Opinion
Case No. 02-82003-SSM.
April 19, 2004
James P. Campbell, Esquire, Campbell Miller Zimmerman PC, Leesburg, VA, Counsel for the Plan Monitoring Committee.
Malcolm Mitchell, Esquire, Vorys, Sater, Seymour Pease, L.L.P., Alexandria, VA, Counsel for Hartzell Propeller, Inc.
Dylan G. Trache, Esquire, Wiley Rein Fielding, LLP, McLean, VA, Counsel for the DANA Liquidating Trust.
Jack Frankel, Esquire, Attorney-Advisor Office of the United States Trustee, Alexandria, VA.
MEMORANDUM OPINION
A hearing on remand from the District Court was held on January 9, 2004, on the renewed motion filed by the debtor in possession on August 23, 2002, to authorize "critical vendor" benefits to Hartzell Propeller, Inc. ("Hartzell"). Hartzell and the Plan Monitoring Committee were present by counsel. Neither the debtor in possession nor its successor, the DANA Liquidating Trust, were present.
The Plan Monitoring Committee is the renamed, post-confirmation successor to the Official Committee of Unsecured Creditors. For ease of reference, both incarnations of the committee will be referred to as the "creditors' committee."
Background
The debtor, Dornier Aviation (North America), Inc. ("DANA"), provided sales and maintenance support in the United States to its indirect parent, Fairchild Dornier GmbH ("FDG"), an aircraft manufacturer now in insolvency proceeding in Germany. Following the commencement of the insolvency proceedings against the German parent, a number of DANA employees were laid off. On April 24, 2002, seventeen of those employees, asserting claims for unpaid severance and vacation, filed an involuntary petition against DANA. The debtor did not contest the petition, and an order for relief, as well as an order converting the case to chapter 11, was entered on May 20, 2002.
An involuntary petition was also filed against Fairchild Dornier Corporation, the parent holding company of both DANA and FDG.
Among the FDG aircraft for which DANA provided parts and maintenance support was the Dornier 328 short-haul turboprop. The propellers used on the Do 328 are manufactured by Hartzell, which is the only source for them in the United States. Hartzell is also the only FAA-certified repair shop in the United States that is authorized to perform certain types of maintenance (in particular, ultrasound testing) of the propeller blades. Hartzell had no contract with the debtor requiring it to supply propellers or maintenance. Soon after the order for relief was entered on May 20, 2002, Hartzell contacted the debtor and demanded that its prepetition invoices in the amount of $99,409.08 be paid as a condition of continuing to do business with the debtor. Additionally, Hartzell had received $540,818 in payments from DANA in the 90-day period prior to the filing of the involuntary petition and during the "gap" period between the filing of the petition and the entry of the order for relief and demanded assurance that it would not be the target of avoidance actions with respect to those payments. The debtor agreed to file a motion requesting authority to pay Hartzell's prepetition claims and to waive any avoidance claims.
The debtor's "Motion for Authority to Make Payment to Critical Vendor Hartzell Propeller, Inc. in Satisfaction of Unsecured Pre-Petition Obligations and Resolve Potential Preference Actions" was filed on July 18, 2002 and was opposed by the creditors' committee. An evidentiary hearing was held on August 16, 2002, at which the debtor's chief financial officer, Christopher Peter Lowe, and its director of flight operations, Benjamin Church White, testified. Additionally, testimony was received from Hartzell's co-owner and co-president, James W. Brown, III.
At the conclusion of the hearing, the court denied the motion to grant "critical vendor" benefits on the ground that there was no assurance of any benefit to the estate, since Hartzell was under no contractual obligation to provide parts or service to DANA, and in theory could simply cease to do business with the debtor notwithstanding the payment of its prepetition claim and the release of the avoidance claims. Following the hearing, DANA and Hartzell negotiated and entered into a Parts and Services Agreement dated August 22, 2002. Under the agreement, Hartzell would provide parts and maintenance services, on a cash-with-order basis, through December 31, 2003, at current market prices and at the same discounts as Hartzell provided to other aircraft maintenance support companies. The agreement would be renewed for one additional year unless either of the parties notified the other party of non-renewal on or before October 31, 2003. Relevant to the present proceeding, the agreement contained the following contingency:
5. Contingency. Hartzell shall have no obligations to DANA or otherwise under this Agreement unless and until an Order granting Hartzell Critical Vendor Status is entered by the Bankruptcy Court . . . and DANA pays Hartzell in full its outstanding account balance. In the event Hartzell is not granted such status by the Bankruptcy Court . . . then this Agreement shall be of no force or effect as against Hartzell.
