In a recent post, our own Harriet Wallace observed a truism in a recent ruling by the United States Bankruptcy Court for the District of Delaware in the chapter 7 iteration of the infamous Jevic case—the wording of an order matters. The Court saw fit to bold and underline that maxim in yet another recent holding in Insys Liquidation Trust v. MeKesson Corporation (In re Insys Therapeutics, Inc.), No. 21-50176 (JTD), 2021 WL 3083325 (Bankr. D. Del. July 21, 2021). To the near certain chagrin of critical vendors everywhere, the Court held that the language of the relevant critical vendor order was insufficient to insulate certain critical vendors from preference claims.
The Insys Therapeutics Critical Vendor Order
Insys Therapeutics, Inc. and its affiliates (the “Debtors”) developed and commercialized drugs and novel drug delivery systems for targeted therapies. After filing their bankruptcy cases in 2019, the Debtors filed certain typical “first day” motions, including the Motion Pursuant to 11 U.S.C. §§ 105(a) and 363(b) for Authority to (I) Maintain and Administer Prepetition Customer Programs, Promotions, and Practices and (II) Pay and Honor Related Prepetition Obligations (the “Critical Vendor Motion”). The Critical Vendor Motion requested, among other things, authority to pay all prepetition amounts owed to certain customers to continue to receive necessary services postpetition.
The Court granted the Critical Vendor Motion. The order (the “Critical Vendor Order”) granting the Critical Vendor Motion included the following common language authorizing payments to critical vendors: “The Debtors are authorized, but not directed . . . to maintain and administer the Customer Programs[.]”
On January 16, 2020, the Court entered an order confirming the Debtors’ chapter 11 plan of liquidation. The plan provided for the establishment of a liquidating trust (the “Liquidating Trust”) and assigned certain causes of action, including avoidance claims, to the Liquidating Trust.
On February 23, 2021, the trustee of the Liquidating Trust (the “Trustee”) filed a complaint for avoidance and recovery of certain prepetition transfers to certain prepetition critical vendors (the “Defendants”) and objected to all claims filed by the Defendants in the bankruptcy case. The Defendants moved to dismiss the preference claim asserted in the complaint, in part, based on the provisions of the Critical Vendor Order. The Defendants argued that the prepetition transfers would have been authorized under the Critical Vendor Order had they not been made prepetition, and that the Critical Vendor Order that would have authorized such transfers was law of the case.
The Trustee countered with three arguments—each of which was adopted by the Court. 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. The language of the Critical Vendor Order did not preclude recovery of preferential payments that were made prepetition. The Court concluded that the plain language of the Critical Vendor Order did not specifically bring prepetition transfers within the ambit of critical vendor relief.
Second, the language of the Critical Vendor Order was permissive rather than mandatory. The language authorizing, but not directing, the Debtors to make critical vendor payments undercut the Defendants’ argument that prepetition transfers would necessarily have been authorized by the Critical Vendor Order had they not been made prepetition.
Third, the Critical Vendor Order included express language making clear that avoidance claims were not waived. The Critical Vendor Order specifically provided 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.”
The Court further distinguished the facts of the case from the limited circumstances in which courts in the Third Circuit recognize a “critical vendor defense.” The Court explained that a critical vendor defense only exists where: (i) the debtor is required to pay the prepetition claims, either by order, stipulation, agreement, or statute; or (ii) the creditor against whom the preference action is asserted holds a priority claim and would therefore have unquestionably been paid in full in a liquidation scenario.
Based on its review of the Critical Vendor Order, the Court concluded that the first prong was not satisfied. The Court distinguished other instances in which the first prong was satisfied by: (i) an order authorizing assumption of the underlying agreement (and, thus, requiring a cure of outstanding amounts) under 11 U.S.C. § 365, (ii) a postpetition agreement specifically obligating payment of any prepetition claim; or (iii) a prepetition priority wage claim that was otherwise required to be paid under an employee wage and benefits order.
Further, whether the Defendants would have “unquestionably” received payment in a full liquidation scenario was a factual question not appropriate on a motion to dismiss. The Court could not conclude at the pleading stage that the Defendants would have unquestionably been paid in full in a liquidation—the transfers were on account of general unsecured claims rather than priority claims.
The “Something More” Critical Vendors Should Request
The Court concluded that “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; something more is required.” The most obvious among the potential cures is specific language in the critical vendor order requiring payment of prepetition claims, which would require debtors to abandon the ubiquitous “authorized, but not directed” language common to first day orders. Mandatory prepetition claim payment may draw heavier scrutiny, particularly early in a case before the appointment of a committee; however, specific language in the order mandating payment of prepetition claims would clearly bring non-priority claims within the ambit of the “critical vendor defense.” Additionally, depending on the vendor’s leverage and preference risk, negotiating an alternative postpetition agreement may prove effective. One thing is certain: the “something more” will certainly be of importance to critical vendors hoping to avoid an unwelcomed preference battle.