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You've Been Selected As A Critical Vendor
Now What? Negotiating Points

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By Scott Blakeley
Reprinted by permission from Trade Vendor Quarterly Blakeley & Blakeley LLP

The credit executive well knows that a customer�s Chapter 11 means long delays before receiving payment on the prepetition 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 the debtor for a meaningful payment. Does a vendor in this situation, especially one with substantial trade relationship, have any additional alternatives? Fortunately, with the development of the critical vendor doctrine, the credit executive may have an alternative that may result in payment in full.

The critical vendor doctrine most commonly applies where a vendor is a key supplier. 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 a 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 postpetition 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 postpetition sales.

Notwithstanding the Seventh Circuit Court of Appeals decision in Kmart, bankruptcy courts continue to consider a debtor�s request to treat certain vendors as critical and have their prepetition claims paid in exchange for postpetition trade credit.

For the credit executive considering this situation, how does the vendor make the critical vendor list? What points does the credit executive negotiate with the debtor before committing to a critical vendor contract? What is the impact of the Bankruptcy Reform Act to measuring postpetition credit risk, including available cash to fund critical vendor payments as well as pay postpetition credit extensions? If the credit executive cannot negotiate a satisfactory critical vendor contract, what alternatives are available for the credit executive to preserve the sale to the Chapter 11 debtor?

A. History of the Critical Vendor Doctrine

Since the early 1990's, Chapter 11 debtors have asked bankruptcy courts to approve payment of vendors� prepetition claims that it believes is essential to its ongoing operations. Payment of these claims has been allowed in the interest of enabling a reorganization that is expected to benefit all creditors, including those that are not designated as a critical vendor. In some jurisdictions, a motion to authorize payment of critical vendors' prepetition claims has become a common first day motion in a Chapter 11 case, wherein the debtor articulates its business judgment to support payment of critical vendors.

1. The Equality of Payment Rule for Unsecured Creditors in Bankruptcy

A central principle of the Bankruptcy Code is equality of treatment of unsecured creditors. The equality of treatment rule is embodied, for example, in the preference laws and treatment of creditors� claims under a plan of reorganization. Creditors of the same priority are generally not entitled to be paid on their prepetition claims in Chapter 11, except through a plan of reorganization, and vendors are to be paid the same pro-rata amount on their claims in both Chapter 7 and Chapter 11 cases.

2. Deve lopment of the Necessity Doctrine

Notwithstanding the general rule of treating creditors of the same class equally, bankruptcy courts have often relied on the "doctrine of necessity" to allow insolvent debtors to pay vendors whose cooperation is deemed essential to a debtor's continued operations and reorganization. The same doctrine has been routinely invoked to justify payment of the prepetition claims such as claims of a debtor's employees for unpaid wages and benefits.

The necessity doctrine developed in railroad receivership cases of the nineteenth century. Survival of the railroad industry was essential to a large segment of the economy and communities in many regions of the United States, courts were willing to be very flexible in allowing receivers overseeing reorganizations of railroads to exercise remedies necessary for a struggling railroad to survive. These measures included the necessity of payment rule, which allowed payment of certain claims that arose before receivers were appointed. Under this doctrine, claims made by suppliers and other entities essential to railroad operations could be paid ahead of claims that would otherwise have priority, including claims of secured lenders.

3. The Necessity Doctrine Outside of Railroad Reorganizations

In the twentieth century, courts began applying the doctrine of necessity to reorganizations of businesses other than railroads, including businesses whose survival was not necessarily linked to the public interest. The doctrine of necessity is believed by its proponents to be incorporated within a bankruptcy court's general equitable powers under section 105(a) of the Bankruptcy Code.

The legislative history of section 105 (a) suggests that this section incorporates equitable powers that bankruptcy courts were previously understood to possess. The United States Supreme Court has stated that it will not read the Bankruptcy Code to erode the past bankruptcy practice absent a clear indication that Congress intended such a departure.

4. The Modern Approach to Critical Vendor Payments

During the past fifteen years, bankruptcy courts in a number of jurisdictions have been inclined to authorize debtors to pay repetition claims of vendors deemed critical, based on a debtor�s business judgment. The concept of "critical vendor" had gone from an extraordinary remedy to something that is done as a first day motion filed by debtors in chapter 11 cases.

