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.
Generally bilateral contracts at the time of declaration of bankruptcy, maintain their force unless otherwise provided in the terms of the contract.
The bankruptcy trustee, with the judge’s permission, has the right to continue performance on all or certain current contracts and to demand performance by the counterparty. Failure to perform by the bankruptcy trustee will give the right to the counter contracting to terminate the contract and to claim damages for non performance, being satisfied as an insolvency creditor.
Contracts of a continued nature will remain in force but financing contracts can be terminated or amended in accordance with their terms.
The declaration of bankruptcy is a due cause for termination in case of contracts which by nature have a “personal” connection with the debtor are terminated.
Subject to the counterparty’s acceptance, or by order of the court, the bankruptcy trustee is entitled to transfer a contract to a third party if such transfer is in the interest of the creditors and the debtor’s counter contracting party consents.
Employment contracts are not terminated automatically but the bankruptcy can be upheld as a valid reason for termination.
The declaration of bankruptcy does not prejudice the right of a creditor to propose set off of a counterclaim against the respective claim of the debtor, as long as the conditions for set off under the GCC were met before the declaration of bankruptcy. The GIC provides that netting of claims arising in connection with over-the-counter derivatives and the netting of claims arising from transfer orders on payment settlement and financial instrument settlement systems, as well as those based on closed-out netting clauses, in the context of financial collateral agreements, is made according to special provisions of law. Namely:
- According to article 16 of law 3156/2003 (the Bond Loan Law) set-off is valid and therefore, the close-out netting provisions are enforceable, even after insolvency, provided the following three conditions are met (i) the claims being set-off derive from transactions between parties, one at least of which is an credit or financial institution , or the State; (ii) set-off is governed by an agreement; and (iii) the agreement has a certain date (i.e. a date, which is established in accordance with one of the formal procedures recognized under Greek law to establish a “date certain”), which is prior to the declaration of insolvency or the commencement of the collective measure or procedure akin to insolvency.
- The Financial Collateral Law provides that within its scope close out netting provisions have to be recognized and given effect in the case of insolvency. As the Collateral Directive contains no condition corresponding to the date certification, after the issuance of the aforementioned law, close out netting provisions falling within its scope are recognized without the requirement that the relevant agreements have a certain date.
The Companies Act empowers the liquidator to disclaim property or contractual obligations of the company if they impose onerous burdens, are unprofitable or not readily realisable. The liquidator can exercise the power of disclaimer only with the leave of the Court or the committee of inspection.
Unless otherwise provided for contractually, the making of a judicial management order does not affect the contracts to which the company is a party. Unlike a liquidator, a judicial manager does not have the power to disclaim onerous contracts. Although in practice the judicial manager may choose not to adopt certain contracts, leaving the contractual counterparty with an unsecured claim for damages against the company.
The judicial manager is personally liable for any contract entered into or adopted by him unless he disclaims the liability. However, the judicial manager is entitled to be indemnified out of the assets of the company in respect of this liability.
In a liquidation, contractual and equitable rights of set-off are displaced by insolvency set-off provisions provided for in the Companies Act. Mutual credits, debts or other dealings may be set off against each other only if they are mutual. Debts or liabilities that are not provable in insolvency are excluded from set-off.
For a company under judicial management, the moratorium excludes creditors’ self-help remedies such as contractual set-off.
The general rule is that a company’s contracts remain enforceable upon insolvency.
Properly drafted, a retention of title clause will survive an insolvency filing.
Contractual provisions allowing parties to terminate upon a counterparty’s insolvency will be upheld save in limited circumstances relating to essential supplies (e.g. gas, electricity, water and communication and IT services). There is also an ‘anti-deprivation’ principle which prohibits any contract from providing that property will transfer to another on the occurrence of an insolvency event.
A creditor who is also a debtor of a company in liquidation or administration may have the benefit of a statutory right of set-off. Set-off is mandatory and automatic, and the relevant rules supersede all other contractual rights of set-off that are inconsistent with them.
A liquidator (but not an administrator) has the power to unilaterally disclaim onerous executory contracts to avoid incurring future liabilities.
