Termination of contract in case of insolvency of the other party | Zeinab Jaafar A-LAW International Law Firm

Termination of contract in case of insolvency of the other party

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Lawyers often include ipso facto clauses in contracts whereby either party has the right to terminate the contract in case of insolvency of the other party.

Inclusion of these clauses should be carefully considered whereby the answer to the following questions is vital :

1 - Are the ipso facto clauses in the contract enforcable? And if not, why are these included in the contract?

2 - What are the competences of the bankruptcy officer when there is a filing for insolvency? And what are the limits of his/her power?

The answer to these questions will vary from country to country.

In Europe different positions exist. While most countries valid and recognize these clauses, others, like for example Spain, consider the clauses void for economic reasons and thus as non-existing in the agreement. 

1 - Bankruptcy, insolvency and termination of agreements

A - Enforcability of ipso facto clauses under Belgian Law

There has been an increase of bankruptcies since the beginning of the economic crisis in 2008.  This economic reality is another reason for careful consideration of the effects of ipso facto clauses.

The effects of insolvency should be considered by the contractual parties from the start of their cooperation.

Obviously it becomes more critical when the contractual parties are confronted with the fact that the ipso facto clauses inserted in the contracts to protect themselves are not valid under the applicable law.

In Belgium the bankruptcy process is governed by the Bankruptcy Act of January 1998 and the Act on Continuity of Enterprises of 31 January 2009, entered into effect in 1 April 2009. These laws have  set out a new framework with respect to judicial reorganization. The purpose of the judicial reorganization is to preserve the continuity of (part of) a company in distress or (part of) its activities under the supervision of the court.

Under Belgian insolvency law, the ipso facto clauses are recognized to be valid and enforcable. This means that every contract containing express contractual terms providing for the termination of the agreement in case of bankruptcy is to be terminated.

Another situation whereby automatic termination of the contract in case of bankruptcy is to be mentioned is in case the contracts were concluded intuitu personae.  In other words for reason of the personal involvement of the other party. 

If there is no clause for termination in the contractual relationship and the contract is not concluded intuitu personae, the decision is left to the bankruptcy officer who may choose whether to maintain the contract or not.

B - In other countries:

In Europe in principle ipso facto clauses are considerd valid.  This is for example the case under Luxemburg, Swiss and German bankruptcy law.

However the situation appears to be completely different in Spain where these clauses are considered void.

Termination clauses based on insolvency were traditionally admitted by most Spanish legal scholars and practitioners and were not under attack in case-law but this has changed recently.

Their acceptance being based on the "principle of the parties’ free will".

In the USA  ipso facto clauses are not enforcable by themselves even though the lawyers and practitioners continue to include these in their contracts.

The most important reason behind this lack of considering the effect of an ipso facto clause is that unenforcability only becomes evident if a bankruptcy is filed.

 

2-Competence of the bankruptcy officer and limits of the power of a licensor:

What is the situation when the option of termination is not mentioned in the contract? What are the effects of filing for bankruptcy by a licensor under an IP license agreement ?

 

A - Competence of the bankruptcy officer:

Under Belgian law bankruptcy in principle does not of itself cause the automatic termination of ongoing agreements. The same applies to IP license agreements as neither the Bankruptcy Act nor the ACE Act on continuation of enterprises) make a distinction according to the type of contracts, assets, and property rights, except for the publication contracts and audiovisual production contracts.

The bankruptcy act entitles the bankruptcy officer to decide whether agreements concluded prior to the bankruptcy and not terminated by the “the bankruptcy order“ will be continued.

Contracts concluded prior to the bankruptcy can therefore be continued by the only decision of the officer;

The competence of the bankruptcy officer is quite similar throughout europe.

In principle, his discretion appears in the absence of ipso facto clauses and under the condition that the contract is not intuitu personae.

The same situation occurs under Luxemburg, Swiss, and German bankruptcy law. It is also the situation in the UK with some nuances

However, in  recent cases the English Courts have held that an insolvency practitioner is not necessarily bound to comply with the licensor's obligations. 

B - Limits of the power of a licensor:

Under a licensee agreement the owner/licensor grants the licensee the right to produce and sell goods, make use of a brand name or trademark, or use patented technology owned by the licensor.

A distinction must be made whether the filing of bankruptcy is made by the licensee or the licensor under a license agreement. 

The above indicates that the licensor has no discretion to terminate the agreement by the only act of filing for bankruptcy.

The law limits the rights of the licensor to the benefit of the licensee who should not be subject to the risk of abusive discretion of the licensor.

The licensor can argument to consider the contract as an intuitu personae (related to the personal nature) but in that case a differentiation should be made between the contracts that are or are not concluded for reasons related to the person of the counterpart, rather than the subject of the contract.

 

Conclusion

Termination clauses in case of insolvency need careful assessment. This counts for all commercial contracts but in particular for international contracts where more than one legislation might be applicable.   The question on the applicable law should be examined at the same time.

Parties constantly include "termination on bankruptcy" clauses in contracts, but without due consideration that these might be unenforceable under some laws. 

It remains advisable to add ipso facto clauses to increase the possibility to invoke the termination in case of bankruptcy of the other party, but proper legal advice at moment of negotiating a contract remains crucial. 

Only then the legal consequences of the applicable legislation with regard to the enforcability of the clauses can be assessed and the related risks managed.


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