The impact of insolvency on the supply chain and how to minimize risks
An unpleasant but increasingly common and realistic scenario: your business partner – whether a customer or supplier – becomes insolvent. How does this affect the business relationship, and what can be done to minimize economic risks for your own company, both reactively and preventively?
Consequences of insolvency
When insolvency proceedings are opened, the debtor loses the (sole) power of disposal over his assets. This is transferred to the insolvency administrator, who assumes the legal position of the debtor.
Outstanding claims that were already established at the time of the opening of insolvency proceedings generally become so-called insolvency claims. The creditor must register them in the insolvency table in order to be satisfied proportionally from the insolvency estate at the end of the insolvency proceedings. Liabilities arising after the opening of insolvency proceedings are so-called estate liabilities, which are satisfied in advance and in full from the insolvency estate.
In the supplier constellation of a supply chain, the contractual relationship is typically governed by mutual contracts (often a type of framework agreement and individual supply contracts based on it). If these have not yet been fully fulfilled (by both parties), the insolvency administrator can choose whether or not to continue the contract (Section 103 InsO (German Insolvency Code)). If he chooses to fulfill the contract, the claim becomes a liability of the insolvency estate. If he refuses to fulfill the contract or if the creditor has made advance performances in total or in relation to individual orders, any claims (for damages) can only be registered in the insolvency table. Until the right of choice is exercised, the existence and content of the contract remain unchanged, but the mutual performance obligations are not enforceable for the time being (Section 320 BGB (German Civil Code)).
Specifically, this means:
- in the event of the insolvency of its own customer, they only have to pay outstanding invoices if they are liabilities of the insolvency estate – either as a result of the choice of performance or because the insolvency administrator has placed new orders. At the same time, the contractual situation may mean that the supplier is obliged to continue deliveries despite outstanding and due invoices.
- in the event of the supplier’s insolvency, the supplier’s obligation to deliver also depends on its classification as a liability of the insolvency estate. If the administrator opts against continuing the contract and further deliveries, the only option is to file any (compensation) claims with the insolvency table.
Therefore, the following generally applies: the insolvency administrator should be contacted at an early stage to agree on how to proceed. Until then, no further exchange of services should take place. The insolvency administrator may also be asked to make his choice of performance in order to end the state of uncertainty.
Impending insolvency of the customer
For the reasons mentioned above, the scope for action is limited once insolvency has occurred. The insolvency administrator will base his decisions solely on the benefit to the insolvency estate. However, if you recognize signs of impending insolvency on the part of your customer, you can try to minimize the economic consequences even before insolvency proceedings are opened by taking the following measures:
- Change in payment terms (agree on advance payment);
- Refuse performance with regard to outstanding deliveries (so-called defense of uncertainty, Section 321 BGB);
- Agree on securities (e.g., warranty/guarantee, retention of title, transfer of ownership by way of security).
The admissibility of individual measures must be examined on a case-by-case basis.
But beware: after the opening of insolvency proceedings, the insolvency administrator may rescind agreements that have reduced the insolvency estate to the detriment of the creditors as a whole under the conditions set out in Sections 129 et seq. InsO, if necessary – especially if they were made in the last three months prior to the application for the opening of insolvency proceedings (so-called insolvency contestation). In terms of time, the closer the agreement is to the opening of insolvency proceedings, the higher the risk of contestability.
Impending insolvency of the supplier
If there are signs that the supplier may be insolvent, the measures already outlined above are also available. If further deliveries are seriously in doubt, early establishment of and switch to an alternative supplier should also be considered. Taking into account any necessary approval, the customer should also be involved at an early stage.
Measures to support the supplier (e.g., by purchasing tools, early amortization, or providing materials) should, on the other hand, be carefully considered. In addition to the risk of ineffectiveness due to insolvency contestation, there is a danger that any return/compensation claims will be lost because they can only be asserted proportionally as insolvency claims. Further safeguards such as letters of comfort from (still) solvent group companies of the supplier can help here.
Prevention
If the business partner’s insolvency is (recognizably) imminent or has already occurred, the options for action are limited for the reasons mentioned above (insolvency contestation, decision-making power of the insolvency administrator).
We therefore recommend taking preventive measures in advance to safeguard against such situations by drafting contracts with foresight. This can be achieved in particular by establishing collateral at an early stage. Advantage: unlike subsequently agreed securities, existing collateral is not subject to insolvency contestation, and creditors are given preferential treatment and receive full payment in the event of insolvency (so-called right of separation or right of segregation, depending on the type of collateral). It also makes it easier to switch to alternative suppliers.
Possible preventive security mechanisms include:
- Regular monitoring of the financial situation of my business partners;
- Agreement on retention of title or transfer of production-relevant equipment in general (e.g., delivery items, tools, materials, facilities, etc.);
- Transfer of intellectual property rights (e.g., patents, designs), licenses, and know-how;
- Agreement on options for the purchase of manufacturing equipment;
- For software: Deposit of source codes with access in the event of insolvency;
- Negotiation of payment/delivery terms: Avoid advance performances as far as possible;
- Agree on termination rights in order to be able to terminate the contractual relationship flexibly. But be careful: according to established case law, termination rights due to insolvency formulated in general terms and conditions are most likely invalid.