The right to withhold performance represents an important protection for suppliers and other contracting parties when a business goes bankrupt. This right means that a party can withhold their performance when the debtor cannot fulfill their part of a mutually burdensome agreement.
Legal Basis and Purpose
The right to withhold performance is regulated in the Satisfaction of Claims Act § 7-2 and gives a supplier the right to prevent their performance from being delivered to the debtor or their bankruptcy estate if the debtor lacks funds to fulfill their part of the agreement on time. The purpose of the right to withhold performance is to protect the party who has not yet delivered their performance, so they avoid being left with only a dividend claim in the estate.
The right to withhold performance functions as a supplement to the principle of performance for performance. It applies even if the time for the debtor's performance has not yet arrived. This is particularly important in bankruptcy, because the creditor normally does not have the right to cancel after the performance has been delivered, cf. the Satisfaction of Claims Act § 7-7 second paragraph.
When is the Performance "Delivered"?
The decisive factor for whether the right to withhold performance is preserved is whether the performance has been "handed over to the debtor or their estate" cf. the Satisfaction of Claims Act § 7-2. To specify this, a distinction must be made between different types of assets:
Movable property: For collection purchases, the right to withhold performance is lost when the buyer has taken possession of the property. For delivery purchases, an independent carrier is considered the seller's representative, and the right to withhold performance is preserved until the movable property is delivered to the buyer.
Real estate: The right to withhold performance is lost when the buyer has both received the deed and taken over the use of the property.
Construction: The building is considered handed over as it is constructed, cf. Rt. 1992 p. 770. For materials that are brought to the construction site and that are to be built in, they become the property of the builder when they have been paid for.
Money and securities: For cash payments, the right to withhold performance is lost when the money is handed over. For payment intermediation, the money is considered handed over when it is credited to the recipient's account.
Practical Significance for the Bankruptcy Estate
For the bankruptcy estate, the right to withhold performance has great significance for what funds can be seized and how unfulfilled agreements can be handled. If the right to withhold performance is preserved, the estate cannot seize the performance. If the estate needs the performance, it must in that case enter into the contract and pay in full.
For businesses, it is important to be aware of the right to withhold performance at signs of economic problems with a contracting party. Quick actions can be crucial to secure one's interests in a bankruptcy. This may include stopping delivery of goods, demanding return from the carrier, or ensuring that legal protection is established for the performances that have already been delivered.
