When you enter into contracts with other businesses, you may give some thought to what would happen if they default on or don’t fulfill their obligations under the agreement. But you are somewhat content because you know that you can sue, and with the right lawyers and the right contractual language, you will at least recover damages for any breach of a contract.
Unless that is, the other side files for bankruptcy. Although some contracts can, in limited cases, survive the other side’s bankruptcy most will not, leaving you holding the bag, with no avenue to recover any kind of damages.
The Chicago business litigation lawyer at Ellis Legal explains more below.
No Bankruptcy Clauses
So what about just having something in the contract that says that the contract, or the obligations under it, cannot be terminated or discharged in bankruptcy? After all, people can contract for what they want—including contracting away rights if they want to.
You’re not the first to think of this—it’s called an ipso facto clause—and it is unenforceable, no matter how you word it and no matter who agrees to it.
Types of Ipso Facto Clauses
Ipso facto clauses come in many forms.
One common form is just saying that the debt cannot be discharged in bankruptcy.
But another less common type of ipso facto clause, which is still legally unenforceable, is one that says that if the other side files for bankruptcy, it will be considered a default under the contract—even if the other side is technically fulfilling its obligations, and thus, is not otherwise in default under the agreement.
Often, people try to take away specific bankruptcy rights—such as saying that you can still collect a debt under the contract, even after the other side files for bankruptcy in violation of the automatic stay.
Unenforceable Provisions
None of these are enforceable. Federal bankruptcy law will take precedence over anything you agree to, which lessens, weakens, or undermines bankruptcy laws. By law, all of a debtor’s creditors are treated equally in bankruptcy court, and you cannot give preference to any one creditor (including yourself) by virtue of an ipso facto clause—whether you’re the one filing for bankruptcy or trying to collect on a debt.
How to Avoid the Other Side’s Bankruptcy
There isn’t much to do to avoid the consequences of a debtor filing bankruptcy. However, if you can make yourself a secured creditor, you have some protection. Collecting on a security (for example, repossessing property or foreclosing on real estate) is still allowed after a bankruptcy (just make sure that you do have legally secured property).
You also can have the other side sign a personal guarantee. That way, if only one of the other side’s entities that signed the agreement (the business or the individual person who signed the guarantee) files for bankruptcy, you can still legally pursue the one that did not file for bankruptcy.
We can help you draft contracts and business agreements that work. Speak with an experienced Chicago business litigation attorney at Ellis Legal at (312) 967-7629 today.