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Matter of Kmart Corporation

United States Court of Appeals for the Seventh Circuit
359 F.3d 866 (2004)


Facts

Immediately upon filing for reorganization under Chapter 11, Kmart Corporation (plaintiff) requested permission to pay the prepetition claims of “critical vendors” in full. Kmart reasoned that such vendors, if unpaid, would cease providing merchandise to Kmart and thereby jeopardize the reorganization. Upon scant evidence and without notifying any “noncritical” vendors, the bankruptcy court entered a critical-vendors order as proposed by Kmart. The order gave Kmart unilateral discretion to select which vendors to pay. The court’s decision was not accompanied by any factual support or legal reasoning, except for a reference to 11 U.S.C. § 105(a). Pursuant to the order, Kmart paid approximately $300 million in prepetition debts to 2,330 suppliers. Kmart was able to make such payments after having received $2 billion in new credit financing. Its largest payment went to Fleming Companies, which held a long-term contract with Kmart under which it sold $70 million to $100 million in goods to Kmart weekly. Approximately 2,000 vendors were not deemed “critical” and therefore not paid. Those vendors eventually received about 10 cents on the dollar for their claims, principally in the form of stock in the reorganized Kmart. One such vendor, Capital Factors, Inc. (defendant), appealed the critical-vendors order as soon as it was entered. Approximately 14 months later, after the critical vendors had been paid, the district court reversed the bankruptcy court’s order on the grounds that it was not supported by § 105(a) or a “doctrine of necessity.” Kmart appealed.

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