Entrepreneurs in difficulty, who are struggling with the performance of a contract, may benefit from a restructuring procedure. Any restructuring procedure guarantees the protection of executed contracts, with the most effective solution being the reorganization procedure (postępowanie sanacyjne).
Recent years have seen a number of extraordinary developments, such as pandemics and the war in Europe. To everyone’s surprise, these events proved capable of affecting the economy as a whole and its various sectors in a relatively short period of time, with a subsequent negative impact on companies and the situation of consumers. The mounting prices of fuels, commodities, services and raw materials make the performance of contracts already concluded, including public contracts, less profitable than before, thereby negatively affecting the profitability of contractors.
Mandatory indexation clauses
Although legislators have provided for mandatory inflation indexation clauses in public procurement contracts, and contractors strive to ensure that appropriate ‘adjustment clauses’ and safeguards are put in place in the contract to allow for change and/or risk management, these solutions may prove insufficient. Market fluctuations in the economy as a whole, or in its constituent sectors, may be so significant in relation to the contract execution phase that the contractor may end up having to foot the bill for the excessive costs generated by the contract. An indexation clause may therefore not serve its intended purpose and may prove to be an overly conservative solution in the face of turbulent economic changes.
Of course, at such a time, it should be a natural solution to try to renegotiate the contract so as to bring it into line with the current market conditions. First and foremost, indexation of the contract performance price is the first viable option. However, renegotiation does not necessarily have to be successful for the contractor. This is because the contracting authority may either refuse indexation altogether or agree to it only to a very inadequate extent.
When negotiations fail
In such a situation, it seems that the only tool available is judicial indexation and the initiation of a typical civil action leading to a modification of the contract. This could be the optimal solution for a contractor who is not affected by liquidity problems and who, although he has signed a public contract, even an unprofitable one, in one of his business areas, are lucky in that this particular predicament, it does not affect the situation of the company as a whole. In such a situation, the contractor can afford to file a lawsuit that will eventually lead to a final settlement after a number of years.
However, for contractors whose portfolios include a significant proportion of no longer profitable public contracts, a typical court-ordered indexation may prove to be a risky measure that arrives too late. After all, litigation is a time-consuming exercise with uncertain outcomes, whereas companies need adequate response tools in the here and now. If too much money is spent on handling key contracts, the company runs the risk of becoming insolvent in the near future. This, in turn, will trigger the legal obligation to file for bankruptcy.
However, this does not mean that the contractor is in a no-win situation. After all, a distressed company may decide on a restructuring procedure and use it as an appropriate response tool to modify executed contracts.
Currently, the law recognizes four different types of restructuring proceedings, each of which aims to avoid bankruptcy and facilitate the execution of an arrangement, i.e. an agreement with creditors. Arrangement agreements are usually signed to reorganize the way in which the company will meet its defaulted liabilities and obligations. On the other hand, the nature of the restructuring process depends mainly on the extent of the company’s business problems, the scope of the corrective measures required and the volume of disputed debts.
Contracts will be protected
Protection of executed contracts is the most important protection for entrepreneurs undergoing restructuring. Articles 225 and 247 of the Restructuring Law (the “RL”) expressly provide that all contractual clauses providing for the modification or termination of a contract in the event of the filing of a petition for a court-approved arrangement, or in the event of the approval of an arrangement, the publication of a notice setting an arrangement date, or the filing of a petition for the opening of restructuring proceedings, or the opening of such proceedings, are null and void by operation of law. Consequently, the contracting authority will not be able to enforce any such clauses, even if they are expressly provided for in the contract. The above mechanism is intended to guarantee that the mere fact that a company is undergoing restructuring procedures will not have negative consequences for the existence of the contracts it has signed. In this way, the contractor will be able to continue with any outstanding contracts that it deems profitable.
Although it is true that any restructuring procedure guarantees the protection of existing contracts, in a situation where the contractor needs to change the way in which the contracts are performed or even rescind them, the reorganization procedure (postępowanie sanacyjne) seems to offer the greatest number of available options. In addition to being fully protected from enforcement, being able to sell redundant company assets without encumbrance, and being able to lay off some employees, this procedure also allows the company to rescind unprofitable contracts. This mechanism can be particularly useful if the contract in question does not allow for rescission and the company has not yet succeeded in having it indexed.
To rescind or not to rescind?
Article 298 RL, which governs the rescission procedure, authorizes the reorganization administrator to file a petition for rescission. Since the contracting authority’s performance is quantifiable (it is expressed in monetary terms), it is possible to rescind the relevant part of the contract that remains to be performed after the procedure has been initiated. The provision does not contain any criteria as to the type of contract, the contracting party or the grounds for rescission. In practice, however, the vast majority of applications relate to contracts that are too costly to perform and adversely affect the company’s ability to recover financial liquidity, where previous attempts to index the contract to inflation through negotiation have been unsuccessful.
