Bankruptcy courts continue to recognize the essential vendor doctrine--The judicial approval of a preference. (Legal Corner).(Brief Article)

Vendors are wrestling with bankruptcy trustees and liquidating agents in record numbers over the bankruptcy preference. The bankruptcy preference requires a vendor to give back payments received within the 90 days prior to the bankruptcy filing, subject to a vendor's defenses such as the subsequent advance and ordinary course of business.

A twist to the preference laws is the recent trend of bankruptcy courts to authorize a debtor in some instances to pay certain vendors post-bankruptcy on account of their pre-bankruptcy claims, the so-called essential vendor or critical vendor. In other words, if the vendor received payment prior to the bankruptcy on account of a delinquent account, the vendor may be subject to a preference for the payment. However, if the vendor is selected as an essential vendor by the debtor and the bankruptcy court authorizes the post-bankruptcy payment on the pre-bankruprcy delinquent account, no preference.

Under the essential vendor doctrine, a vendor may find that the product or service it provides a Chapter 11 debtor is essential to continued operations. The uniqueness of the product or service may give the vendor leverage in negotiating post-bankruptcy sales. More and more bankruptcy courts are considering a debtor's request to treat certain vendors as essential and have their pre-bankruptcy claims paid in exchange for post-petition trade credit. A number of bankruptcy courts, from Owens Corning to Bethlehem Steel, to the Warnaco Group, Baldwin Piano, AGA Flowers and Federal Mogul, have recently approved the debtor's request for an essential vendor program. Vendors in the Kmart Chapter 11 proceeding witnessed the bankruptcy court approve Kmart's request to pay Fleming Foods, as well as irs liquor and music suppliers, among others. Two bankruptcy courts recently published opinions recognizing the essential vendor program.

The bankruptcy court in the Payless Cashways retail stores Chapter 11 considered the debtor's request to treat certain lumber suppliers as essential vendors (In re Payless Cashways, Inc., 268 B.R. 543 (Bankr. WD. Mo. 2001)).

The essential vendor program provided that in exchange for the debtor's payment of all or part of the vendor's pre-bankruptcy claims, the following terms: the vendor provides standard industry terms, open up to one year following confirmation of a plan of reorganization; critical trade vendor payments would not exceed $10 million. The court's ...