Insolvent hospitals – a risk for the medical supply industry

A limited liability company (which is the business structure typically used for hospitals) is obliged to file for insolvency when it is over-indebted (Section 19 German Insolvency Code) or unable to pay its debts (Section 17 German Insolvency Code). Inability to pay means that the debtor no longer has sufficient liquid funds to meet its obligations to pay when due. Over-indebtedness means that the debtor’s assets no longer cover the existing liabilities, unless it is more likely than not that the business will continue to be carried on. Suppliers often do not become aware of the risk of a contractual partner becoming insolvent until payments remain unpaid for an extended period of time or an application to initiate insolvency proceedings has already been filed.

Upon the initiation of insolvency proceedings, there is not only a risk of losses resulting from unpaid invoices, but also a risk of losing future sales and, in the worst case, of payments already received being contested. In the event of insolvency, the debtor’s assets are realised in the best possible manner with a view to satisfying creditors’ claims. If, however, the business is closed down, high winding-up costs and very low proceeds from realisation regularly lead to disappointing dividends on the creditors’ claims.

Several strategies are available to prevent that the expected settlement will be limited to a future dividend in insolvency:

• Prepayments, instalments or short billing cycles and/or short invoice payment periods;
• Reservation of rights (for example, retention of title) to ensure the items supplied will not become part of the debtor’s estate in the event of insolvency. A drawback of this strategy is, however, that if the goods supplied are consumed quickly, a retention-of-title agreement may prove futile, for example;
• Third-party security taken from solvent collateral providers (surety, guarantee, assumption of liability as a co-debtor or the like).
• Trade credit insurance guaranteeing payment by the hospital. Of course, the insurer will charge insurance premiums and, in addition, check the hospital’s credit standing. With a poor credit standing, no insurance contract will be offered or there will be quantitative restrictions.

A secured supplier who obtains knowledge that (preliminary) insolvency proceedings have been initiated against its customer’s assets must assert its rights. If a retention-of-title agreement has been made, the rights must be notified to the (preliminary) insolvency administrator.

Ideally, even an impending insolvency is recognised by the supplier at an early stage and the associated risk minimised or avoided. This is why it is important to recognise the signs of insolvency. Once a customer is in a crisis situation, it is often too late to start optimising.

As soon as a (preliminary) insolvency administrator has been appointed, suppliers usually receive letters informing them that the (preliminary) insolvency administrator is striving to reorganise the hospital’s operations and, therefore, wishes to receive further supplies, and that whereas outstanding invoices for former deliveries (old liabilities) can no longer be paid, payment for newly supplied goods can be promised under certain conditions. As almost all insolvency administrators handle such matters with sufficient professionalism, promises to that effect can normally be relied upon. In this respect, continued supply – at least for a couple of months, if the prospects of reorganisation of the failing hospital are good – can normally be justified.

In summary, it can be said that taking third-party security always makes sense when a solvent collateral provider can be found. Retention-of-title agreements may be useful depending on the items supplied and should be incorporated into the supplier’s own terms of delivery. Shorter billing cycles and/or shorter invoice payment periods are also always helpful.

When it comes to insolvency, those with foresight actually have little to fear, provided they stick to a couple of basic rules. In particular, it should be clear that making advance deliveries to a hospital based on tradition is a risk that should not be taken without compensation at the present time.