However, during the last four years, critical vendor payments have come under increased criticism by some courts, bankruptcy attorneys, and scholars. Some critics have noted that there is no provision in the Bankruptcy Code that expressly allows for payment of critical vendors ahead of other creditors. Other critics have maintained that the Bankruptcy Code may allow critical vendor payments, but have argued that this practice has been abused with payments being authorized when a vendor is not truly necessary to a debtor's reorganization. This criticism culminated in the Kmart appellate rulings.

B. The Critical Vendor Doctrine

To be classed as �critical� by a Chapter 11 customer is usually an extraordinary result for the vendor as it usually 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, especially with the enactment of the Bankruptcy Reform Act, and the constraints imposed by the Seventh Circuit Court of Appeals under the Kmart decision. Further, lenders, bondholders, noteholders, a creditors� committee, the U.S. Trustee�s office, and even competing vendors who want to be elevated to critical vendor status scrutinize (and possibly object) to the critical vendor request.

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 their prepetition claim. 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.

1. Selling to a Chapter 11 Debtor Invoice by Invoice Compared with an Executory Contract

A vendor that has sold a debtor on an order-by-order basis has no continuing obligation to sell the Chapter 11 debtor. Because of this, the vendor has leverage on whether to sell the debtor. An element of the debtor�s critical vendor request is that the vendor provides a product or service that is indispensable for its continued operations. Should the critical vendor decide not to provide the product or service, the prospects for the debtor�s reorganization is diminished.

However, with the vendor who is a party to an executory contract, such as a long-term supply contract, the debtor may seek to compel the vendor to comply with the terms of the contract. The automatic stay bars the vendor that is a party to an executory contract with the debtor from terminating the contract postpetition, wit hout bankruptcy court authorization. Thus, only those vendors selling invoice by invoice should have the leverage to seek critical vendor status. Having said, that debtors have given critical vendor status to vendors that have executory contracts.

C. Notwithstanding the Kmart Decision, the Critical Vendor Doctrine Continues

Kmart�s Chapter 11 was one of the largest filings by a retailer. In an effort to obtain unsecured credit from its vendors and maintain key vendor relationships, Kmart, in the opening days of the bankruptcy, rewarded certain key domestic and foreign vendors with payment on their prebankruptcy claims under the critical vendor doctrine. As part of its first-day motions, Kmart filed a motion seeking authority to pay prepetition obligations to its critical vendors. Kmart served its critical vendor motion on about 65 of its key creditors, notwithstanding it had thousands of vendors. Kmart argued these payments were necessary to maintain business relationships with the respective vendors, and the vendors' goods were essential to Kmart's continued operations and a successful reorganization.

Vendors supplying a range of products from food to music to publishing services were paid on their prepetition claims in exchange for these vendors providing postpetition trade credit. The critical vendors agreed to provide credit on customary trade terms for two years. The bankruptcy court authorized payments to the critical vendors totaling $327 million under the �doctrine of necessity� using its equitable powers of section 105 of the Bankruptcy Code. The bankruptcy was satisfied with Kmart�s business judgment that without paying vendors their prepetition debt the vendors would not make shipments postpetition, and without these goods Kmart�s reorganization would be threatened.

The Seventh Circuit Court of Appeals affirmed the district court's reversal of the bankruptcy court�s approval of the debtor�s critical vendor motion. The Seventh Circuit�s decision does not flatly reject the critical vendor doctrine, but it does indicate that a debtor seeking authority to pay its critical vendors must be prepared to satisfy heightened procedural and evidentiary standards.

The Seventh Circuit noted that the bankruptcy court ruling was overbroad where the court had allowed unlimited permission to pay any debt deemed critical. Rather, the debtor must identify which vendors are critical.

The debtor must establish: (1) Such payments are in fact critical to their reorganization; (2)Discrimination among unsecured creditors is the only way to facilitate a reorganization; (3) Non-critical vendors will be at least as well off as they would otherwise be if the critical vendor order is not entered; and (4) Such payments will not diminish the amount of funds that ultimately will be available for payment to non-critical vendors. In addition, the Seventh Circuit has expressed concerns about notice of a critical vendor motion to noncritical vendors.

