The Lehman and Charter Attack on Ipso Facto Clauses

08/16/2010

Congress included five sections in the Bankruptcy Code that limit the enforcement of ipso facto clauses1 in a bankruptcy case (“Anti-Ipso Facto Sections”).2 Generally, the Anti-Ipso Facto Sections prevent the operation of any clause that triggers a default under, modification of, or termination of an agreement after the commencement of a bankruptcy case because of: (1) the insolvency or financial condition of the debtor; (2) the commencement of a bankruptcy case; (3) the appointment of or taking possession of the assets of a debtor by a bankruptcy trustee; or (4) the appointment of a custodian before a bankruptcy.

The Anti-Ipso Facto Sections allow a bankruptcy trustee or debtor-in-possession to retain and use property of the estate, assume and assign contracts, and retain contract rights as they existed immediately before the filing of the bankruptcy petition. Simplified, the Anti-Ipso Facto Sections prohibit creditors from using contract language to improve their pre-petition positions. Most sophisticated contracting parties understand that, as a general rule, ipso facto clauses are unenforceable in bankruptcy.

If asked, however, most practitioners probably would say that a debtor’s bankruptcy filing does not trigger the Anti-Ipso Facto Sections in an affiliated debtor’s bankruptcy. However, that may not be the case after two recent decisions from the United States Bankruptcy Court for the Southern District of New York in In re Lehman Brothers Holdings Inc. and In re Charter Communications.3 In light of these decisions, the Anti-Ipso Facto Sections may be more powerful than commonly understood. Familiarity with these decisions is critical for future litigation involving the Anti-Ipso Facto Sections.

Excerpted from Bloomberg Law Reports - Bankruptcy, Vol. 4, No. 33, August 16, 2010 © Bloomberg Finance L.P. 2010. Originally published by Bloomberg Finance LP. Reprinted by permission. The full article appears in the PDF below.
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1 Black’s law dictionary defines an ipso facto clause as “a contract clause that specifies the consequences of a party’s bankruptcy.”

2 The Anti-Ipso Facto Sections are 11 U.S.C. §§ 363(l), 365(b)(2), 365(e)(1), 365(f)(1), 365(f)(3), and 541(c)(1)(B).

3 Judge James M. Peck is the judge in both of these cases.

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