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Are you a critical vendor?


By James B. Angell

What is a critical vendorAfter a chapter 11 bankruptcy is filed, the debtor often needs goods or services from its vendors that are critical to the debtor’s ability to stay in business. Although the general rule is that claims that arose before the case was filed (often called “prepetition claims”) may not be paid until the debtor has a confirmed bankruptcy plan. Bankruptcy judges will sometimes enter orders that allow the debtor to pay prepetition claims of “critical vendors”, on the condition that the vendors agree to continue to provide goods and services on credit after the case is filed.

Is it good to be a critical vendor? Most creditors who don’t have collateral to look to for payment of their claims will only receive payment against their claims once a chapter 11 plan has been confirmed at the end of the case. This can mean years of waiting for payment and frequently means receiving only a fraction of the amount owed, if anything. A vendor must make a decision as to whether to continue to extend credit to the debtor in light of the bankruptcy filing or to lose the debtor’s business. Being a critical vendor allows a creditor to be paid shortly after the case is filed, either part of the claim or payment in full, on the condition that the vendor must continue to provide credit terms to the debtor.

It is good to be a critical vendor if you have a large claim against the debtor and the credit terms under which you must provide goods or services are not overly broad and are properly limited. How you will be treated will depend on your relative value to the debtor, as well as how you negotiate with the debtor.

What is the procedure? The debtor will generally file a motion for authority to pay critical vendors on the same day that the bankruptcy case is filed. Frequently, the debtor has negotiated with creditors who have accounts receivable or other cash-like assets as their collateral in advance of the bankruptcy filing. Those creditors generally want the debtor to continue in operations because their collateral is more valuable if the debtor is a going concern, rather than if the debtor’s assets are simply sold to pay creditors. The creditors agree to carve out specific amounts from their collateral to pay the critical vendors.

The Bankruptcy Court will then allow the debtor to pay critical vendors up to a specified amount as a temporary measure. The Court will set the motion for a final hearing after an objection period.

Once the interim order has been entered, the debtor will send a copy of the order to vendors it deems to be its critical vendors with a letter agreement for the critical vendor to sign stating the terms on which the payment will be made and credit is to be extended.

Once the Court has held the final hearing, it will issue a final order allowing payment of critical vendors. The final order will sometimes increase the total amount that can used to pay critical vendors from the amount allowed in the interim order.

What should I do? The answer to this question is complicated and depends on the facts. It is important to obtain legal counsel to assist you with the process so that you do not unwittingly provide overly generous credit terms or squander any leverage that you might have.

  • Assess your leverage. A vendor whose goods or services cannot be easily replaced in the market has greater leverage than a vendor that sells generic products or services that can be purchased from a competitor.
  • Determine the credit terms you are willing to provide after the bankruptcy filing. You will want to address due dates, default dates, discounts, interest on late payments, and caps on credit among other things.
  • Call your lawyer. Your lawyer should review the order and determine what is required by the order. The letter agreement offered by the debtor is often much more generous to the debtor than the order and you may find yourself at risk for additional losses in the future if you sign the letter agreement offered by the debtor.
  • Strategize. Don’t settle too soon or too cheaply. If the debtor indicates that it will provide you with a percentage of your claim now and, at its discretion, a greater percentage of your claim later, you should assume that you will only receive the first payment. The debtor wants to pay you as little as possible, as it is unlikely you will be paid in full through the bankruptcy plan. In some cases, it may be in your interest to wait until the final order is signed to get as high a payment as possible on your claim.
  • Counter-offer. Your lawyer should assist you in making a counteroffer to the letter agreement. Only by negotiating will you get the best deal. What are the Risks? Once signed, the letter agreement will be in the nature of a contract. If you fail to provide credit as provided in the letter agreement, frequently, the debtor can require you to repay the critical vendor payment. You want to be sure that you can stop extending credit once a cap is reached or the debtor fails to make payments as agreed. If the credit terms are overly general, you may be forced to continue to wait for payment for goods or services provided to the debtor after the case was filed. On the other hand, you may risk both the critical vendor payment and the debtor’s ongoing business if you are too aggressive in your negotiations. This again may depend on the strength of your negotiating position – some vendors can require payment of their pre-bankruptcy claims in full because the debtor cannot survive without them; others may be lucky to receive what the debtor offers because the debtor could order a similar good from your competitor. In Conclusion. It is generally a good thing to receive a letter from the debtor identifying you as a critical vendor – it provides you with the chance to have your claims paid early and in a higher amount. However, there are strings attached to the payment and negotiating with the debtor should be done with the assistance of an experienced professional.

         If you have questions, or need assistance please contact James B. Angell at (919) 821-7700 or email at


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