The story that has come to light in Lithuania—involving nine door showrooms that suddenly ceased operations and hundreds of customers left not only without the goods they had ordered but also without their advance payments—raises questions that go beyond business risk. It also serves as a reminder of the threshold beyond which a company’s financial difficulties can become a matter of legal liability for its CEO.
Customers who had ordered doors from the three affiliated companies had paid advance payments ranging from a few hundred to a few thousand euros. At the end of July, all three companies reported financial difficulties and insolvency. There may be several hundred victims, some of whom have already contacted the relevant authorities regarding the situation.
Egidijus Langys, managing partner and attorney at the AVOCAD law firm, says that in such situations, it is very important to distinguish between ordinary business failure and actions taken by a manager who is already aware of the company’s critical financial situation. “Business is inherently a risky endeavor. A company may lose customers, face supply issues, incur losses, or ultimately become insolvent. The mere fact that a business has failed and failed to settle its debts with creditors does not, in and of itself, imply personal liability on the part of the manager. However, the situation changes fundamentally when a manager knows or should know that the company will no longer be able to meet its obligations, yet continues to enter into new contracts and accept payments from customers,” says E. Langys.
A leader's responsibility is not only to grow the business but also to assess its status in a timely manner
A company director’s responsibilities are not limited to the day-to-day management of operations or the pursuit of business results. A director must act honestly and prudently, be loyal to the company, manage its assets properly, avoid conflicts of interest, and take the company’s actual financial situation into account when making decisions. These duties become particularly important when the company faces financial difficulties. The manager must assess whether the company is capable of meeting its obligations on time, whether its liabilities are being increased unreasonably, and whether newly entered into contracts can actually be fulfilled.
According to E. Langis, in practice, a manager cannot simply argue that he or she hoped the situation would improve. “A manager must constantly understand the company’s actual financial situation—what its obligations are, how much assets it has, which payments are overdue, and whether there are realistic possibilities to fulfill newly assumed obligations. As insolvency approaches, a manager’s decisions are scrutinized much more closely. This is especially true when new orders and advance payments continue to be accepted, even though the objective ability to fulfill the contracts may already be highly questionable,” the attorney notes.
The issue of a manager’s civil liability may arise if he or she fails to respond in a timely manner to the company’s insolvency, unreasonably increases the company’s liabilities, enters into transactions that are detrimental to the company or its creditors, provides misleading information, or causes harm to the company or its creditors through other unlawful actions. In certain cases, the manager’s direct liability to specific creditors may also be considered. Relevant circumstances in this regard may include whether the manager, through his or her actions, misled specific clients, provided information that did not correspond to reality, or encouraged them to enter into contracts or make advance payments, even though he or she was already aware of circumstances that made the fulfillment of the obligations highly doubtful.
When can financial difficulties exceed the limits of civil liability?
In this case, one of the legally significant circumstances is that orders and customer advance payments were accepted by three affiliated companies, which reported their insolvency at nearly the same time. Therefore, when assessing the situation, it is not only the fact of insolvency itself that becomes important, but also when it actually became clear that the companies would no longer be able to fulfill their obligations and what their managers knew at that time. According to E. Langis, it is precisely the chronology of events that becomes particularly significant in such situations. “The fundamental question would be very simple: what did the company executives know about the companies’ financial situation at the time when new orders and payments were still being accepted from customers? If it were determined that advance payments were accepted while already knowing that it would no longer be possible to actually fulfill the orders, this would no longer be merely a story of business failure. Such circumstances could also be evaluated in the context of potential signs of fraud. However, only the authorities conducting the pre-trial investigation and the court can determine this, after evaluating the specific evidence, the flow of funds, the timing of order acceptance, and the actual financial condition of the companies,” emphasizes E. Langys.
An unfulfilled contract, an unpaid advance, or a bankrupt company does not in and of itself constitute fraud. For such an assessment, it is important to determine what the individuals’ intent was at the time the money was accepted, whether customers were provided with misleading information, and whether, at the time their money was accepted, there was a genuine intention and ability to fulfill the obligations undertaken. “This should serve as a very clear reminder to business leaders: when a company is approaching the point beyond which it will no longer be able to meet its obligations, the decision to continue financing operations with advances from new customers can lead to legal consequences that are entirely different from those of a simple business failure. The hope that the situation will improve tomorrow does not replace a manager’s duty to act responsibly today,” says E. Langys.
For a consumer, bankruptcy may mean that it will not be possible to recover the money
The biggest problem for the consumer in such a situation is that even if they have a completely legitimate claim to a refund of the advance payment, that does not mean the money will actually be returned.
In insolvency proceedings, the client becomes one of the company’s creditors. If the company’s assets are insufficient to cover all of its liabilities, the chances of recovering the full amount of the advance payment may be very limited.
The situation is even more complicated when the consumer incurs additional expenses: removing the old door, scheduling other work, hiring contractors, adjusting the repair or construction schedule, and then having to urgently purchase the product from another supplier. Such losses may have to be proven separately, and even a recognized claim does not in itself guarantee actual compensation if the insolvent company does not have sufficient assets.
Therefore, according to E. Langis, consumer protection must begin even before a large advance payment is made.
How can users reduce the risk?
“We often choose the product itself very carefully, but we pay far less attention to who we’re transferring money to. When an advance payment amounts to a thousand, two thousand, or several thousand euros, taking a few minutes to verify the company can be just as important as reading the terms of the contract,” says E. Langys.
Before paying a larger down payment, it's a good idea to:
- Verify the legal entity. Make sure you know exactly which company you are paying and that it matches the seller specified in the contract. It’s also worth finding out how long the company has been in business, whether there is any public information about its financial difficulties, insolvency proceedings, or a significant increase in the number of customer complaints.
- Be cautious about making large advance payments. If the goods will not be manufactured or delivered for several months, it is worth negotiating a smaller initial payment.
- Negotiate installment payments. A portion of the price can be paid at the time of the order, another portion upon receiving confirmation that the goods have been manufactured or delivered, and the balance upon receipt or installation of the goods.
- Carefully evaluate any sudden changes to a contract or payment terms. If, after a contract has been signed, you are asked to pay another company or into a different account, or if the contracting party changes, you should find out the reasons for such a change.
- Keep all documents and correspondence on file. This includes contracts, invoices, payment orders, order confirmations, emails, and messages regarding production and delivery dates. In the event of a dispute, this information may serve as important evidence.
- Respond to the first warning signs. Repeatedly delayed deliveries, unanswered phone calls, recurring promises of “next week,” vague explanations regarding production, or requests for additional payments may be a sign that you shouldn’t wait any longer and should take action.
“This case demonstrates once again that a limited liability company does not mean that its manager remains beyond liability under any circumstances. An honest business failure is one thing. Deliberately taking on new obligations and accepting other people’s money while knowing that it will likely be impossible to fulfill them is something else entirely. “Where this line lies in a specific situation is determined by the authorities and the court, but every business leader must recognize it well before the company’s doors close for good,” concludes the AVOCAD attorney.