Vol 8 (2011) - Issue 2

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Corporate Rescue Proceedings and the Enforcement of Ipso Facto Termination Clauses: A Comparison of the English and US Approaches

Introduction

The prevalence of Chapter 11-style restructuring techniques in the UK and European markets has helped bridge the gulf between corporate reorganisations on both sides of the Atlantic. Despite this welcome trend, English insolvency law still remains less debtor-friendly and rehabilitation-oriented than the Chapter 11 system. Chapter 11, which has debtor-in-possession as its underlying principle, has historically favoured the restructuring of viable businesses by providing a broad automatic stay on the enforcement of security with a mechanism for the approval of a creditor negotiated reorganisation plan. The Enterprise Act 2002 reforms, inspired by Chapter 11, were intended to represent a shift in focus towards corporate rescue and away from liquidation by promoting administration as the principal insolvency procedure under English law for distressed companies. The consensus amongst restructuring professionals, however, is that the reforms fell far short of their aim. There are still many aspects of Chapter 11 that are more favourable to the debtor than even the amended English law which is why many large corporate restructurings in the UK are conducted voluntarily outside any formal insolvency process and, therefore, without the benefit of a statutory moratorium.

One such area where it is considered that the reforms did not go far enough is the treatment of termination provisions in executory contracts which are conditioned on the insolvency of a party - the so-called 'ipso facto' clauses in American legal parlance.

Executory contracts are those in which obligations remain to be performed on both sides. In an insolvency context, the late Professor Vern Countryman, a renowned American lawyer, enunciated what has now become the most widely adopted test of an executory contract by the US bankruptcy courts. According to Professor Countryman’s definition, an executory contract is:

'a contract under which the obligations of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.'

Under English law, in the absence of any ipso facto clause, the advent of administration does not in itself bring executory contracts to an end. The administrator has a discretion whether and for how long to continue performance of the company’s existing contracts depending on the purpose of the administration. Where the administrator declines to procure further performance, the other party may treat the non-performance as a repudiatory breach entitling it to terminate the contract and claim damages against the company under ordinary principles of contract law. In practical terms, however, damages provide little recourse where the company is insolvent. Moreover, where there has been no breach and the administrator wishes to continue the contract, the counterparty may wish to terminate instead of risk trading with the insolvent company.