October 28, 2021

Volume XI, Number 301

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Equitable Mootness Strikes Again: The Near Impossibility of Challenging a Debtor’s Critical Vendor Decisions

Although debtors who file for Chapter 11 bankruptcy generally cannot pay prepetition debts until a plan which complies with the “absolute priority rule” is confirmed, there are a number of now well-established exceptions to this rule.  As noted (although not actually ruled upon) by the United States Supreme Court in its controversial “Jevic” decision, “[c]ourts, for example, have approved ‘first-day’ wage orders that allow payment of employees’ prepetition wages, ‘critical vendor’ orders that allow payment of essential suppliers’ prepetition invoices, and ‘roll-ups’ that allow lenders who continue financing the debtor to be paid first on their prepetition claim.”  Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973, 985 (2017).

With regard to so-called “critical vendor” orders, it has been common practice for more than two decades for debtors who commence chapter 11 bankruptcy cases immediately to seek authority to deem certain of their vendors as “critical,” thereby allowing such vendors to leapfrog their prepetition and otherwise second-to-last-in-line (only above equity) claims to the top of the feeding order, resulting in the lucky creditors potentially being at least partially, if not fully, paid in the very early stages of the proceeding.

Courts have adopted a fairly uniform, yet somewhat amorphous and circular test for what type of creditor can reasonably be deemed “critical”—it is one to whom payment is “critical to the debtor’s reorganization.”  In re Financial News Network Inc., 134 B.R. 732, 736 (Bankr. S.D.N.Y. 1991).  In practice, courts routinely leave the determination as to which vendors are “critical” to “the sound business judgment of the debtor.”  In re United Am., Inc., 327 B.R. 776, 782 (Bankr. E.D. Va. 2005).  This wide grant of discretion, however, often leads to disgruntled creditors who have not been designated as “critical” and other parties in interest—including creditors’ committees—questioning whether the debtor’s decisions in this regard are truly objective, made at arm’s length and otherwise justified.  However, as evidenced by the Second Circuit Court of Appeals’ recent decision in GLM DFW, Inc. v. Windstream Holdings, Inc. (In re Windstream Holdings, Inc.), 2021 U.S. App. LEXIS 4630 (Feb. 18, 2021), it is nearly impossible to obtain redress in this regard, given both the wide discretion provided to debtors and other nearly impenetrable roadblocks, such as the doctrine of equitable mootness.

The Windstream Case

In the jointly administered bankruptcy cases styled as In re Windstream Holdings, Inc., Case No. 19-22312 (the “Bankruptcy Case”) filed in the United States Bankruptcy Court for the Southern District of New York, Windstream Holdings, Inc. and its debtor affiliates (“Windstream” or the “Debtors”) filed a critical vendor motion [Bankruptcy Case, Docket No. 16] (the “Vendor Motion”), seeking authority to pay prepetition claims of creditors whose goods or services were claimed to be essential to the success of the incipient reorganization.  Windstream alleged that “[a]ny material interruption in the provision of the Critical Vendor Products and Services – however brief – would disrupt the Debtors’ operations and could cause irreparable harm to the Debtors’ businesses, goodwill, employees, customer base, and market share” and a vendor would be deemed “critical” if a loss of its goods or services would “immediately and irreparably harm” the Debtors’ business.  Vendor Motion at ¶¶ 13, 16.  As is common, however, the Vendor Motion did not name the vendors whom the Debtors believed might potentially qualify as critical, claiming that to do so would compromise the Debtors’ ability to negotiate with those vendors if they knew that they were eligible for this preferred treatment.

GLM DFW, Inc. (“GLM”), a creditor holding a $2 million unsecured claim against the Debtors, filed an objection to the motion [Bankruptcy Case, Docket No. 204] (the “Objection”), on three grounds:

(i) that it was for the Bankruptcy Court to decide who was a critical vendor . . . and not the Debtors; (ii) that the Bankruptcy Code required the disclosure of the identity of the prepetition creditors being paid and the amounts being paid, and that no grounds to seal this information existed; and (iii) that the Bankruptcy Court either failed to impose any standard, or identified an impermissible standard, on what facts and circumstances qualified a creditor to be a critical vendor.

