KMART VENDOR PAYMENT RULING STANDS 2004-11-22 (1)

Joanna Ramey

WASHINGTON -- The U.S. Supreme Court declined to intervene last week in a lower court ruling that said Kmart, Troy, Mich., after filing for bankruptcy in 2002, erred in paying debts owed to suppliers deemed crucial to keeping the discount chain open.

The high court left intact a February decision by the U.S. Seventh Circuit Court of Appeals, based in Chicago, which found Kmart discriminated against vendors that weren't on the retailer's list of "critical vendors" owed immediate payment.

"This is important because most [federal] courts have been flexible to use critical vendor status to pay pre-bankruptcy petition obligations," said New York bankruptcy attorney Alan Miller, who was not involved in the case.

The Seventh Circuit is the only federal appeals court to rule against the common practice of a company that has filed for bankruptcy to first pay suppliers it needs to stay in business. The court didn't quash the practice entirely, setting up a rigorous three-part test that could be used to determine if a vendor could be deemed vital to business.

The test requires that a vendor be crucial to a company's reorganization, and that the vendor would otherwise refuse delivery without having earlier debts paid. Other creditors also cannot be adversely affected by being excluded from the critical vendor list, the appeals court said. It concluded that Kmart was given too much leeway by a lower court to decide on its own which vendors were crucial.

The Supreme Court did not comment on refusal to consider an appeal.

Kmart is required to request rebates from some 2,330 suppliers that were paid a total of $300 million. The remaining 2,000 secured creditors and some 43,000 unsecured creditors already have received about 10 cents on the dollar for their debts, mostly in stock for the reorganized Kmart.

It is unclear how the rebates might take place or former debts owed noncritical vendors might be affected. A Kmart spokesman said the company had no comment.