The start of a new business partnership is often an exciting time. Like any new relationship, expectations for the future are bright and it’s easy to see the best in your partner.
Months (or years) later, when your business partner’s outlook has cooled and the company is struggling to pay its creditors, your own business could be in jeopardy.
Avoid getting caught up in the moment and protect your business from the bankruptcy of a partner by not neglecting the following provisions each time you draw up a contract.
Recover your lawyer’s fees in the event of breach of contract
When a person who owes money under a contract does not pay as obligated – that is to say., breaks the contract – it is an unfortunate fact of life that it will cost money to hire a lawyer to pursue collection of what is owed. You would think that the defaulting party would also have to pay your lawyer’s fees, wouldn’t you? They are the failing party here!
Well, not necessarily. If your contract does not contain a specific provision regarding who must pay attorneys’ fees and when, the default rule is that each party is responsible for paying their own attorneys’ fees.
The easy “fix” is actually to include a specific provision in the contract regarding the payment of attorney fees. This provision is part of the overall bargain between the parties. Courts will generally apply specific provisions on attorneys’ fees. Typically, the contract will state that in the event of default, the prevailing party’s attorney fees must be paid by the defaulting party. If there is a breach of contract and you need to hire an attorney to sue the defaulting party, your attorney will seek judgment against the defaulting party for all amounts due and payable under the contract (principal; interest), but in addition of this, all attorneys’ fees incurred to legitimately collect what is owed. It’s really the only way to make yourself “whole”.
If the defaulting party declares bankruptcy, the good news is that the bankruptcy court will also, in general, enforce the attorney’s fee provisions in the contracts. So, if you incurred attorney’s fees to try to collect a debt before filing for bankruptcy and your contract includes an attorney’s fee clause, you can file a proof of claim (a document proving that you are entitled to payment) in the bankruptcy case not only for the principal and interest due on the date of the bankruptcy filing, but also for the total amount of attorneys’ fees you incurred before the bankruptcy case was filed .
But some bankruptcy cases are much more complicated for creditors than simply filing a proof of claim. Can you receive “post-demand” attorney fees (after filing the bankruptcy case) if your attorney needs to actively pursue your rights in the defaulting party’s bankruptcy case? In certain prescribed situations, the answer is “yes” – provided, of course, that your contract includes an attorney’s fee provision.
Hone your interest in security
If your contracts include payment terms, you probably know that a provision securing the payment obligation with a guarantee improves your chances of being reimbursed. The prospect of losing valuable assets encourages borrowers to make payments on time. If a borrower defaults, you can seize the pledged assets to cover or offset your losses. In a bankruptcy, secured creditors generally receive at least the value of the collateral, or the collateral itself.
To get the most out of a secured bond, you need to “hone” it. Perfection lets the world know about your interest in the warranty. If you fail to perfect your secured interest, later creditors may obtain superior rights to the property. In the event of bankruptcy, unperfected security can be avoided so that your claim is treated as a general unsecured debt.
The perfection mode depends on the type of pledged asset. For example, a mortgage must be filed with the competent authority where the property is located. A UCC-1 financing statement is sufficient to perfect a security interest in many types of personal property. Certain other assets, such as intellectual property or motor vehicles, are governed by different filing requirements. Often, ownership or control of an asset trumps a funding status.
Because perfection is so important, prudent secured creditors will include a contractual provision expressly permitting the perfection of security. Similarly, secured creditors should consider language requiring the borrower to cooperate with efforts to remedy defects of perfection.
Bankruptcy as event of default
It is also common to include in your contract a provision that bankruptcy is an event of default and that the non-defaulting party has the right to terminate the contract. Courts often refer to clauses such as “ipso facto“, that is to say. a clause in an agreement stipulating consequences. While such a provision seems ominous enough to deter the offending party from filing for bankruptcy, it may not be enforceable in all cases.
Normally, when a company files for bankruptcy, it seeks to reorganize its commercial or financial activities by reducing debt, but also by optimizing the profitable parts of its activity. With few exceptions, the Bankruptcy Code allows debtors to “choose” which enforceable contracts they wish to retain (in bankruptcy, “assume”) or reject. Enforceable contracts are essentially contracts whose performance has not yet been completed on either side of the transaction, such as equipment leases or other long-term contracts. Debtors can reject many enforceable contracts that they deem economically unprofitable, thus facilitating its reorganization.
But many enforceable contracts are valuable to the debtor and its reorganization, so the debtor would prefer to keep (assume) the contract. If a ipso facto clause says that a non-offending party can terminate the contract in the event of a bankruptcy filing, which would violate the debtor’s right to assume it.
It is therefore not surprising that the Bankruptcy Code stipulates that any provision of an enforceable contract which allows one party to terminate the contract in the event of the insolvency of the other or in the event that the other files a bankruptcy petition is inapplicable.
As mentioned, however, there are certain exceptions to a bankrupt debtor’s right to assume an enforceable contract. For example, contracts for personal services cannot be inferred if applicable law excuses performance, or without consent. In addition, contracts to extend additional credit to a debtor and contracts for non-residential real estate that had been terminated prior to filing for bankruptcy cannot be presumed.