Termination of contracts in the event of a crisis

Insolvency-dependent termination clauses

According to the case law of the highest German civil court (BGH), provisions according to which the contract can be terminated for cause or ends automatically if a contractual partner gets into payment difficulties or is insolvent are only effective if there is an objective reason (sachlicher Grund) for the provision. 

This is due to the right of choice with regard to the fulfillment of contracts not yet fully fulfilled at the time the insolvency proceedings are opened which the German Insolvency Code grants the insolvency administrator for reasons of creditor protection. In addition, according to the BGH, the obligation to remain committed to a mutual contract continues to exist in principle also during economic crisis. This precludes a right of termination without cause according to the BGH.

Principles by the BGH

The BGH has established general principles as to the cases in which the existence of the required objective reason for an insolvency-dependent termination clause can be assumed. 

Existence of an objective reason

Accordingly, as a rule, an objective reason exists in the following cases, with the result that a termination of contract can regularly be based on it: 

• It cannot be assumed – for reasons existing prior the conclusion of the contract, the application for insolvency or the opening of insolvency proceedings – that the parties ultimately aim to undermine the insolvency administrator's right of choice and thus dispose of the interests of the insolvency creditors. The only decisive factors in this assessment are the view prior to or at the time of the conclusion of the contract and the objective facts of the case. Subjective ideas in the individual case are irrelevant. 
• The contracting parties – according to the interests at the time the contract is concluded – are pursuing an objective justified under insolvency law. The BGH gives the example where the contract in question is concluded as part of a restructuring of the insolvency debtor and the termination clause serves to mitigate the risks of failure of the restructuring.
• The termination clause is closely based on a statutory solution or termination option, in particular because it is not linked to insolvency-specific circumstances, such as default or other breaches of contract.
• Statutory law permits termination for good cause, and the classification of the petition for insolvency or the opening of insolvency proceedings as good cause is justified. This is the case, for example, if the risks associated with the insolvency would jeopardize the further performance of the contract. Such would be the case with a private construction contract, where the reliability of the contractor is essential for achieving the purpose of the contract as well as for the subsequent enforcement of any warranty rights of the client.

Non-existence of an objective reason

In contrast, there regularly is no objective reason in the following cases, meaning that termination of the contract cannot generally be based on a corresponding termination clause:

-      The termination clause in question constitutes a circumvention of the insolvency administrator´s mandatory right of choice. This is the case if 

o    the insolvency-dependent circumstance in itself makes it possible to terminate the contract, so that the purpose of the clause, when viewed objectively at the time of concluding the contract, is limited to releasing the contracting party from the contractual obligations, thus thwarting the insolvency administrator's right of choice. Thereby the contracting parties do not ultimately dispose of their own interests, but only of the insolvency creditors´ interests. 

o    the clause deviates from possible statutory terminations without there being justified reasons for these deviations when viewed objectively at the time of concluding the contract. This is the case, for example, if the clause sets lower requirements for the termination of the contract than the law. As an example, the BGH cites the termination block for landlords and lessors, according to which a rental/lease agreement cannot be terminated after the application for the opening of insolvency proceedings due to a default in payment that occurred prior to the application. 

-      The termination clause is intended to benefit the cash creditor – i.e., the debtor of the payment in kind – who is obliged to deliver goods on an ongoing basis under the contract in question. However, the cash creditor is adequately protected by the law, entitled to refuse performance until payment is made. Similarly, in case of an obligation to perform in advance, he may refuse performance if it becomes apparent after conclusion of the contract that his claims to consideration are jeopardized by the other party's inability to pay.

-      The party entitled to terminate lacks an interest worthy of protection, or the interests of the insolvency debtor worthy of protection outweigh the interest of the party entitled to terminate, so that the latter is exceptionally prevented from exercising the right of termination. For example, the party entitled to terminate is not acting in legitimate interest if using the insolvency to enforce higher prices or to terminate a contract whose performance is not made any more difficult by the insolvency.

Individual assessment of contract in times of crisis

The effectiveness of insolvency-dependent release clauses depends on the individual case. The decisive criteria for the final assessment are 

• the type of contract, 
• the objective circumstances at the time of the conclusion of the contract, and
• the interests of the parties. 

It may be doubted whether all this increases legal certainty, especially as a legal dispute about the effectiveness of the termination of a contract based on an insolvency-dependent release clause (and, thus, about the effectiveness of the release clause) may last years. 

If you have any questions, please do not hesitate to contact us.