Paying Wages and Critical Suppliers

The premise of a bankruptcy case is that prepetition claims are paid through the case, in the order the statute sets, and not before. Two categories routinely depart from that in the first week. Employees are paid for work done before the filing, and selected suppliers are paid old invoices to keep shipping. The two departures rest on entirely different foundations.

The wage priority and what it covers

The priority scheme places allowed unsecured claims for wages, salaries and commissions, including vacation, severance and sick leave pay earned by an individual, at the fourth level, limited to a capped amount for each individual and confined to amounts earned within one hundred eighty days before the date of the filing or the date of the cessation of the debtor's business, whichever occurs first.

The cap is a figure stated in the section and adjusted at intervals under the provision governing dollar amounts, so it moves over time. It applies per individual rather than per claim, and it is a ceiling on priority treatment rather than on the claim itself: the excess remains an allowed general unsecured claim.

The same level reaches certain sales commissions earned by an individual, or by a corporation with only one employee, acting as an independent contractor selling goods or services for the debtor, where at least three quarters of what that person earned as an independent contractor in the preceding twelve months came from the debtor. Employee benefit plan contributions sit at the next level, capped by reference to the number of employees covered and reduced by amounts already paid under the wage priority.

The first-day wage motion

What the priority does not do is authorize early payment. It fixes the order of distribution, and distribution happens later. A debtor that wants to run payroll covering the days before the filing has to ask, and the request is made in a first-day motion for authority to pay prepetition employee obligations.

The argument offered is arithmetical rather than equitable. Priority claims within the cap will be paid in full before any general unsecured creditor receives anything, so paying them in the first week alters the timing and not the distribution. Courts accept the reasoning readily where the estate can plainly cover its priorities and examine it closely where it cannot.

These motions usually reach further than base wages. Withheld taxes and garnishments held but not remitted, employee expense reimbursements, contributions to benefit plans, and the continuation of insurance programs are all commonly included, each on its own justification. Insiders are ordinarily carved out or presented separately, because the Code restricts retention payments to them.

The critical vendor order

A critical vendor order authorizes payment of prepetition unsecured claims held by suppliers the debtor says it cannot operate without. The vendor is paid ahead of every other unsecured creditor, generally in exchange for an undertaking to continue supplying on stated terms for a defined period.

Unlike the wage priority, there is no provision that names the practice. Courts approving such orders have relied on the general power to issue orders necessary or appropriate to carry out the provisions of the Code, sometimes combined with the authority to use estate property outside the ordinary course. Orders typically require the vendor to sign an agreement, cap the aggregate amount, and provide for recovery if the vendor stops supplying.

The argument about the practice

Supporters describe the mechanism as preserving value that would otherwise be destroyed. A supplier of a sole-source component can shut a plant, and the loss to the estate from a halt in production may exceed the prepetition claim many times over. On that view the payment is not a preference but an operating expense that happens to be denominated in old invoices, and every creditor benefits from the business continuing.

Objectors describe it as a departure from the distribution scheme made without the protections of the plan process. The argument is that the Code fixes the order in which unsecured creditors are paid, that the general equitable power cannot be used to override a specific priority scheme, and that critical status is asserted by the debtor and the vendor with little independent testing. Committees also point out that the vendors best placed to demand payment are those with the most leverage rather than those with the strongest claims.

Courts have divided. Some have approved orders on a showing that the vendor is genuinely irreplaceable, that the payment is necessary to avoid harm, and that the estate is likely to be better off, while others have refused for want of statutory authority. The requirement that the vendor bind itself to continue supplying is common to most approvals, and the absence of that undertaking is the objection most often sustained.

The twenty-day goods claim

A separate provision changes the picture for some suppliers without any order. The value of goods received by the debtor within twenty days before the commencement of the case, sold to the debtor in the ordinary course of business, is allowable as an administrative expense. A supplier within that window does not need to be declared critical; it already ranks ahead of general unsecured creditors.

The provision narrows the population for whom a critical vendor order matters, and it is a standard first question when such a motion is presented. It also interacts with the financing and cash collateral orders, because payments to vendors come out of the same budget approved under the cash collateral order or funded by a postpetition facility.

Suppliers outside all of these categories are left where the Code puts them, holding general unsecured claims and bound by the freeze that began on filing. A supplier that responds by withholding goods it is contractually obliged to deliver, or by demanding payment of an old invoice as a condition of shipping, has taken an act to collect a prepetition claim.