As a company prepares to file for protection under chapter 11 of the Bankruptcy Code, one of the most important business issues for the company to address is the way in which it manages its vendors. This article will address the elements as well as the benefits of a well-executed debtor's Vendor Communication Program (VCP), and the use of authority to pay pre-petition claims.

A successful VCP will increase the likelihood of a successful reorganization, reduce the time spent in bankruptcy and decrease the administrative expense of the reorganization. The how and why of this is discussed in the article below; generally, bringing constituencies into the process reduces the battles the debtor has to face, thus shortening and reducing the cost of the process. Also, gaining cooperation from potentially adversarial constituencies can serve to turn them from a force of opposition into a partner in achieving a mutually beneficial reorganization. For vendors, this partnership can take the form of extending post-petition trade credit, shipping hard-to-obtain or rationed goods, allowing damage returns and quantity or early payment discounts.

In many bankruptcies, it is not unusual for the vendor community to develop a deep-seated distrust of the debtor. Vendors' feelings of being treated poorly or dishonestly can effectively block any hope of reorganizing the debtor. Vendors can deny cash discounts and volume discounts that account for much of the profit in low-margin businesses like distribution. Vendors sometimes have an attitude that somebody will need to buy their product (and thus the vendors would not lose sales) and they are going to punish the debtor by putting it out of business. Left unchecked, a great deal time can be required to work with the vendor community to try to turn their perception around. In less-hostile situations, a well-planned VCP will help ensure that the debtor remains on good terms with its vendors during and after the bankruptcy.

A tool that is becoming more common, especially in Delaware cases, is the use of special authority to pay certain pre-petition claims. As described below, this is a powerful tool that can backfire if used injudiciously. However, if used properly, it can accelerate the debtor's return to normal operations. For example, with a manufacturer of sophisticated printing equipment, we used payments of pre-petition claims to vendors to jump-start the shipment of critical components that had been held up because of the debtor's pre-petition cash and payment shortage, allowing the debtor to resume fabrication and completing shipments to customers. By accelerating the ramp-up of production, the debtor was able to minimize delivery schedule disruptions and accelerate cash receipts tied to those deliveries.

Planning

A well-executed VCP begins before the company actually files for bankruptcy protection. It is important to look for certain factors in the initial reconnaissance. Many companies will print checks that end up in desk drawers because there wasn't cash to honor them. Unless and until these checks are voided and added back to the A/P balance, the debtor will be understating the amount it owes to its vendors. Additionally, this is the point to try to assess the relationships between the vendors and the company's employees. In some cases, the debtor employees may be more aligned with the vendors than with the interests of the debtor. The vendors may have gone so far out on a limb for the debtor that they face losing their jobs. Also, debtor employees may become preoccupied with preserving their reputation in the industry. It is critical to evaluate the pressures placed on the employees (and how the employees will react) that you will rely on to implement the VCP.

Although planning is essential to the success of the VCP, one very critical decision to make is when to inform the employee working group that will be involved in the vendor communications. In order to be organized to communicate with its vendor constituency, the debtor's employees must be organized in advance, and the message must be planned, clear and honest. However, there is a trade-off with the company's need for confidentiality. If the debtor's employees are overly sympathetic to their contacts at the vendor, then there is substantial risk that word will leak of the potential filing. Such a leak will most likely accelerate the filing and negate efforts to plan for the filing.

The relationship with the vendors will change because of the bankruptcy filing. Assuming that the decision is made to communicate and plan the VCP in advance of the bankruptcy filing, the debtor can manage how the relationship with its vendors will change. Typically, prior to the filing, communications are characterized as evasive and misleading. The VCP must be designed to educate the vendors about the company's new position—that of a debtor-in-possession (DIP)—and the company's responsibilities as a DIP in a factual and honest manner. There is no need to sugarcoat the message, but there is also no need to be hostile or aggressive.

