A “Critical Vendor” may be Subject to a Preference Claim

Michael A. Solimani

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

Under title 11 of the United States Code (the “Bankruptcy Code”), a trustee or debtor in possession may avoid or recover certain payments made by the debtor before the bankruptcy filing as a “preference.”[1] During a debtor’s bankruptcy case, the debtor may want to continue obtaining goods or services from a creditor. As a condition for such goods or services, the creditor may demand payment of any amounts that were outstanding as of the date of the bankruptcy filing.[2] Such payments must be approved by the bankruptcy court and are often authorized in a “critical vendor” order.[3] In Insys Liquidation Trust v. McKesson Corp., a bankruptcy court in Delaware held that critical vendor status would not preclude a trustee/debtor in possession from recovering payments made to the critical vendor prior to the bankruptcy filing.[4] Pursuant to multiple pre-petition agreements, McKesson Corp., RelayHealth Pharmacy Solutions, and McKesson Specialty Arizona, Inc. (collectively, the “Defendants”) agreed to assist Insys Therapeutics, Inc. (“Insys”), a company that developed certain drugs and novel drug delivery systems for targeted therapies, with the development and implementation of certain programs related to drugs Insys sold.[5] Facing financial distress, Insys filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code, and in connection therewith, obtained an order authorizing it to pay prepetition amounts owed to critical vendors (the “Customer Order”).[6] Prior to filing the voluntary petition, Insys paid $15,524.17 to RelayHealth and $139,296.90 to McKesson Specialty Arizona, Inc. (the “Transfers") for goods and services provided prior to the bankruptcy filing.[7] Almost 2 years after entry of the Customer Order, a trustee appointed by the debtor’s Chapter 11 plan, filed a complaint seeking to avoid and recover the value of the Transfers.[8] In response, the Defendants filed a motion to dismiss the complaint, arguing that they were critical vendors and would have been paid such amounts, if outstanding, pursuant to the Customer Order.[9] After reviewing the facts, circumstances, and arguments, the bankruptcy court denied the Defendants’ motion to dismiss.[10]

In the Third Circuit, which includes Delaware, the so-called “critical vendor defense” has been found to successfully bar preference claims where (1) the debtor is required to pay the pre-petition claims, either by order, stipulation, agreement, or statute; or (2) where the creditor against whom the preference action is asserted holds a priority claim and would therefore have been paid in full in a Chapter 7 liquidation.[11] Here, the court found that there was no order, stipulation, agreement, or statute which would bar a preference claim.[12] Indeed, the Customer Order did not include a release of claims. It merely authorized Insys to maintain the Customer Programs and make the payments to critical vendors, including Defendants.”[13] Because the Defendants were not paid the Transfers under the Customer Order and could not show that Insys was required to pay such pre-petition amounts by order, stipulation, agreement or statute, or that they held a priority claim against Insys, they were unable to bar a preference claim from being asserted against them for the Transfers.[14]

Critical vendor status will only bar a preference claim when there is an order, stipulation, agreement, or statute demanding pre-petition payment or a priority claim.[15] A critical vendor that was paid prior to the petition date may be subject to a preference claim notwithstanding that it was paid other amounts under a critical vendor order absent obtaining a release of such preference claims.[16]