Foamex International Inc. (“Foamex” or “Debtors”), located in Media, Pennsylvania, filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware on February 18, 2009.  Foamex is one of the largest manufacturers of polyurethane and polymer foam products. (Read Foamex’s Declaration in Support of First Day Motions here).  Foamex generated $980 million in revenue for the four quarters ending in September 2008.  Foamex operates facilities in the United States, Canada, Mexico and China and manufactures goods that fall into four categories:  technical products, foam products, automotive products and carpet cushion products.

The Critical Vendor Motion

One of the first motions Foamex filed in its bankruptcy was a Motion to Honor Prepetition Obligations with Critical Vendors (the “Critical Vendor Motion”).  Pursuant to the Critical Vendor Motion,  Foamex sought an Order from the Court allowing it to pay prepetition obligations to critical vendors up to $29 million.  Foamex sought to pay the prepetition invoices for those vendors that agree to deal with it during bankruptcy under “normal trade terms.”

In preparing for bankruptcy, the Debtors created a list of vendors they deemed “critical.”  According to Debtors, for a vendor to be categorized as a critical vendor, it had to meet four criteria.  These criteria include supplying “essential” products or services; providing products or services that cannot be replaced;  the vendor indicated that it will not work under similar terms postpetition unless its prepetition invoices are paid; and, the vendor is not contractually obligated to continue working with the Debtors.

Foamex sought relief under the Critical Vendor Motion under section 105(a) of the Bankruptcy Code and pursuant to the “necessity of payment” doctrine.  Under 11 U.S.C. 105(a), bankruptcy courts may invoke equitable powers to “issue any order, process, or judgment that is necessary to carry out the provisions of this title.”  To support its use of the necessity of payment doctrine, Foamex cited the Court’s decision in In re Just for Feet, Inc., 242 B.R. 821, 826 (D. Del. 1999) (holding that the doctrine requires the debtor to show that payment of the prepetition claims is critical to the debtor’s reorganizaton).

The Lenders’ Objection

Foamex’s Second Lien Lenders objected to the Critical Vendor Motion, arguing that the necessity of payment doctrine applied to railroad bankruptcies and did not apply to non-railroad bankruptcies.  The lenders cite In re Kmart Corp. in their Objection where the 7th Circuit viewed the necessity of payment doctrine as “just a fancy name for a power to depart from the Code.”  359 F.3d 866, 871 (7th Cir. 2004).  By “depart from the Code,” the 7th Circuit was recognizing a string of decisions that find that the Bankruptcy Code does not permit a debtor to make distributions to unsecured creditors unless a plan of reorganization has been presented and confirmed.

Despite the Lenders’ Objection, the Court ultimately entered an Order approving Debtors’ Motion.  The Lenders, however, cannot be totally dissatisfied with the result.  Instead of granting Foamex critical vendor relief up to $29 million, the Court entered an Order granting relief up to $10 million. As is common in bankruptcy, the parties may have reached an agreement on the Motion prior to the hearing.

Second Time in Bankruptcy

Finally, it should be noted that Foamex previously filed for bankruptcy in Delaware in September 2005.  Under its first bankruptcy, Foamex confirmed a plan of reorganization on February 12, 2008.  As stated in Debtors’ Critical Vendor Motion, Foamex experienced one of the “best years in the history of the Debtors” in 2007.  Debtors performance was so strong toward the end of its first bankruptcy that they revised the plan of reorganization to include paying unsecured claims in full.  What Debtors were not aware of at the time was that the stronger than anticipated revenue in 2007 was the result of a temporary reduction in supply in 2005 following a strong hurricane season.