Most businesses rely on enforceable contracts, which often contain at least one bankruptcy clause. It is important that businesses are aware of common bankruptcy provisions which cannot be applied in a bankruptcy setting and therefore can be ignored. Likewise, it is important to understand the provisions that can be applied in the event of bankruptcy. In this alert, we identify the clearly unenforceable provisions and examine the provisions that may be enforced after a bankruptcy filing, and which, therefore, require careful consideration.
You can ignore Ipso facto Most automatic stay clauses and exemptions
Ipso facto Clauses
Bankruptcy provisions often provide that “upon filing for bankruptcy of a party to the contract, the filing for bankruptcy itself is an event of default under the terms of the contract”, or, more aggressively, “upon filing for bankruptcy. from the bankruptcy of any party to the contract, the contract will be deemed terminated and unenforceable. These types of provisions are inapplicable under the plain language of Article 365 (e) (1) of the Bankruptcy Code, which provides that the mere occurrence of a bankruptcy or insolvency “of a contracting party to an enforceable contract can only be used by the non-debtor counterparty to terminate or modify the contract after filing a bankruptcy petition. ipso facto clauses. If your contract includes such ipso facto clause which is a model of bankruptcy, then this can be ignored.
Automatic stay exemptions
Contractual waivers of the automatic suspension (established by article 362 of the Bankruptcy Code) are not in itself inapplicable as ipso facto clauses, but the enforceability of such waivers is the exception and not the rule. Most people know that automatic stay is meant to be a broad and comprehensive injunction against creditors’ activity that might have been started before filing for bankruptcy or that a creditor might want to continue after filing, as long as where such an action is in the nature of a recovery action or an attempt to assert a debt, obtain a lien or seek to exercise rights of set-off. The automatic stay creates this pause in such creditor collection activity to protect debtors and their creditors by stopping the race to the courthouse and giving each creditor an equal chance to collect their debt.
If any provision of the contract is intended to eliminate automatic suspension by agreement, it is very unlikely that such a provision will be enforced because it ousts these protective powers from the Bankruptcy Code. However, an automatic stay waiver that is part of a forbearance agreement, in which the creditor attempted to help the debtor avoid bankruptcy completely, could be enforceable because the creditor tried to work with the debtor. debtor when in financial difficulty. Bankruptcy courts support these efforts and recognize pre-petition sacrifices that may have been made by the creditor.
However, even if an automatic stay waiver is part of a forbearance agreement, parties should still go to bankruptcy court and request that the waiver be enforced before proceeding with any collection activity. This reality, applicable to all automatic stay exemptions, adds a layer of uncertainty to their application and makes all these provisions less useful than they appear.
Furthermore, even a well-designed automatic stay waiver may end up being considered unenforceable if allowing such relief would be detrimental to the overall objectives of the debtor’s bankruptcy case. As such, unless you prepare an automatic stay waiver in a forbearance agreement, the language used is unlikely to be tested. Given these challenges to their applicability, in almost all cases the automatic stay waiver provisions can be ignored.
You should review most of the other bankruptcy provisions in your contract
Beyond ipso facto automatic stay clauses and waivers, most references to the bankruptcy process in your contract should be carefully considered. Such provisions could unintentionally invoke confusing provisions of the Bankruptcy Code at the time of application, seek to avoid Bankruptcy Code requirements in a way that will never be tolerated in a bankruptcy context, or bring welcome clarity to a stressful bankruptcy situation. Whatever form your bankruptcy arrangements take, you need to understand the terms at the time of performing the contract rather than trying to figure out what you agreed to after filing for bankruptcy. At the very least, there is a chance that you can optimize the terms of your contract to better ensure the desired result.
Here are some general considerations when you find a bankruptcy provision in your contract:
- The Bankruptcy Code is constantly revised and interpreted by the courts and Congress. Depending on the length of your contract, the provision of the Bankruptcy Code that you seek to invoke in your contract may be amended or reinterpreted in the future. If your contractual reference to the Bankruptcy Code becomes obsolete, your agreement may contain an unintentional ambiguity in its terms. There are ways to incorporate a current concept of the Bankruptcy Code into your contract while taking this future uncertainty into account. Careful writing is essential.
- A contractual agreement require a debtor to provide a particular result in bankruptcy proceedings must be regarded as a false promise. Debtors are bound by a fiduciary duty to serve the competing interests of many parties after a filing. This fact makes it difficult for a debtor to obtain a particular result for a creditor that he cannot offer to all, or which only benefits one creditor and potentially harms other creditors.
- Contractual agreements obliging a debtor to request some bankruptcy court remedies are likely to be more enforceable, but the debtor’s ability to achieve the end result may be unreliable. Careful drafting of such a provision could add significant value in the form of bargaining leverage, at the very least.
- Contractual agreements requiring a debtor to seek to assume an enforceable contract or lease at some point in a bankruptcy case might be unrealistic as the Bankruptcy Code sets the time limits for the assumption and rejection of such agreements. A provision requiring the assumption of an agreement at some point after the request may be applied more realistically, particularly if the obligee has assumed significant burdens to secure the assumption of the agreement. The chances of execution are greatly improved if your contract is truly essential to the debtor’s future business plan.
- Although it may be difficult to apply contractual arrangements for a debtor to seek special treatment for a creditor’s claims or to pay such claims at a higher priority level than permitted by the Bankruptcy Code, with a such provision in a contract, a creditor may be able to influence the budget and potentially be paid more quickly within an approved budget. While the search for such treatment may meet fierce opposition from a lender or committee, such a provision creates an opportunity for dialogue with debtors and other influential parties.
- Attempts to draft provisions to circumvent Bankruptcy Code requirements should be approached with great caution, and parties should recognize that enforcement will require at least one argument in court.
Since the Bankruptcy Code and its interpretation are constantly evolving, it is not inappropriate to seek to contract an innovative remedy before filing for bankruptcy. Again, the parties to the contract will have to take the matter to court to test the applicability of such creative wording.