How are existing contracts treated in restructuring and insolvency processes? Are the parties obliged to continue to perform their obligations? Will termination, retention of title and set-off provisions in these contracts remain enforceable? Is there any an ability for either party to disclaim the contract?
Restructuring & Insolvency
In case of In-court Settlement, the debtor can seek the court authorization to terminate or suspend existing contracts. In case of termination/suspension, the other party is entitled to compensation for damages but the relevant claim is treated as an unsecured pre-petition claim. However, such rules do not apply to certain contracts, including property lease contracts and employment contracts.
In case of In-court Settlement with business continuity, counterparties are not allowed to terminate outstanding contracts and clauses whereby the sole opening of an insolvency proceeding (or the failure to pay pre-commencement claims) causes termination of the agreement are per se ineffective and unenforceable.
In case of bankruptcy, the general rule is that when bankruptcy is declared the performance of the executory contracts is suspended until such time as the trustee declares that he is assuming the contract (having been authorized to do so by the creditors’ committee) or rejecting it. Contractual clauses whereby bankruptcy constitutes a ground for termination are ineffective and unenforceable.
If the trustee opts for assuming the contract, termination, retention of title and set-off provisions set forth therein remain enforceable (provided that debts arisen before commencement of the bankruptcy procedure cannot be set-off against debts arisen after commencement thereof).
However, the above general rule does not apply either to such contracts as are deemed terminated by operation of law as a result of the commencement of the procedure (e.g. the mandate when the agent becomes bankrupt) or to such other contracts as shall continue to be performed (e.g. employment contracts and real property lease contracts or business branch lease contracts, provided that the trustee may terminate the agreement subject to certain limitations).
Under article 61 of the Spanish Insolvency Act, all clauses that entitle any party to terminate an agreement based solely on the other party’s declaration of insolvency are deemed void
However, there are cases in which the law expressly allows agreement for termination in the case of insolvency (i.e., insurance policies, administrative contracts and powers of attorney, and cases falling under the scope of special legislation such as the close-out netting agreement).
A declaration of insolvency does not affect agreements with reciprocal obligations pending performance by either the insolvent or the other party (the insolvency estate will fulfill the insolvent’s obligations pending performance). However, the insolvency authorities (together with the insolvent party or by themselves if the insolvent party is not allowed to run its business) may request the court to terminate the agreement if they believe that termination is in the interest of the insolvency estate. Recent court rulings have been guided by the criterion of upholding agreements that are vital for maintaining the insolvent as a going concern.
Further, financial securities granted under RDL 5/2005 including set-off agreements would not be affected by the insolvency declaration and will remain enforceable.
The debtor may cancel a bilateral contract having obligations that neither the debtor nor the counterparty has yet completely performed. Even though existing contracts with the debtor often contain a termination clause providing that the filing of restructuring or insolvency proceedings is a cause of termination, such termination clauses are often regarded as void.
Where a creditor owes a debt to the debtor at the time of commencement of restructuring or insolvency proceedings, the creditor can set-off its claim against the debtor’s claim under some circumstances.
• Contracts in restructuring processes
With the consent of the restructuring administrator the debtor may as a start-ing point continue contracts/bilateral contracts entered into. The debtor may also terminate the contracts with the consent of the restructuring administrator which is usually also the case for non-terminable contracts unless the non-terminability is secured by registration.
In restructuring proceedings, contracts are treated under the same rules as contracts in insolvency proceedings so please see the section on such con-tracts.
It is noted that the debtor cannot continue the contract without the consent of the other contracting party if except from the restructuring proceedings the other contracting party was entitled to terminate the contract without notice for other reasons that debtor’s delay in the contractual payment.
In restructuring proceedings, the debtor may in certain circumstances continue agreement than the other contracting party had terminated without notice no later than 4 weeks prior to the restructuring.
If the creditors approve a restructuring proposal that includes a transfer of business, the contracts may in certain cases be transferred to the buyer with-out the consent of the other contracting party.
• Contracts in insolvency proceedings
The insolvent estate may decide to let the insolvent estate adopt the contract or not. Consequently, it cannot be effectively agreed in advance that insolvency or restructuring proceedings means that the agreement be terminated without notice. The other contracting party may require that the insolvent estate de-cides on the adoption of a contract without undue delay.
If the insolvent estate does not adopt the contract, the other contracting party may as a starting point terminate the agreement without notice and claim damages for its loss suffered by the non-performance of the contract.
If the insolvent estate adopts the contract, the insolvent estate assumes the rights and obligations under the terms of the contract.
The maintenance of retention of title in restructuring and insolvency proceed-ings requires that the retention of title is valid prior to the commencement of the restructuring proceedings or the issue of the insolvency order. Right of set-off may as a starting point be maintained but it is governed by the Danish In-solvency Act.
If the insolvent estate adopts the contract, the other contracting party may only terminate the contract without notice if the insolvent estate is in breach of its contractual obligations unless the other contracting party could terminate without notice on the basis of the general rules of Danish law of obligations.
