In a World of Reimagination: A New York Bankruptcy Court Rejects a Creditor’s Hindsight Approach to the Critical Vendor Defense

In Devices Liquidation Trust v. KMT Wireless LLC (In re Pers. Commc’ns Devices LLC), the U.S. Bankruptcy Court for the Eastern District of New York denied a critical vendor’s motion for summary judgment that advocated for a “hindsight extrapolation” approach to the critical-vendor defense.[1]

Personal Communications Devices LLC (PCD) and Personal Communications Devices Holdings LLC (“Holdings” and, collectively with PCD, the “debtors”) were wireless telecommunications companies that filed for chapter 11 relief.[2] PCD sold, repaired and refurbished various wireless communications devices and accessories.[3] Pre-petition, more than 97 percent of PCD’s warranty repair work was performed by third parties, including KMT Wireless LLC (“KMT”).[4]

On the day following the petition date, the debtors filed both a motion to sell substantially all of their assets and a customer programs motion (the “CP Motion”), in which the debtors sought to preserve PCD’s business until the proposed sale could be consummated.[5]

In the CP Motion, the debtors asserted that unnamed repair service vendors, later agreed to include KMT, which were owed unspecified pre-petition amounts, were critical to PCD’s ongoing operations, particularly with respect to PCD’s ability to honor warranties and refurbish devices.[6] The debtors maintained that the loss of any one repair service vendor would severely disrupt PCD’s business and the proposed sale.[7] The debtors did not seek to waive any chapter 5 causes of action against any repair service vendors in the CP Motion.[8]

The court granted interim and final orders approving the CP Motion, and those orders allowed but did not require the debtors to honor, maintain and administer pre-petition customer programs.[9] In effect, the court’s orders authorized the debtors to pay repair service vendors on account of their pre-petition claims in order to facilitate such vendors’ continued provisions of post-petition services, for which the debtors were also authorized to pay.[10]

KMT was paid its pre-petition invoices, continued to perform services for the debtors post-petition, and was paid for the post-petition services it rendered.[11]

The debtors’ proposed sale was eventually consummated, and a liquidating plan was confirmed.[12] The plan trust subsequently commenced an adversary proceeding, in which it sought to avoid and recover preferential transfers made to KMT.[13]

KMT argued, in a case of first impression in the Second Circuit, that because the CP Motion entitled it to critical-vendor protection, the court should engage in a hindsight, hypothetical-driven analysis and ask itself what it would have done had the debtors asked the court to waive preference liability as to KMT in the CP Motion.[14] KMT argued that if the court did not deem a response to this inquiry too speculative, such that the record showed that the court would have approved the preference payments had they been included in the CP Motion, the critical-vendor defense should apply and summary judgment should be granted in its favor.[15]

In its synthesis of the case law, the court observed that other courts had been unreceptive to critical-vendor defenses raised in preference actions where (1) there had been no court-mandated payment of the amounts at issue, (2) the court had not previously approved a release of preference liability, or (3) the debtor had not sought to assume and assign any executory contract with the vendor such that the cure provisions in § 365 would have been triggered.[16] Applying these principles, the court noted that the debtors had not been required by the court’s CP Motion orders to pay any critical vendors, there had been no mention of a waiver of preference liability in the CP Motion, and the debtors were not attempting to assume and assign any contracts with KMT such that they would be required to cure pre-petition defaults.[17] Three creditors had also filed declarations in which they asserted they would have objected to a preference waiver had it been included in the CP Motion.[18]

In rejecting KMT’s theory of the critical-vendor defense and denying KMT’s motion for summary judgment, the court explained that it was “not prepared to reimage what it might have done had it been asked to provide significantly different relief on notice to parties-in-interest with an opportunity to object and be heard.”[19]

Importantly, Personal Communications Devices teaches that critical-vendor motions should be detailed, transparent and request all related relief therein. It appears unlikely that a court will entertain a creditor’s request for retroactive application or expansion of critical-vendor protection absent explicit support from a court order or an applicable Code provision.[20]