Karol Czepukojć

Payment gridlock can push a company into bankruptcy

Companies nowadays are frequently late in paying their suppliers, which in turn fall behind in paying their own creditors. But sometimes even a few days’ delay in payment can force a debtor to file a bankruptcy petition.

Late payment may constitute grounds for a business to enter bankruptcy. Under Polish law, bankruptcy may be declared, among other reasons, when the debtor fails to pay its debts as they become due. The law does not provide for a permissible period of delay. Thus even a few days’ delay in payment imposes on a business an obligation to file a bankruptcy petition with the court. This should be done within two weeks after the first delay in payment occurred. Creditors may also file a bankruptcy petition if they have not received payment when due and, in their view, their claims are unlikely to be satisfied through judicial execution.

The court is required to grant the bankruptcy petition and declare the debtor bankrupt if payments to creditors are at least three months overdue. In the case of shorter delays, the court may deny the bankruptcy petition, but only if the total unpaid debts do not exceed 10% of the balance sheet value of the debtor’s enterprise. The court will generally issue such a decision if it finds that the delay in payment involves relatively modest amounts and is not a long-term problem, and the debtor resumed payments soon after the delay occurred or is likely to do so soon. This therefore has to do with instances of a short-term lack of liquidity on a small scale. Nonetheless, the court may not deny the petition if to do so would be detrimental to the creditors.

The approach taken under Polish bankruptcy law is thus that in the case of minor delays in payment, it is up to the court rather than the debtor to determine whether it is a temporary problem that need not require the debtor to enter bankruptcy, or a long-term problem which, in the best interest of the creditors, justifies entering bankruptcy. The debtor should always file a bankruptcy petition if it loses the ability to pay its debts as they become due. The court may then, at most, deny the petition in the case of temporary delays in payment of relatively small amounts. When denying a bankruptcy petition, the court may also, as a rule, permit the debtor to commence rehabilitation proceedings if it wishes.

In practice, debtors rarely file timely bankruptcy petitions. They tend to file them late if ever. This is particularly common among SMEs. One of the reasons is the stigma in the business community attached to companies that have filed for bankruptcy. When the debtor is branded a “deadbeat”, it may deepen the debtor’s existing financial difficulties. But failure to act entails a risk of personal liability on the part of an individual operating his own business, or on the part of the debtor’s representatives (e.g. management board members) in the case of a corporate entity, for failure to file a timely bankruptcy petition. More specifically, such persons may be liable in damages for injury resulting from failure to file a timely bankruptcy petition, or even criminal liability up to and including imprisonment. A debtor that is having difficulty maintaining financial liquidity should assess these risks in each case—and be aware of their existence.

Poland is now one of the leaders in Europe in payment gridlock, behind Spain and Portugal. According to a survey in May 2012 by the Business Centre Club among its corporate members from all over Poland, 79% of the respondents wait over a month to pay outstanding debts. In Poland, payments that are over three months overdue constitute 9.8% of all payments, compared to a European average of 2.9% (according to figures provided at the Business Centre Club’s “Roundtable on Payment Gridlock”). These figures may foreshadow an increase in bankruptcies among Polish companies, which, given the imperfections in Polish bankruptcy regulations, may lead to the liquidation of a significant number of the debtors. Some 415 companies were declared bankruptcy in the 1st half of 2012, 82% of which were liquidating bankruptcies (according to a Coface report dated 2 July 2012). In the future this could lead to a widespread domino effect, as the bankruptcy of one company causes its suppliers to become insolvent, and then their suppliers in turn, and so on. A current example is the escalating difficulties of construction companies working as subcontractors in motorway construction.

Rehabilitation proceedings could offer an opportunity to head off the domino effect caused by payment gridlock. In theory, they are available to companies that are beginning to face financial pressures but are still managing to pay their debts on time. The purpose of rehabilitation proceedings is to protect against insolvency. But under the current regulations, it is difficult to qualify for rehabilitation proceedings, and in practice they are hardly ever used. Thus one of the challenges facing Polish lawmakers is to amend to the regulations to make rehabilitation proceedings much more accessible and encourage more extensive use of this procedure among businesses.

Karol Czepukojć, Bankruptcy and Restructuring practices, Wardyński & Partners

The Polish version of this article was published on 11 September 2012 at eGospodarka.pl