Are Critical Vendors Insulated from Preference Actions?
No, says the Delaware Bankruptcy Court in In re Maxus Energy Corp. In Maxus, the defendant, Vista Analytical Laboratory, Inc. (“Vista” or the “Defendant”), a designated critical vendor, sought summary judgement dismissing the preference complaint. The Court denied summary judgement finding that the critical vendor status did not per se insulate Vista from preference actions.
On June 17, 2016 (the “Filing Date”), Maxus Energy Corporation and certain of its affiliates (collective, the “Debtors”) filed for Chapter 11. In the ninety days before the Filing Date, the Debtors made payments to Vista in the aggregate amount of US$217,410. In the course of the bankruptcy, the Debtors moved for an order authorizing them to pay up to US$2 million for certain pre-petition claims of specific critical vendors, and the Bankruptcy Court granted the critical vendor motion. The Debtors recognized Vista as a critical vendor under the critical vendor order.
The Debtors’ confirmed liquidation plan provided, among other things, for the creation of the liquidating trust. After confirmation, the liquidating trustee initiated a complaint against Vista seeking to avoid and recover the US$217,410 pre-petition payment as a preference. Vista moved for summary judgment.
Section 547(b) of the Bankruptcy Code provides the elements that must be met to establish a prime facie preference. The undisputed facts established that the elements of section 547(b)(1)-(4) (i.e., a transfer for the benefit of a creditor, on account on an antecedent debt, made while the debtor was insolvent and within 90 days of the Filing Date) were met.
The only remaining element was section 547(b)(5), which requires that the transfer sought to be avoided “enables such creditor to receive more than such creditor would receive if (A) the case were a case under chapter 7 of this title; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title.”
The Third Circuit held that “[t]o satisfy the requirements of § 547(b)(5), the trustee must establish that the transfer yielded the creditor a greater return on its debt than it would have received if the transfer had not taken place and it had received a distribution under a Chapter 7 liquidation.” Accordingly, the court should consider what the creditor received and what it would have received under a chapter 7 liquidation to determine whether the creditor received more than its entitlement.
Vista argued that, as a critical vendor, it would have received full payment under the critical vendor order, and therefore section 547(b)(5) was not satisfied. The Court disagreed and found that a genuine issue of material fact as to Vista’s recovery in a hypothetical chapter 7 case existed.
In denying Vista summary judgement, the Court made several observations. First, the Court noted that the nature of a chapter 7 liquidation generally results in general unsecured creditors receiving less than full, if they receive any recovery at all. While Vista argued that it would have received the same full payment under the critical vendor order, the disclosure statement provided that “the recovery for General Unsecured Claims is between 2.7-11.5%.”
Second, Vista and the Debtors did not enter into a separate, binding trade agreement that would require the Debtors to pay Vista in full, after the Court entered the critical vendor order.
Third, the Court determined that if the Debtors had sought to pay Vista the full US$217,410 pursuant to the critical vendor order, that act would have plausibly drawn objections. Comparing the pre-petition payment with the total amount authorized to pay critical vendors, the Court noted that the amount paid to Vista represented 11% of the aggregate payout authorized by the critical vendor order.
Fourth, the Court emphasized that the critical vendor order gave the Debtors discretionary authority to pay the critical vendors, but the Debtors were not required to pay critical vendors, such as Vista, in full.
Maxus Energy reminds vendors that a critical vendor designation does not per se insulate them from preference exposure. Vendors should be mindful of the possibility of a liquidating rather than a reorganization plan and should take care to actually execute a critical vendor agreement, which Vista failed to do. Thus, there is a difference between an assumed contract and critical vendor designation, and a critical vendor designation is not an absolute defense to preference actions.