Critical Vendors Aren’t Immune from Lawsuits to Recover Preferential Transfers

Patterson Belknap Webb & Tyler LLP

Patterson Belknap Webb & Tyler LLP

Some courts permit debtors to designate vendors crucial to their business as “critical vendors.”  These vendors supply debtors with necessary goods or services.  Debtors are permitted to pay them amounts owing when a bankruptcy case is filed.  Accordingly, critical vendors often recover more on their pre-petition claims than other unsecured creditors.  In other words, critical vendors could receive a full recovery, while other creditors only receive a fraction of what they are owed.

But what if, before a bankruptcy is filed, a creditor that is later designated as a critical vendor received prepetition payments on amounts owed to it?  Can the debtor (or a trustee) sue the creditor in the bankruptcy case to recover those amounts (but not those paid postpetition under a critical vendor program) as preferential, even if such creditor might receive all amounts owed to it on prepetition transactions once it is designated as a critical vendor?

The issue arose in a recent case in Delaware.  Judge John T. Dorsey allowed the bankruptcy trustee to pursue those preference claims against critical vendors.  Insys Liquidation Trust v. McKesson Corp. (In re Insys Therapeutics, Inc.), Case No. 19-11292. Adv. No. 21-50176, 2021 Bankr. LEXIS 1923 (Bankr. Del. July 21, 2021).

The debtors had prepetition contracts with the creditor defendants.  The debtors filed for chapter 11 on June 10, 2019.  An initial motion designated defendants and others as “critical customers.”  The debtors sought court permission to pay these creditors amounts owed on their prepetition claims.  The Court granted the motion.  Of significance, the debtors were authorized, but not required, to make payments to the critical customers.

In February 2021, a liquidating trustee of the debtors’ estates brought an adversary proceeding against the defendants.  Among other things, the complaint sought to avoid and recover transfers the defendants received in the 90 days before the bankruptcy filing under Bankruptcy Code section 547.

The defendants moved to dismiss the case for failure to state a claim under Fed. R. Civ. P. 12(b)(6).  Judge Dorsey noted that he was required to apply a three-part analysis: (i) review the elements of the claim, (ii) accept the complaint’s facts as true, and (iii) consider whether the facts alleged showed the plaintiff had brought a plausible claim. 

The elements of a claim under section 547 are: a transfer was made to or for the benefit of a creditor; on account of an antecedent debt; while the debtor was insolvent; within 90 days before the filing of the bankruptcy petition (or between 90 days and one year for transfers to insiders of the debtor; and the creditor would receive more than if the case were a chapter 7 liquidation.

In their motion to dismiss, the defendants argued that the trustee couldn’t satisfy the last element.  They asserted that even if they hadn’t received the payments subject to the preference complaint, they would have been paid in full in accordance with their designation as critical customers.  In response, the trustee noted that the payments to critical customers were authorized but not required.  Thus, there was no guarantee that the critical customers would have been paid more than they would receive in a chapter 7 liquidation. 

Judge Dorsey concluded that how much a creditor would receive in a liquidation was a factual issue that couldn’t be decided on a motion to dismiss.  Discovery would be needed to answer that question.  And, importantly, not only was the critical customer program optional, the Order approving the motion didn’t bar the trustee from recovering prepetition payments.

The defendants also argued that the customer order was controlling as law of the case, and therefore the trustee couldn’t seek to recover any transfers made to the defendants.  Judge Dorsey rejected this argument too, characterizing it as an unsupported “sweeping conclusion.”  2021 Bankr. LEXIS 1923, at *14.

Judge Dorsey summed up the analysis by saying “the fact that a creditor was named in a court order as a ‘critical’ or otherwise important customer of a debtor is not in and of itself enough to bar a preference claim . . . .” Id. at *16.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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