Under the Bankruptcy Law, the counter party who has entered into a reciprocal agreement with the debtor may request certainty from the receiver (in the event of a Delay of Payment from the administrator) with regard to the continuance of the existing/ongoing reciprocal agreement within a specific time frame, as to whether the obligations will be complied with. If there is no agreement on the time frame, the supervisory judge will make decision on the time frame. If confirmation is given, the receiver (or the administrator) must provide security for the performance of the obligation. However, this does not apply to agreements under which the bankrupt debtor must personally perform an obligation.
If there are contractual delivery of goods commonly traded items in the agreement/contract imposing a certain time limit, and the party obliged to deliver them is declared bankrupt before delivering them, the agreement is terminated by the bankruptcy declaration. The parties harmed thereby may name themselves unsecured creditors (Kreditor Konkuren) to claim compensation. However, if the termination causes harm to the bankruptcy estate (budel pailit), the counter parties to the agreement must receive compensation for their losses.
If the debtor has been leasing certain objects, either the receiver or the lessor, may terminate the lease agreement (in the event of a Delay of Payment, the debtor, with the consent of the administrator), but a prior termination notice must be served in accordance with the local custom, or the notice period stated in the lease agreement or according within 90 days. If the lease fee has been paid in advance, the lease agreement cannot be terminated early before the lease period covered by the lease fee ends. Note that from the declaration of bankruptcy or Delay of Payment, the lease fee is considered a debt of the bankruptcy estate.
In safeguard or judicial reorganisation proceedings, the judicial administrator has the exclusive power to continue or terminate the debtor’s contracts. The judicial administrator may request the termination of a contract which is deemed necessary to the safeguard of the debtor and if the contract involved does not excessively prejudice the other party’s rights. If contracts are continued, all its provisions remain the same as prior to the opening of the proceeding. The creditor shall continue to honor its commitments despite the default of payment by the debtor prior to the proceedings. If the contract is rejected, the effect may also be favorable to the debtor since the burden will be reduced. The creditor will have to file its claim (stemming from the rejection of the contract). In liquidation proceedings opened with an observation period, the same provisions will apply.
Article 350(H)(c) of the Companies Law stipulates that an existing contract can be continued even if it was breached, and cannot be terminated by the other party without the consent of the administrator or the court. Article 350(H)(d) of the Companies Law provides that the court will not allow such contract to continue, unless the company convinces the court that it will satisfy its obligations pursuant to the contract as of the date on which the court authorizes such continuation. Article 350(H)(b) of the Companies Law provides that a contract that includes a termination-in-case-of-insolvency provision will not terminate in case of insolvency, despite the contractual provision to this effect.
Articles 360-361 of the Companies Ordinance stipulate that the liquidator may, subject to leave by the Court, disclaim onerous assets, including unprofitable contracts.
One of the principles of Dutch insolvency law is that contracts are in principle not affected by insolvency procedures. However, another important effect is that the bankrupt can no longer be forced to perform under a contract.
The trustee can (on behalf of the insolvent estate) demand performance from the debtor’s counterparty, if the debtor has performed his obligations prior to the commencement of bankruptcy proceedings.
Furthermore, the Bankruptcy Act deals with contracts that – at the time of declaration of bankruptcy – have not yet been (fully) performed by both the debtor and his counterparty. In that respect, the counterparty can request the trustee to notify him within a reasonable period of time whether the trustee shall perform the contract. If the trustee does not timely respond or in the event the trustee states that the liquidation estate is not bound by the contract, the trustee will lose his right to demand performance from the counterparty.
Under Dutch law, a retention of title, a right to terminate an agreement and a right of set-off are generally enforceable in bankruptcy.
Bankruptcy: contracts will automatically continue (except for intuitu personae contracts and contracts whereby bankruptcy is a termination event) following the opening of a bankruptcy proceeding. The receiver cannot, in principle, reject or disclaim a contract after the judgment opening the insolvency proceeding and must comply with its terms. However, upon establishing that it is in the interest of creditors, the Insolvency Officer may request that the insolvency judge terminates an agreement to which the debtor is a party.
