Investigative Duties for Counterparties: From Supplier to Detective?

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.

authors: Miriam Simsa, Matthias Cernusca