What exactly is a “termination on bankruptcy” clause? Do you have them in your business contracts? Has someone pulled out of a contract with you based on this provision?
A “termination on bankruptcy” clause is standard in most business contracts. It allows one party to terminate the contract if the other party is bankrupt, insolvent, or likely to be so. If you are having financial difficulties, perhaps you have had others try to end their contracts with you by citing this clause. Can they do that?
Although these “termination on bankruptcy” clauses do appear in many contracts, they are often not enforceable. And they are less likely to be enforceable if the financially struggling person files for bankruptcy.
No one starts out wanting to file for bankruptcy, whether it’s personal or for their business. But the United States Bankruptcy Code is specifically designed to protect those in financial distress. Bankruptcy law creates a safe haven for individuals and businesses to regroup and it can be a very useful tool for creating a path to a fresh start.
One of the reasons for you to file for bankruptcy is to prevent others from utilizing these “termination on bankruptcy” clauses against you. If you have entered bankruptcy, these are rarely enforceable provisions.
Once you are in bankruptcy, you can work with the court to map out a new plan. One of the advantages of being in bankruptcy is that you, with the help of the court, get to re-examine many of your existing and ongoing contracts. You get to decide if you want to keep them, sell them, or reject them. Even if those contracts contain those “termination on bankruptcy” clauses, if you are in bankruptcy, the US Bankruptcy Code (sections 365 and 514) says they are not enforceable.
What kind of contracts are protected by being in bankruptcy? Leases are an obvious example – the other party is renting a bulldozer to you, for example, and you are paying a monthly rental fee. If your finances have become precarious, they might try to take the bulldozer back as part of the “termination on bankruptcy” clause. But if you have already filed for bankruptcy, they will likely have to leave that bulldozer with you until the leasing contract has been evaluated by the bankruptcy court.
Another advantage is that while your contracts are being examined by you and the bankruptcy court, the other party has to keep holding up their end of the deal, even if you aren’t. Again, the bankruptcy code is designed to give the debtor some breathing room. You get to keep using that bulldozer while you are in bankruptcy and deciding the fate of your ongoing contracts, even if you can’t be paying for it. This doesn’t last forever, of course, and if you want to keep that bulldozer contract after bankruptcy, you’ll have to catch up on the payments. Or, if you decide you want to end the bulldozer leasing agreement (aka “reject” it), you can do so; you return the bulldozer, but you don’t complete your payments, leaving the other party with few options.
There are, of course, exceptions to every rule, and bankruptcy law is no different. Certain kinds of contracts are treated a little differently, and there are times when the termination on bankruptcy provisions can be enforced. However, outside of these area, and even if there are state laws that seem to support the enforceability of “termination on bankruptcy” provisions, federal law, as provided by the United States Bankruptcy Code, trumps any and all of these. (Federal laws almost always beat out state laws.)
So, if termination on bankruptcy clauses are generally unenforceable, why are they so common, and should they be abandoned? Keep in mind that they usually only become unenforceable under the US Bankruptcy Code in the event of an actual bankruptcy filing. And don’t forget there are myriad exceptions. But the clauses remain because they are traditionally part of a contract, and as long as both parties understand that they are often unenforceable in the event of a bankruptcy, they can still be relevant prior to filing and/or in specific situations.
Bankruptcy is not something you should handle by yourself. It can be complicated and stressful, which is why you need a lawyer who specializes in bankruptcy law to guide you through all your options. If you think it might be time for you to explore bankruptcy, please contact me or call at 970-283-7133. I’m here to help you get a fresh start.