Can You Prevent Someone From Declaring for Bankruptcy?

If you enter into a business contract, you may have some concern about how to ensure that the other side complies with its end of the bargain. And while your contract can contain stiff financial penalties, you know that companies can and do, go out of business.

You’re concerned, so you include a provision in your contract that says that if the other side to the contract files for bankruptcy, that will be considered a default under the contract.

Ipso Facto Clauses

That’s called an ipso facto clause, and it won’t be very effective in protecting you, because they are usually unenforceable.

Ipso facto clauses take two main forms.

Some clauses say that even if a party is complying with the terms and conditions of an agreement, if that party files for bankruptcy, the bankruptcy will constitute a breach of the agreement, allowing you to do whatever the contract allows in the event of such a breach.

In the other kind of contract, the ipso facto clause will say that even in the event of bankruptcy, the money under the contract will still be owed—the contract purports to make the debt nondischargeable in bankruptcy.

Unenforceable by Law

But these clauses are not enforceable for two main reasons.

The first reason is that bankruptcy is a matter of federal law, and the bankruptcy code doesn’t allow you to alter a debtor’s rights or force a debtor to waive his or her rights in a contract.

More importantly, once a debtor files for bankruptcy, everything the debtor owns (the debtor’s estate) belongs to the bankruptcy court, at least temporarily. You have no claim on anything the debtor owes you, outside of what is allowed in the bankruptcy code. So, saying that the debt is still owed to you despite a bankruptcy, is attempting to take the debtor’s property, which belongs to the bankruptcy court upon the filing.

What Can You Do?

So is there anything you can do to avoid not being paid because of the other side’s bankruptcy?

One way to do this is to transform your debt into secured debt. Secured debt is treated differently in bankruptcy court. While you won’t ever be able to collect money against the other party individually, you can collect upon (sell or foreclosure on) the foreclosed property.

Bear in mind that to secure property, the Uniform Commercial Code must be complied with—it isn’t as easy as having someone sign a piece of paper agreeing to allow you to foreclose on property.

One drastic method is allowing you a say or a vote on whether a company can file for bankruptcy in the first place. But this can be difficult—it would require that the other party to the contract allow you a seat on a board of directors, or grant you control over the other party’s management—something that isn’t likely to happen.

Worried about enforcing your business agreements? Call our West Palm Beach business law attorneys at Pike & Lustig today.

Sources:

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