The Rights Protection in Cases of Business Partner’s Insolvency

13. 10. 2016

Many transactions performed are fairly complex and the stakes may be rather high when business is conducted and that is why it is often recommendable to bear in the mind that your business counterpart may not be able to meet their financial obligations and, put simply, go bankrupt. Such a situation might prove especially difficult with complex development/construction projects.

In case of one of the business parties becoming bankrupt, a provision which enables to claim and collect at least a part of the financial investments back (should the “nightmare scenario” come true) is most appropriate to be included in the respective contract; generally, such a provision will usually provide for the non-bankrupt party to fulfil their obligations to the other party either only partly or not at all since the degree of probability of collecting at least a majority of the claim by means of insolvency proceedings is rather low.

To make the argument easier to understand, we shall provide a specific example illustrating the issue. With the aforementioned construction projects, the insolvency clause is usually connected with a so-called retainage or retention money. Should the contractor go bankrupt, the ordering party is not obliged to pay back the part of the price set as retainage (retention money), but in doing so, they forfeit the right to claim the defective supply. In other words, although the client will not have to pay a part of the purchase price, they will not be able to register a complaint concerning any defects in the construction.

We believe that such a strategy provides, depending on circumstances, rather an efficient way of way of getting insured against significant financial losses should the business partners declare bankruptcy. Not only will such a party be able to fulfil their financial obligations, the execution of the contract will be at the bankruptcy trustee’s discretion; the ordering party (or the other contractual party) may, then, be faced with the necessity to bear further expenses. The insolvency clause included in the contract will help avoid these.

So as to guarantee the creditor’s protection, the provision ought to be made and contained in the contract entered into at the beginning of the co-operation; should the clause be included into the contract after the insolvent party has gone bankrupt (which does not necessarily mean the insolvency proceedings have been started, a mere fact of the bankruptcy being imminent /judging from the circumstances/ suffices), any security measures are in vain.

Apart from the aforementioned construction projects, the insolvency clause might be negotiated in cases in which one of the parties is required to pay their liabilities in the form of regular instalments – typically when a payment schedule has been arranged.

As can be seen, the economic status of your business counterpart is to be duly assessed when planning more complex projects with them; bearing this in mind, we strongly recommend that you negotiate the insolvency clause provided your partner has not become bankrupt yet.

Generally, however, a co-operation with a specialist who is capable of providing you with a qualified legal assistance and to ensure that, among others, the wording of the insolvency clause is appropriate is highly recommended when entering into more complex transactions.

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