Enforcing Unenforceable Contract Provisions in Bankruptcy

Contracts routinely include anti-assignment and ipso facto provisions, which are typically unenforceable in bankruptcy cases. Such provisions restrict contracting parties from transferring their obligations and rights under the agreement to a third party without obtaining permission. They are known as “anti-assignment clauses.” They also permit termination due to the bankruptcy, financial condition or insolvency of a party — known as “ipso facto clauses.”

Personal service contracts are not assignable without consent. Bankruptcy Code also prohibits the assignment of contracts without consent if other applicable law specifically provides that the identity of a contracting party is crucial to the contract, or when public safety is at issue. Certain contracts are not assignable in bankruptcy, even if the other party to the contract consents. These include loans, debt financing or other “financial accommodations.” Ipso facto clauses, which provide, for example, that a contract terminates upon bankruptcy filing by a party, are typically unenforceable. They will be enforced in non-assignable contracts to make loans or other financial accommodations or issue securities. Ipso facto clauses contained in forward and commodity contracts are enforceable, provided that various preconditions are satisfied, among them that the contract fits the Bankruptcy Code’s definition of a forward or commodity contract.

It is typically the debtor in bankruptcy that benefits from the unenforceability of some of its contractual provisions. Entities doing business with other entities in financial distress may want to incorporate contractual terms that closely align with the applicable exceptions.