Controlled management: once placed under controlled management, the debtor cannot, without the commissioners' prior approval and under penalty of nullity, dispose of its assets or take any actions, including granting mortgages, making commitments or payments, borrowing money or receiving funds. The commissioners can also compel the company to perform a given action.
Composition with creditors: during the proceedings and up to the date of the ratification of the composition, the debtor cannot dispose of its assets, grant mortgages or make any commitments without the authorisation of the delegate judge. Once the plan is adopted, the debtor must act within the frame of the latter.
Reprieve from payments. The debtor cannot, without the commissioners' prior approval, dispose of its assets or take any actions, including granting mortgages, making payments, borrowing money or receiving funds.
Restructuring procedure. Existing agreements are not automatically terminated; any contractual provision to the contrary is deemed ineffective (exception: a close-out provision of a netting agreement). The debtor has the right to decide not to perform (except for employment contracts) during the stay if such non-performance is necessary for its reorganisation, or to enable a transfer of activities. The opening of judicial reorganisation proceedings does not have an impact on a retention of title clause.
Bankruptcy. Existing agreements are not automatically terminated, unless parties agreed otherwise, or if the agreement was concluded intuitu personae. The trustee may decide not to perform under the existing agreement (a party can force the trustee to decide within 15 days); in such case, the damages for non-performance will be treated as an unsecured claim. Under certain conditions, movable assets sold under a retention of title clause may be recovered.
Set-off. Under the Financial Collateral Law of 15 December 2004, set-off provisions will be enforceable notwithstanding insolvency proceedings if certain conditions are met. Insolvency proceedings include bankruptcy, judicial reorganisation proceedings or other situations of concurrence of creditors known under Belgian law, and foreign administrative, judicial or voluntary collective or reorganisation proceedings. Certain limitations apply to the enforceability of set-off provisions in case of judicial reorganisation.
Once the reorganization procedure is open, the debtor may continue performing their obligations under the existing contracts in which there are still pending mutual obligations. In those cases, the debtor must ask for the court’s authorization and the counterparty may ask for the fulfillment of any due obligation at the time in which the procedure was filed. Should the debtor not notify their will to continue performing the contracts within thirty days of the filing date, then the counterparty is entitled to terminate the contract.
In case of an out-of-court restructuring process, there are no limitations as regards the existing contracts or new ones: the debtor must comply with their obligations and is free to enter into new business.
Finally, if bankruptcy is declared, the principle is that the debtor loses the administration of their business and assets and the sale process starts. Additionally, every existing contract is finished and the debtor cannot enter into new ones. However and exceptionally, the liquidator might recommend the court to continue the debtor’s business if it is considered beneficial for the debtor (and the creditors) or if two-thirds of the debtor’s employees request so.
Pursuant to section 365 of the U.S. Bankruptcy Code, a debtor has the unilateral right to assume (i.e., continue) or reject (i.e., terminate) executory contracts, subject only to a highly deferential business judgment test. An executory contract is a contract with material obligations remaining unperformed by both parties. A debtor typically has until confirmation of a plan to decide whether to assume or reject executory contracts. Both parties must continue to perform under the contract until such contract is assumed or rejected, regardless of if the debtor has not paid outstanding prepetition amounts. If the contract terminates postpetition pursuant to its own terms, neither party is obligated to continue performance under such contract, however, a creditor may have an administrative claim for any postpetition defaults. If the debtor chooses to assume a contract, then the debtor must cure any pre or postpetition defaults and is bound by the contract going forward. If the debtor choses to reject a contract, then the debtor is no longer bound by the contract and the counterparty is entitled to file a claim for any damages arising from such rejection.
A debtor must assume or reject the entire contract and cannot seek to disclaim only certain portions of the contract. Therefore, as a general matter, any provisions that existed in the contract prior to assumption or rejection remain enforceable. One exception, however, is the existence of so-called “ipso facto” termination provisions, which provide that a contract will terminate upon bankruptcy. Section 365(e)(1) of the U.S. Bankruptcy Code specifically states that, except in very limited circumstances, such provisions are unenforceable. Additionally, while setoff rights are generally preserved under section 553 of the U.S. Bankruptcy Code, a creditor is precluded from exercising such setoff rights without bankruptcy court approval.