Following execution of the agreement, the DANA filed a renewed motion to approve the critical vendor benefits. A hearing on the renewed motion was held on September 9, 2002. At the conclusion of the hearing, the court ruled from the bench that DANA had presented sufficient evidence to support the payment of Hartzell's prepetition claim and the waiver of the avoidance claims under what is generally termed the "necessity of payment" rule. Specifically, the court found that "the reasonable likely result" of not granting the motion "is that this whole line of business of the debtor's [i.e., support and maintenance of the 328 turboprop aircraft] would be basically wiped out, would eliminate the ability to sell it off separately as part of a going-concern sale or to use it to in effect fuel a reorganization of the debtor." An order reflecting that ruling was entered on the docket on September 11, 2002. DANA then paid Hartsell's $99, 409.08 prepetition claim by check dated September 19, 2002. On September 23, 2002, the creditors' committee filed a timely appeal of the order to the United States District Court for the Eastern District of Virginia.
While the appeal was pending before the District Court, DANA filed a proposed plan of liquidation and disclosure statement in November 2002 revealing that it had abandoned its efforts to effect a going-concern sale of its business and now proposed to pay creditors by liquidating its inventory and other assets. The creditors' committee brought this development to the District Court's attention. On February 7, 2003, the District Court issued a memorandum opinion and order vacating the order authorizing the critical vendor benefits to Hartzell and remanding for further consideration in light of the changed circumstances. The District Court ruled that a bankruptcy court could, in the exercise of its equitable powers, authorize payment to a critical vendor of its prepetition claim under the "necessity of payment" exception. The District Court also ruled, however, that the propriety of such equitable relief should be revisited if the underlying facts supporting the relief changed significantly, and it held:
[T]he factual circumstances which supported the equitable decision of the bankruptcy court have now fundamentally changed, such that the basis of the bankruptcy court's equitable decision has collapsed. Specifically, because DANA no longer intends to sell its business as a going concern or to reorganize, pre-plan payment of the pre-petition debt is no longer "critical" to the debtor, at least for the reasons cited by the bankruptcy court in its September 9, 2002 decision.
Official Committee of Unsecured Creditors v. Dornier Aviation (North America), Inc. (In re Dornier Aviation (North America), Inc.), No. 02-1633 A, slip op. at 9 (E.D. Va. filed February 7, 2003).
Three days following the District Court's decision, a consolidated hearing was held on confirmation of the DANA's amended liquidating plan and on approval of an asset sale to an entity known as M7 Aerospace, LP. Under the asset purchase agreement, M7 would purchase parts and equipment related to the Do 328 turboprop and its sister aircraft, the 328JET, from DANA for $6 million. Among the listed assets being sold to M7 was the "benefit" of the post-petition parts and service agreement between DANA and Hartzell. The plan of liquidation provided for the transfer of DANA's assets and avoidance claims to a liquidating trust and for the continuation of the creditors' committee — renamed the "Plan Monitoring Committee" — for specific stated purposes, including the appeal of the order that had authorized the critical vendor benefits to Hartzell. The estimated payout to unsecured creditors under the plan of liquidation is between 3 and 41%, depending on the ultimate outcome of the committee's challenge to the $146 million claim of FDG. Following the hearing, orders were entered on February 14, 2003, approving the sale of the 328 assets to M7 and confirming the plan of liquidation. No appeals were taken from either order.
In the meantime, Hartzell noted an appeal of the District Court's order to the United States Court of Appeals for the Fourth Circuit, which eventually dismissed the appeal in May 2003, on jurisdictional grounds. At the remand hearing before this court, the DANA Liquidating Trust, as successor to the debtor, did not appear to prosecute the critical vendor motion. Hartzell, as the beneficiary of the now-vacated order, did appear and made legal argument but did not present any evidence. In particular, no evidence was presented as to the amount, if any, of services actually provided by Hartzell to DANA (or later M7) following entry of the order approving the critical vendor payment or of any detriment to Hartzell from having provided such services.
Discussion A.
As noted, this court's order authorizing the payment of Hartzell's nearly $100,000.00 prepetition claim and the waiver of nearly half a million dollars in potential avoidance claims was vacated by the District Court on the ground that the factual underpinning for the order had "collapsed" in light of DANA's changed business strategy, such that the reasons given by this court in granting the motion no longer supported a "critical" need to pay Hartzell's prepetition claim. Accordingly, the narrow issue before this court on remand is whether the facts, as they now exist, support payment of Hartzell's prepetition claim and the associated waiver of potential avoidance claims. Before reaching the merits of the motion, however, there are two threshold issues that must be addressed.