D. Bankruptcy Reform Act Does Not Bar Critical Vendor Doctrine, But Debtor�s Cash Availability Restricted

The Bankruptcy Reform Act is silent as to the critical vendor doctrine. Therefore, debtors are free to request the bankruptcy courts approve critical vendor motions. However, debtors will likely have less cash and liquid assets available to fund critical vendor requests as a result to changes brought by the Reform Act. Likewise, vendors must be more vigilant with their postpetition credit analysis as a result of changes brought by the Reform Act.

With the development of the critical vendor doctrine, vendors found themselves committing to long term sales contracts� on credit-in exchange for payment on their prepetition claims. Even those vendors that did not qualify as �critical�-an amorphous standard-considered selling their Chapter 11 customers with the added inducement of a junior lien on the customer�s assets. Some vendors, eager to continue the sale of its goods or services, would sell without any credit enhancements.

Prior to October 17, 2005, vendors would often measure postpetition credit risk by whether the debtor had obtained postpetition debtor-in-possession financing. If a satisfactory DIP facility had been obtained, the vendor would sell on credit. However, with the arrival of the Bankruptcy Reform Act of 2005, the credit risk model used by credit executives for selling to Chapter 11 debtors may have fundamentally changed.

A debtor�s cash availability is restricted under the Reform Act as a result of provisions favoring special creditor interests. Some of the provisions include:

1. Employee Wages

Prior to the Reform Act, employee wages were given priority up to $4,000 for each individual earned within 90 days before bankruptcy. Under the Reform Act, employee wages and salaries are increased to $10,000 for each individual up to 180 days before the bankruptcy.

2. Landlord Claims

Under the Reform Act, a debtor must assume or reject its real estate lease within 120 days following the petition date. A court may extend the 120 day period to assume or reject for up to an additional 90 days. Further extensions require the lessor's consent. Early assumption requires the debtor to dedicate more of its liquid assets to the early stage of the case.

3. Utilities

Under the Reform Act, a debtor offering a utility an administrative expense claim no longer constitutes adequate assurance of payment. Adequate assurance of payment is limited to: a cash deposit; a letter of credit; a certificate of deposit; a surety bond; a prepayment of utility consumption; or another form of security that is mutually agreed on.

4. Reclamation

The Reform Act expands the time for reclaiming creditors to make their reclamation demand to 45 days after the debtor receives the goods or 20 days after the bankruptcy. The value of the goods shipped to the debtor within 20 days prior to the bankruptcy are given an administrative claim. This means that more of the debtor�s assets will be dedicated to reclamation claims.

E. 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, even after the Bankruptcy Reform Act that pressures debtors to exit bankruptcy earlier.

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 order approving the motion also binds the vendor that agrees to critical vendor status to continue to sell with the debtor on terms equal to or better than pre-petition terms. 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 vendor.

1. Dealing with the Automatic Stay

The automatic stay is an injunction that automatically and immediately goes into effect upon the bankruptcy filing. It is filed, whether the bankruptcy filing is one under Chapter 7 or 11.

The automatic stay prohibits any creditor from taking action against the property of the estate and against the debtor, unless relief from the stay is obtained. For example, a vendor is barred from seeking or levying writs of attachments or garnishments, and also stays the vendor from a judicial lien against the debtor, but has not yet levied on any property.

The creditor needs to be mindful when requesting critical vendor status that the manner in which the request is made does not violate the automatic stay. To that end, the creditor should consider contacting the customer (debtor) and determine who within the company is responsible for the critical vendor program. Once that contact is identified, the vendor may negotiate with the representative to make the list.

F. Negotiating Points for the Critical Vendor

1. How Much Are You Getting Paid?

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 critical, but only the minimum for the vendor to continue selling on credit.

