Monday, March 26, 2012

Insolvency - should it be an event that allows termination for cause?

Insolvency is described as the condition of having more debts or liabilities than total assets available if the assets were liquidated. Many agreements provide for the right to terminate for cause if the other party becomes insolvent,files for bankruptcy protection or has bankruptcy claims filed against it a petition in bankruptcy. As there are specific laws regarding bankruptcy you may only be able to terminate to the extent permitted by law. The question is why would you do it? There are a number of reasons:

1. You simply don’t want to accrue additional obligations to a company that is not be able to perform. For example a supplier doesn’t want to be obligated to sell more to a company that already isn’t paying them.

2. If the company goes into bankruptcy, the trustee in bankruptcy does not have to honor the agreement.

3. It excuses you of existing contract obligations other than paying for what you had already received and accepted. That frees you up to source product or sell your good or services elsewhere. For example, firm purchase commitments or requirements type provisions would not need to be honored. This allows you to manage you own future destiny.

4. If you terminate you can sue for damages you sustained, While a court judgment would not make you a secured creditor, it would place your claim for payment above the company’s shareholders in any liquidation of the assets.

5. You avoid having to deal with the bankrupt firm and the bankruptcy trustee whose primary focus is the interest of the creditors.

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