Value of Determining Critical Vendors

As defined in bankruptcy lexicon, critical vendors are those that are vital to a Debtor’s continued operations. A critical vendor provides goods or services that cannot be easily and efficiently replaced, or rather a vendor with a specialized skillset, mandatory safety certification or proprietary product whose discontinuation of service would have a significant negative impact on a Debtor’s operations.

Correctly identifying critical vendors and obtaining court approval to pay any unpaid pre-petition balances owed to critical vendors in the normal course of business is an important step that puts the Debtor in a position to maintain operations and relationships with key vendors during the restructuring. A Debtor’s legal counsel and financial advisor should prioritize a review of all trade vendors early in the preparation for a bankruptcy filing. The vendor review should include back-office and operational employees from all service lines to ensure all vendors are adequately evaluated. The flowchart below walks a Debtor through the thought process required to support the inclusion of a vendor on the Critical Vendor Order:

Click here for diagram

There is value from both a Debtor and Creditor’s perspective in trimming down the number of critical vendors included in the Critical Vendor Order. For starters, unpaid pre-petition amounts owed to non-critical trade vendors will likely be classified as general unsecured claims that sit towards the bottom of the debt waterfall. Fewer critical vendors result in a larger general unsecured claim balance owed to trade vendors potentially allowing for greater recovery to the other creditor groups and postponing payment until a global settlement between all debtors is reached. Further, labeling a vendor as critical inadvertently puts the vendor in a position of power. Critical vendors are made more aware of their importance to the ongoing success of the Debtor and are therefore less likely to renegotiate trade terms or reduce prices despite the Debtor’s financial position.

From a Creditor’s perspective, limiting critical vendors will force the Debtor to reevaluate its terms and relationships with its non-critical normal course vendors. One of the benefits of a Chapter 11 Restructuring is the opportunity and added pressure to cut costs and renegotiate or reject contracts with normal course vendors. Prior to receiving bankruptcy protection, a Debtor may be uncomfortable ruffling the feathers of their vendors and pushing for lower prices due to either believing that they are paying market prices or that the relationship with a vendor is critical to the Debtor’s success.

By limiting the number of critical vendors, a Creditor can force a Debtor into these uncomfortable conversations with vendors regarding pricing or even push them to find alternative and often less expensive vendors resulting in a healthier Company post-bankruptcy. Efficiently and effectively identifying critical vendors is a key early step in a Ch. 11 Reorganization, and when done so correctly is a win/win for both Debtors and Creditors. By stressing the identification of critical vendors, a Debtor’s advisors can put the Company in the best position to maintain operations through the course the bankruptcy allowing for the case parties to focus on reaching a global settlement.