What Is the Status of Vendor Payments During Bankruptcy?

In the event of a company's bankruptcy or insolvency, the status of vendor payments is significantly impacted. Vendors, who are often suppliers of goods or services to the company, are considered creditors. Their claims for payments are treated under the Insolvency and Bankruptcy Code (IBC), which sets out a clear process for resolving the debts of a company and determining the priority of claims during insolvency proceedings.

How Vendor Payments Are Handled During Bankruptcy

Vendor Payments as Part of Creditors' Claims

Vendors are generally classified as unsecured creditors unless they have specific agreements that give them priority, such as secured creditors.

During the Corporate Insolvency Resolution Process (CIRP), the Insolvency Resolution Professional (IRP) or Resolution Professional (RP) is responsible for managing the company's debts, including payments to vendors.

Priority of Payments in IBC

Under Section 53 of the Insolvency and Bankruptcy Code (IBC), the order in which creditors are paid is specified. Secured creditors (those with collateral) are paid first, followed by workmen and employees, then unsecured creditors such as vendors.

Vendor payments typically fall under unsecured creditors unless the vendor has provided specific security, in which case they may be classified as secured creditors.

Vendor Claims During Insolvency Resolution

During the CIRP, vendors can file their claims for unpaid dues. The Resolution Professional (RP) will review and verify the claims and include them in the creditor’s list.

Vendors must submit proof of their claims to the RP in the prescribed format within a specific time frame, usually within 14 to 30 days from the date of commencement of the CIRP.

If the company successfully undergoes restructuring under the resolution plan, vendors may receive partial or full payment depending on the resolution terms agreed upon by the Committee of Creditors (CoC).

Effect of Vendor Payments on Ongoing Operations

Vendors who continue to provide goods or services to the company during the insolvency proceedings may be prioritized for payment for new supply made post-commencement of the insolvency process.

These post-insolvency supplies are treated as operational debts and are generally paid before pre-insolvency debts.

In practice, if vendors continue business relationships with the company during the insolvency resolution period, they may be paid for the goods and services provided after the initiation of the insolvency process, making their claims higher in priority compared to those made before the process began.

Liquidation of the Company

If the company is liquidated, the vendor payments are treated according to the liquidation hierarchy. Vendor debts fall under the unsecured creditors category, and they are paid after the more prioritized creditors (e.g., secured creditors, employees).

If the company's assets are insufficient to cover the debts, vendors may only receive a partial payment or, in some cases, none at all.

Payment During the CIRP

In the resolution process, a Committee of Creditors (CoC) is formed, and this body plays a key role in deciding how to treat unpaid vendor debts. If the resolution plan is accepted, the vendors might receive payment as per the terms of the plan, which could include a haircut (reduced amount) based on the company’s financial status.

Secured vs. Unsecured Creditors

Secured vendors who have liens or collateral against their payments will have higher priority than unsecured vendors during the repayment process. However, most vendors typically fall under the unsecured creditors category.

Unsecured vendors are typically last in line when it comes to receiving payments and may face significant shortfalls, depending on the liquidation or resolution outcomes.

Example

A textile company is undergoing insolvency proceedings. It owes significant amounts to various vendors who supplied raw materials. Under the CIRP, the Resolution Professional (RP) processes the vendors’ claims, and some of the vendors continue supplying goods to the company during the insolvency period. These vendors are classified as operational creditors, and their post-insolvency dues will be prioritized for payment. However, the vendors’ pre-insolvency claims will be settled only if there are funds left after the payment to higher-priority creditors.

In case the company goes into liquidation, the vendors will be considered unsecured creditors and will receive payment only after secured creditors, employees, and other priority creditors have been paid.

Legal Protections for Vendors

Vendor Claims in Insolvency: Vendors have the right to file their claims for unpaid debts during the insolvency proceedings. If their claims are not acknowledged by the RP, they can approach the National Company Law Tribunal (NCLT) for a resolution.

Ongoing Supply Post-Insolvency: Vendors who continue supplying goods or services to the company during insolvency proceedings are entitled to be treated as operational creditors with priority over pre-existing debts.

Vendor Rights in Liquidation: In the event of liquidation, vendors can file their claims as part of the liquidation process, but they are typically among the last to be paid.

Conclusion

Vendor payments during bankruptcy or insolvency are handled in accordance with the Insolvency and Bankruptcy Code (IBC). Vendors are typically unsecured creditors and have lower priority in the repayment process. However, they may receive payments for post-insolvency supply of goods or services. The repayment of vendor claims depends on the available assets and the resolution or liquidation process, and vendors are usually the last group to receive payments after secured creditors and employees.