Bankruptcy / 3 min read
We have recently been dealing with critical vendor/critical supplier issues in bankruptcy cases and specifically critical trade vendor agreements. This article examines what those agreements are, why they may be important and certain issues to be aware of before agreeing to sign a trade agreement.
What is a Critical Vendor agreement? Debtors in Chapter 11 cases often have a group of important/critical suppliers of goods and services. These vendors may supply goods and services that are specific to the debtor’s business, support difficult to reach locations, and/or are governed by agreements on terms favorable to the debtor. When a bankruptcy is filed, the debtor owes money, often substantial sums of money, on account of pre-bankruptcy work to this group of critical vendors. In turn, the debtor may find it difficult and/or more costly to try and replace these vendors and/or vendors may not be willing to continue their work, or commence new work, because of the pre-bankruptcy claims that are unpaid and the additional risk of payment working for a company in bankruptcy. A critical vendor agreement seeks to bridge these issues by outlining the terms and conditions upon which a debtor will pay for some of the pre-bankruptcy amounts owed, and the vendor in turn agrees to continue working on the same terms as existed when the bankruptcy case was filed (in other words, it seeks to prevent a vendor from changing terms/prices because the debtor is in bankruptcy).
Why may a Critical Vendor Agreement be important? Once in bankruptcy, a debtor cannot pay any pre-bankruptcy claims outside of a court-approved plan unless there is a court order permitting such payment. A Critical Vendor motion and agreement is often the best and quickest way for vendors to get paid for their pre-bankruptcy work within the framework of the Bankruptcy Code. We often see in large Chapter 11 cases, a debtor seeking special relief, both on an immediate, interim basis, and on a final basis, to pay critical vendors, along with parties that have filed, or may file, liens (for example, mechanics and materialmen’s’ lien, warehouse liens, other liens recognized by applicable law). This motion is often referred to as a “critical vendor” motion. While the identity of any specific critical vendor is not disclosed, there is generally a maximum budget amount the debtor has available to try and negotiate Critical Vendor agreements. Even if you as a vendor have filed liens, or have lien rights, those rights are often subject to existing liens and mortgages in favor of senior secured creditors and, in the absence of signing a trade agreement, you are then faced with litigation to determine your lien claim, and importantly, lien priority versus the senior creditors. This type of litigation is often expensive and difficult to predict specific outcomes. These litigation issues need to be evaluated when comparing a specific amount being offered to be paid, even if that amount is not payment in full.
Issues to be aware of. Critical vendor trade agreements, while offering an opportunity for vendors to be paid now, have a number of caveats or issues that need to be evaluated. As noted above, often the claim amount to be paid is less than the full amount even if there are no disputes as the underlying amount owed. The debtor is using the leverage of prompt payment now to negotiate payment of less than what they owe. A typical claim agreement includes waiver/release of any unpaid pre-bankruptcy amounts, costs, interest and fees that may be applicable, along with a waiver/release of any lien notices or filed liens. Further, as described above, the typical trade agreement “locks in” contract terms, including pricing so that in exchange for prompt payment of a substantial portion of your claim, you are agreeing to continue to provide goods/services on the same terms as existed pre-bankruptcy. You are generally prevented from increasing pricing during the bankruptcy case due to the unpaid sums and increased risk of working for a debtor in bankruptcy. And while the Bankruptcy Code provides some protections for new post-bankruptcy work, it is not risk free but you are prevented from increasing prices/terms to compensate for that risk. Lastly, the typical trade agreement is very one-sided and only addresses breaches/obligations by the trade vendor. We often add language to make the trade agreement more balanced.
Overall, while critical vendor agreements may be of benefit and provide a pathway for prompt payment of a substantial portion of what a debtor owes, there are trade-offs that need to be considered.