2. Length of Postpetition Trade Commitment

How long are you committing to provide your product or service? Through confirmation? Post confirmation? With the development of the critical vendor doctrine, vendors found themselves committing to long term sales contracts�on credit-in exchange for payment on their prepetition claims. Even those vendors that did not qualify as �critical�-an amorphous standard- considered selling their Chapter 11 customers with the added inducement of a junior lien on the customer�s assets. Some vendors, eager to continue the sale of its goods or services, would sell without any credit enhancements.

Prior to October 17, 2005, vendors would often measure postpetition credit risk by whether the debtor had obtained postpetition debtor-in-possession financing. If a satisfactory DIP facility had been obtained, the vendor would sell on credit. However, with the arrival of the Bankruptcy Reform Act of 2005, the credit risk model used by credit executives for selling to Chapter 11 debtors may have fundamentally changed.

3. Debtor Defaults on Postpetition Credit Purchase

If the debtor fails to pay per invoice terms what are your rights? Can you revoke your postpetition credit contract, yet preserve critical vendor payment? How do you get paid on the delinquent invoices?

4. Postpetition Credit Risk

The vendor needs to ensure that its postpetition credit does not exceed its prep etition debt, unless comfortable with the credit risk. For example, the vendor may have a nominal pre-bankruptcy balance, yet the debtor is entering their selling season, and therefore under the terms of a common critical vendor agreement, the vendor has committed a sizeable postpetition credit risk. As noted, with debtors filing Chapter 11 under the Reform Act, vendors must be mindful that they have less cash to meet operating expenses. Therefore, there may be even greater credit risk for the vendor contracting for postpetition credit sales.

In evaluating the credit risk under the Reform Act, the vendor needs to consider the cash commitment and administrative claims that the debtor faces at the filing date as well as the confirmation of the plan.

5. Amount of Postpetition Credit Terms

What are the postpetition credit terms the debtor expects the vendor to commit to qualify as a critical vendor? The debtor commonly insists that the vendor provides terms most favorable terms in the past six months. Generally, the debtor forwards a letter agreement reciting the terms of the postpetition agreement.

Recent trade credit agreements approved by courts have required vendors to provide postpetition credit through confirmation of the Chapter 11 proceeding. If the vendor breaches the postpetition credit agreement, that may be cause for the vendor to disgorge the payment on account of the prepetition claim.

If the postpetition trade credit agreement does not contain a provision that allows for the vendor to terminate the trade relationship should the debtor fail to pay according to the credit terms, the vendor should write in such a provision. Further, the vendor may want to include a provision that permits the vendor to terminate the trade relationship if the debtor falls below key financial ratios, even if the debtor has not defaulted on the postpetition credit agreement. This would allow the vendor to hold orders in the face of a debtor�s deteriorating postpetition financial operations.

6. Timing of Critical Vendor Payment

When do you get paid on your prepetition debt? Is the debtor attempting to force vendors to ship on credit prior to making the critical vendor payments. The vendor should negotiate immediate payment for the full amount, if possible. You may be able to do this through assumption of your contract, also.

7. Payment Terms on Prepetition Debt

a. Immediate Payment in Full

As noted, the vendor should negotiate immediate payment in full of the its prepetition claim.

b. Payments Over Time

Another alternative a debtor may offer to vendors immediate payment in full of its critical vendors, is to pay those vendors prepetition claims over time, for example over several months. As with the percentage payment, there is no legal basis that requires a debtor to pay the vendors� prepetition claim immediately.

c. Payment of Less than 100%

Under a critical vendor cap, the debtor may offer only a percentage of each trade claim to be paid, say 60%. This allows the debtor to offer more vendors to participate in the critical vendor program, and thereby increase the amount of postpetition trade credit.

d. Cross-Collateralization Provision

A debtor may insist that the critical vendor payments be paid through the vendor�s future shipments. In other words, when the vendor ships postpetition on credit, the debtor�s payment on the postpetition sale pays down the prepetition debt. The vendor�s postpetition debt builds up, which is entitled to administrative priority, and is ultimately paid down after the crosscollateralized prepetition debt is paid.

