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Lessors and Bankruptcy

By Robert S. Bernstein and Kirk B. Burkley
August 26, 2003

Obtaining the authority to make Critical Vendor payments is becoming more 'critical' than ever in the early stages of a bankruptcy case. Bankruptcy proceedings are supposed to be fair and reasonably predictable. However, the fair and predictable system of who gets what and in what order is becoming a lot less clear due to recent high-profile cases involving Critical Vendor payments.

Critical Vendor payments fall under the Necessity of Payment Doctrine, also referred to as the Rule of Necessity, which basically says that because rehabilitating a struggling business is the fundamental purpose of Chapter 11, the courts can look first at which creditors are essential to the bankrupt's business. These 'critical' creditors get paid first to avoid a disruption in service, while creditors with greater or equal priority interest just have to wait in line and hope that there is something left over after the Critical Vendors are paid.

Similarly, whether, and to what extent, a lessor will receive delinquent payments and/or will have the lease terminated by the debtor often depends on whether the lease arrangement is considered important to the reorganization process. An understanding of the bankruptcy process can make the difference between losing out completely in a bankruptcy or at least being treated fairly during the proceedings.

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