What’s A Critical Vendor In A Chapter 11 Case?
When a company files for Chapter 11 bankruptcy, just like with any kind of bankruptcy, the debtor cannot simply pay some creditors, and not others. This is prejudicial to the creditors who were not paid.
Why are Some Vendors so Important?
The problem is that a business has some vendors that it absolutely needs to maintain relationships with in order to continue operating the business. And since Chapter 11 bankruptcy is a plan to reorganize the business, it is vital that certain vendors get paid in full if they are essential to the operation of the business.
Otherwise, the vendor can just leave—it can opt to just stop doing business with a Chapter 11 debtor, unless there is some contractual obligation that says otherwise.
In fact, paying a critical vendor is vital to the claims of all creditors—if the business can’t survive and make money, it can’t pay the claims by higher priority creditors in the Chapter 11 bankruptcy, and as such, nobody gets paid, and the business could go under.
Unsecured Creditors and Proving Critical Vendor Status
But often, a critical vendor is nothing more than an unsecured creditor—a low priority creditor that normally would receive little or nothing in a bankruptcy case.
A debtor in Chapter 11 case can petition the court, and ask the judge for permission to pay the critical vendor its claims in full. In return for being paid in full on its claims, the critical vendor—who may normally not be paid anything—must agree to continue to provide the needed goods or services, at the same price as it was previously supplying the goods or services.
Every bankruptcy court uses a slightly different test to see if a creditor is a critical vendor, but generally, the test is:
- Whether the business dealings between the debtor and the critical vendor are indispensable to the operation of the business
- Whether not paying the vendor would create a harm to the business that would be much greater than if the vendor gets paid in full;
- Whether there is no other way to pay the claim
Critical vendor motions are often filed at the outset of a Chapter 11 bankruptcy case. The motions are usually filed by the debtors, although creditors can file them as well.
Often, multiple creditors vie for critical vendor status. Debtors can use this as a bargaining tool, to negotiate favorable post-bankruptcy terms for goods and services these vendors may provide.
Vendors who want critical vendor status have to be careful. They need to assert their status as a critical vendor, without threatening. A threat to cut off goods, services, terminate contracts, or take an adverse action against the debtor, can be seen as a collection attempt, and thus, a violation of the bankruptcy automatic stay.