Top Considerations for Vendors Dealing with Distressed Companies

As of March 2023, commercial chapter 11 filings were up 79% compared to the same period of 2022, which includes a number of large retailers.[1]  The first quarter of 2023 saw the highest number of corporate bankruptcy filings in the U.S. since 2010.[2]  Leading up to these chapter 11 filings, vendors often suffer delinquencies and unpaid invoices from struggling or distressed businesses.  There are a number of things these vendors should consider to obtain payment or to better position themselves for an eventual filing.

When determining the best course of action, vendors need to balance many considerations including:

• the cost of pursuing payment relative to the outstanding amount due,
• the desire to resolve issues and continue an ongoing business relationship with the distressed company, potentially on more favorable terms to the vendor, and
• the likelihood that the distressed company will file bankruptcy.

A chapter 11 filing impairs a vendor’s ability to collect a debt as it imposes an “automatic stay” of all collection activity and lawsuits against the company and gives the company a “breathing spell” to explore the best path forward in bankruptcy. This means that once a chapter 11 case is filed, vendors are prohibited from taking any action to collect, including filing or continuing a lawsuit.  

The following considerations are designed to help vendors obtain favorable results and prepare them to actively and meaningfully participate in a chapter 11 filing.

Key STRATEGIC considerations for vendors

1. Be Informed: Before negotiating with or taking action against the distressed business, the vendor should try to obtain information from industry sources to determine the likely direction of the distressed company’s business and how similarly situated vendors have resolved their claims and/or preserved the ongoing business relationship. Ultimately, the vendor may find other vendors who are not receiving payment.  This creates options for the vendors, including asserting their position collectively to obtain payment, bringing an involuntary bankruptcy, and, if a bankruptcy is filed, consulting counsel and acting as an ad hoc committee of vendors.  Involuntary bankruptcies are only recommended in limited circumstances as they are often costly and hotly contested, subject to strict requirements by the courts and could open the vendor to sanctions if the involuntary petition is unsuccessful.

2. Taking Legal Action: Assuming the distressed company has not yet filed a bankruptcy case, the vendor could consider a collection action.  While this may result in a judgment, the vendor can incur attorney fees and court costs and not receive payment.  If all unpaid vendors were to take this course of action against a distressed company, it could drive the company into bankruptcy and leave the vendors as unsecured judgment creditors with the same priority as other unsecured creditors in the bankruptcy proceeding. 

3. Negotiate: An often more cost-effective way to maximize value would be for the vendor to consider negotiating a payment plan and/or discounting the claim.  In such a scenario, the vendor should use this as an opportunity to negotiate more favorable terms which could include payment due upon receipt or even in advance. The officers and directors of the distressed company typically desire to continue the business and negotiate payment plans with creditors outside of a bankruptcy proceeding as such a proceeding is very expensive, involves rigorous reporting, transparency and discovery concerning the debtor’s affairs. Various factors will determine whether the vendor should focus its efforts on maximizing the repayment of its claim or if the vendor should focus on the ongoing business relationship and the ability to sell product going forward. These factors include:

a) the amount owed to a given vendor;

b) the balance sheet and financial projections of the debtor;

c) the chances for the debtor’s survival;

d) the likelihood that the debtor will continue to buy product from the vendor;

e) whether the vendor is a “critical vendor”, such that the debtor cannot operate without it, warranting favored treatment in a bankruptcy case and leverage in any negotiation; and

f) whether a potential buyer of the debtor’s assets has a relationship with the vendor that the vendor can use to sell product.

4. Operate as a Collective: A good option for vendors is to form an ad hoc committee to share in costs and assert its position collectively and negotiate both outside of a bankruptcy proceeding or after the bankruptcy proceeding has commenced. Once a chapter 11 bankruptcy case is filed, an “Official Committee” of Unsecured Creditors is formed to look out for the interests of similarly situated creditors. The committee plays a key role in investigating the company, negotiating with the company for a repayment plan, participating in identifying and negotiating the identity of the purchaser, the price and terms for the sale of assets, sometimes commencing litigation to recover funds for creditors and other administrative aspects of the chapter 11 case. Before a chapter 11 case is filed, similarly situated vendors or creditors having common interests can band together to form an “unofficial” or ad hoc committee to have more clout and influence than if the various vendors were acting on their own. Many times, an unofficial pre-bankruptcy committee becomes the Official Committee after the case is filed.  In some instances, the expenses incurred by an unofficial committee can be reimbursed by the bankruptcy estate after the chapter 11 case is filed.

5. Understanding the Potential Outcome:   In recent years, a sale of all the company’s assets is a very common outcome from a bankruptcy filing, especially in retail-related bankruptcy proceedings. A sale in bankruptcy allows for the transfer of the assets to a buyer “free and clear” of the liens, claims and interests of creditors if certain requirements are met. Vendors and other unsecured creditors can’t object to the sale other than, generally, on the grounds that the sale price or process is insufficient. Conversely, a lender or secured creditor can object to the sale if the price is less than what is owed to the lender. The sale can nevertheless be approved over the objection of the secured lender in the rare instance where there is a bona fide dispute concerning the validity of the lender’s liens on the collateral. Typically, the debtor will coordinate closely with the secured lender(s) to obtain its consent to the sale since the secured lender’s cooperation is needed by the debtor in the bankruptcy proceeding, such as for the debtor’s consensual use of the lender’s cash collateral in the chapter 11 case.  To prepare the best strategy, vendors must understand this potential outcome.

The best time for a vendor to act in these distressed situations is early so it can maximize value and prepare for a possible filing.

[1]https://www.cfo.com/credit-capital/bankruptcy/2023/04/chapter-11-bankruptcy-subchapter-v-epiq-commercial-filings-svb-financial-diamond-sports/#:~:text=March%202023%20commercial%20bankruptcy%20filings,year%20ago%2C%20to%205%2C733%20filings

[2]https://www.globest.com/2023/04/11/corporate-bankruptcies-rose-dramatically-in-q1/?slreturn=20230423133045#:~:text=The%20first%20quarter%20of%202023,bringing%20the%20total%20to%20183