How to Get What's Yours When Your Business Partner Goes Bankrupt

"Capitalism without bankruptcy –

is like Christianity without hell."

Frank Borman

Many entrepreneurs are well aware that, in a number of situations, it makes sense to structure a commercial relationship as a so-called framework agreement (Rahmenvertrag). The advantage of a framework agreement can be seen in the example of a supply contract. At the time such a document is signed, the parties generally cannot precisely define the goods that the supplier will deliver and the buyer will accept and pay for. Strictly speaking, a framework agreement is a form that any future contract can take. It sets out the general terms of the relationship between the parties within a given obligation. It can be performed either through the conclusion of other agreements that it envisages, or in some other way. This kind of structure is most often used for long-standing, stable relationships between business partners. Framework agreements can differ in their form and substance. In some cases the agreement sets out the general terms of the deal and an intention to carry out certain steps so that its subject matter comes into being. The opposite variant assumes that the subject matter of the deal exists, but the general terms remain undefined. In one case, only the intention to conclude a deal is fixed; the parties agree to settle the remaining terms later, for example by concluding additional agreements. In the other case, the framework agreement contains only a number of general terms for carrying out the deal, while agreement on the essential terms (for example, the subject matter of the agreement itself) is postponed to the future. In the example of a supply of goods, the parties agree to determine the description and/or quantity of the goods later, in appendices, specifications, orders and other supplementary documents drawn up along the way.

Thus, within the framework of a concluded framework agreement, the parties may subsequently sign separate documents, agreeing the specific terms of each one as it arises. Although, in keeping with one of the basic principles of civil-law relations, transactions are supposed to be conducted while respecting the equal rights and interests of the participating parties, in practice this principle is far from always observed. It is obvious that the more interested one party or the other is in concluding the deal, the more readily it makes concessions on the commercial terms. In addition, long, stable relationships between business partners in a number of cases also lead to a loss of vigilance and to commercial relations being built purely on trust.

In particular, when performing the widely used contract for the supply of goods, commercial risks arise:

- for the supplier – where delivery of the goods is made before payment for them is received;

- for the buyer – where an advance payment is made before the goods are delivered.

The parties try to protect their legitimate interests by agreeing that the advance payment will not cover the full price, or that title to the delivered goods passes to the buyer only after payment in full. Frequently, experienced managers already turn to professional attorneys with experience in the relevant field of law at the stage of drafting the framework agreement, as well as the standard supplementary agreement containing the specific terms of a given deal. This makes it possible to substantially minimise the risk that the parties will fail to perform their respective contractual obligations. In other cases, entrepreneurs consult lawyers only once problems have already arisen and skilful, prompt action is needed to protect interests that have already been infringed. In this article we would like to tell you about one interesting case where it could rightly be said that "the devil was in the details."

A client came to our law firm who was the director of a company registered in Germany. The client — let us call him Roman (the name has been changed) — ran a firm engaged in manufacturing and supplying mechanisms and spare parts for agricultural equipment. For a long time, the firm had cooperated successfully with a large plant manufacturing agricultural machinery, until, as the saying goes, "thunder struck out of a clear sky." Roman told us a fairly common, unhappy story: on one occasion involving a standard delivery of goods to the buyer worth around 20,000 euros, no payment had been made. What is more, representatives of the counterparty had not responded to either warning letters or phone calls for about two weeks already. The sum in question represented a significant portion of Roman's company's assets, so he asked us for skilled, urgent legal assistance. Naturally, our first step was to request and analyse the documents governing the business relationship between the partners. First, there was a signed framework agreement for the supply of goods in accordance with an attached specification. Second, for each individual delivery, the parties concluded a separate supplementary agreement specifying all the essential terms — namely, the subject matter of the delivery, the price of the goods, the deadline, and the payment arrangements. This kind of cooperation had existed between the parties on a regular basis for around five years already, without giving rise to any problems or difficulties. The standard term of delivery was an advance payment of 50 percent of the price, and this term was also recorded in the supplementary agreements the parties concluded on each occasion. Problems and uncertainties with performance by the buyer — the plant — had begun roughly a year earlier. The director of the plant receiving the deliveries had already repeatedly asked our client for a deferral of payment, citing various circumstances and temporary difficulties. Nevertheless, the parties continued to work together, since payment for the goods delivered, although with significant delays, was still being made. It was to Roman's advantage to continue cooperating with the plant, so he hoped for a swift resolution of the problems that had arisen and a return to "business as usual." Unfortunately, instead of the situation improving, a crisis set in, expressed in a complete absence of payment.

The attorney at our firm who took on the client's case set about tracking down the "vanished" counterparty. Unfortunately, some fairly unhappy circumstances soon came to light. The plant had declared itself unable to pay its debts — in other words, bankrupt. The enterprise was under provisional administration, and measures were under way to assess its remaining assets and the claims of its numerous creditors. At first glance, it might have seemed that our client's prospects in this matter were fairly bleak — he would have had to "join the general queue" for satisfaction of creditors' claims. Anyone who has faced such circumstances knows that the chance of getting anything at all in such a case, let alone satisfying one's financial claims in full, is decidedly murky. Nevertheless, the attorney did not give up and thoroughly analysed all the circumstances surrounding this unpaid delivery. Fortunately, it turned out that our client, despite having delivered the goods in full without an advance payment, had nevertheless managed to reduce his legal risk under the contract. When making this delivery, he had sent the counterparty written notice that title to the delivered goods would pass to the buyer only once the goods had been paid for in full — a so-called retention-of-title clause (Eigentumsvorbehalt). Representatives of the plant had replied to this notice with a short letter of agreement. Thus, although the delivered goods were by now actually in the buyer's possession, it was not, from a legal standpoint, their owner. Our firm's attorney therefore prepared and sent the debtor a demand either for the return of the goods, if they were still at the enterprise's disposal, or for an assignment of the right to claim their purchase price, if they had already been passed on to some third party.

Consequently, the written notice the supplier sent to the buyer at the time of actual delivery of the goods made it possible to avoid having to claim the amount owed through the ordinary insolvency queue. Moreover, a well-drafted demand letter, prepared and sent in good time by our firm's attorney, considerably improves our client's chances of getting his expensive goods back, or compensation for them. Naturally, having taken on this case, we will see it through to a successful conclusion. If the pre-litigation demand sent by the attorney does not have the desired effect, we will represent the client's interests in court, and in the enforcement proceedings as well.

In conclusion, we would like to note that carrying on any kind of entrepreneurial activity is closely bound up with a wide variety of adverse situations that have a negative effect on a company's operations. Such situations are called "business risks." A counterparty's refusal to perform its contractual obligations, and its bankruptcy, are among the most significant risks in entrepreneurial activity. It must be acknowledged that business risks are an inherent part of any business and cannot be avoided; however, by understanding their causes and the ways out of risky situations, they can be minimised. Broadly speaking, business risk is an inherent part of the economic freedom that exists today; however, without overcoming risky situations, it is impossible to earn a profit — in other words, those who do not take conscious risks reap no reward. Among the principal ways of reducing risk is choosing reliable counterparties who have stood the test of time, as well as drafting contractual documentation on the basis of which the work is carried out, with due regard for the possibility that unforeseen adverse situations may arise. Only careful monitoring and the wise choice of ways to overcome crisis situations will allow your company not only to preserve its profitability, but to reach a high level of it.

Civil Law

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