Why Do Vendors Get Burned Twice in Bankruptcy?

In the intricate world of bankruptcy proceedings, vendors often find themselves in precarious positions, facing the risk of financial losses and uncertainty regarding the fate of their unpaid invoices. This vulnerability stems from the inherent nature of bankruptcy, where debtors prioritize debt restructuring and asset preservation, potentially leaving vendors with unpaid dues.

Myth 1: Administrative Claims Guarantee Full Payment

A common misconception among vendors is that holding an administrative claim ensures full payment of their outstanding invoices. While administrative claims do take precedence over general unsecured claims, there's no absolute guarantee of full reimbursement. In recent years, an increasing number of Chapter 11 cases have faced administrative insolvency, leaving vendors with unfulfilled claims.

Myth 2: DIP Financing Guarantees Liquidity

Debtor-in-possession (DIP) financing often creates a false impression of improved liquidity, leading vendors to extend further credit. However, DIP financing may simply represent a continuation of pre-bankruptcy financing arrangements, not necessarily adding to the debtor's working capital. Vendors should carefully scrutinize the terms of DIP financing and inquire about the actual amount of new money being provided.

Myth 3: Critical Vendor Status Ensures Payment

Debtors often promise critical vendor status to entice suppliers to continue shipping goods on open credit terms. However, critical vendor status is not a guarantee of payment and is subject to a multi-stage approval process involving the debtor's lender, the bankruptcy court, and the creditors' committee. Vendors should refrain from extending post-petition credit until their critical vendor status is formally confirmed.

Myth 4: Pre-Bankruptcy Credit Terms Must Be Continued

Vendors often face pressure to maintain pre-bankruptcy credit terms, even after the debtor's bankruptcy filing. However, Section 2-702 of the Uniform Commercial Code allows vendors to withhold goods and stop delivery upon discovering the buyer's insolvency, including the commencement of a Chapter 11 case. Vendors are not obligated to continue the same credit terms.

Myth 5: 20-Day Claims Should Be Sold at Unsecured Claim Rates

Pre-bankruptcy claims generally fall into two categories: 20-day claims and regular unsecured claims. 20-day claims have administrative priority, meaning they hold the same status as claims arising from post-petition goods deliveries. Vendors should avoid selling their 20-day claims at the same price as regular unsecured claims.

Myth 6: Reorganization Guarantees Customer Retention

Supporting a debtor's reorganization plan does not guarantee long-term customer retention. Reorganization can take various forms, including orderly liquidation or bulk asset sales, potentially leading to the loss of a customer. Vendors should carefully assess the debtor's long-term viability before extending further credit.

Myth 7: "Too Big to Fail" is a Reliable Indicator

The "too big to fail" mentality is often misleading. The bankruptcy landscape is littered with large Chapter 11 cases that failed or stalled. Vendors should not rely on a company's size as a proxy for its ability to successfully reorganize.

Navigating the complexities of bankruptcy as a vendor requires a combination of vigilance, skepticism, and professional guidance. Understanding the myths and misconceptions surrounding vendor protections is crucial for making informed decisions and safeguarding financial interests. Vendors should consult with bankruptcy counsel whenever necessary to ensure their rights are protected throughout the bankruptcy process.

Key Takeaways

• Vendor protections in bankruptcy are often subject to misinterpretations and false assurances.

• Administrative claims, DIP financing, critical vendor status, and pre-bankruptcy credit terms are frequently misunderstood.

• 20-day claims should not be sold at the same price as regular unsecured claims.

• Reorganization does not guarantee customer retention, and "too big to fail" is not a reliable indicator of success.

• Vendors should exercise caution, seek professional advice, and understand their rights to protect their financial interests.