Insolvency & Restructuring

Investigative Duties for Counterparties: From Supplier to Detective?

When dealing with companies in financial distress, counterparties have certain investigative duties. But just how far do these duties go?

Difficult times for retailers

Retail­ers have had a rough cou­ple of years. Some, such as Cos­mos, dayli and Hol­land Blu­men Mark, were put into insol­ven­cy. Oth­ers, such as Sport Eybl, had to be sold to third par­ty investors or, like bau­Max, are sell­ing parts of their busi­ness to achieve a turn-around.

When retail­ers strug­gle their sup­pli­ers face dif­fi­cult ques­tions. Should they ter­mi­nate the busi­ness rela­tion­ship, poten­tial­ly ruin­ing the retailer’s busi­ness, or con­tin­ue sup­ply­ing? The answer to this ques­tion depends large­ly on void­ance laws and their inter­pre­ta­tion by the courts.

After the open­ing of insol­ven­cy pro­ceed­ings over the assets of TAP dayli Ver­triebs GmbH (dayli), the insol­ven­cy admin­is­tra­tor filed claims against a mul­ti­tude of sup­pli­ers demand­ing repay­ment of amounts received with­in the pre­vi­ous 12 months due to pref­er­en­tial treat­ment. If he suc­ceeds with his argu­ments, this may have seri­ous con­se­quences for oth­er com­pa­nies in dis­tress.

A pre­con­di­tion for void­ance due to pref­er­en­tial treat­ment is that, at the time the pay­ment was received, the rel­e­vant coun­ter­par­ty knew or should have known of the inten­tion of the debtor to pre­fer him over anoth­er cred­i­tor. The con­se­quence of a suc­cess­ful void­ance claim is that the sup­pli­er must repay any amounts received from the debtor. In exchange, the sup­pli­er may request the assets sup­plied, if they are still in the insol­ven­cy estate and can be dis­tin­guished from oth­er assets. If the assets are no longer part of the insol­ven­cy estate or can­not be dis­tin­guished from oth­er assets, the sup­pli­er has a quo­ta claim for pay­ment.

Could have, should have, would have

As it is usu­al­ly dif­fi­cult to prove what a sup­pli­er knew, insol­ven­cy admin­is­tra­tors focus on what the sup­pli­er should have known had he act­ed with due care. Due care implies in this con­text that even slight neg­li­gence (ie, an error that a dili­gent per­son may make from time to time) is harm­ful to the sup­pli­er’s posi­tion.

To make mat­ters worse, the courts have held that, if the sup­pli­er knew or should have known (again, slight neg­li­gence is harm­ful) of the insol­ven­cy of the debtor, this may indi­cate (or in some cas­es even be equal to) being aware, or slight­ly neg­li­gent­ly not being aware, of an inten­tion of pref­er­en­tial treat­ment.

Thus, to avoid the risk of a trans­ac­tion being chal­lenged for pref­er­en­tial treat­ment, a sup­pli­er must ver­i­fy whether he knows or should know that his cus­tomer is insol­vent each time before sup­ply­ing goods. This pos­es the ques­tion: When should a sup­pli­er know about the insol­ven­cy of its cus­tomer?

The courts impose con­sid­er­able inves­tiga­tive duties upon sup­pli­ers. Even if there are only indi­ca­tions that the cus­tomer might be in finan­cial dif­fi­cul­ties, the sup­pli­er must inves­ti­gate the eco­nom­ic sit­u­a­tion of its cus­tomer. The applic­a­ble stan­dard of care varies for dif­fer­ent coun­ter­par­ties. It has been held that it is espe­cial­ly high for tax author­i­ties and social secu­ri­ty author­i­ties, but also for major sup­pli­ers. Depend­ing on the cir­cum­stances, an indi­ca­tion of finan­cial dif­fi­cul­ties may be if (i) the cus­tomer dis­charges only the most press­ing oblig­a­tions, (ii) the cus­tomer requests a pay­ment plan, (iii) the cus­tomer offers an out-of-court set­tle­ment (includ­ing a hair­cut) and (iv) news­pa­pers report on the customer’s dire finan­cial sit­u­a­tion. In the case of dayli, the insol­ven­cy admin­is­tra­tor is even argu­ing that news­pa­per arti­cles on the finan­cial sit­u­a­tion might trig­ger inves­tiga­tive duties even if they are explic­it­ly con­tra­dict­ed by the com­pa­ny’s man­age­ment.

If a coun­ter­par­ty should be aware of indi­ca­tions of finan­cial dis­tress of its coun­ter­par­ty, the inves­tiga­tive actions it may be required to take include (i) request­ing lists of out­stand­ing receiv­ables and oblig­a­tions, (ii) request­ing up-to-date accounts, (iii) obtain­ing dec­la­ra­tions of the man­age­ment that the com­pa­ny is sol­vent and, in one extreme case, (iv) the court call­ing for the sup­pli­er to request excerpts of the cus­tomer’s bank accounts and tax state­ments. Some insol­ven­cy receivers even ven­ture to claim that sup­pli­ers have the duty to active­ly ques­tion a com­pa­ny’s going con­cern prog­no­sis (Fortbeste­hen­sprog­nose).

Forcing suppliers to jump the gun?

The out­lined ten­den­cy of the courts to assume knowl­edge of finan­cial dis­tress and to impose bur­den­some inves­tiga­tive oblig­a­tions on sup­pli­ers might end up doing more harm than good. If the insol­ven­cy admin­is­tra­tors suc­ceed with their argu­ments that even vague news about a com­pa­ny’s finan­cial dis­tress might trig­ger sub­stan­tial inves­tiga­tive duties of sup­pli­ers, sup­pli­ers might choose to take the safe way and end busi­ness rela­tion­ships with cus­tomers upon the slight­est sign of finan­cial trou­bles. This would ren­der suc­cess­ful restruc­tur­ings of com­pa­nies, and espe­cial­ly retail­ers, vir­tu­al­ly impos­si­ble.

It can only be hoped that the courts will not place fur­ther bur­dens on coun­ter­par­ties of dis­tressed com­pa­nies, or that the leg­is­la­tor will step in and clar­i­fy just how cum­ber­some inves­tiga­tive duties are for such coun­ter­par­ties.

(Schoen­herr rep­re­sents sup­pli­ers of dayli in ongo­ing pro­ceed­ings on void­ance claims.)

The tendency of the courts to assume knowledge of financial distress and to impose burdensome investigative obligations on suppliers might end up doing more harm than good.