Contracts That Limit Or Take Away Your Bankruptcy Rights Are Not Enforceable

If you sign a contract, especially one that involves the payment of money, one party may know that the party that has to pay money could discharge their debt in bankruptcy. Or, a party may know that if the other files for bankruptcy it could affect that party’s ability to fulfill their obligations under a contract.

Void Provisions

To protect themselves, parties may include provisions in contracts that say one of three things:

1. That a debt that is owned under an agreement cannot be discharged in bankruptcy.
2. That the filing of a bankruptcy is automatically considered a default in the contract, and the filing party will be in breach of the contract if he or she files for bankruptcy. In other words, even if you are complying with the contract and fulfilling your obligations, the mere filing of bankruptcy will put you in default.
3. That the party will be somehow exempt from something in bankruptcy—for example, that the automatic stay won’t apply to them, or that they will be paid first from the bankruptcy estate

These are surprisingly common provisions in contracts. However, they are also unenforceable.

Why Are They Unenforceable?

These are known as ipso facto clauses. And they are completely unenforceable, for a number of reasons.

First, when you file for bankruptcy, your property isn’t really “yours.” For a temporary time, your property belongs to the “bankruptcy estate.”

To some extent, this is a fiction—no property immediately physically transfers to anyone. But the bankruptcy estate is, at least in law, the owner of your property, and as such, no third party can make any claims on it.

Additionally, bankruptcy law is federal law. Parties generally can’t force another party to contract away rights that are otherwise available under federal law. This is especially true in bankruptcy, which strikes a delicate balance between the rights of creditors and debtors. The law won’t allow third parties to upend that balance through a contract.

Likewise, bankruptcy intends to treat all creditors equally. Allowing some creditors to avoid being discharged by contract, gives those creditors an advantage over others.

Furthermore, saying that a party is in default, simply by virtue of filing for bankruptcy, is in effect “punishing” someone for filing for bankruptcy. It also puts the debtor in even more debt, as now there is a default in the contract, meaning that whatever assets a debtor may have to give to creditors, is now spread out amongst even more creditors.

The Fresh Start

But perhaps the main reason why these provisions are void, is that they affect the “fresh start” that bankruptcy is supposed to provide consumers.

A consumer that still has debts after a discharge doesn’t actually get a fresh start. Yes, there are some debts that legally can’t be discharged—but the law won’t allow someone to add to that list through contracting. Otherwise, everybody would include a non-discharge ability provision in their contract, and bankruptcy would be ineffective,

Contact the Boca Raton bankruptcy attorneys at the Law Offices of Stephen Orchard at 561-455-7961 for help determining which of your debts will be discharged after bankruptcy.

Resource:

abi.org/abi-journal/ipso-facto-clauses-and-reality-i-dont-care-what-the-documents-provide#:~:text=An%20ipso%20facto%20clause%20is,have%20found%20such%20agreements%20unenforceable