The validity of contract clauses allowing a party to exit the contract solely for the reason that the other party becomes illiquid and/or a petition for insolvency is filed or insolvency proceedings are instituted is a matter of intense debate. To date, the case law of the highest court instances has dealt with exit possibilities only in relation to certain specific types of contract.

It is only now that the Insolvency Senate of the German Federal High Court of Justice [Bundesgerichtshof – BGH] has fortunately taken a pending case as a basis for a landmark decision issuing instructions on the treatment of insolvency-based exist clauses in the future.

Facts of the case

The matter on which the judgment was entered related to a contract of carriage for school- passengers between a bus company and a regional authority. Once the insolvency court had placed the bus company under provisional insolvency administration in response to a petition to this effect by the latter, the regional authority terminated the contract of carriage without notice, invoking a termination right agreed by contract, on the ground that a petition for insolvency had been filed.

The Insolvency Administrator appointed by the Insolvency Court took the view, referring to Sec. 119 of the German Insolvency Code [Insolvenzordnung – InsO], that the notice of termination issued by the local authority was not valid and filed a complaint for payment of the agreed remuneration until the agreed end of the contract term, deducting only the saved expenses. After the complaint had been dismissed in the first instance, the appellate court granted the complaint (as reported earlier in German language).

Decision

The BGH did not concur with the view of the appellate court and decided to remit the case back to the Higher Regional Court for further negotiation.

The BGH also takes the view that the law currently has no final provisions for regarding the validity of insolvency-based exit clauses. Sec. 119 InsO stipulates that provisions by which the application of Secs. 103 to 118 InsO, in particular the right of the insolvency administrator to choose or reject performance, is excluded or restricted is invalid. On the other hand, the BGH continued, it follows precisely from the legislative procedure regarding Sec. 119 InsO that the legislator did not proceed on the assumption that exit possibilities of this kind are invalid in principle. In the absence of a clear statutory basis, therefore, any insolvency-based exit clause building up on Sec. 119 InsO requires a particular justification which should take into account the principle of freedom of contract.

In the opinion of the BGH, the decisive point in order for an insolvency-based exit clause to be valid is that there must be an objective factual reason for such a clause that goes beyond the mere intention of the party concerned to undermine the provisions of Secs. 103 to 108 InsO.

On that basis, exit clauses in favour of a “payment” creditor are always invalid if they go beyond the scope of the exit possibilities provided by statute. The reason the BGH gives for this is that payment creditors, unlike other creditors, are sufficiently protected, in particular by the defence of non-performance (Sec. 320 of the German Code of Civil Procedure – BGB) and the defence of uncertainty (Sec. 321 BGB).

On the other hand, according to the BGH, exit clauses are valid if they are agreed between the parties under contracts pursuing aims that are justified under insolvency law, e.g. a reorganisation of the debtor. Such clauses are also valid if the law allows for them to be terminated for cause and the insolvency of one party would significantly affect the performance of the contract. In this context, the Senate made express reference to the matters of reliability with a view to the continued performance of the contract, the loss of warranty claims or the legitimate interest of the creditor in any additional services to be provided in the future, e.g. preventive maintenance, if applicable.

Accordingly, in the opinion of the BGH, the appellate court did not determine sufficiently whether a legitimate interest in the exit possibility is sufficient for the specific contractual relationship at hand. Therefore, the BGH issued a judicial instruction to the appellate court, stating inter alia that it should be determined whether there was a need for such a clause at the time when the contract was entered into because there was reason to expect that, following the submission of a petition by a party itself, performance failures would occur which have to be excluded as far as possible given the nature of the contract of carriage. The BGH may see another legitimate interest in the absence of cover for the consequences of an accident.

Practical note

By its decision on the case at hand, the Senate responded to the demand of practitioners for “guidance” on the treatment of the question of whether insolvency-based exit clauses are valid. It will certainly be necessary to examine this with regard to the individual case in question. This is appropriate given the significance of such an exit right for both the practice of restructuring and the principle of freedom to contract. However, the Senate also opened a new discussion: It mentioned in passing that it at least considers the possibility of adopting a general prohibition on insolvency-based exit clauses in cases of insolvency under self-administration. In such cases, it is and remains advisable, if possible, to base the termination of a contract not merely on the fact that a petition for insolvency has been filed.

(BGH, judgment of 27 October 2022 – IX ZR 213/21)