Article

Factual Summary: Retailer applied for various letters of credit payable to suppliers. When Applicant filed for bankruptcy protection, it sought authority to repay certain "critical vendors," certain foreign vendors, and issuers of prepetition LCs. Over the objection of a factoring agent for apparel suppliers, the bankruptcy court granted Applicant's motion, stating:

Because the foreign vendors are integral to the reorganization of this Debtor and the Court already ruled on the payment of certain foreign vendors as part of the critical vendors motions and I believe that this is just a component of that particular transaction, and further finding that I may be inconsistent if I do not grant the relief that is requested here, I am going to go ahead and sign your order authorizing the reimbursement of the obligations to the issuers of Letters of Credit.

Prior to a hearing on the Factoring Agent's appeal of that order, Applicant substantially made the payments. On appeal, the district court reversed the order.

Legal Analysis:

1. Insolvency; Doctrine of Necessity: Applicant argued that the bankruptcy court's orders were justified by the equitable doctrine of necessity, which justifies "the pre-plan payment of prepetition claims of creditors who threaten to withhold goods or services believed critical to the debtor's continued viability and reorganization." Reviewing a series of Seventh Circuit decisions, the district court held "that the bankruptcy court did not have either the statutory or equitable power to authorize the pre-plan payment of prepetition unsecured claims."

2. Insolvency; "Equitable Mootness": Applicant argued that because it had substantially made the payments approved by the bankruptcy court "the parties receiving the payments have already acted in reliance on them" and that the reversal of those orders would be "imprudent and inequitable." The district court noted, however, that no bankruptcy plan had yet been confirmed and so "it is not too late to order the monies paid be returned."

3. Insolvency; Adequate Protection of Secured Reimbursement Claims: In its supplemental brief, Administrative Agent argued that the LC order should not be reversed because issuers "had statutory liens in the documents and the proceeds thereof presented by the foreign vendors to obtain payment under the letters of credit, and the issuers were entitled to adequate protection of those liens under § 361 of the [Bankruptcy] Code." The court found, however, that adequate protection was not argued before the bankruptcy court and so "there is an insufficient basis in the record to allow a finding that the payments to the issuers constituted adequate protection under § 361 of the Bankruptcy Code."

[JEB/bso]

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