When Your Business Partner Becomes Insolvent

Segregation and preferential satisfaction: the decisive distinction

The Insolvency Code distinguishes whether an asset belongs to the estate at all. A party holding a right that excludes the asset from the estate may segregate it, that is, demand its return. The typical case is ownership of an asset merely in the debtor's possession, such as provided tooling or goods the supplier still owns.

A right to preferential satisfaction applies in a different situation. Here the asset belongs to the estate, but a creditor has a security right in it, such as a pledge or security ownership. That creditor receives not the asset itself but preferential satisfaction from the proceeds of its realisation, after deduction of the costs of establishing and realising it.

In practice, the classification is the very first question. A supplier entitled to segregate stands far better than a creditor merely lodging for the dividend. It is therefore worth looking at every open position at the outset: am I still the owner, do I have a security right, or am I an ordinary creditor?

The classification bears directly on the dividend. Those entitled to segregate usually recover their asset or its value in full, those entitled to preferential satisfaction the proceeds after deduction of costs, while ordinary insolvency creditors are referred to the general dividend. The economic difference between these positions can be substantial.

Retention of title and the administrator's right of election

Simple retention of title keeps ownership of the delivered goods with the seller until the purchase price is paid in full. If the buyer becomes insolvent and the goods are still present, the supplier remains the owner. It cannot, however, simply demand their return, because where a contract is not yet fully performed on either side, the insolvency administrator has a right of election: it may demand performance and then pay the price, or it may refuse performance, and the supplier segregates the goods.

The supplier does not have to wait indefinitely for the administrator to decide. It may call on the administrator to declare its position. If the administrator makes the decision on performance only after the report meeting, the supplier need not deliver into uncertainty until then. What matters is being able to prove the retention: it must be validly agreed before or at the conclusion of the contract, not added afterwards on an invoice. We cover separately how the retention is anchored as payment security in international business before any crisis.

Extended retention of title additionally covers the case of onward sale; the buyer's claim against its own customer is assigned in advance to the supplier. Expanded retention secures further claims. A group-wide retention that keeps ownership until claims of affiliated companies are settled is, however, invalid. In insolvency these forms usually give rise to a right of preferential satisfaction in the substitute, that is, in the proceeds or the assigned claim.

Current contracts: what happens to performance and counter-performance

For mutual contracts not fully performed by either side at the time of opening, the administrator's right of election applies generally, not only in the case of retention of title. The administrator decides whether to perform the contract, thereby rendering the full counter-performance from the estate, or to refuse performance. If it refuses, the counterparty may lodge its claim for non-performance only as an insolvency claim.

For the supplier this means: performances rendered and unpaid before the opening are in principle ordinary insolvency claims. If, on the other hand, the administrator elects to perform a current contract, the claims arising after the opening become debts of the estate, to be satisfied from the estate in priority. That can make continued delivery economically sensible, but only with a clear declaration from the administrator.

For the customer the mirror image applies. If the supplier is insolvent and the customer has paid in advance without receiving the goods, it bears the risk of refusal. Its claim for repayment is then an insolvency claim. A party dependent on continued supply should clarify early with the administrator whether, and on what terms, delivery continues.

The avoidance periods attach to the time of the transaction before the request to open proceedings and differ by ground. For intentional-disadvantage avoidance, a shortened period applies to congruent coverage, while other grounds reach only a few months before the request. A party receiving payments from an ailing partner should document the timing and its own state of knowledge about the crisis.

Avoidance: when payments are clawed back

A further risk is often underestimated: the administrator can avoid transactions that disadvantage the creditors and reclaim payments already received. A party that manages to get an outstanding invoice paid quickly during the partner's crisis is therefore not automatically safe.

The Insolvency Code recognises several grounds of avoidance. Among the transactions that can be avoided are securities or payments a creditor received while aware of the debtor's inability to pay or of a request to open proceedings, as well as acts a creditor received to which it had no claim in that form or at that time. A special ground covers acts the debtor carried out with the intention of disadvantaging its creditors, where the other party knew of that intention.

Not every payment can be avoided. An exchange in which performance and counter-performance are swapped directly and at equal value, a so-called cash transaction, is largely protected. In practice this means: anyone working with an ailing partner during a crisis should ensure prompt step-by-step settlement and scrutinise unusual securities or advance payments, because those in particular can later be clawed back.

The claim is lodged with the insolvency administrator, whose appointment and address appear from the opening order and the public notice. The cause and amount of the claim must be stated, and security rights expressly identified. A lodgement made after the deadline is possible, but it can trigger additional costs and jeopardise participation in interim distributions.

Immediate steps: the first days decide

As soon as the partner's crisis becomes known, the response should be structured and immediate. First, review the contractual position: which deliveries are outstanding, which payments have gone out, and which security rights exist in which position? All documents relating to retention of title, security arrangements and provided assets should be collected in one place.

Next, assert the rights towards the administrator. Segregation claims, for instance in tooling or retained goods, must be asserted and their return demanded. Rights of preferential satisfaction in proceeds or assigned claims must be disclosed. Further deliveries should be made only after a clear declaration from the administrator, so that advance performance does not turn into a mere insolvency claim.

Finally, the claim itself must be lodged with the administrator on time, with supporting documents and an express marking of any preferential rights or securities. The deadline follows from the opening order. A party that orders these steps in the first days secures the stronger position; a party that waits is often referred to the ordinary dividend.

Customer and supplier: different levers

The situation differs by role. The supplier relies above all on retention of title and the segregation of goods still present, and on preferential satisfaction in proceeds and assigned claims. Its most important lever is clean contractual security, which must be agreed before the crisis and provably documented.

The customer of an insolvent supplier has other approaches. Provided tooling, moulds or materials in its ownership can be segregated. Advance payments for undelivered performance remain insolvency claims unless a security exists. A party dependent on continued supply negotiates early with the administrator over performance of the current contracts.

In both roles, preparation decides. A party that knows its contracts, can prove its security rights and observes the deadlines of the proceedings limits the damage. A party that takes the partner's crisis seriously only once the opening order is in hand has already forgone many of its options.