The vendor population needs to be identified. While this sounds simple, most companies have many small vendors of ancillary services that can easily get lost in the shuffle. A small investment of time, and possibly money, ahead of the filing can prevent nuisance disruptions later in the case. Each vendor should be assigned a primary contact person. This serves two purposes. First, it makes the job of communicating more efficient. Second, it prevents conflicting information from being delivered to vendors, many of whom talk regularly with each other.

Initial Communications

Typically, the front line of communication starts with the purchasing group, as they have the day-to-day contact with the vendors. Obviously, the largest and most important vendors should be called by more senior management. The message should be carefully thought out and discussed with the employees responsible for communicating with the vendors. In most cases, you will find that your employees need assistance with understanding the impact and rules of bankruptcy. Also, it is common to find a strong feeling of relief at finally having some information to share with the vendors after months of avoiding communication with them because of uncertainty over what to say.

The initial message should focus on the following points:

• The company has filed for reorganization, not liquidation; operations will continue as usual.
• The company has plenty of liquidity in the form of a DIP loan to make ongoing post-petition payments. Post-petition bills will be paid as they come due.
• While the company is reorganizing, it is not allowed to make any payments on pre-petition payables.
• The company needs the cooperation of its vendor partners to continue to ship its products, provide reasonable credit terms and keep its customers.

In addition, this is the time to set up several other critical communications. First, it is a good idea to set up standard responses to common questions that are likely to be asked of the debtor's employees. In my experience, a one-page Q&A addressing basic facts of the filing (i.e., filing date, filing entities, which court and judge has jurisdiction, case number, name and phone number of bankruptcy counsel) will be a valuable tool to employees who probably have never been through this experience. Second, especially in larger debtors, setting up a vendor hotline where vendors can call in to ask questions will resolve many smaller issues quickly and efficiently. The hotline operators should have scripted responses to common questions. Any questions that are not covered in the script should be referred to the debtor's professionals for follow-up.

The next phase of communications is to set up conference calls and face-to-face meetings with the largest and most important vendors. The timing of these meetings should be in the few weeks following the bankruptcy filing. The content of the next phase is covered in the next section.

At these initial meetings the debtor should be prepared to answer certain basic questions. It is ok to respond with an answer indicating that it is too early to know, but under no circumstances should the debtor try to mislead or create false expectations. Typically, the information the vendors will be interested in will include some or all of the following:

• projections or financial forecasts
• details of the reorganization plan
• timing for filing the plan
• anticipated recoveries for creditors
• status of employee layoffs or retention programs
• reconciliation of claim amount

The debtor should make it clear that these are reasonable requests for the vendors to ask, but it is too early in the case to have all the answers. The debtor should offer to keep the vendors updated as this information does come available. In the case of publicly traded companies, the debtor will have to be careful to only share public information and advise the vendors of this limitation on the debtor's ability to disclose information.

Ongoing Communications

After the initial contact with its vendors, the debtor needs to maintain continued communication to achieve improvements in the relationship. These meetings will usually be face-to-face with a specific agenda. The goal, from the perspective of the debtor is usually one or more of the following:

• return to normal trade terms
• return to normal returns policy;
• return to rebate and quantity discount programs;
• elimination of any product or quantity rationing and/or
• timely completion of works-in-progress and delivery to the job site.

The progress may be as simple as asking for the help of a partner/vendor. In other instances it will involve incremental progress with each step of improvement, requiring documented achievement of preset goals by the debtor and a specific vendor. Keep in mind that the debtor probably has lost considerable credibility with its vendors in the time leading up to the filing because of incomplete or evasive communication. In some cases, there may be outright hostility that must be defused (as in the case of the distribution company).

The debtor will not be successful with all vendors. Some vendors will have rigid policies for credit and delivery terms to companies in bankruptcy. Some vendors will be unwilling to extend any credit as long as the company is in bankruptcy for fear the chapter 11 bankruptcy will convert to a chapter 7 proceeding. Other vendors will have very emotional reactions that must be respected and dealt with appropriately. Vendors frequently feel that the company deceived them to induce the additional extension of credit before the company filed for protection.

