Article courtesy of Michael Robson (Greenberg Traurig, LLP)
In re Murray Metallurgical Coal Holdings, LLC et al., 2020 WL 1307378, 68 BCD 143 (Bankr. S.D. Ohio 2020)
Overruling an objection brought by two employee benefit funds, the Southern District of Ohio Bankruptcy Court (“Court”) held that a debtor in possession may pay prepetition claims of critical vendors prior to confirmation of the debtor’s Chapter 11 plan.
In February 2020, Murray Metallurgical Coal Holdings, LLC (the “Debtor”) filed for Chapter 11 protection to restructure its debts. At the same time it filed for Chapter 11 protection, Debtor filed a motion to pay up to $7.3 million in prepetition claims of critical vendors, which supply it with critical goods and services. Debtor argued that payment of the critical vendor claims preserves liquidity and allows Debtor to operate smoothly during the Chapter 11 case. As part of its motion, Debtor listed criteria against which creditors would be assessed to determine which creditors should receive payments. These criteria included: (i) whether the vendor is the sole or limited–source supplier or service provider of the quality and quantity Debtor requires in a particular market; (ii) whether Debtor would be able to reasonably obtain comparable products or services from alternative sources; (iii) whether the vendor is able or likely to refuse to provide products or services to Debtor if their claim is not paid; (iv) whether the Debtor could compel the vendor to continue to provide products or services to Debtor under a contract; and (v) whether Debtor has sufficient inventory or service coverage to meet customer demands while an alternative vendor is found. Debtor did not, however, individually identify the creditors. Two employee benefit funds (UMWA 1974 Pension Plan and Trust and UMWA 1993 Benefit Plan) objected to Debtor’s motion, arguing that Debtor must present evidence of why payment is necessary on a vendor–by–vendor basis.
The Court overruled the funds’ objection, holding that a debtor need not provide evidence on a vendor by vendor basis to pay prepetition claims of critical vendors prior to confirmation of a debtor’s Chapter 11 plan. At the outset, the Court noted that payment of prepetition claims is typically not considered within the ordinary course of the debtor’s business and, therefore, debtors must usually wait for plan confirmation. However, under Section 363(b)(1) of the Bankruptcy Code, a court may authorize a debtor–in–possession to “use” property of the bankruptcy estate prior to plan confirmation if the transaction serves a “sound business purpose.” Stephens Industries Inc. v. McClung, 789 F.2d 386 (6th Cir. 1986). A transaction serves a sound business purpose if two elements exist: (1) the vendor would refuse to provide goods to the debtor due to the absence of a contract between the parties and unless the vendor’s prepetition claim is paid; and (2) the debtor can show its “business will gain enough from continued transactions with the favored vendors to provide some residual benefit to the remaining, disfavored creditors, or at least leave them no worse off.” In re Kmart Corp., 359 F.3d 866, 872 (7th Cir. 2004).
The funds’ primary argument is that Debtor must prove that each individual vendor is critical to Debtor’s business and that the vendor will not perform absent payment of their prepetition claim. The Court pointed out that the Seventh Circuit in Kmart did not decide how the Debtor must go about proving that a vendor will not perform absent payment of their prepetition claim and noted that courts have regularly approved critical vendor motions utilizing a protocol or criteria similar to what Debtor seeks to use in this case without identifying vendors or providing individualized evidence as to each vendor. The Court held that if the criteria set forth in the critical vendor motion are sufficient to establish the above elements, bankruptcy courts may allow debtors–in–possession to exercise their business judgment to pay prepetition claims of critical vendors. The Court further found that the vendor–by–vendor approach advocated by the employee benefit funds would likely result in debtors facing increased costs that would be paid out of the bankruptcy estate to the detriment of other creditors, which does not align with bankruptcy’s goals of promoting successful reorganization and maximizing the value of the bankruptcy estate.
