Oftentimes in a Chapter 11 bankruptcy case, a payment of a vendor’s pre-petition claim can be overlooked. Yet, if a vendor is regarded as being “critical,” the vendor can leverage this status to enforce its pre-petition claim and to be paid throughout the bankruptcy.
Critical Vendor Treatment in Bankruptcy
Critical vendor treatment in bankruptcy is a process that allows a debtor to pay a vendor its pre-petition claim based on the idea that the vendor is so important to the debtor’s business, that ending the relationship would make it very difficult if not impossible for the debtor to reorganize.
What is most interesting is that there is no reference to the term “critical vendor” in the Bankruptcy Code. Instead, it has developed over time as an equitable remedy regarding the debtor’s reorganization. In most of these situations, if there is no enforceable contract, a vendor may be treated as violating the automatic stay if it refuses to conduct business with the debtor, even if the vendor is owed money. In this situation, the vendor may be required to file a motion to modify the stay to terminate its relationship with the debtor unless it is adequately protected. On the other hand, if there is no contract, a debtor cannot force a vendor to continue to do business with it.
If a debtor deems a vendor critical to its reorganization, the debtor can offer to pay the vendor its pre-petition claim conditioned on the vendor continuing to supply the debtor with goods or services on the same credit terms as were in place prior to the bankruptcy filing going forward and that it will be timely paid.
Elements of Critical Vendor Status
If critical vendor status is requested, the debtor must establish that (a) the vendor is indispensable to the reorganization of debtor; (b) the harm in not treating the vendor as critical far outweighs the advantage the vendor is receiving by being treated differently than other vendors who are not deemed as critical; (c) there is no other vendor who can reasonably perform similar services or provide similar goods; and (d) there is no other alternative than to treat this vendor as critical.
Typically, if a vendor is treated as critical, the order will permit the debtor to pay all pre- and post-petition claims and require the debtor to timely pay the vendor on an ongoing basis, per its pre-petition terms and conditions. It will further require the vendor to return all the payments it received by virtue of being treated as critical if it refused to provide its critical services or goods, so long as the debtor was not in default. .
In re Zachry Holdings and Critical Vendor Status
Now in a recent case, In re Zachry Holdings, pending in the United States Bankruptcy Court, Southern District of Texas, Case No. 24-90377, when presented with a critical vendor order, the bankruptcy judge required the debtor to revise the critical vendor order to add as an additional remedy: that should the critical vendor refuse to supply its goods to the debtor, it would be held in contempt of court facing potential damages of not only actual but also consequential damages caused to the debtor.
What makes this so interesting is that the debtor did not make such a request. It arguably is the first case of this kind. It is concerning in that the order eliminates certain rights of any vendor under applicable law including the Uniform Commercial Code as it’s routine for critical vendor agreements to allow a vendor to stop shipping or provide services or goods under credit terms if (a) not timely paid, (b) if certain other conditions are breached, or (c) other events occur during the Chapter 11 that indicate a lack of working capital or liquidity to operate and pay invoices as they come due.
It remains uncertain whether or not courts will require such language in their critical vendor orders and it remains to be seen whether a critical vendor accepts such terms and risks being held in contempt — if it ceases providing post-petition services or goods when it believes the debtor is in default or lacks the ability to pay for such services or goods.
