TLC Lawfirm,Tayman Lane Chaverri LLP

Protecting Agreements from The Impact of Bankruptcy

By admin

Between tariffs, substantial investments in AI and data centers, persistent inflation, rising unemployment, and geopolitical and policy changes and developments, many sectors within the U.S. and global economy are facing uncertainty, which has led to a 10% year-over-year increase in overall U.S. bankruptcy filings. In this environment, businesses invariably find themselves having to adjust and react to the business distress of their key constituents (customers, vendors, suppliers, partners, etc.).

In considering how to protect ourselves against the financial distress of others, it is important to remember that whenever a key counterparty files for bankruptcy, every type of agreement – whether a commercial lease, broker agreement, settlement agreement, supply contract or other vendor contract or arrangement, oral or written – can be upended and the relationship disrupted. A recent decision from the U.S. Bankruptcy Court for the District of Delaware highlights how easily a party’s bargained-for rights can disappear when a bankruptcy case intervenes, and illustrates how crucial it is to plan for and anticipate bankruptcy and default risks.

In the case of In re Former BL Stores, Inc. (involving the retailers formerly known as Big Lots), a real estate broker’s commission vanished when the sale of a retail property collapsed and later closed after the seller filed a chapter 11 bankruptcy petition. The broker claimed an administrative expense for the earned fee, arguing the broker had produced the buyer that brought millions into the estate. The court disagreed.

 Why the Broker Lost

The judge ruled that the broker’s contract had expired before the sale closed and conditioned payment on “consummation” and “closing of escrow.” Because no sale occurred while the agreement was in force, and because the later sale that did close arose from a new post-bankruptcy petition transaction, the broker had neither an earned commission nor a post-bankruptcy claim. The court also noted that the broker had not been properly retained under the Bankruptcy Code, and that the property sale in question had been approved by the court “free and clear” of all claims. As a result, the broker’s $60,000 claim for the commission was completely disallowed.

 Broader Lessons and Key Takeaways

Although delivered in the context of a broker agreement, the court’s reasoning and analysis in BL Stores provides broader lessons on potential traps that are often lurking in just about every contract, lease, or other agreement or business arrangement with a counterparty. These traps can spring if  that counterparty files for bankruptcy.

• Pre-bankruptcy contract rights can die at the petition date. Even contingent commission rights can become unsecured pre-bankruptcy claims.
• A “closing-based” commission or other performance-based payment right is risky. If the deal closes after bankruptcy, the right to payment may be lost.
• Depending on the Services, Court approval may be critical. The engagement of many professionals (including brokers) to work post-bankruptcy, as well as the assumption of any pre-bankruptcy agreements, must be approved by the bankruptcy court. Failure to do so may result in the professional not getting paid or the counterparty not getting the benefit of their bargained-for agreement.
• Bankruptcy sale orders cut off rights. Bankruptcy courts can issue “free and clear” sales orders, which can legally extinguish existing and pre-bankruptcy claims, whether such claims arise under contracts, leases or otherwise.

 How to Protect Rights Under a Contract or Other Agreement

Whether negotiating a lease, settlement agreement, commercial supply contract or any other agreement, a party should consider certain protective strategies:

1. Make payment or performance obligations earned upon execution or partial performance, even if payable at a later date (e.g., in the case of a broker commission, upon procurement of a ready, willing, and able buyer, not at closing on the underlying deal).
2. Include survival and tail provisions extending key rights beyond expiration or termination.
3. Provide that the agreement expressly survives bankruptcy and require assumption or reaffirmation by any debtor-in-possession, as applicable.
4. Provide for court retention and administrative expense treatment under § 503(b) or other bankruptcy code provisions, as applicable.
5. Analyze any applicable state and/or non-bankruptcy laws, to determine appropriate treatment in the event of a bankruptcy filing.

The Bottom Line

Without careful drafting, a party’s hard-earned contractual rights, whether a broker’s commission or other critical payment rights under an agreement, can vanish in a bankruptcy case. Properly structuring agreements, e.g., using survival, procurement, and bankruptcy-specific language, can help protect payment rights and improve the chances of recovery on the claim if the deal goes south.

If you are dealing with financially distressed counterparty, or a counterparty in bankruptcy, Tayman Lane Chaverri LLP can help and we welcome your inquiries and referrals.  For more information, please contact Jeff Rhodes (jrhodes@tlclawfirm.com or (202) 921-4080) or David Tayman (dtayman@tlclawfirm.com or (202) 695-8147).