Ipso Facto Clauses: Funny Name, Serious Meaning?
Usually, contracts mean what they say, and courts are hesitant to tell parties what they can or cannot do or agree to in a contract. Rarely will something that someone puts in a contract be automatically invalid or void. But bankruptcy law does contain one such provision that does just that.
The Ipso Facto Clause
It’s called an ipso facto clause, and although the name sounds funny, you’ve probably seen these clauses in many different kinds of contracts. These are clauses that say that filing for bankruptcy is considered an automatic default of a contract or an agreement.
In other words, even if you are otherwise in full compliance with your contract, the act of filing for bankruptcy—even if that bankruptcy won’t actually affect the other side to the contract—will allow the other side to declare you in breach of the contract and pursue any remedies that a breach or default would allow.
Ipso facto clauses also can sometimes require that a party waive a right that they would otherwise have in bankruptcy. Examples would be someone agreeing in a contract that the automatic stay won’t apply to them, or that a debt won’t be dischargeable in bankruptcy if filed.
Why These Clauses are Unenforceable
There are loads of reasons why these provisions are unenforceable. First, when you file a bankruptcy, a bankruptcy estate is created. This is really just a fiction—an idea—but bankruptcy law considers your bankruptcy estate to be a separate legal entity than you, or the trustee, or the bankruptcy court.
That means that parties can’t bind, restrict, or limit the bankruptcy estate in their private contracts.
The other reason these clauses are generally unenforceable is that these agreements infringe on, or limit, federal bankruptcy law. Bankruptcy law has established a delicate balance between the rights of creditors and debtors. While some laws can be waived by parties agreeing in contracts, bankruptcy provisions cannot.
The last reason why these provisions are unenforceable is that bankruptcy is supposed to be a fresh start for consumers. The idea of bankruptcy isn’t to make consumers’ lives more difficult—it’s to make their lives easier and allow them to start their financial lives over again.
Clauses that make bankruptcy harder, or discourage people from filing, or punish them from filing, go against those ideas.
They’re Still Around
These clauses have long been unenforceable, but that somehow doesn’t deter people or businesses from including them in their contracts. For larger companies, many creditors are getting around these clauses by forcing businesses to allow creditors to have a seat on the company’s board of directors, or requiring the company’s board vote by unanimous consent to file for bankruptcy.
But for “normal” people that aren’t large companies with boards of directors, these clauses are unenforceable, and you should not be afraid to file a bankruptcy because you agreed to one.