What to Do When a Vendor Files for Bankruptcy

Anyone that has played Monopoly can probably remember pulling the dreaded bankruptcy card – DO NOT PASS GO. DO NOT COLLECT $200. But, in the real world, corporate bankruptcy is more serious than a board game, especially when it involves one of your third-party vendors.

Whether you heard about a vendor’s bankruptcy firsthand, or read a concerning headline, you likely have a lot of questions about how this might affect your organization and what you should do next. Consider the following steps to get started.

4 Steps to Take When a Vendor Files for Bankruptcy

1. Confirm the facts – Depending on the source, you may have gotten inaccurate or incomplete information. If possible, reach out to the vendor directly to confirm the details of the bankruptcy filing. For instance, is this a Chapter 7 bankruptcy, in which the vendor will shut down? Or, is this Chapter 11 bankruptcy, which may still offer some possibility of the vendor returning to a profitable, viable, and potentially more focused business? It’s important to gather information, such as the expected timelines for shutting down or restructuring, so you know how to proceed accordingly with a plan to either keep the vendor or explore alternative options for service. The vendor's response during this step should provide insight into how you need to proceed with the relationship. It can also help you determine the ideal strategy for mitigating risk and disruptions to your operations. 
   
   Example: If the vendor is unresponsive to your questions, not communicating well, or only giving vague information, your organization may choose to move quickly and proceed with your exit strategy to mitigate the risks. However, if the vendor is responsive and gives you the information you need, there may be less urgency and concern. 
2. Consult with your stakeholders – A vendor relationship often involves many different stakeholders, like the legal team, procurement, operations, and information security. All these stakeholders should be informed about the vendor’s bankruptcy to ensure any potential issues are addressed quickly before they have a significant impact on your organization or customers. Senior management and the board should also be informed, especially if the bankruptcy involves a critical or high-risk vendor. This collaboration should be consistent and proactive, not just in response to the news of a bankruptcy. That’s why performing regular oversight and due diligence on your critical and high-risk vendors is prudent, so you do not get caught flat-footed in an evolving situation with a vendor at or near bankruptcy. 
3. Review the contract – Vendor bankruptcy can be unexpected and unpredictable, so ask your legal team to carefully review the contract and provide guidance on any next steps, especially as it pertains to the vendor’s ability to continue providing uninterrupted services your organization. It is always important to determine whether you have any provisions in place to protect your organization during any significant events like a vendor bankruptcy. Ideally, your critical vendor contracts should have provisions that state your ability to transfer accounts or activities to another third party in the event of bankruptcy. 
4. Refer to your exit strategy – If your organization decides to terminate the vendor relationship, refer to your exit strategy to confirm it is still a viable option. From there, you can move forward with the step-by-step procedures of your exit plan, which describes the responsibilities of your organization and the vendor. 
   
   Example: Your organization may need to revoke the vendor’s access to your networks or systems. Likewise, your vendor may need to return or destroy any of your data they have in their possession.

3 Red Flags for Vendor Financial Stress

Maybe your vendor’s bankruptcy filing came as a complete surprise because their financial health appeared stable during recent due diligence reviews. In reality, a vendor’s decision to file for bankruptcy probably consists of many different factors that may not be fully known to your organization. 

When you don’t have insight into these other factors, it helps to know three common red flags that can signal a vendor’s financial stress, so your organization is prepared: 

1. Declining service levels – A vendor’s performance should be monitored continuously to identify any changes. Declining service levels may indicate that the vendor lacks sufficient staffing or resources because of poor financial health. 
2. Layoffs or high turnover rates – Vendors that are struggling financially may choose to save costs by going through a round of layoffs. You may also notice a high employee turnover rate because of the vendor’s financial health and its inability to retain talent. 
3. Negative news – Monitoring your vendors for adverse media and negative news can reveal the potential for financial stress. Headlines about legal issues, data breaches, regulatory violations, and more might signal that the vendor will be facing significant financial costs in the near future. 

Ultimately, your organization must decide for itself how to respond when a vendor files for bankruptcy or is showing signs of financial stress. With some careful planning and consistent vendor monitoring, your organization will be prepared and know how to proceed if the situation arises.  

Be proactive and prepare accordingly through the usage of monitoring and assessing a vendor’s financial viability and financial health profile on a regular basis. Although it does not fully cover you for the reality of getting ahead of every potential bankruptcy event a vendor faces, it can provide you with enough insight and regular input on how prepared your organization is for this event. It’s also a best practice to help mitigate the disruption and risks vendors may pose to your organization if and when they go through a bankruptcy process.