How Bankruptcy Affects Business Contracts
Existing business contracts do not simply disappear after a business files for bankruptcy in California. Depending on the agreement, the type of bankruptcy, and the business’s plans, contracts may continue, be rejected, or become part of negotiations designed to make the company financially sustainable.
For a company that depends on supplier agreements, commercial leases, licenses, service contracts, or other ongoing relationships, bankruptcy-related decisions can directly affect whether the business can continue operating. Our Los Angeles business bankruptcy lawyers at Weintraub Zolkin Talerico & Liu LLP can assess how particular business agreements may be treated before and during bankruptcy.
Assuming Business Contracts
Under 11 U.S.C. § 365, a debtor in bankruptcy may, subject to court approval and statutory limitations, assume, reject, or transfer an executory contract or unexpired lease. Assumption generally means the debtor chooses to continue being bound by the agreement.
If a business has defaulted under the agreement, however, assumption or transfer may require curing the default or providing adequate assurance that it will be promptly cured, compensating certain financial losses caused by the default, and providing adequate assurance of future performance.
For that reason, a company should not evaluate contracts solely according to what it owes today. The agreement’s value to future operations, including whether it can be transferred to a buyer or successor, can be equally important.
Rejecting Burdensome Business Contracts
Bankruptcy may also give a debtor the ability to reject an executory contract that no longer makes financial sense. Rejection allows the bankruptcy estate to stop performing future contractual obligations, subject to the Bankruptcy Code and court approval. Importantly, rejection is generally treated as a breach, not as though the contract never existed.
The U.S. Supreme Court reinforced this distinction in Mission Product Holdings, Inc. v. Tempnology, LLC, holding that rejection of an executory contract under Section 365 has the effect of a breach rather than a rescission. Rights that would survive an ordinary breach are not automatically erased simply because the contract was rejected in bankruptcy.
The other party may therefore have a bankruptcy claim for damages resulting from the rejection. How that claim is treated will depend on the agreement, the nature of the claim, and the circumstances of the bankruptcy case.
Assigning Business Contracts
Some valuable contracts may potentially be assumed and then assigned to another party. Section 365 generally permits assignment in qualifying circumstances if the contract is properly assumed and adequate assurance of future performance by the new party is provided.
This can become important when a company sells assets or restructures operations. A favorable contract may have substantial value to a buyer and could contribute to the value of the bankruptcy estate.
Assignment is not available for every agreement. Federal bankruptcy law recognizes exceptions, including circumstances where applicable law excuses the non-debtor party from accepting performance from someone else. Certain agreements involving loans, debt financing, or financial accommodations also receive different treatment.
A bankruptcy lawyer in California can review the agreement itself along with applicable bankruptcy and non-bankruptcy law before determining whether assumption or assignment is possible.
Does a Bankruptcy Clause Automatically End a Contract?
Many commercial agreements contain provisions stating that bankruptcy, insolvency, or a bankruptcy filing permits termination. These provisions are commonly called “ipso facto clauses.” Such a clause does not necessarily allow the other party to immediately terminate an executory contract solely because bankruptcy was filed.
Understanding how bankruptcy affects business contracts can help your business determine which agreements should support the company going forward and which may stand in the way of a workable restructuring. Weintraub Zolkin Talerico & Liu LLP can review contractual obligations in connection with Chapter 11, debt restructuring, and other bankruptcy options. Our bankruptcy lawyers in Los Angeles can help determine how federal bankruptcy law may apply to the agreements your business depends on.
Call us at (310) 207-1494 or request a consultation with one of our bankruptcy lawyers to evaluate your case.