Mike Collier in Riga -

As anyone who has been through it will tell you, declaring a business insolvent is not pleasant; admitting all that hard work and optimism has ultimately failed is an upsetting experience. So imagine how much more upsetting it must be to have your successful multi-million-euro business declared insolvent from underneath you.

That's what has happened to Lithuanian retailer Palink, operator of the 34 IKI and 17 Cento supermarkets in neighbouring Latvia, which has invested more than €120m in the country since it entered the market in 2008 and where it employs around 1,200 people and recorded turnover of €73m in 2010.

Any doubts about the depth of Palink's pockets should be dispelled by the fact that since 2007 (via German giant REWE Group, turnover €53bn in 2010) it has been part of the Coopernic group - a strategic alliance of five huge companies that also includes Italy's Conad, France's E. Leclerc, Colruyt of Belgium and Coop of Switzerland, which is Europe's second-largest food retailer with 19,000 stores.

As might be expected, the reaction of Palink to the threat of seeing its assets possibly auctioned off under administration has been one of incredulity.

Courting controversy

On January 19, REWE formally submitted a complaint to the European Commission over Latvia's insolvency laws, which saw Palink declared insolvent in a Riga court on January 5 at the initiative of an individual named Sergei Gushkin, who is involved in a dispute with Palink over a construction project.

Gushkin says Palink owes €30,000 to his construction firm for a project that was put on hold when Palink scaled back its expansion plans as Latvia slid into the world's deepest recession in 2008-09. Palink says the contract was terminated in a timely fashion and that it actually overpaid. But Gushkin took the option provided to him by the law to have Palink's entire Latvian operation declared insolvent.

At a press conference on January 12, Palink board member Oliver Ortiz was apoplectic. "It is shocking and painful to see today, in the 21st century, in independent Latvia, a full member of the European Union, how a judge of the Kurzeme district court in Riga is able to declare Palink insolvent based on €30,000. It is a scandal!" he thundered.

Marcel Harasti, Palink's managing director, says the decision threatened future investment in the country. "It seems that in Latvia even a millionaire can be declared insolvent in one day - it doesn't matter how many proofs he can give to the court... If large foreign enterprises with a strong financial base, who want to invest in this country and create new jobs, are subjected to the risk of being declared insolvent without any reason whatsoever, then that is absurd... Latvia's reputation in the field of business and investment could be damaged."

It's by no means the first time the nuclear button has been pressed to resolve what should really be run-of-the-mill business disputes, and recent years have seen several cases of big businesses threatened with an insolvency ruling over relatively minor disagreements. Many cases are thrown out, but even when that happens a company's reputation runs the risk of being dragged through the dirt and potential investors always get the shivers when the word "insolvency"is in the air, no matter how far-fetched the claim might be.

Egons Pikelis of the pan-Baltic LAWIN law firm says Latvia's insolvency laws aren't actually that unusual, but there can be a tendency for the law to be used tactically during a dispute over as little as €5,000 instead of when a company really has run out of money. "The law was changed about a year ago - the court isn't required to assess whether the company is insolvent or not," he tells bne. "There used to be a balance sheet test and a cash flow test, but those have been removed now, so all the court has to do is look at whether the money is due, whether the creditor has asked to be paid and whether there has been a response from the company. If the company hasn't responded, then the court doesn't have much choice but to issue the order for insolvency. An administrator is appointed and has to decide whether to wind up the company or put it into a legal protection procedure - even if it is solvent."

As Pikelis notes, ignorance of the law is no excuse, and businesses should be aware that they have to make official responses to claims against them within three weeks or face the possibility of having the insolvency procedure levelled against them. It's also worth remembering that insolvency laws are not based on EU directives, but vary from country to country, he adds.

Bad for business

According to Palink's owners, the court decision is already affecting their bottom line with "a noticeable drop in the turnover of IKI and Cento stores."

At no time ever was there a situation where Palink was insolvent or where there was any reason to believe that it could become insolvent, REWE said in a statement to bne, adding: "The declaration of insolvency and the transfer to an external administrator will lead to significant reputational and financial damages."

Manfred Esser, member of the REWE Group Management Board is incensed. "Latvian law is being blatantly abused," he says. "In our opinion, the initiation of insolvency proceedings represents a flagrant abuse of the law, which sends a fatal warning to investors. The fact that this is causing considerable - and unjustified - economic damage is being deliberately accepted without any consideration. The arbitrary and unfair application of Latvian insolvency law is an important barrier to the realization of the Internal Market in the Baltic region. The insolvency of SIA Palink is a bitter example of how easily a healthy company can get ruined within a few days and without having the appropriate legal means to react on it."

The fuss that Palink is kicking up is increasing pressure on Latvia to revise its insolvency law. A stream of Palink's suppliers and business partners in the country, including builders RBS Skals and Bukoteks, Swedish bank SEB and security firm Evor, have stepped forward to vouch for the company's reputation and promptness in paying its bills.

bne sources suggest the government is keen to make sure other investors don't get scared away by redrafting the law. It had better do so as a matter of urgency or risk seeing investors putting up a sign familiar in any supermarket aisle: "Everything must go!"