B.
The first issue is that of standing. The motion to authorize critical vendor payments to Hartzell was brought by the debtor in possession as the representative of the bankruptcy estate. Given that the DANA Liquidating Trust — which is now the representative of the bankruptcy estate — did not appear at the remand hearing, the court can only conclude that the bankruptcy estate has abandoned the motion. So far as the court can determine, no reported case has ever permitted a creditor, proceeding in its own right, to bring a motion seeking "critical vendor" status. The payment of a creditor whose continued business dealings with the debtor is "critical" to the reorganization process can be justified, if at all, only where the payment benefits the bankruptcy estate. At this time, however, no representative of the bankruptcy estate is asking for that relief. (Nor, for that matter, has M7 — as purchaser of the 328 assets — intervened to argue for such payment.) Thus, at the present time there is no "live" motion to be decided, and thus no apparent basis upon which the court may authorize payment of Hartzell's prepetition claim.
Hartzell, not surprisingly, takes the position that as the beneficiary of the now-vacated order, it necessarily has standing to assert or protect the rights conferred on it by that order. The court is frankly doubtful that a creditor who would have had no standing to bring a critical vendor motion in the first instance acquires standing to prosecute it on remand simply because it received a benefit under the order. See In re Kmart Corp., 359 F. 3d 866, 870 (7th Cir. 2004) (holding that creditor receiving payment under "critical vendor" order was not a "party" to that order for appeal purposes). But even if the court is mistaken on that point, the fact that the representative of the bankruptcy estate is no longer asking for the relief sought in the motion is certainly a factor that weights heavily against granting it.
C.
The second threshold issue is whether, as Hartzell vigorously asserts, any attack on the critical vendor order is now equitably moot, not only because Hartzell has already been paid, but more importantly because the order approving the asset sale to M7 provided for the assumption and assignment of the parts and services agreement between DANA and Hartzell.
As to the first point, the fact that the debtor in possession has already made payment to Hartzell plainly does not insulate the order from reversal or the payment from recovery. As the Seventh Circuit has recently held in a case procedurally much the same as this, the payment of critical vendor payments does not moot an appeal from the order authorizing the payments:
Appellants insist that, by the time [the district judge] acted [to reverse the bankruptcy judge's order authorizing the payments], 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. If the orders in question are invalid, then the critical vendors have received preferences that [the debtor in possession] is entitled to recoup for the benefit of all creditors.
Id. at 869 (citations omitted).
With respect to the asset sale, it is true that the parts and services agreement between DANA and Hartzell was specifically included among the assets to be sold to M7. However, nothing in the sale order adjudicated the status of that agreement. Everyone at the sale hearing was fully aware that the critical vendor order had been vacated by the District Court. Moreover, the confirmation order — entered at the same time as the sale order — specifically recognized the continued vitality of the committee's challenge to the critical vendor order. The debtor could convey no greater rights to M7 than the debtor itself possessed. The sales and services agreement specifically stated that it was "of no force and effect" in the absence of an order approving the critical vendor benefits sought by Hartzell. That condition was plainly not satisfied on the date the court approved the sale, for although an order had been entered, it had been vacated. Without an order approving the critical vendor benefits, there was quite simply no agreement for the debtor to assign.
This is not to say there might not be circumstances in which equity would protect a party that had relied to its detriment on a vacated order. However, Hartzell presented no evidence that would support a finding of detrimental reliance. In particular, there was no evidence of the amount of services and parts, if any, it provided to the debtor under the terms of the agreement and, more importantly, no evidence that any such services and parts were provided at a loss, or that Hartzell forwent other business opportunities in continuing to supply the debtor. As the Seventh Circuit has noted in rejecting a similar reliance argument, "[c]ontinued 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." Kmart, 359 F.3d at 870. The only time detrimental reliance would exist, the Seventh Circuit suggested in Kmart, is if the vendor was not paid in full for post-petition services. In that event, and if the debtor became administratively insolvent and unable to compensate the vendor 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." Id. No evidence has been presented in this case, however, suggesting that Hartzell was not fully paid for the services and parts, if any, that it supplied to DANA after the critical vendor order was signed. Indeed, since under the parts and services agreement the payment terms were cash-with-order, the likelihood that Hartzell was left holding the bag with respect to parts and services supplied post-petition is remote, to say the least. Thus, while Hartzell may have relied on the order, it has not shown detrimental reliance.