Use of Court Authority to Pay Pre-petition Claims

In large cases filed in Delaware, it is not unusual for the debtor to propose, as a part of its first-day motions, to pay certain pre-petition claims of creditors. The most common creditor group is employees, and the reason is obvious: Without payment of their pre-petition wages, many employees would not continue to work for the debtor. In addition, the employee claims enjoy a priority in order of payment under the Code. Insurance vendors and utilities also are often scheduled for payment of pre-petition claims. Notwithstanding statutory treatment as in the case of utilities, if these vendors are vital to the debtor's operation, payment of the pre-petition claim may be necessary to preserve the value of the estate.

Recently, there has been an extension of this authority under the "necessity" doctrine. As part of first-day motions, debtors have proposed, and courts have granted, limited authority to pay vendors prior to the confirmation of a reorganization plan. The logic is that some vendors are so important to the company's business that if they stopped providing goods and services, either because they choose to or because the non-payment of the pre-petition debt causes the vendor's own financial problems, the impact on the likelihood of reorganization harms the interest of all creditors. Vendors such as common carriers and overnight delivery services have learned to exert considerable muscle by refusing service when a company files a petition for relief. Unless there is an executory contract, there is little the debtor can do to force the vendor to provide services. Even when there is an executory contract, by time the debtor can go to court to enforce the contract, irreparable harm can be done to the business.

However, great caution should be used in the use of this authority to pay pre-petition claims. Vendors will quickly learn that "the squeaky wheel" gets paid. Soon all vendors will be refusing to ship unless they get their pre-petition claim paid. Very few debtors have enough money to pay all or even a large portion of their pre-petition claims; if they did, they wouldn't have filed for relief in the first place.

If a company is going to pay some pre-petition claims, it should be as part of a well-thought-out plan—including a budget and an understanding of the benefits to be gained in return for making the pre-petition payment. Some of the typical reasons to pay pre-petition claims include the following:

• Efficiently resolve small, nuisance claims.
• Keep small businesses that provide goods or services that cannot be sourced elsewhere from going out of business.
• Keep sole-source suppliers shipping products or providing necessary services.
• Obtain post-petition trade credit.

Typical plans for implementing pre-petition payments might include a cap on the percentage of any vendor's claim that would be paid and a formula relating post-petition trade credit to the amount of pre-petition payment.

Negotiating with Recalcitrant Creditors Without Pre-petition Payment

In some cases, the debtor will not receive authority to pay pre-petition claims or vendors may not agree to the terms requested. In a recent case involving a regional grocery chain, a trade group representing many of the large-branded products rejected the debtor's offer to pay pre-petition claims in return for post-petition trade credit. This vendor group sought to have their post-petition extension of credit treated as secured, super-priority debt, and as additional security, a letter of credit to be drawn upon if the debtor defaulted on its post-petition obligations. In cases such as this, negotiating with recalcitrant creditors may become more difficult because the debtor has fewer tools. The most typical response is to provide the vendor with a deposit or pay cash in advance. In some cases, the debtor may have no choice but to do business without that particular vendor. In the grocery store example, the debtor was so dependent on these vendors that it negotiated a security carve out with its DIP lenders and provided the letter of credit.

Conclusion

An effective and well-planned Vendor Communication Program can quickly stabilize the debtor's relationship with its vendors and stretch precious DIP financing. Another tool that is becoming more frequently used in Delaware cases is the authority to pay pre-petition claims. This tool, if used without a well-thought-out plan, can backfire. However, when used judiciously, it can smooth delivery issues at moderate cost to the debtor's estate. In both cases, careful planning is the key to success.

As always, it is important to manage expectations. The debtor will invariably take actions prior to its bankruptcy filing that severely damage its relationship with its vendors. In some cases, this damage cannot be undone. In other cases, the damage may require extraordinary measures. By planning and organizing the debtor's response to these vendors, you will maximize the improvement possible. The goal is to improve the relationship as much as possible as a critical component of maximizing recoveries for the claimants of the company (creditors and equity interest holders).