November/December 2009 / Features
Know Your Termination Rights
Commercial contracts often contain provisions that give each party the right to terminate the agreement if the other party becomes insolvent or subject to bankruptcy proceedings. The Bankruptcy Act of 1978 generally makes these “ipso facto” clauses unenforceable.
One section of the U.S. bankruptcy code provides that any property interest of the debtor becomes property of the estate in bankruptcy. Contract rights are one type of property subject to this provision. Another section provides that an executory contract (one in which some performance remains to be accomplished) may not be terminated because of a provision conditioned on the debtor’s financial condition. These sections, together with code provisions that allow trustees to avoid transfers of property interests of the debtor made prior to the bankruptcy case or while the debtor was insolvent, make contractual termination rights conditioned on insolvency or bankruptcy generally unenforceable.
There is a limited exception, in that most courts have ruled that IP law constitutes “applicable law” that can excuse a party from accepting performance from parties other than the one with which it contracted.
Other types of termination rights should be considered during contract negotiations. The right to terminate for convenience would effectively replace termination rights conditioned on bankruptcy or insolvency and might be appropriate.
