Legal Definitions - bankruptcy clause

A bankruptcy clause is a specific type of ipso facto clause. An ipso facto clause is a provision within a contract that automatically triggers a change in the parties' rights or obligations, or even terminates the contract entirely, upon the occurrence of a specified event.

Specifically, a bankruptcy clause is a contractual provision designed to automatically modify or terminate a party's rights or obligations under an agreement *solely* because that party files for bankruptcy, becomes insolvent, or experiences a similar financial distress event. The intent is for the contract to change or end without any further action needed from the non-bankrupt party.

However, it is crucial to understand that in many legal systems, particularly under U.S. bankruptcy law, these clauses are often unenforceable. The law generally prevents a contract from being automatically terminated or modified simply because one party files for bankruptcy. This protection allows a debtor in bankruptcy to continue using valuable contracts and assets as part of their reorganization or liquidation efforts, preventing creditors from immediately seizing or terminating essential business relationships.

Here are some examples illustrating how a bankruptcy clause might appear in a contract, even if its enforceability is limited:

• Commercial Lease Agreement: Imagine a clause in a commercial lease stating, "In the event Tenant files for bankruptcy protection under any chapter of the U.S. Bankruptcy Code, this Lease Agreement shall automatically terminate, and Landlord shall have the immediate right to repossess the premises without further notice."

  This illustrates a bankruptcy clause because it attempts to automatically end the lease agreement *solely* due to the tenant's bankruptcy filing, without requiring the landlord to take any separate legal action to terminate the contract.

• Software Licensing Agreement: Consider a contract where a software developer licenses its proprietary software to a client. A bankruptcy clause might state, "Should Licensee become insolvent, file for bankruptcy, or make an assignment for the benefit of creditors, all licenses granted hereunder shall immediately revert to Licensor, and Licensee's right to use the software shall cease."

  Here, the clause aims to automatically revoke the client's software license upon their insolvency or bankruptcy, directly linking the termination of rights to the financial distress event.

• Supply Contract: A contract between a manufacturer and a raw material supplier might contain a clause like, "If Buyer initiates any proceeding under bankruptcy or insolvency laws, Supplier's obligation to deliver goods under this contract shall immediately cease, and Supplier may terminate this agreement without penalty."

  This example demonstrates a bankruptcy clause because it attempts to automatically relieve the supplier of their delivery obligations and grant them the right to terminate the contract, triggered exclusively by the buyer's bankruptcy filing.