- May 22, 2012
- Posted by: Seth Heyman
- Categories: Business Law, Contract Law
The legal profession is replete with fancy Latin phrases that apply to court proceedings, criminal matters, contracts, and other areas. One such phrase, Ipso Facto, is applied to a certain clause often included in business contracts.
Ipso Facto means “by the fact itself,” and an ipso facto clause is a contract provision which states that the contract may be terminated if either party declares bankruptcy. In other words, the very fact that one party declares bankruptcy is supposedly enough to end the contract and terminate the benefits and obligations of both parties.
Although often seen in contracts, Section 365(e)(1) of the U.S. Bankruptcy Code states that ipso facto clauses are unenforceable in bankruptcy, with certain exceptions. Once the other party files for bankruptcy, all of its property and debts (including contracts) are under the control of a federal bankruptcy court trustee, who will determine the rights and obligations under the agreement. The bankruptcy court can keep contract rights tied up for months or even years while the trustee attempts to sort out the financial mess. If the trustee determines that the contract is an asset, it can even be assigned to another company in order to pay off creditors.
Unenforceable ipso facto clauses often included in agreements because they’re legacy clauses, which are copied, cut and pasted from previous agreements drawn up by other lawyers over the course of decades and passed down from generation to generation- not unlike a family heirloom.
Although these termination provisions are often included in agreements, they are almost always invalid and should be avoided.