Making the Critical Vendor List
and the Trade Claims Cap
Critical Vendor Update:
By Scott E. Blakeley
The credit professional well knows that a customer's
Chapter 11 means long delays before receiving any payment on the
prepet ition account, which payment is usually but a fraction of
the claim. Indeed, it is not uncommon for the vendor to receive
stock in the reorganized debtor in exchange for its prepettion
claim. Traditionally, the vendor would file a proof of claim, perhaps
serve on the creditors' committee, and press for a meaningful payment.
Does a vendor in this situation, especially one with substantial
trade relationship, have any recourse? Fortunately, with the development
of the critical vendor doctrine, the credit professional may have
a meaningful alternative.
On occasion a vendor may be a key supplier to a customer
which files Chapter 11. Given this key supplier relationship, the
vendor often holds a sizeable unsecured claim upon the Chapter
11 filing. The vendor, selling invoice by invoice (as opposed to
long term supply contract), may elect not to continue to sell the
debtor postpetiton. However, the vendor's product or service may
be viewed by the debtor as essential to its continued operations.
In this situation the debtor may request that the
court authorize it to immediately pay the vendor's prepetition
claim, in exchange for the vendor selling to the debtor post-bankruptcy
on credit. Under the critical vendor doctrine, a vendor may find
that the product or service it provides a Chapter 11 debtor is
essential to continued operations. The uniqueness of the product
or service may give the vendor leverage in negotiating post-bankruptcy
More and more bankruptcy courts are considering a
debtor's request to treat certain vendors as critical and have
their pre-bankruptcy claims paid in exchange for postpetition trade
credit. As a bankruptcy court noted, "[p]ayment of the prepetition
claims of these vendors as set out in the Debtor's motion is necessary
to realize the possibility of a successful reorganization. . .
the Court may authorize the payment of prepetition claims when
such payments are necessary to the continued operations of the
Debtor." In re Wehrenberg, 260 B.R. 468 (Bankr. MO 2001).
The Critical Vendor Doctrine
To be classed as "critical" by a Chapter 11 customer
is usually an extraordinary result for the vendor as it means payment
in full or a substantial portion or the prepetition claim, given
the alternative of waiting, perhaps for years but for a fraction
of the prepetition claim. However, a Chapter 11 debtor's funds
available for the critical vendor class is limited, as well as
scrutinized (and perhaps objected to) by lenders, bondholders,
noteholders, a creditors' committee, the U.S. Trustee's office,
and even competing vendors who want to be elevated to critical
With some of the largest public companies filing
Chapter 11, critical vendor motions are more common - - and more
scrutinized than ever. Bankruptcy judges are now often insisting
on detailed support to pay a vendor immediately on the prepetition
claim. The judges are also granting immediate relief on an interim
basis in order to give other parties involved, such as a creditor's
committee, time to review the request.
The critical vendor doctrine may be viewed as conflicting
with a fundamental principle of bankruptcy which is equal treatment
(e.g. payment) for the same class of unsecured creditors' claims.
In bankruptcy, the general rule is that vendors may be paid on
their unsecured claims only through a confirmed plan of reorganization
or court-authorized liquidation.
A number of courts throughout the country have carved
an exception to this general rule and labeled it the critical vendor
doctrine. Under the doctrine, a debtor may pay certain prepetition
claims, with court approval, at the commencement of the bankruptcy
case where it can be established that payment of those claims will
help to stabilize the debtor's business without significantly harming
any party. The payment of these claims is to induce vendors to
continue supplying key goods and services post-bankruptcy on credit,
which may enable a debtor to continue to operate and perhaps exit
bankruptcy. In exchange for the vendor being paid in full, the
debtor conditions the vendor extending comparable credit terms
postpetition. The critical vendor agreement is reflected in a letter
agreement between the debtor and the vendor. The agreement also
provides for a "claw back" provision that permits the debtor to
recapture the critical vendor payment if the vendor refuses to
continue to extend credit.
A number of bankruptcy courts, from United Airlines
to Encompass, have recently approved the debtor's request for a
critical vendor program, subject to a claims' cap. How does the
vendor get on the critical,vendor list? What is a claims cap?
Making the Critical Vendor List
A Chapter 11 debtor that is an operating business
must decide which vendors they need most, and then negotiate a
payment. The debtor places the "critical" vendors on a list. Those
vendors that do not make the list will receive payment through
a confirmed plan of reorganization or Chapter 7 liquidation, often
years after the filing. The critical vendor motion is filed by
the debtor with the bankruptcy court and provides that the vendor
will receive payment on the prepetition claim. The motion also
binds the vendor to continue to sell with the debtor on terms equal
to or better than prepetition terms. The dollar amounts sought
are high. WorldCom Inc. was authorized to pay vendors up to $70
million. The average relief granted to a midsized debtor has ranged
from $8 million to $25 million. The responsibility to define the
vendors typically has been placed in the hands of the debtors.
When a company files for bankruptcy, it reviews a list of its vendors
and decides which ones are critical in order to stay in business.
Another strategy for a debtor is not identifying
their critical vendors in court pleadings, which are public documents,
to avoid alienating those vendors who don't make the list. It seems
the leverage of the critical vendor request may be shifting from
the vendor to the debtor. The vendor may hold out continued sales
to the debtor thereby threatening the debtor's ongoing operations,
perhaps only to find a replacement vendor who qualifies as a critical
The Trade Claims Cap
The critical vendor doctrine has evolved from the
debtor requesting a particular vendor be paid immediately as a
critical vendor, to the debtor requesting a class of vendors qualify
as critical vendors, to the debtor requesting the bankruptcy court
establish a critical vendor "trade claims cap". For example, in
the United Airlines Chapter 11, the carrier requested that the
bankruptcy court pay trade claims totaling $35 million as critical.
United Airlines did not identify the vendors it would deem critical.
Rather, United Airlines requested the court authorize payment of
a class of vendors it deemed critical which represented about 14%
of vendors unsecured claims. United Airlines did not propose to
pay in full each vendor deemed criticritical, but only the minimum
for the vendor to continue selling on credit.
The courts application of the critical vendor doctrine
continues to evolve. Debtors more frequently request courts' approval
of the critical vendor program. Where the doctrine is approved,
courts reason, both the debtors and creditors stand to gain something.
The critical vendor benefits by receiving early payment on its
prep etition claim. The debtor and its vendors benefit by receiving
needed product on credit, which may lead to a successful reorganization.
A vendor being deemed an essential vendor can have a dramatic impact
on the account. The credit professional is not forced to wait what
may turn out years for uncertain payment from a reorganizing debtor
-so get on the list!
Corporate Credit Executive
Reprinted by permission from
Trade Vendor Quarterly, Spring 03