Moreover, Hartzell can hardly claim that the equities favor preserving the advantage it obtained over other creditors when it insisted on payment of its prepetition debt as a condition of continuing to do business with the debtor. Hartzell was the only creditor that demanded critical vendor treatment in DANA's case. It received 100% payment on account of its prepetition debt, while other unsecured creditors will receive no more than 28%, and possibly as little as 2%, of their claims. There is authority for the proposition that a creditor violates the automatic stay by demanding payment of its prepetition debt as the price of doing business with the debtor post-petition:
The goal of equal treatment in liquidation or under a plan suggests Congress would not countenance use by a general unsecured prepetition creditor of a "critical" position to force payment of a prepetition debt. Section 362(a)(6) on its face appears to prohibit such "economic blackmail." See In re Structurlite Plastics Corp., 86 B.R. 922, 932 (Bankr.S.D.Ohio 1988) ("Selective re-payment [sic] of pre-petition debt should not be authorized as a result of threats or coercion by disgruntled creditors. Such activity is violative of the automatic stay imposed by 11 U.S.C. § 362(a) and, if tolerated, would negate the fundamental principle of equality of treatment among similarly situated creditors[.]")[.]
In re CoServ, LLC, 273 B.R. 487, 494 (Bankr. N.D. Tex. 2002) (footnote omitted); see also In re Mirant Corp., 296 B.R. 427, 430 (Bankr. N.D. Tex. 2003) (issuing order placing creditors on notice that refusing to deal with the debtor by reason of nonpayment of prepetition debt, where debtor has provided guarantee of payment for post-petition deliveries, violates the automatic stay). But regardless of whether a demand for "critical vendor" treatment violates the automatic stay, it clearly amounts to economic extortion, and a creditor who engages in such conduct is hardly entitled to special consideration to protect an unwarranted advantage it may have obtained over other creditors.
D.
That leaves finally for consideration the issue which the District Court directed this court to consider on remand, namely whether adequate cause now exists to support payment of Hartzell's prepetition claim and the waiver of potential avoidance claims in exchange for Hartzell's agreement to continue supplying services and parts to the debtor. Such payment, the District Court ruled, could only be justified under the widely-recognized "necessity of payment" exception to the general rule that pre-plan payments of pre-petition debts "violates the clear policy of Chapter 11 reorganizations by allowing piecemeal, pre-confirmation payments to certain unsecured creditors." Dornier Aviation (North America), Inc., No. 02-1633 A, slip op. at 4 (quoting Official Comm. of Equity Sec. Holders v. Mabey, 832 F. 2d 299, 302 (4th Cir. 1987)). In its opinion, the District Court quoted with approval from the thoughtful test set forth by the Bankruptcy Court for the Northern District of Texas in the CoServ case:
First, it must be critical that the debtor deal with the claimant. Second, unless it deals with the claimant, the debtor risks the probability of harm, or, alternatively, loss of economic advantage to the estate or the debtor's going concern value, which is disproportionate to the amount of the claimant's prepetition claim. Third, there is no practical or legal alternative by which the debtor can deal with the claimant other than by payment of the claim. In re CoServ, LLC, 273 B.R. 487, 498 (Bankr. N.D. Tex. 2000).
Dornier Aviation (North America), Inc., No. 02-1633 A, slip op. at 7. The Seventh Circuit, in a decision issued subsequent to the District Court's opinion, suggested an alternative and simpler test of whether "the disfavored creditors were at least as well off as they would have been had the critical-vendors order not been entered." Kmart, 359 F. 3d at 874.
Applying either test to the case at hand, it is apparent that the motion cannot be granted. The debtor is no longer in business, and there is no longer any prospect of a goingconcern sale. Nor can the court find that payment of Hartzell's prepetition claim has resulted in a greater price for the 328 assets. The purchaser of those assets did not seek any abatement or adjustment of the $6 million purchase price after it learned (prior to entry of the sale order) that the order approving the critical vendor benefits to Hartzell had been vacated (thereby rendering the parts and services agreement "of no force and effect" by its own terms). The fact that the creditors' committee from the outset has opposed the payment of Hartzell's prepetition claim is rather strong evidence that the creditors do not believe that such payment leaves them "at least as well off" as if the payment were not made. Accordingly, even if the court could find that Hartzell had standing to pursue the motion for critical vendor treatment after the debtor in possession had effectively abandoned it, the court would be unable to find that the present circumstances justify granting the motion.
A separate order will be entered denying the motion to approve payment of Hartzell's prepetition claim and the waiver of potential avoidance claims against it.