A petition to terminate a contract is submitted to the bankruptcy judge in charge of the restructuring process. The administrator, as a court-appointed body empowered to act on behalf of the debtor, is therefore not entitled to take a decision to rescind a contract. This decision must be accepted by the judicial authority.
At first sight, it would seem that in a situation where the judge-commissioner has granted the administrator’s petition to rescind a contract on the basis of a final and non-appealable decision, the only further scenario is for the administrator to terminate the contract by serving a notice of rescission. The other party is then bound by the notice.
However, the practice of reorganization proceedings shows that the approval of the judge-commissioner could actually create space for further negotiations with the contracting authority. In fact, once the administrator has obtained a final and non-appealable decision from the judge-commissioner, he is not obliged to implement the terms of the decision. This is because the decision does not constitute an unconditional order for the administrator to terminate the contract, but rather a kind of “green light” for the administrator to proceed with the proposed rescission. Nevertheless, the administrator can use the decision as a strong argument in further negotiations to amend the contract so it becomes more favorable to the contractor. This tool can be particularly useful for contractors performing a public contract that constitutes an investment project. Such projects, especially technological projects, rely very heavily on the knowledge, skills and know-how of the contractor. In performing a public contract, the contractor may contribute some of its own assets to the project, e.g. by reselling its licenses. In such a case, it may be unprofitable for the contracting authority to rescind the contract and to abandon it altogether, as this would mean hiring a new contractor, who may need a lot of time to understand and take over the project. For this reason, the mere possibility that the administrator may rescind the contract on behalf of a company in reorganization may encourage the contracting authority to negotiate a favorable amendment to the contract.
Restructuring by arrangement
The other tool available in reorganization proceedings, as in all other restructuring proceedings, is the possibility of restructuring the defaulted liabilities of the company on the terms set out in an arrangement which has been put to the vote of the creditors and then finally and non-appealably approved by the court. Although arrangements in restructuring proceedings mainly concern unperformed monetary obligations (for example: they provide for payment deferrals, payment in installments, repayment of 80% of the principal, redemption of interest, etc.), they may also concern unperformed non-monetary obligations arising from contracts not performed before the opening of the restructuring proceedings. This possibility is provided for in Article 150 (2) RL. In order for such non-monetary obligations to be included in the arrangement, the underlying contract must be unperformed in a situation where the contracting party has performed but has not received adequate consideration before the opening of the restructuring proceedings (or — in the case of proceedings for approval of the arrangement — before the date of the arrangement). In such a case, the contracting party’s claim for the paid part of the contract to be performed becomes its non-monetary claim included in the arrangement. The law does not prescribe how such claims are to be restructured, but leaves this matter entirely to negotiation between the debtor and the creditor, i.e., in the present case, between the contracting authority and the contractor. Accordingly, arrangement proposals may, for example, provide for the deferral of a certain part of a public contract, in the case of infrastructure projects — a change in the timetable and project performance rules, and in the case of technology projects — a change in the product functionality. As restructuring proceedings practitioners are familiar with cases where non-monetary claims have been restructured in return for an adequate additional payment made by the creditor, this form of contract modification cannot be ruled out either. This, a final and non-appealable arrangement may result in the modification of the performance of a certain part of a public contract in favor of the contractor.
Modification for the duration of the restructuring procedure
In addition to the above mentioned restructuring instruments, Article 248 RL may provide complementary solutions regarding the way the contract is performed. This article stipulates that any provision of an agreement (contract) to which the debtor is a party that prevents or hinders the achievement of the purpose of the restructuring proceedings shall be ineffective against the ‘arrangement estate’. This means that a particular contractual provision may not be implemented during the restructuring process if it stands in the way of a successful restructuring. The provision is worded broadly enough to apply to a very wide range of factual situations. Thus, if the relevant contractual provisions do not include an optimization of the subject matter of the contract and the approach to its implementation, the contractor may use the aforementioned article to achieve this objective for the duration of the restructuring proceedings.
The authors’ view
The options described in the article can be used as a method of public contract indexation, especially when the company is facing insolvency and previous attempts to modify the contract have proved unsuccessful. However, restructuring is by no means a smooth route without risks and difficulties. In reorganization proceedings, the company generally loses control of its assets in favor of a court-appointed administrator. Conversely, in other restructuring procedures, it must obtain the approval of the court supervisor for any action outside the day-to-day management. Each restructuring procedure is a time of intense effort for the company to take corrective action and restructure its liabilities and operations. It is also crucial to convince the creditors to support the arrangement proposals, otherwise the restructuring process will be terminated and bankruptcy will become a reality. The “second chance” offered to the entrepreneur by the restructuring procedure is therefore not unconditional, and should be accompanied by active efforts — not only during the restructuring procedure, but also in the period leading up to the restructuring. Only then will it be successful and help restore financial stability and full solvency.
By Piotr Bartosiewicz, Senior Associate, Dentons