When a shipper files bankruptcy, it’s generally not good news for a motor carrier. However, motor carriers are often in a unique position that might allow them to do better than fellow creditors from other industries, recovering some or all of the unpaid pre-petition debt, while continuing to do business and get paid on a post-petition basis. Although under a bit more scrutiny since a federal circuit court decision in In re Kmart Corp., 359 F.3d 866 (7th Cir. 2004), the so-called “critical vendor” doctrine is alive and well and regularly used in bankruptcy courts throughout the country.
Upon the filing of a Chapter 11 bankruptcy case, the Debtor continues to operate as a “Debtor-in-Possession.” However, the bankruptcy code puts certain restrictions on the Debtor’s powers, so it is not business as usual. One such restriction is that pre-petition debts (i.e. debts incurred prior to the date of the bankruptcy filing) are not paid until a distribution is made pursuant to a confirmed plan or other court order.
Nevertheless, courts have recognized that sometimes it is necessary for a so-called “critical vendor” to be paid on its pre-petition debt. If a vendor is not paid on pre-petition debt, a vendor may refuse to continue to do business with the Debtor. In some situations, a vendor could be so critical to the Debtor’s operations that it would be difficult or impossible to continue to do business while reorganizing its debts without the vendor. For example, in large retail bankruptcies, motor carriers and others in the shipping industry are critical to getting goods from the warehouse to the retail floor, and without its motor carriers, a retailer won’t be able to stock its shelves.
In these situations, it is possible for the Debtor to file a critical vendor motion requesting that a specific carrier, group of carriers, or just all carriers generally be deemed critical vendors so that the Debtor can pay some or all pre-petition debts in exchange for an agreement from the carrier to continue doing business with the Debtor post-petition, generally required to be on ordinary or standard business and credit terms. If the Court is convinced that the vendor is “critical,” then it will enter a critical vendor order approving the Debtor’s request. Depending on how “critical” a motor carrier may be in the Debtor’s particular circumstance, it may be possible to negotiate specific items into the order, for example, a waiver of preference liability or post-petition security interest or lien.
Of course, doing business with a company in bankruptcy may be a risky proposition. However, if the Debtor is truly in the act of reorganizing or can successfully pull off a quick § 363 sale of all of its assets, it can still be profitable to do business with the Debtor post-petition. Moreover, if there is already significant exposure of unpaid pre-petition debt and/or preference liability exposure, a critical vendor order can oftentimes be beneficial even if the Debtor’s reorganization efforts fail in that pre-petition debts may be recovered and post-petition debts are entitled to administrative priority status.
If one of your shippers or brokers files bankruptcy, contact experienced bankruptcy counsel to guide you on the bumpy roads and choppy waters of the bankruptcy world.