In re Kmart Corp.

• Decision Date: 24 February 2004
• Docket Number: No. 03-2346.,No. 03-2001.,No. 03-2262.,No. 03-2035.,No. 03-2348.,No. 03-1999.,No. 03-2347.,No. 03-2000.,No. 03-1956.,03-1956.,03-1999.,03-2000.,03-2001.,03-2035.,03-2262.,03-2346.,03-2347.,03-2348.
• Citation: 359 F.3d 866
• Court: U.S. Court of Appeals — Seventh Circuit
• Parties: In the Matter of: KMART CORPORATION, Debtor-Appellant Additional intervening appellants: Knight-Ridder, Inc.; Handleman Company; Irving Pulp & Paper, Limited.

359 F.3d 866

In the Matter of: KMART CORPORATION, Debtor-Appellant

Additional intervening appellants: Knight-Ridder, Inc.; Handleman Company; Irving Pulp & Paper, Limited.

No. 03-1956.

No. 03-1999.

No. 03-2000.

No. 03-2001.

No. 03-2035.

No. 03-2262.

No. 03-2346.

No. 03-2347.

No. 03-2348.

United States Court of Appeals, Seventh Circuit.

Argued January 22, 2004.

Decided February 24, 2004.

COPYRIGHT MATERIAL OMITTED

Steven B. Towbin (argued), Peter J. Roberts, Shaw, Gussis, Fishman, Glantz, Wolfson & Towbin, Chicago, IL, for appellee.

Richard C. Godfrey (argued), Kirkland & Ellis, Chicago, IL, for intervenor-appellant.

Andrew N. Goldman, Wilmer, Cutler & Pickering, New York, NY, William J. Barrett, Barack, Ferrazzano, Kirschbaum, Perlman & Nagelberg, Chicago, IL, for debtor-appellant.

George Eric Brunstad, Jr., Bingham McCutchen, Hartford, CT, for appellant Irving Pulp & Paper, Limited.

Joseph D. Frank (argued), Neal, Gerber & Eisenberg, Chicago, IL, for appellant Knight-Ridder, Inc.

Kevin D. Finger, Greenberg Traurig, Chicago, IL, for amicus curiae Meridian Retail Inc.

Before EASTERBROOK, MANION, and ROVNER, Circuit Judges.

EASTERBROOK, Circuit Judge.

On the first day of its bankruptcy, Kmart sought permission to pay immediately, and in full, the pre-petition claims of all "critical vendors." (Technically there are 38 debtors: Kmart Corporation plus 37 of its affiliates and subsidiaries. We call them all Kmart.) The theory behind the request is that some suppliers may be unwilling to do business with a customer that is behind in payment, and, if it cannot obtain the merchandise that its own customers have come to expect, a firm such as Kmart may be unable to carry on, injuring all of its creditors. Full payment to critical vendors thus could in principle make even the disfavored creditors better off: they may not be paid in full, but they will receive a greater portion of their claims than they would if the critical vendors cut off supplies and the business shut down. Putting the proposition in this way implies, however, that the debtor must prove, and not just allege, two things: that, but for immediate full payment, vendors would cease dealing; and that the business will gain enough from continued transactions with the favored vendors to provide some residual benefit to the remaining, disfavored creditors, or at least leave them no worse off.

Bankruptcy Judge Sonderby entered a critical-vendors order just as Kmart proposed it, without notifying any disfavored creditors, without receiving any pertinent evidence (the record contains only some sketchy representations by counsel plus unhelpful testimony by Kmart's CEO, who could not speak for the vendors), and without making any finding of fact that the disfavored creditors would gain or come out even. The bankruptcy court's order declared that the relief Kmart requested — open-ended permission to pay any debt to any vendor it deemed "critical" in the exercise of unilateral discretion, provided that the vendor agreed to furnish goods on "customary trade terms" for the next two years — was "in the best interests of the Debtors, their estates and their creditors". The order did not explain why, nor did it contain any legal analysis, though it did cite 11 U.S.C. § 105(a). (The bankruptcy court issued two companion orders covering international vendors and liquor vendors. Analysis of all three orders is the same, so we do not mention these two further.)

Kmart used its authority to pay in full the pre-petition debts to 2,330 suppliers, which collectively received about $300 million. This came from the $2 billion in new credit (debtor-in-possession or DIP financing) that the bankruptcy judge authorized, granting the lenders super-priority in post-petition assets and revenues. See In re Qualitech Steel Corp., 276 F.3d 245 (7th Cir.2001). Another 2,000 or so vendors were not deemed "critical" and were not paid. They and 43,000 additional unsecured creditors eventually received about 10¢ on the dollar, mostly in stock of the reorganized Kmart. Capital Factors, Inc., appealed the critical-vendors order immediately after its entry on January 25, 2002. A little more than 14 months later, after all of the critical vendors had been paid and as Kmart's plan of reorganization was on the verge of approval, District Judge Grady reversed the order authorizing payment. 291 B.R. 818 (N.D.Ill.2003). He concluded that neither § 105(a) nor a "doctrine of necessity" supports the orders.

