Intro
Certain of your termination and anti-assignment clauses might be unenforceable. Here’s why, when and how, and what you can do about it.
The Scenario
You’re shopping to license hardware or software from a reliable company. Maybe the company you settle on is a household name—let’s call it Tech Company—an industry leader in the service you’re seeking. After some fruitful internal discussions, you reach out to Tech Company’s sales squad and within a matter of days or weeks money changes hands, new products are installed, and your organization is changed for the better. Soon your employees learn to deftly handle the upgrade and before you know it, you and your customers rely on its speed and interface.
A month later a notice arrives in the mail. It’s from your new partners at Tech Company, but they’re not inviting you to the corporate Labor Day BBQ. This letter is terser than the communications they’ve sent in the past. You don’t understand its jargon, but you catch the gist. Tech Company has filed for Chapter 11 bankruptcy. Now it is assigning your contract to another company you’ve never heard of, called New Entity. It seems Tech Company has suddenly washed its hands of you and introduced New Entity in its place without your knowledge—certainly without your consent.
The Roller Coaster
Here’s when you might scramble to your agreement with Tech Company. Your review of the PDF begets more questions than answers, though; it’s practically a rollercoaster of positive and negative results.
First, in the assignment section, you see something like this:
“Neither Party may assign this Agreement nor any rights or obligations hereunder...”
Point for the home team.
Then, a couple lines later, you read:
“…except to any entity that acquires the applicable assets of Tech Company as a result of a bankruptcy proceeding…”
Point for the away team.
You lighten back up as you come across a backdoor to the exception:
“…provided that You may, in such an instance, terminate this Agreement for convenience under Section…”
You flip to the termination section, and it’s all there, in slightly pixilated black and white.
“You may terminate this Agreement at any time upon sixty (60) days written notice to Tech Company…”
You breathe a little easier. You still control some measure of your fate. Tech Company cannot unilaterally unload you onto one of its competitors that you’ve never so much as spoken to. If you don’t like what New Entity is selling, you can terminate the agreement for convenience based on Tech Company’s bankruptcy-fueled assignment. Reassured, having disembarked the rollercoaster with your lunch intact, you ring your attorney to talk it over.
And she straps you right back in.
Apparently, there’s something called the Bankruptcy Code, Ms. Attorney says, and it rejiggers your agreement. Per the Code’s §365, not only is Tech Company’s assignment permitted, but your right to terminate as a result of this assignment is void.
What?
Via §365(f), anti-assignment clauses are often useless in the face of bankruptcy. Regardless of any provision that “prohibits, restricts, or conditions [an] assignment,” the Bankruptcy Code permits an assignment by the trustee of a bankrupt entity. The only prerequisites, per the same section, are that:
(A) the trustee assumes such contract or lease in accordance with the provisions of this section; and
(B) adequate assurance of future performance by the assignee of such contract or lease is provided, whether or not there has been a default in such contract or lease.
Since the Bankruptcy Court has already approved the assignment—a.k.a. sale—of your contract to New Entity, these prerequisites have already been met; otherwise the Court wouldn’t have let the process go this far. According to the Court Order referenced in the letter you received, Ms. Attorney continues, Tech Company’s trustee took control of the contract along with the rest of Tech Company in line with the Code. Thus, (A) above has been met. In terms of (B), whether or not Tech Company provided you with “adequate assurance” of New Entity’s ability to future perform your contract, Tech Company has assured the Court that it can and will “promptly take any actions reasonably required to obtain a Bankruptcy Court finding that there has been sufficient evidence of adequate assurance of future performance,” per the Order. Satisfied with this promise and that New Entity’s performance of your contract wouldn’t result in material, economically significant detriment to you, the Court moved forward, and blessed the assignment.
But don’t I have a right to be notified at least? To object to the assignment? you ask.
Ms. Attorney reads from the Court Order: “If any consent is not obtained or notice is not given prior to the assignment’s closing, the closing shall nonetheless take place subject to the terms and conditions herein…”
And what about my termination rights? you follow up. These rights were expressly provided for in your contract’s assignment section.
§365(f)(3) erases those, Ms. Attorney replies.
Under this subsection of the Code: “Notwithstanding a provision in an executory contract” that grants a termination right “on account of an assignment of such contract,” the subject contract “may not be terminated or modified under such provision because of the assumption or assignment of such contract or lease by the trustee.”
So, bankruptcy and its ensuing assignment cannot be the root of a termination right. If it is, that right is itself terminated.
Keep the Code in Mind
§365 intends to help trustees elicit the max value from debtors’ estates. To do so it allows trustees to assign executory contracts that benefit the estate—no matter what the contract itself might prohibit or permit. As long as the trustee assures the Bankruptcy Court that the assignee’s future performance will be adequate as compared to the performance promised under the contract, then the non-debtor (in this case, your company) is in a position level to the one it bargained for with the debtor in the first place, business can proceed, and everyone wins. Though, as here, it might not feel that way.
This scenario begs the question: Why do anti-assignment and termination rights hinging on bankruptcy persist if they’re rendered meaningless by the Bankruptcy Code? Why include them at all?
The prevailing guess is that sometimes, folks don’t know the law.
Whatever side of the table a party and its attorney may occupy, anti-assignment and termination rights—along with an unfamiliarity with §365—can underpin a party’s confidence in their agreement. However, this confidence could be false. Through §365, the Bankruptcy Code seeks to right the ship when one entity to an executory contract is sinking. Bankruptcy can be tricky, and a working knowledge of the Bankruptcy Code at the negotiation stage is key. When negotiating technology agreements in general—and their assignment and termination clauses in particular—parties and attorneys must keep §365 in mind, or certain rights might be unenforceable after all.