8. Debtor Waivers to Protect the Critical Vendor

The vendor should negotiate certain waivers to ensure that the critical vendor payment made is not later clawed back.

a. Preference Waiver

Although the vendor may be deemed a critical vendor, that designation does not protect the critical vendor from a preference suit for payments received during the preference period. The vendor should insist on a preference waiver, for any payments you received during the preference period. Absent an express waiver that is approved the bankruptcy court, you are at risk of a trustee demanding the return of the preference payment.

b. Disgorgement Waiver in the Event of Conversion

Does the critical vendor face risk that the critical vendor payment may be clawed back if the Chapter 11 be converted to Chapter 7 liquidation? If the critical vendor order provides that the vendor is free from such claims if the case converts from a Chapter 11 to a Chapter 7, that language should protect the vendor from any later claims asserted by a Chapter 7 trustee.

c. Disgorgement Waiver in the Event of an Appeal

Kmart has raised the issue of whether a vendor that is selected as a critical vendor may later be sued to recapture the critical vendor payment in the event the critical vendor order be reversed, even if the vendor extended credit to the debtor as required under the critical vendor order. A vendor should consider including a provision in the critical vendor order that bars a claw back of the critical vendor payment should the order be reversed. The most effective way to gauge this risk is whether the critical vendor order was appealed. The general rule is that the critical vendor order must be appealed within 10 days of entry. Should a party fail to timely do so, the appeal is lost.

9. Proving up Uniqueness

Although the debtor files the motion with the bankruptcy court to approve critical vendor status, with those courts following the Kmart decision, the vendor may be required to provide specifics for the bankruptcy court, as well as creditors, as to why vendor is so valuable to justify paying its claim ahead of other vendors. To that end, the vendor should review the debtor�s motion to pay critical vendors and determine whether the debtor has classified vendors. Below are examples of types products or service that may qualify the vendor as unique. Likewise, below are examples where the competitive situation may make the vendor unique.

a. Sole Source Vendors

Some vendors may be a debtors� only providers of essential materials or services. There may be no replacement vendors for sole source vendors. Even should competing vendors exist, a debtor may classify certain vendors as sole source vendors where the transition to a new vendor may interrupt a debtor�s operations. Where a vendor is the only sole source vendor who readily can provide a debtor with materials or services, it may refuse to continue materials or services due to the prepetition indebtedness, and the debtor�s operations could be disrupted while the debtor seeks to locate a substitute vendor, in excess of the amount of sole source suppliers� prepetition claims.

b. Capacity Vendors

Some vendors of materials may be the only vendors to produce such materials in quantities sufficient to meet a debtor�s demands, even though there may be vendors that produce some of the materials.

c. Quality Vendors

Some vendors may be deemed critical as they are the only vendors that provide the debtor with certain high-quality materials. In some cases a debtor may have customer contracts that require the high quality materials.

d. Knowledge Vendors

Some vendors may be deemed critical because they have unique knowledge of a debtor�s business, or have been responsible for certain aspects of a debtor�s business. These vendors have maintained the debtors operations for a period of time and have acquired unique knowledge of the business.

e. Vendors Providing Unique Service

Specialized service vendors are similar to unique product vendors, except that their uniqueness lies in their service instead of their goods.

f. Lack of Competition within Industry

Lack of competition within an industry may give a vendor leverage over the debtor and result in critical status for the vendor. Rather than a unique product or service that a vendor may provide, the mere fact that the vendor lacks competition creates the critical vendor situation.

g. Foreign Vendors

Vendors that provide their product from overseas may create a critical vendor situation. Offshore vendors may find that the debtor cannot find a replacement vendor in a timely manner.

h. Vendors Selling to Companies Subject to Mass Tort Claims

Over the last few years, companies that used or consumed asbestos in their operations (as opposed to manufacturers of asbestos) have been shocked to find themselves the target of mass asbestos litigation and personal injury claims.

This mass asbestos litigation has resulted in scores of companies filing Chapter 11 to stay this litigation. In the asbestos and mass tort cases, debtors generally have sought critical vendor status for a large portion of its vendor class.

i. Small Vendors

Those vendors whose financial survival is dependent on the debtor paying their prepetition claim have qualified as a critical vendor.

