Critical Vendor Status Is Not a Preference Defense Without ‘Something More’

Some trade creditors are so important to a customer’s business that, after filing for bankruptcy protection, the customer will seek authority from the bankruptcy court to pay these creditors’ prepetition claims. Debtors frequently obtain this relief immediately after their bankruptcy filing on the premise that they could not maximize value for stakeholders if these critical vendors refuse to provide goods and services post-petition. The bankruptcy court’s order authorizing the payment of prepetition claims—often referred to as a “critical vendor order”—induces these creditors to continue providing goods and/or services on credit terms where the debtor pays the creditors’ outstanding prepetition claims.

Being sued on a preference claim is frustrating for any creditor, but particularly so for critical vendors that continue to do business with, and extend credit to, a debtor post-petition under the comfort of the court’s critical vendor order. Critical vendors have attempted to defeat preference claims by arguing that the plaintiff cannot prove one of the required elements—that the prepetition payment resulted in the creditor receiving more than it would have received in a hypothetical Chapter 7 liquidation—because the court authorized the debtor to pay the creditor’s outstanding prepetition invoices during the bankruptcy case. However, it is becoming increasingly clear from recent decisions from one of the most active districts in the country for large Chapter 11 filings—the District of Delaware—that being granted critical vendor status, by itself, may not be enough to defeat a preference claim. As the Delaware Bankruptcy Court noted in its recent opinion in Insys Therapeutics, Inc., “something more is required” to eliminate preference risk.