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How insolvency-proof are your contracts?

June 18, 2015
Nienke Bobbert, Höcker Advocaten, Netherlands

Hocker-logoThe economy is on the mend, but the number of insolvencies remains high. What happens if a contracting party of your company becomes insolvent? To what extent can you anticipate this when entering into new contracts? Sound insolvency clauses can limit the damage.

 

If a contracting party becomes insolvent, the basic premise is that this has no effect on an ongoing agreement. However, under the terms of the Dutch Bankruptcy Act, the insolvent party can in actual fact no longer be forced to comply, since the trustee for the insolvent contracting party has what is known as ‘right to breach’. This means that the agreement will not be complied with and that the resulting claim for damages from said breach can be submitted as an unsecured claim in the insolvency. In practice this scarcely, if ever, results in payment.

As the insolvent party’s counterparty you are not automatically released from your contractual obligations. This is because the trustee does actually have the right to perform this contract as well, if it is in the interests of the insolvent assets. To gain some certainty, you can ask the trustee to fulfil the contract. If he does so, then your claims under the agreement become a claim on the assets, which considerably improves your position. All the more so because you can demand security for compliance.

Many agreements contain clauses setting out, in advance, arrangements in the eventuality of one of the parties becoming insolvent, referred to as insolvency clauses. These are often termination clauses that stipulate that, in the event of the bankruptcy/insolvency of one of the contracting parties, the agreement will end by operation of law or the counterparty will have the unilateral right to terminate the agreement.
There are other clauses that go further. These are to the effect that, for instance, in the event of insolvency, or termination of the agreement as a result of it:
•goods or proprietary rights will automatically accrue to the solvent party
•or obligations of the counterparty will expire
•or the insolvency will trigger certain penalty clauses or a contractual compensation scheme.

With these forms of insolvency clauses, though, it doesn’t take much to end up skating on thin ice. An insolvency clause to the effect summarised above can, in fact, under certain circumstances turn out to be so disadvantageous for the insolvent party’s creditors that it will not stand up in court.

One such case occurred in 2013 in the winding-up of white goods chain Megapool. As a result of Megapool’s insolvency, the agreement with a cooperative credit provider was terminated. It therefore no longer owed Megapool any commission on the finance it had taken out with it. The Dutch Supreme Court ruled that a clause of this nature, ‘where the counterparty that has already received consideration no longer needs to carry out its own performance’, may be null and void, or invoking the clause may be impossible because it is contrary to the principles of reasonableness and fairness. According to the Supreme Court, whether this is the case depends on the context of any such clause and the other circumstances of the case.

In practice what is relevant is whether the ‘beneficial’ effect of the clause is justified by the harm that the counterparty suffers – or may suffer – as a result of the insolvency. It is therefore important for an insolvency clause to be looked at in the context of the negative effects of the insolvency on the counterparty and for those effects to be proportionate. Good wording and editing of an insolvency clause can ensure that, if necessary, this actually stands up and offers protection should the contracting party become insolvent. Certainly, if a contractual right to (fixed) compensation in the event of insolvency can also be secured with a bank guarantee, a sound insolvency clause can considerably limit the harm to you.

Tips & Tricks:
•Include an insolvency clause to the effect that an agreement can be terminated immediately.
•Make a list of the harmful consequences of the insolvency of your contracting party on your continuing performance contracts (cooperation/order/licences) and protect yourself with tenable insolvency clauses.
•For employment contracts and leases/tenancy agreements (including movable property) a separate rule applies.

About the author
Nienke BobbertNienke Bobbert is a partner at Höcker Advocaten and works in the company law and insolvency law division. Her litigation and advisory practice covers the areas of insolvency law, liability and contract law with a strong focus on dispute settlement. Nienke also has experience with arbitration proceedings and acts as mediator. She is frequently appointed as trustee in bankruptcy proceedings by the Court of Amsterdam.