GLM DFW, Inc. v. Windstream Holdings, Inc. (In re Windstream Holdings Inc.), 19-4854 (S.D.N.Y. April 3, 2020) (the “District Court Opinion”) (citing the Objection).

On April 22, 2019, the bankruptcy court entered an order (the “Order”) overruling the Objection and granting the Vendor Motion on the basis that the requested relief would “provide a material net benefit to the Debtors’ estates and creditors after taking into account the Bankruptcy Code’s priority scheme.”  Order at p.1.  The Order, as is typical, was very broad, authorizing the Debtors, “in their sole discretion, to . . . pay any accrued but unpaid prepetition Vendor claims on a postpetition basis in the ordinary course of business or as may be necessary to secure a vendor’s agreement to continue business with the Debtors on Customary Trade Terms, up to the amount set forth for each category of Vendor Claims set forth in the Motion.”  Id.  The Debtors were only required to provide the full list of critical vendors to the United States Trustee, the Official Committee of Unsecured Creditors and the bankruptcy court for in camera review, but not to the public.  Id.

GLM appealed to the District Court for the Southern District of New York, arguing that “[t]he most serious problem with the Order is the delegation of the judicial function to the Debtors, whereby the Bankruptcy Court has permitted the Debtors to decide questions of fact,” including “who is a critical vendor.”  District Court Opinion at p. 14.  In affirming the bankruptcy court’s decision, the district court rejected GLM’s “improper delegation” argument, finding that courts routinely allow payments to be made in the sound business judgment of the debtor and that determination of critical vendor status would be “impractical” and “unnecessary” in large cases, given oversight by the U.S. Trustee and the creditors’ committee.  Id. at p. 15.  The district court also rejected GLM’s argument that it was error to allow the Debtors to keep secret the identities of the proposed critical vendors.  Id. at pp. 17-18.  According to the court, because a list of critical vendors had never been publically filed, Section 107(b)(1) of the Bankruptcy Code—which permits redaction of protected commercial information in public filings—was inapplicable.  Id. at p. 19.  Moreover, even if Section 107 did apply, the court pointed to decisions of other courts holding that the names of critical vendors could be redacted in public filings under Section 107(b)(1).  Id. at pp. 20-21.

On the merits, the district court held that under Section 363(b) of the Bankruptcy Code, a debtor has “broad flexibility” to make payments outside of the ordinary course of business after articulating “some business justification, other than mere appeasement of major creditors.”  Id. at p. 23.  The court listed three requirements for invoking the “doctrine of necessity” under Section 105(a), which is often relied upon as the basis upon which a debtor may pay prepetition claims:  “(1) the vendor must be necessary for the successful reorganization of the debtor; (2) the transaction must be in the sound business judgment of the debtor; and (3) the favorable treatment of the critical vendor must not prejudice other unsecured creditors.”  Id. (quoting In re United, 327 B.R. at 782).  The district court rejected GLM’s contention that there needed to be “a formal refusal to provide services,” and “while the existence (or not) of such a refusal is a factor to be considered, [the objector] has failed to support its contention that it alone is dispositive.”  Id. at p. 26.  Accordingly, the district court affirmed, holding that the bankruptcy court “appropriately applied the doctrine of necessity in this case.”  Id. at p. 28.

GLM appealed the district court’s affirmance to the Second Circuit Court of Appeals, but did not seek a stay pending appeal.  However, while the appeal was pending, the bankruptcy court confirmed Windstream’s chapter 11 plan.

On appeal, GLM raised two alleged errors in the decisions below:  (1) that the bankruptcy court improperly delegated its judicial authority to the Debtors to decide who should be paid, such that “the bankruptcy court essentially rubber-stamped Windstream’s proposed list of creditors, and should have instead conducted a creditor-by-creditor analysis before allowing Windstream to offer any creditor preferential treatment, and (2) the bankruptcy court erred by not requiring the debtors to publically disclose the identities of those creditors being paid.”  GLM DFW, 2021 U.S. App. LEXIS at *1-2.

In a non-precedential summary order, the Second Circuit dismissed the appeal as equitably moot.  According to the circuit court,

[T]he primary purpose of equitable mootness is to give courts a tool “to avoid disturbing a reorganization plan once implemented.”  As a result, where, as here, such a plan has already been substantially consummated, we presume that an appeal is equitably moot.