However, even though the insolvent estate has adopted the contract, the insol-vent estate is always entitled to terminate the contract by giving a month’s notice if the contract concerns the delivery of an on-going service.
None of the formal insolvency processes in Australia result in the automatic termination of contracts between the debtor and third parties. Often, however, contracts will contain ipso facto clauses which allow counterparties to terminate or renegotiate on the occurrence of an insolvency event.
Part 5.6, division 7A of the Corporations Act gives liquidators the specific ability to disclaim certain property or uncommercial contracts in certain circumstances. A liquidator will usually require the Court’s leave to do so (except in the case of unprofitable contracts or a lease of land) as this is likely to adversely affect third-party interests. There are no specific provisions for disclaimers in a voluntary liquidation, although the court has wide powers to control these reorganisations and application can be made to the court.
Although receivers and administrators are not given specific powers to disclaim contracts, they may look to ignore contracts with any resulting damages claim being unsecured against the company (and not the receiver or administrator personally). However, any contract a receiver continues with may result in the receiver being held personally liable under the Corporations Act.
Section 553C of the Corporations Act provides statutory set-off is available in a liquidation scenario where there have been mutual dealings between the distressed company and the relevant creditor. In such circumstances an automatic account is taken of the sum due from one party to the other in respect of those mutual dealings, and the sum due from one is to be set-off against any sum due from the other. Administrations and DOCAs will likely also recognise this statutory set-off as to not to do so would entitle an aggrieved creditor to recourse on the grounds of unfair prejudice.
The Corporations Act allows a broad range of claims capable of set-off. The rule entitles creditors who are also debtors to have preference over the general body of creditors. Only unsecured creditors and secured creditors who choose not to rely on their security can take advantage of the rule. A creditor is, however, unable to claim the benefit of set-off if he or she had, at the time of the relevant transaction, notice of the insolvency of the company. Further, a creditor cannot off-set any existing claim or debt of the company against new claims or debts that may arise during any period of administration.
As described above, retention of title provisions will remain enforceable so long as the creditor’s security interest in the property has been perfected and registered on the PPSA register.
A liquidator has no right to disclaim either onerous property or unprofitable contracts, which will therefore continue to bind a company in liquidation, although the commencement of insolvency proceedings may constitute an event of default allowing a counter-party to terminate an existing contract.
Under common law, a winding-up order serves to terminate all employment contracts of the company in official liquidation.
Employees' rights will only be affected by a scheme of arrangement in the event that the scheme purports to compromise their rights as creditors under their employment agreement. Similarly, the impact of a scheme on existing contracts and the parties ongoing obligations under those contracts will depend on the terms of the scheme (in particular, the extent to which the scheme purports to compromise rights under the contracts) and the terms of the contracts.
The commencement of a voluntary or provisional liquidation will have no legal effect on employees' rights, except as for provided for in the relevant employment agreement.
Termination, retention of title and set-off provisions contained in the contracts to which the company was party prior to its winding up will remain enforceable by the contracting counter-party on any winding-up. In the absence of any set-off provision, account must be taken of what is due from each party to the other in respect of their mutual dealings, and a set-off is applied in relation to those amounts.
In case of bankruptcy proceedings, there are certain types of contracts that are terminated automatically under applicable substantive contract law (e.g. mandates governed by Swiss law). For other types of agreements, the applicable substantive contract law or the specific contract may provide for a termination right in case of bankruptcy. Automatic termination or termination rights are generally upheld in a Swiss bankruptcy. A contract which has not been terminated continues to exist as a matter of Swiss bankruptcy laws. If so, the receiver in bankruptcy may choose to perform the bankrupt's obligations under a so-called synallagmatic agreement (so called cherry-picking right). If the receiver in bankruptcy decides to perform the bankrupt party's obligations to secure performance by the other party, these obligations qualify as so-called estate obligations which are satisfied in advance and in full prior to all other creditors. Special rules apply to long-term contracts. In case no cherry-picking right has been exercised by the receiver in bankruptcy, even if they are not terminated upon the opening of bankruptcy procedures, future claims arising under such long-term contracts will only be admitted to the schedule of claims if they cover the period until the next possible termination date (calculated from the opening of bankruptcy) or until the end of the fixed duration of a contract. In addition, the cherry-picking right can be exercised for future obligations only. It is heavily debated under Swiss law whether an obligation of the non-affected party to perform agreements which have not been terminated and where no cherry-picking right has been exercised continues to exist.
In composition proceedings, contractual relationships between the debtor and its counterparties generally continue to be effective during the moratorium unless terminated ex lege or based on a contractual termination right (which, again, would generally be upheld). For contracts which have not been terminated, the administrator has the authority to order conversion of a performance owed by the debtor into a monetary claim of corresponding value which will then become subject to the terms of the composition agreement. Furthermore, the debtor may terminate long-term contracts without respecting the contractual notice periods during the moratorium against full indemnification of the counterparty (but only as an unsecured and non-privileged insolvency claim) if the continuing existence of these contracts would jeopardise the restructuring as a whole. The administrator's consent is required for such a termination.
