Kmart Asking Key Suppliers to Return $300M After R
Troy, MI, Mar. 1--Kmart Holding Corp. is asking suppliers who received about $300 million in preferential payments in its bankruptcy case two years ago to hand over the money they were given or potentially face a court battle.
The request comes after an appeals court this week ruled that the judge overseeing the retailer's bankruptcy case here shouldn't have allowed the company to make so-called "critical vendor payments" to more than 2,300 suppliers.
Court permission for such payments, which are typical in most large corporate bankruptcy cases, is often sought to ensure a steady flow of goods and services during the bankruptcy process.
But in a bit of a twist, the retailer is now seeking to recover the payments despite seeking court approval to make them in the first place.
"Kmart values its relationships with its vendors and expects they'd be willing to return the payments as clearly required by the court," Kmart spokesman Jack Ferry said on Friday.
Fleming Cos. and Handleman Co. are among those who received the largest payments from Kmart.
The U.S. Court of Appeals for the Seventh Circuit, which covers Illinois, Wisconsin and Indiana, said in a 10-page ruling on Feb. 24 that Judge Susan Pierson Sonderby shouldn't have signed off on the critical vendor motion because the Kmart failed to show why such payments were absolutely necessary.
Judge Frank Easterbrook, who wrote the appeal on behalf of a three-person panel, wrote that Judge Sonderby approved the motion "without notifying any disfavored creditors, without receiving any pertinent evidence and without making any finding of fact that the disfavored creditors would gain or come out even" as a result, according to court documents.
Judge Easterbrook appeared to set up a two-pronged test for future critical vendor motions. Companies must first prove that the payments would benefit all creditors in the case and prove that the critical vendors would actually cease deliveries if the old debts were left unpaid, he wrote.
Another solution might have simply been a standby letter of credit, which the judge could have authorized unpaid vendors to draw upon, Judge Easterbrook wrote.
"Kmart secured a $2 billion line of credit when it entered bankruptcy," he said. "Some of that credit could have been used to assure vendors that payment would be forthcoming for all post-petition transactions."
The initial suit on the matter was brought by Capital Factors Inc., which at the time held about $20 million in unsecured trade claims against the company and was among about 2,000 others not on Kmart's critical vendor list.
Kmart, of Troy, Mich., filed for federal bankruptcy protection in January 2002. Mr. Ferry said the retailer won't appeal the most recent ruling.
Several bankruptcy experts said the Seventh Circuit's ruling would have a number of significant effects. For one, large corporations may be more reluctant to file their cases in Chicago, where the Seventh Circuit decision is binding, due to potential difficulties in court over the critical vendor payment issue, said Douglas G. Baird, professor of law at the University of Chicago.
Chicago had become a hotspot of sorts for such cases over the past year after landing high-profile filings from Kmart, Conseco Inc. and UAL Corp.'s United Airlines.
The ruling will also have more than just a local impact, said bankruptcy attorney Adam Strochak of Weil, Gotshal & Manges LLP.
"It's certainly an issue that bankruptcy counsel and judges nationwide will be taking a new look at," he said.
Attorneys now will need to be more careful and precise in their requests for such payments, Mr. Strochak said.