Appellants insist that, by the time Judge Grady acted, it was too late. Money had changed hands and, we are told, cannot be refunded. But why not? Reversing preferential transfers is an ordinary feature of bankruptcy practice, often continuing under a confirmed plan of reorganization. See Mellon Bank, N.A. v. Dick Corp., 351 F.3d 290 (7th Cir.2003). If the orders in question are invalid, then the critical vendors have received preferences that Kmart is entitled to recoup for the benefit of all creditors. Confirmation of a plan does not stop the administration of the estate, except to the extent that the plan itself so provides. Compare In re Hovis, 356 F.3d 820 (7th Cir.2004), with In re UNR Industries, Inc., 20 F.3d 766 (7th Cir.1994). Several provisions of the Code do forbid revision of transactions completed under judicial auspices. For example, the DIP financing order, issued contemporaneously with the critical-vendors order, is sheltered by 11 U.S.C. § 364(e): "The reversal or modification on appeal of an authorization under this section to obtain credit or incur debt, or of a grant under this section of a priority or a lien, does not affect the validity of any debt so incurred, or any priority or lien so granted, to an entity that extended such credit in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and the incurring of such debt, or the granting of such priority or lien, were stayed pending appeal." Nothing comparable anywhere in the Code covers payments made to pre-existing, unsecured creditors, whether or not the debtor calls them "critical." Judges do not invent missing language.

Now it is true that we have recognized the existence of a longstanding doctrine, reflected in UNR Industries, that detrimental reliance comparable to the extension of new credit against a promise of security, or the purchase of assets in a foreclosure sale, may make it appropriate for judges to exercise such equitable discretion as they possess in order to protect those reliance interests. See also In re Envirodyne Industries, Inc., 29 F.3d 301, 304 (7th Cir.1994). Thus once action has been taken to distribute assets under a confirmed plan of reorganization, it would take some extraordinary event to turn back the clock. These appeals, however do not question any distribution under Kmart's plan; to the contrary, the plan (which was confirmed after the district court's decision) provides that adversary proceedings will be filed to recover the preferences that the critical vendors have received. No one filed an appeal, which means that it is appellants in this court that now wage a collateral attack on the plan of reorganization.

Appellants say that we should recognize their reliance interests: after the order, they continued selling goods and services to Kmart (doing this was a condition of payment for pre-petition debts). Continued business relations may or may not be a form of reliance (that depends on whether the vendors otherwise would have stopped selling), but they are not detrimental reliance. The vendors have been paid in full for post-petition goods and services. If Kmart had become administratively insolvent, and unable to compensate the vendors for post-petition transactions, then it might make sense to permit vendors to retain payments under the critical-vendors order, at least to the extent of the post-petition deficiency. Because Kmart emerged as an operating business, however, no such question arises. The vendors have not established that any reliance interest — let alone any language in the Code — blocks future attempts to recover preferential transfers on account of prepetition debts.

Handleman Company, which received $49 million as a critical vendor, makes a different procedural objection: that the district court's order does not affect it because Capital Factors' notice of appeal did not name Handleman as an appellee. Handleman was not a "party" in the district court and, consistent with the due process clause of the fifth amendment, cannot be bound by the district judge's decision — or so it says. We permitted Handleman to intervene in this court. Thus it is a party today and will be bound by our decision, so it is hard to see why it matters whether the district judge's resolution would have had independent effect.

Notices of appeal in bankruptcy must name "all parties to the judgment, order, or decree appealed from". Fed. R. Bankr.P. 8001(a)(2). Handleman was not a "party" to the critical-vendors order; Kmart was the sole party at the time. Kmart filed an ex parte application that did not specify any particular creditor. It had notified only 65 creditors of its impending request, and none of these was among the 2,000 vendors to be left high and dry. The bankruptcy judge's order likewise did not identify any creditor that acquired rights, for no creditor acquired rights. All the order did was authorize Kmart to pay any vendor that Kmart in its discretion deemed "critical." The party that Capital Factors had to name thus was Kmart itself, and this it did. If the lack of personal notice about the proceedings before the district judge deprived Handleman of due process, then Kmart's application to the bankruptcy judge deprived about 47,000 unsecured creditors of due process! That would render the critical-vendors order void, and Handleman would be worse off — for then it would have to repay the money even if the order's entry...