During the current economic slowdown businesses in many industries, including some in the industrial engineering sector, are struggling to make payments to suppliers; some have even gone into bankruptcy. However, under Polish law it is possible for a creditor to achieve some protection even if specific provisions are absent from the contract.

When entering into a contract, particularly one of high value, each party should check the financial condition of the other party. In commercial dealings, this approach is common when concluding a contract with a new supplier or customer but it can, unfortunately, be overlooked when simply renewing an existing agreement.

It may happen, for example, that a manufacturer is not aware that an existing customer is in a poor financial condition so enters into a contract to supply a complicated, valuable piece of machinery. The situation becomes more complex when information about the customer’s payment problems or insolvency reach the supplier after they have signed the contract but before they have completed their side of the agreement, especially if payment is not due until they have done so.

 In such a situation the supplier has little room to manoeuvre:

  1. if the supplier delivers the equipment as agreed in the contract it is then at risk of not receiving payment (if, for example, the buyer goes bankrupt between the agreed delivery date and payment date)
  2. if the supplier does not deliver the equipment as agreed but waits to see how the situation develops (possibly the outcome of negotiations between the buyer and its creditors) it could expose itself to a contractual penalty for failure to make timely delivery of the equipment, a claim for damages for shutdown of the buyer’s factory caused by lack of the piece of equipment in question, or even renunciation of the contract by the buyer citing the supplier’s fault.

Issue not covered by the contract?

In the event of a dispute a lawyer will review the provisions of the contract addressing such a situation; permitting the supplier to withhold delivery until it obtains advance payment or other security, for example.

But what if the contact does not include such provisions and the supplier is concerned about the risk of contractual penalties or renunciation of the agreement?

There is a provision in the Polish Civil Code which applies when the parties to a bilateral contract are not required to perform at the same time.

What are the options under the Civil Code?

Under Civil Code Art. 490, if one of the parties is required to perform earlier, but the other party’s performance is doubtful because of its financial condition, the party required to perform earlier may withhold its performance until the other party performs or provides security.

In practice, this provides the supplier in this example with an opportunity to withhold delivery of the equipment until the buyer pays the full price or provides other security for the supplier’s claim for payment.

In order to make use of this option, the contractor must first call upon the other party to pay in advance or present appropriate security (e.g. a bank or insurance guarantee) under penalty of withholding performance (delivery of the equipment). The legal basis for this demand would be Art. 490 §1 of the Polish Civil Code.

But bear in mind:

The opportunity to exercise the right to withhold performance under Civil Code Art. 490 is not available if the party knew of the poor financial condition of its counterparty at the time of conclusion of the contract.

Under the law, there is a right to withhold delivery only if the supplier was not aware of the customer’s poor financial condition. The burden of proof of this issue rests on the party demanding early performance: the supplier, in this example.

This legal construction is intended to avoid rewarding careless enterprises. Polish lawmakers accepted that if a party enters into a contract, even though it has knowledge of the other’s poor financial condition, it consciously assumes the risk of performance failure by the other party and should at least bear the risk of their insolvency.

If you knew, you assumed the risk

Thus if the customer demonstrates that upon conclusion of the contract the supplier knew of the customer’s poor financial situation, the supplier will not be able to lawfully withhold delivery by relying on Civil Code Art. 490, and the other party may duly demand performance on the agreed terms.

It should also be borne in mind that the burden of proving that there are doubts surrounding the ability to perform due to the party’s poor financial situation also rests on the party seeking to withhold performance: the supplier in this example. Significantly, doubt concerning the party’s financial condition is not the same as the party’s insolvency. Rather, this means a justified doubt that on the date that a specific performance is due (here, the date of delivery) the other party will be able to perform as agreed (i.e. pay for the delivery).

Performance may not be withheld indefinitely

The right to withhold performance is primarily intended to secure the claim and thus is limited in time. It may be exercised only until the other party performs or provides appropriate security.

Thus, if one party tenders performance or offers appropriate security, the other party’s right to withhold performance automatically lapses.