Q: “I received ‘critical vendor’ documents from a company in bankruptcy. What is the legal significance of these documents, and what are my options?”
June 24, 2020
Answered by Sean Williams and Harold Israel
Due to the COVID-19 pandemic, not only are the number of corporate bankruptcies on the rise, but companies are filing more quickly. In these cases, unlike the more typical case where a company better plans, many corporate debtors are unlikely to have kept all their major suppliers current. Therefore, the need to pay “critical vendors” during the pendency of the bankruptcy case is likely to increase, and it is important that creditors understand this concept.
Generally, once a company files bankruptcy, it cannot pay any debt that arose prior to the filing date. However, case law and bankruptcy practice have evolved to allow bankrupt companies to make payments to certain “critical vendors” (those companies whose services are absolutely necessary to the ongoing operation of the debtor’s business), in exchange for those vendors providing favorable credit terms. A critical vendor letter is often accompanied by a vendor agreement, which is usually approved by the bankruptcy court. If you receive a critical vendor letter and agreement, there are several things to review and keep in mind.
- Amount. Occasionally, a bankrupt company may offer to pay 100% of a vendor’s prepetition claim. Recently, however, many companies are paying less than 100% of a vendor’s prepetition claim. Regardless of the amount offered to a vendor, it is usually in the vendor’s best interest to take the money when offered, given the risks associated with bankruptcy and potential low recoveries for unsecured creditors.
- Payment Terms. Companies in bankruptcy usually make critical vendor payments in a single lump sum amount paid shortly after the critical vendor agreement is approved, and an order is entered. In other cases, the debtor may agree to make payments over a longer period, which can extend to several months into the case. In the event a debtor seeks to pay over a longer period of time, a vendor must determine based on all available information whether it believes that the debtor will be able to stay financially viable and continue operating in chapter 11 to determine the potential risk of nonpayment of both the prepetition and post-petition amounts.
- Credit Terms. Vendor agreements will require a vendor to continue providing goods to the debtor under the terms of the pre-filing agreement between the debtor and the vendor or other terms favorable to the debtor.
- Negotiability. Generally, the terms of the critical vendor agreement are non-negotiable as they have been approved by the bankruptcy court. However, if a company is offering to pay less than 100% of a vendor’s claim over time, the amount and timing of payments may be negotiable. Lastly, you may be able to negotiate the reinstatement of any rights you gave up in the agreement upon a default by the debtor. You should: (i) ensure that payment is due on a date certain (as opposed to “monthly”) and (ii) consult your attorney if you wish to negotiate the terms of a critical vendor agreement.
- Releases. A vendor may be required to give up certain rights to receive critical vendor payments. For example, in exchange for payment, the critical vendor may give up its right to file a proof of claim for the remainder of its prepetition claim if its claim is not paid in full. If you are worried about potential releases in a critical vendor agreement, you should contact your attorney.
- Preferences. If you received a payment in the 90 days before the bankruptcy case was filed, commonly referred to as preference payments, you may still get sued to return those payments, even if you are designated as a critical vendor.
Understanding this process will allow you to make a more informed decision as to what is best for your business.