In a recent experiment with a client (“Jane Doe”), she told me that after six months of collecting her deductible directly from her retirement accounts, her deductible was hurting and she didn`t know how to get out of the hole. To add salt to the wound, she personally guaranteed i) the lease of the commercial space; (ii) the franchise agreement; and the small business loan the company needed to get started. This is obviously a worse scenario for a business owner, especially if the business does not make a profit, because it is only a matter of time before the business is closed and the creditors come after the business owner. After an hour when I got an idea of her personal and business finances, I began to explain to Ms. Doe what her options were and how these executory contracts would be handled in the context of her bankruptcy. The Bankruptcy Act essentially authorizes an agent or debtor, subject to the agreement of the bankruptcy court, to take over advantageous enforcement contracts and to refuse advantageous enforcement contracts. In general, each party, if it has material obligations not fulfilled under a contract, is enforceable. Acceptance binds the debtor (and non-debtor) to the expenses and benefits of the contract. Refusal is a violation of the contract concerned, but damages resulting from the breach of a denied contract become general unsecured (non-priority) rights subject to bankruptcy proceedings. A leniency agreement can be considered a performance contract to the extent that both parties must comply: the borrower must pay some or all of the debt on the lender and the lender must continue to exist for a period of time.
As such, the debtor may accept or refuse the leniency agreement, and the lender cannot use an ipso facto clause to automatically terminate the leniency and avoid the risk that borrowers will accept (and maintain) the leniency agreement. However, if the leniency agreement provides for an extension of the additional credit to the debtor that was not requested before the petition, the agreement is instead considered a loan agreement and is not subject to the restrictions of the ipso facto clauses. Most credits contain termination clauses triggered by the borrower`s bankruptcy application. These so-called “ipso facto” clauses are generally unenforceable in execution contracts (discussed below), but may be enforceable in loan contracts1. In addition, lenders cannot be forced to extend financing to a bankrupt borrower, despite a previous agreement.