The Fate of Ongoing Contracts When Dealing With a Company in Financial Difficulty

16 September 2003

Jan Decorte

The recent fate of various Belgian companies such as Lernout & Hauspie, Sabena and Ebone has once again painfully demonstrated that insolvency impacts far beyond the company itself.

A looming insolvency throws up all manner of questions but the issues that arise time and time again relate to ongoing contracts with the company in difficulty. Existing contracts must be examined swiftly and questions addressed without delay. Can execution be enforced against the company in difficulty? Do our obligations continue? What about payments, penalty clauses and obtaining damages for early termination or otherwise? The list goes on.

A reform of Belgian insolvency law resulted in, on the one hand, the Act on Court-approved Settlements 1997 which aims to protect the company from its creditors with a view to avoiding its liquidation and, on the other hand, the Bankruptcy Act 1997, which provides for a quick and efficient liquidation of the company in the best interest of the creditors. This dual approach impacts on existing contracts with a company in difficulty.

The purpose of the Act on Court-approved Settlements is to preserve the continuity of existing contracts. This can have a substantial impact on business relations. Once a company is under judicial administration, the creditor is forced to honour the contract whilst the company in difficulty only has to propose ‘reasonable arrangements’ for the repayments of its debts in light of the recovery plan. Any contractual provision that provides for the automatic termination and even for the suspension of a contract in the event of a Court-approved settlement is deemed null and void. Moreover, penalty clauses become ineffective, although interest and other costs related to the debt remain due.

The situation is different when dealing with a company that is declared bankrupt (the correct term would be “insolvent” under English law) under the Bankruptcy Act. All contracts will inevitably terminate upon, if not in fact before, the liquidation or cessation of the company. As soon as a bankruptcy order is made (i) interest ceases to accrue on non-guaranteed debts; (ii) all outstanding debts become due; and (iii) all means of enforcement are suspended. Thereafter, there is a hiatus during which a creditor can terminate under a contractual provision to that effect and a trustee can either disclaim or temporarily continue with a contract (other than one for personal services). If there is no contractual right to terminate, a creditor can require the trustee to confirm his position with 15 days, failing which the contract will be automatically terminated.

This dual approach by the Belgian legislator aims to create a fair balance between the interests of the company in difficulty and its creditors. In reality, however, there are occasions when a creditor is itself placed in difficulty by being obliged to continue a contract with an insolvent company. Hence, notwithstanding that the legislation establishes a number of fair and efficient measures, a proactive management of bad debtors remains of major importance.