Protecting Yourself From The Other Side’s Bankruptcy

If you are about to contract with someone else or another company, you may want to make sure that the other side fulfills its contractual obligations. Yes, you can put in the contract any penalty you want (within reason), and can sue if the other side doesn’t abide by their obligations…but what about bankruptcy? You don’t want the other side never fulfilling their obligations because they file for bankruptcy.

Ipso Facto Clauses

There are really two kinds of what are known as “ipso facto” clauses.

The first kind of clause is one that says that even if the other side is in compliance with an agreement, if that party should file for bankruptcy—even if the bankruptcy is unrelated to your contract—that the mere act of filing for bankruptcy will be considered an act of default, enabling you to enforce any default provisions that may be in the contract.

The other bankruptcy clause is one that says that any debt or obligation under a contract is not dischargeable in bankruptcy.

Other clauses may require that parties to a contract waive rights they would otherwise have in bankruptcy courts. For example, saying that the bankruptcy automatic stay won’t apply, or that you will be able to access the debtor’s assets, that you normally wouldn’t be able to access in bankruptcy law.

Unenforceable Provisions

But these clauses are usually not good ways to protect you or your business, because they generally are unenforceable. When someone (or a company) files for bankruptcy, their property is no longer theirs—it is property of the bankruptcy estate. That means that you can’t just say that they still have to pay a debt, even after bankruptcy. You can’t tell the bankruptcy court what it can and can’t do with its property.

Bankruptcy courts also want to make sure that debtors get a fresh start after their bankruptcy. This means that you can’t just contract and make a debt nondischargeable.

Protecting Yourself

You can use some strategies to protect yourself or your company, in the event that you are concerned the other side that you are contracting with may be a bankruptcy risk.

You should always assess the possibility that a company could declare bankruptcy before you contract with them.

Another way of protecting yourself is by making yourself a secured creditor—that is, having provisions in your contract that comply with the Uniform Commercial Code that properly secures some of the debtor’s property. This won’t stop a bankruptcy, but secured creditors don’t lose their security in most bankruptcy cases.

You also have the right to intervene in a bankruptcy, if you feel that the debtor committed a fraud, or incurred a debt knowing that they would file a bankruptcy. In a Chapter 11, you may even have a fighting chance of still getting paid some of what you may be owed.

We can help review and negotiate your business contracts and agreements. Call the West Palm Beach business litigation lawyers at Pike & Lustig for help today.