at issue in Insys Therapeutics provided that “[t]he Debtors are authorized, but not directed . . . to maintain and administer the Customer Programs” and that “[n]othing contained . . . in this Final Order is intended to be or shall be construed as . . . (c) a waiver of any claims or causes of action that may exist against any creditor or interest holder.”  These common provisions proved critical in the Court’s holding that “something more is required” to insulate critical vendors from preference liability.

In the opinion, the Court denied a motion to dismiss the complaint brought by a group of critical vendors for three reasons.  First, the Court held that preferential payments that occur before the entry of a critical vendor order cannot be protected by a subsequent authorization to pay outstanding prepetition claims unless specifically provided in the order.  Second, the permissive language of the critical vendor order did not support the vendors’ claim that the prepetition payments would necessarily have been authorized had they been made postpetition.  Third, the critical vendor order expressly preserved the estates’ claims against critical vendors.  Additionally, the Court analyzed and rejected application of the limited “critical vendor defense.”

The article discusses the Court’s holding in greater detail and offers practical considerations for practitioners. The full article is available here.

Absolute Priority Redux: First-Day Orders and Pre-Plan Settlements in Chapter 11 Post-Jevic
by | posted in: Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Jurisprudence, Priority | 0

By Bruce Grohsgal (Delaware Law School Widener University)

Bankruptcy’s absolute priority rule arose 150 years ago to prevent insiders from using their control over an enterprise – often coupled with hypothetical valuations, contrived sales, and collusion with other parties – to obtain a greater distribution or “control premium” from estate assets.  This premium came at the expense of parties who had a higher distributional priority but were not “in on the deal.”  The Supreme Court again considered this issue in Jevic in 2017, when it held that a chapter 11 case-ending settlement called a “structured dismissal” must comply with the same absolute priority rule that applies to the similarly case-ending confirmation of a chapter 11 cramdown plan.  The Court emphasized that insider control and collusion can endanger bankruptcy’s core principle of an orderly distribution in accordance with statutory priorities.

The Jevic Court explicitly left open, though, the extent to which a pre-plan settlement or court-ordered “first-day” distribution in chapter 11 may deviate from the absolute priority rule.  It suggested only that a court approving these pre-plan distributions must show some respect for – or a “proper solicitude” to – the statutory distributional priorities.

I propose in this paper that, for a proposed pre-plan, priority-skipping settlement with an insider, secured lender or other party who exercises some control over the debtor, the absolute priority rule is sufficiently respected when a bankruptcy court subjects to an auction the claim proposed to be settled.  If at the auction, a third party bids the same or a higher price for the claim absent the priority-skipping, then it will be clear that the initially proposed transaction included a control premium.  If instead a higher third-party bid is not obtained, it will be clear that the settling insider is not paying a discounted settlement price based on its control and that the priority-skipping has a legitimate basis that does not implicate the problem of insider control.  The auction, by displacing suspect hypothetical valuations, can address the precise mischief sought to be remedied by the absolute priority rule.

I further contend that a market test for a “first-day” distribution to a critical vendor, employee or other creditor that is challenged as priority-skipping will be limited to whether the debtor sought and failed to obtain in the market the same good, service, or credit from an alternative supplier on the same or better terms than those proposed in the first-day motion.  The reason for this is simple – a bankruptcy court will not be able in most cases to obtain, at the time of the first-day hearing, a market determination of case-ending distributions to creditors.  Any hypothetical valuation at a first-day hearing of the end-of-case distributions to creditors will be highly unreliable.  Because of these obstacles, I suggest that the question of whether a first-day payment will comport with end-of-case distributional priorities should be replaced with the question of whether the debtor sought and failed to obtain an alternative supply in the market on the same or better terms, and by a rebuttable presumption that preserving the going concern value of the chapter 11 debtor likely will benefit even the disfavored creditors.  This approach – which essentially adopts the occasionally maligned “doctrine of necessity” and rejects the Seventh Circuit’s Kmart rule – recognizes the disturbing weakness of a hypothetical determination, made at the first day hearing, of end-of-case distributions in a chapter 11 case.

The full article is available here.