Set-off rights generally continue to be available in insolvency proceedings, subject, however, to certain restrictions which may, in particular, prohibit set-off of pre-insolvency with post-insolvency claims. Retention of title arrangements are not typically effective in an insolvency scenario of a Swiss debtor unless the very strict rules, including registration requirements for retention of title arrangements under Swiss law have been properly followed (which is the exception rather than the rule).
As from the opening of insolvency proceedings, creditors are prevented from enforcing their contractual claims.
In respect of a mutual contract which is not or not completely performed by the debtor and its counterparty when the insolvency proceedings are opened, the insolvency administrator has the option to perform such contract and claim the counterparty's performance (Sec. 103 Insolvency Act). If the administrator refuses to perform such contract, the counterparty is entitled to claims for non-performance only as an insolvency creditor. The counterparty may request the administrator to opt for performance or non-performance, in which case the administrator must make this decision without undue delay; otherwise, performance may no longer be requested.
While provisions entitling the debtor’s counterparty to terminate a mutual contract which has not yet been fully performed by both parties or providing for automatic termination because of the insolvency or the insolvency petition are void, termination provisions for reasons other than the insolvency and the insolvency petition remain valid.
By retaining title, the creditor generally ensures the right to separate his property from the estate without paying any fees to the insolvency administrator. The insolvency administrator or debtor in self-administration are also entitled to pay the contract price and obtain title to the goods.
Only those debts which were legally established prior to the opening of insolvency proceedings are capable of set-off, which, thus, is not available if the creditor has
- become an obligor to the insolvency estate only after the opening of the insolvency proceedings or
- obtained its claim against the debtor from a third party after the commencement of the insolvency proceedings or pursuant to a transaction which is avoidable.
There are specific, less restrictive set-off rules applying in certain cases of the insolvency of financial institutions.
As a general rule, the insolvent entity must continue to comply with its obligations under existing agreements, except (i) if the Mediator opposes to such performance in protection of the entity’s estate or (ii) as provided in the Insolvency Law. The Insolvency Law provides specific rules for certain types of contracts, for example:
- Purchase of goods. If an insolvent entity acquired goods prior to the Insolvency Judgement, the relevant seller shall not be bound to deliver them unless the price has been paid or secured. In the event of goods in transit for their delivery that have not been paid, the seller may oppose to such delivery.
- Purchase of real property. If the seller of real property is declared insolvent, the purchaser shall have the right to receive the real property, provided that (i) such transaction was duly perfected prior to the Insolvency Judgement; and (ii) seller received the relevant purchase price.
British Virgin Islands
The commencement of liquidation does not prima facie affect existing contracts, though the liquidator has a power to disclaim an unprofitable contract into which the company has entered by filing a notice of disclaimer with the court under section 217 of the IA. The liquidator also has a power to carry on the business of the company so far as this is necessary to facilitate the liquidation. In certain cases, however, the contract will include express provisions in contemplation of either party’s insolvency.
Nothing in the BVI’s insolvency legislation invalidates termination, retention-of-title, or set-off provisions in commercial contracts, though the general common-law rules concerning these principles apply, such as the need in retention-of-title cases for the assets in question to remain identifiable and not to have been worked into new property or transferred to an innocent third party. As stated above, the IA expressly provides for a right of set-off in relation to mutual credits.
A contractual counterparty may apply to the court for an order rescinding the contract on such terms as to payment between the company and the counterparty of damages for non-performance as the court may think fit. If a counterparty is awarded damages, these may be claimed as a debt in the liquidation. No contractual counterparty may commence or proceed with any proceedings against the company without permission of the court having jurisdiction in the insolvency.
Again, the legislative provisions relating to restructuring procedures do not make express provision in relation to existing contracts.
Subject the disclaimer of onerous contracts discussed below and the transaction avoidance provisions under the Companies Act 1981 discussed above, existing contracts are generally unaffected by insolvency processes. The terms of the contract in question however may of course provide for what is to happen in case of insolvency.
Retention of title
Under a retention of title clause, a creditor retains legal title to goods supplied to the debtor until they have been paid for provided that the goods remain capable of being identified and have not been transformed into other property or sold to a third party.
In a liquidation, there is a mandatory set-off where there have been mutual credits, mutual debts or other mutual dealings between the company and a creditor (section 37 Bankruptcy Act 1989 and section 235 Companies Act 1981). The set-off extends to non-contractual claims as well as debts. In the case of mutual dealings, an account is taken of what is due from one party to the other.
Disclaimer of property
The liquidator of a company can, with the Court’s permission, disclaim any property belonging to the company, or any rights under any contracts, which he considers to be onerous, unprofitable or unsaleable (section 240 Companies Act 1981). The Court may, on an application by a person interested in disclaimed property, make an order for the vesting of the property in, or the delivery of the property to, any persons to whom it may seem just. Any person who suffers loss by the operation of a disclaimer is a creditor of the company entitled to prove for his loss in the winding-up.