Termination for Bankruptcy Myth
Contracts often call for a termination right in cases of bankruptcy, but are such provisions enforceable? Rachel Albanese, a restructuring partner at DLA Piper, addressed this common misconception. Despite the widespread inclusion of termination clauses in contracts (allowing one party to terminate the agreement if the other faces insolvency or bankruptcy), Albanese reveals that these clauses are broadly unenforceable under the Bankruptcy Code. The fundamental aim behind this legal stance is to preserve the bankruptcy estate and ensure fair treatment among creditors, aligning with Chapter 11's goal of debtor rehabilitation.
The creation of a bankruptcy estate upon a debtor's filing halts creditor actions against the debtor and its assets through an automatic stay. This measure prevents a "race to the courthouse," ensuring that creditors are treated equally. Furthermore, specific provisions in the Bankruptcy Code, such as Section 365(e), explicitly prohibit terminating a contract solely because of a debtor's bankruptcy or insolvency. This legal structure is crucial for protecting the debtor's assets and facilitating the successful rehabilitation of the debtor within the bankruptcy process.
Despite the general unenforceability of these termination clauses in bankruptcy contexts, they continue to be standard in many contracts. Albanese suggests this persistence may stem from their routine inclusion in contractual templates and the possibility of enforceability outside bankruptcy proceedings. For parties reviewing their contracts, however, the assumption should be that such termination rights are broadly not enforceable in the event of a counterparty's bankruptcy or insolvency.
