It is safe to assume that the aftermath of COVID 19 epidemic will lead to an increased number of insolvency procedures. Consequently, a domino effect is not to be underestimated; even if a particular business itself seems to be in a good shape, turbulences on any end of its supply chain may significantly influence its operations. Therefore, cutting the ties (read: terminating contractual relationships) with a partner undergoing insolvency may seem like a good idea in mitigating the risk.
For this very reason, in various commercial contracts a clause entitling one party to terminate the contract in case of commencement of insolvency procedure against the other party, or even stipulating an automatic termination for such case, became a commonplace. But does it really work?
In this paper it would be argued that it does not necessarily work, i.e. that such clause could be without legal effect. Additionally, a judgment by the Commercial Court of Appeal which is contrary the interpretation offered herein, shall be briefly presented.
As it follows from the article 94 of the Serbian Insolvency Law, it is a prerogative of the insolvency administrator to decide on future destiny of any of contracts between the insolvency debtor and its business partners which, at the moment of the commencement of the insolvency procedure, remained unfulfilled. The rationale for this is straight forward – it is the insolvency administrator’s role and duty to preserve the insolvency estate to the greatest possible extent in order to enable the satisfaction of claims by the insolvency creditors. There is a general consent, that the subject empowerment is granted to the insolvency administrator so that he/she may, in accordance with its best judgment, decide to terminate those contracts not serving the said purpose. Why should it than be different the other way around – the right of insolvency administrator to preserve contracts which he/she considers to be advantageous for enabling the satisfaction of insolvency creditors is just the other side of the same coin. Further performance of certain contracts unaffected by insolvency procedure may be significantly beneficial for insolvency estate (take for example energy supply agreements).
Apart from this argument which follows from the interests analysis, there is also another, more formalistic one: the Insolvency Law itself stipulates the consequences of the initiation of the insolvency procedure on legal transactions of insolvency debtor in a very detailed manner. An agreement of the parties, which results in consequences other than these, would represent a deviation from what seems to be mandatory law. A stance contrary to this one, would have to plausibly argue that parties are free to agree on their mutual rights and obligations in case one of them becomes subject to insolvency procedure, which is very difficult, if not impossible. Additionally, an agreement pursuant to which the initiation of insolvency over one of the parties would represent a ground for either an automatic or a declared termination, could be seen as (unpermitted) benefit in favor of the solvent party. As far as fulfilment of the contract is beneficial for the insolvency estate, enabling an agreement pursuant to which the party being the partner of the insolvency debtor would be released from its obligation, solely due to the fact that the insolvency procedure has commenced, would violate the principle of equal treatment of insolvency creditors.
The legislative procedure in which the subject Law (i.e. its article 94) has been amended back in 2018 (Article 6 of the Law on Amendments to the Insolvency Law – Official Gazette 44/2018) provides an useful insight and argument for the above argued understanding. By said amendments to the article 94, an additional paragraph has been inserted, which stipulates that the provisions granting the insolvency administrator the right to opt for the fulfilment of the contract does not apply in respect to financing agreements and financial securitization agreements. When elaborating the necessity of subject change, the Proposal presented to the National Assembly literally stated that the authorization of the insolvency administrator should “not apply to contracts whose subject is a financial obligation secured by a financial security contract – if this agreement stipulates that the existence of a bankruptcy reason, submission of a proposal for initiating bankruptcy proceedings or opening of bankruptcy proceedings is an automatic basis for termination of this agreement or grounds for termination at the request of the bankruptcy debtor’s creditor”. More concretely, as per the elaboration of the proposed amendment, it has been stated that “the proposed solution, in order to reduce the so-called cherry-picking risk, excludes the possibility of the bankruptcy administrator” to opt for the fulfilment of subject agreements. Argumentum a contrario implies that in respect to all other contracts (even when the termination option or automatic termination is stipulated), this cherry – picking right is vested in the insolvency administrator.
Finally, a comparative view may also be helpful for better understanding of the limits of parties’ contractual freedom and unrestricted right of the insolvency administrator. Take for example the decision of the German Federal Court of Justice (BGH) (file number IX ZR 169/11) which has declared insolvency-dependent termination clauses ineffective in 2012.
Based on the above, it could very plausibly be argued that any clause which provides for a n automatic termination of a contract, or enables a party to unilaterally terminate, due to an insolvency related reason on the side of other party (the existence of a bankruptcy reason, submission of a proposal for initiating bankruptcy proceedings or opening of bankruptcy proceedings) is null and void.
Although it may be considered that such conclusion does not require extensive argumentation, unfortunately it is not so – the court practice in the Republic of Serbia may directly deviate from such understanding.
In its decision No. Pž 6265/2016 dated 17.8.2017 (quoted based on the sentence contained in the Paragraf Lex data base) the Commercial Court of Appeal took, ex mea sententia, a dubious standing. To be straight, the Court has not directly ruled over the question of the validity of insolvency related termination clause but implicitly assumed full validity of such clause. In the particular case, the contract between the insolvency debtor and his contractual partner creditor contained a provision on automatic termination in case of the opening of insolvency procedure against one of the parties. As it happens, at the moment of the opening of insolvency procedure, the contract had still not been fulfilled. Apart from informing the partner on the commencement of the insolvency procedure, the insolvency administrator remained silent on the further fulfilment of the subject contract. The Court had been faced with the particular question whether to consider the claims of the insolvency debtor’s partner as insolvency claim, or as claim against the insolvency estate arising from the contract which “survived” insolvency procedure commencement. The Court came to the conclusion that the claim in the subject case should have been reported upon the insolvency opening and as insolvency claim, since the contract has been terminated by insolvency event pursuant to the stipulations of the contract itself.
Such decision of the Commercial Court of Appeal, if taken for granted, triggers completely different concerns: would it be more beneficial for the interests of the insolvency debtor’s partner that such termination clause has been omitted? I.e. could it be derived from the subject Court’s decision that in the absence of the insolvency related automatic termination clause, the claim of the insolvency debtor’s partner would have been considered as claim to be settled as liability of insolvency estate, thereby potentially increasing the chances for its full collection?
The reasoning of the Commercial Court of Appeal is sometimes as unfathomable, as the corridors of the building of the Court’s venue.
In any case, in days like these one should consult its doctor or a pharmacist. Or was it an attorney at law…?