The termination of contracts with reciprocal obligations in bankruptcy proceedings

The main purpose of bankruptcy proceedings is to safeguard the interests of the creditors and ensure the continuity of the company declared bankrupt. In Spain, articles 61 and following of Law 22/2003, of 9th July (Bankruptcy Law) regulate the termination of contracts with a reciprocal obligation in the context of bankruptcy proceedings.

The effects on the contracts, as set out in those articles, include:

• Its validity when there are reciprocal obligations
• The termination for non-compliance.

The validity of Contracts with Reciprocal Obligations

Contracts with reciprocal obligations are those of a synallagmatic nature, that is, those in which each contracting party assumes a bilateral obligation.

Bankruptcy Law provides that: the declaration of bankruptcy alone shall not affect the validity of contracts with reciprocal obligations pending fulfilment by both the company declared bankrupt and the other party. In other words, the declaration of bankruptcy will not affect the validity of the synallagmatic contracts pending compliance by both parties, which shall need to be complied with, irrespective of the bankruptcy situation.

A different question arises however if at the time bankruptcy is declared, one of the contracting parties has fully complied with its obligations, while the other party is still yet to fulfil its obligations (whether fully or partially). In such cases, and as appropriate, the credit or debt corresponding to the debtor, will be included in the assets or liabilities of the bankruptcy proceeding. The term full compliance refers to both the main obligation and all those accessory obligations that are necessary for the main obligation to take effect.

Where is the interest of the bankruptcy

As an exception to this principle of validity, when at the time of the declaration of the bankruptcy the reciprocal obligations were pending on both parties, the Bankruptcy Law allows the insolvency receiver (in the case of suspension), or the insolvent debtor (in the case of intervention) to request the termination of said contracts. As long as this is in the interest of the bankruptcy proceedings.

Upon completion of the request, the legal secretary in charge of the bankruptcy will summon the parties to a hearing. If there is an amicable agreement on the termination and its effects, the issue of an order will declare the contract terminated. If the parties do not reach an agreement, the disputes shall be settled by the proceedings of the bankruptcy. The judge will decide on the termination of the contract and, where appropriate, agree on the effects of such termination and applicable refunds/indemnities.

Termination for Non-Compliance

Besides that, article 62 of the Bankruptcy Law grants the power to terminate contracts with reciprocal obligations when there has been a subsequent breach by either party. The termination of successive contracts is also possible when the non-compliance takes place prior to the declaration of bankruptcy.

Once again, the judge will be the one who, even if there is a cause for termination based on non-compliance, may agree to comply with the contract in the insolvency proceeding. The benefits due or to be fulfilled by the insolvent party will be paid from assets.

Finally, and agreed, if appropriate, the termination of the contract, the pending obligations will be deemed fulfilled. With regard to overdue obligations:

• If the non-compliance of the insolvent party is prior to the declaration of bankruptcy, the credit pertaining to the creditor who has fulfilled his contractual obligations, will be included in the insolvency proceeding
• If the non-compliance of the insolvent party is subsequent to the declaration of bankruptcy, the credit of the compliant party will be satisfied directly from assets.

It is worth emphasising that all clauses in synallagmatic contracts that provide for the termination of the contract in the event of a declaration of bankruptcy by one of the parties will be considered null and void. The former with the aim to protect the interest of creditors, as well as the continuity of the bankrupt company.

Ines Castro Rivera y Manuel Álvarez-Sala

For additional information regarding the termination of contracts with reciprocal obligations in Spain,