Id. at *3 (internal citations omitted).  According to the court, a party seeking to overcome the presumption of equitable mootness may do so only by demonstrating that five factors—referred to as the Chateaugay factors—are met:

(1) the court can still order some effective relief; (2) such relief will not affect the re-emergence of the debtor as a revitalized corporate entity; (3) such relief will not unravel intricate transactions so as to knock the props out from under the authorization for every transaction that has taken place and create an unmanageable, uncontrollable situation for the [b]ankruptcy [c]ourt; (4) the parties who would be adversely affected by the modification have notice of the appeal and an opportunity to participate in the proceedings; and (5) the appellant pursued with diligence all available remedies to obtain a stay of execution of the objectionable order if the failure to do so creates a situation rendering it inequitable to reverse the orders appealed from.

Id. (internal quotations omitted).  The court also noted that “it is the appellant’s burden to show that all five of these factors are satisfied.”  Id.

GLM took the position that the equitable mootness doctrine was inapplicable because it was not appealing the bankruptcy court’s confirmation order, an argument rejected by the Second Circuit:

Our precedent is clear that equitable mootness can be applied ‘in a range of contexts,’ including appeals involving all manner of bankruptcy court orders.

Id. at *4.

According to the Second Circuit, the creditor’s argument “makes little sense,” because it “overlooks the important interest of finality that attaches once a reorganization plan is approved and consummated.”  Id.  The court decided that equitable mootness applied, “even though [the appellant] has not expressly asked us to reject the bankruptcy court’s approval of [the Debtors’] plan of reorganization.”  Id. at *5.  The court ruled that GLM had “clearly failed” to satisfy the five Chateaugay factors, including by failing to seek a stay or an expedited appeal.  Id.  The court also found that granting the relief sought on appeal “could cause tens of millions of dollars in previously satisfied claims to spring back to life, thereby potentially requiring the bankruptcy court to reopen the plan of reorganization,” and that “it would likely be highly disruptive for the creditors that received these funds to return them more than a year later.”  Id. at *6.  Finally, the court ruled that even if the court could provide GLM with relief that did not unwind Windstream’s plan of reorganization, GLM had “no cognizable interest” in finding out which critical vendors were paid, because “it lacks the ability to parlay them into a possible financial recovery.”  Id. at *6 n.1.

Implications of Windstream

For those who regularly represent individual creditors or unsecured creditors’ committees, Windstream is emblematic of critical concerns about the critical vendor process, including:  (a) the difficulty of challenging the debtor’s determination as to the criticality of a particular vendor to a successful reorganization; (b) the degree to which pre-filing and likely potential post-emergence relationships—both good and bad—might influence the “business judgment” being exercised in making the decision; and (c) the degree to which enticing individual creditors with the possibility of receiving critical vendor status may influence their behavior in the case, including for those creditors who sit in a fiduciary capacity as members of a creditors’ committee.

At bottom, however, as can be seen in the Windstream trio of rulings, critical vendor motions are (i) routinely granted, (ii) left almost entirely to a debtor’s discretion to determine who is “critical,” and (iii) extremely difficult to challenge—either when the relief is initially sought (typically within days of the chapter 11 filing, at least on an interim basis), or on appeal as a result of, among other things, the ever increasing breadth and application of the equitable mootness doctrine.  While critical vendor orders can often serve a useful or even critical purpose, more transparency, real accountability and a meaningful opportunity to challenge a debtor’s determinations in that regard would promote much needed confidence in the fairness of the process.

 

© Copyright 2021 Squire Patton Boggs (US) LLPNational Law Review, Volume XI, Number 76
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About this Author

Norman N. Kinel Restructuring & Insolvency Attorney Squire Patton Boggs New York, NY
Partner

Norman Kinel is a partner in the firm’s Restructuring & Insolvency Practice and the national chair of the firm’s Creditors’ Committee Group. With more than 30 years of experience as a bankruptcy practitioner, Norman has successfully represented and litigated on behalf of clients in some of the nation’s largest and most intricate bankruptcy cases, involving numerous industries. Norman’s clients value his responsiveness to their needs and his tenacity in pursuing dynamic strategies to protect and maximize their interests.

Norman regularly represents debtors, creditors, bondholders...

212-407-0130
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