Kmart’s Rocky Road: $1B Creditors Reject Bankruptcy Exit Plan

Just when Kmart thought it had bankruptcy court approval of its reorganization plan all sewn up, a few creditors are throwing up roadblocks.

There is a split among bankruptcy courts over whether the federal Bankruptcy Code permits pre-plan payments of pre-petition unsecured claims.

Chicago Bankruptcy Judge Susan Pierson Sonderby OK’d those payments to certain Kmart unsecured creditors, but Capital appealed that decision to the federal district court in Chicago. Last week, U.S. District Court Judge John Grady reversed Judge Sonderby’s decision.

In an opinion dated April 8, Judge Grady concluded that the Chicago bankruptcy court had neither the "statutory [nor] equitable power to authorize" the pre-plan payment of pre-petition unsecured claims, and sent the matter back to the bankruptcy judge for further adjudication.

The Kmart spokesman said, "Kmart has appealed Judge Grady’s ruling to the 7th U.S. Circuit Court of Appeals in Chicago. However, Kmart believes that Judge Grady’s ruling has no material effect on our confirmation of the company’s plan of reorganization."

While the reversal could have implications for how future decisions are made by bankruptcy judges, the immediate implication for Kmart is a possible delay in its desire to exit Chapter 11 as soon as possible.

According to legal documents filed by Capital Factors with the bankruptcy court, confirmation of the reorganization plan should be postponed until the court orders the vendors who received the payments to repay the $367 million. Those payments include $76 million paid to Fleming Cos. Inc., a food distributor that is now itself a Chapter 11 debtor. Capital also said the return of the $367 million would necessitate an amended reorganization plan, and consequently another vote by creditors.

Kmart has been proceeding as if it will exit Chapter 11 at the end of the month.

Julian Day, president and chief executive officer, said in court documents seeking confirmation of Kmart’s reorganization plan that the retailer over the last 15 months has rid itself of more than 950 real estate leases, and has renegotiated more than 80 leases for a cost savings of more than $12 million in annual rent concessions.

Kmart will operate 1,513 stores as a reorganized firm, with the average rent costing $3.99 per square foot, down from $4.42 before its Chapter 11 filing in January 2002. Inventory turns are projected to increase to 4.2 times from 3.7 times, according to court papers.
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