G. If You Are Unable to Negotiate Favorable Points to Support Critical Vendor Status, Consider Critical Vendor Alternatives

1. Selling on Credit Postpetition

To encourage vendors to sell a debtor postpetition on credit, the Bankruptcy Code provides that should the debtor default on the credit sale, the vendor is entitled to an administrative claim for the unpaid balance. Unlike the critical vendor doctrine, a postpetition credit sale does not allow for payment on the vendor's prepetition claim.

a. The Catch Up Issue

If the vendor does not qualify as a critical vendor, the vendor may decide to find an alternative to have its prepetition claim paid. A vendor may not be paid on its prepetition claim post bankruptcy. However, a vendor may attempt to have the debtor pay down its prepetition debt by inflating its postpetition invoices. This �catch up� scheme may be illegal, and can result in disgorgement of the inflated invoices and, possibly, criminal action.

2. Junior Lien Sales

To those vendors who do not qualify as critical, a debtor may offer a junior lien on assets in exchange for their selling on credit. The purpose of the junior lien is to reduce the risk that if the debtor fails to pay for the credit sale, the vendor may have some assets to look to for payment. However, the junior lien sale does not pay a vendor�s prepetition claim. Therefore, this alternative is more risky for the vendor.

3. Sale of Claim

A vendor that is not selected as critical may elect to sell its prepetition claim. Third parties, unrelated to the debtor, offer to purchase a vendor�s prepetition claim, at a discount. Unlike the critical vendor doctrine, a vendor does not have a continuing obligation to sell the debtor on credit when it sells its claim to a third party. Also, unlike the traditional critical vendor doctrine, a vendor selling its claim does so usually at a steep discount.

4. Payment of All Vendors� Claims Through Prepack

If a debtor is contemplating Chapter 11, it may negotiate with its major creditor constituencies, such as bondholders and noteholders, with hopes to reach agreement as to their treatment under a plan of reorganization. These pre-bankruptcy negotiations may result in a consensus not only as to bondholders and noteholders, but vendors as well.

F. Consider Negotiating Points of Critical Vendor Agreement

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 executive is not forced to wait what may turn out years for uncertain payment from a reorganizing debtor. But consider negotiating favorable terms including waivers before committing to postpetition trade credit.

Exhibit A: Post-bankruptcy Critical Vendor Agreement

_____________, 200_


[Critical Trade Vendor]



Dear Vendor:

     As you are no doubt aware, [DEBTOR NAME] and certain of its affiliates (“Debtors”),
filed a voluntary petition under chapter 11 of the United States Bankruptcy Code in the
United States Bankruptcy court for the District of _______________ on ________________
(the “Petition Date”). On the Petition Date, we requested the Bankruptcy court’s authority to
pay certain suppliers. On _________200_, the Bankruptcy Court authorized us to pay prepetition claims of certain trade creditors that agree to the terms set forth and to be bound by the terms of the Order.

     In order to receive payment on prepetition claims, each selected trade creditor must agree to continue to supply goods to the Debtors based on “Customary Trade Term.” Customary Trade Terms are defined as the normal and customary trade terms, practices and programs (including, but not limited to, credit limits, pricing, cash discounts, timing of payments, allowances, rebates, coupon reconciliation, normal product mix and availability and other applicable terms and programs) in effect between such trade creditor and the Debtor for the period prior to the Petition Date or such other trade terms that are at least as favorable as those that were in effect during such time.

     For purposes of administration of this trade program as authorized by the Bankruptcy court, the Debtors and you agree as follows:

1. The balance of the prepetition trade claim (net of any setoffs, credits or discounts) (the “Trade Claim”) that the Debtor will pay you is $________________.

2. You will provide open credit terms as follows:


3. The open trade balance or credit line that you will extend to the Debtor for shipment of postpetition goods is $___________ : ((a) on __________200___, or; (b) on normal and customary terms on a historical basis for the period immediately before the Petition Date).

4. Payment of your claim may only occur upon execution of this letter by a duly authorized representative of your company and the return of this letter to the Debtor.


[Applicable Debtor]



Agreed and Accepted by:
[Name of Trade Vendor]

By: __________________________

Its:________________________           Dated: ________________________

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