What To Do If Contract Partner Goes Under

While the economies of New York and New Jersey have rebounded since the 2008 recession, small businesses still face challenges. Unfortunately, when a company with which you do business with closes, it may leave you seeking options so that you are not a victim of that company’s failure. So, what can you do if your contract partner goes under?

In most cases, your legal remedies depend on the circumstances of the business closing and the terms of the underlying contract.

Best-case scenario

In some cases, businesses that are suffering financial trouble will be proactive and reach out to their contract partners. If the other party seeks to make a contract modification, make sure any deal you make is memorialized in writing. If you have rights under the existing contract that you do not want to lose, make sure the new writing protects those rights.

If the business owes you money or product then state that in the writing so that it is not a subject for later dispute. Although, as a compromise, you may be waiving a portion of what you are owed.

Dealing with mergers

If another firm bought the company, as in a corporate merger, usually the new company must take responsibility for the contract obligations of the former company. Many agreements specifically address “contract assignment” in which a new party steps into the shoes of an existing party and assumes all of the obligations and rights under the contract. Some contracts may include a provision prohibiting assignment while others may require the other party to consent to the assignment.

If you have such rights, notify the acquiring company that you have them. You could try to assert yourself into the mix in the sale, using your contract as leverage for a new direct agreement with the acquiring company. Keep in mind the politics of the situation. That is, if it appears that the acquiring company may walk away if you interfere, and the continuation of the contract relationship is not threatened by the merger, you will want to stay silent.

Worst-case scenario

If the company has initiated the bankruptcy process, the United States Bankruptcy Court may notify you as a potential claimant. Under the federal bankruptcy code, a debtor can often decide whether to either “assume” or “reject” certain executory contracts. There is a potential trap here with regard to payments made within 90 days of bankruptcy that may be subject to recapture as a preference over other creditors.

If the company has completely ceased its business operations, with no likelihood of continuing or sale, or has filed for bankruptcy protection, your ability to recover your losses is less certain.

Bankruptcy reorganization 

If the company reorganized in bankruptcy decides to assume the contract, it must cure all prior defaults and show that it will be able to satisfy its future obligations under the contract. If the company in bankruptcy rejects the contract, it is considered a breach and you may seek to recover damages.

However, as to claims under your contract, you will likely be in line with other unsecured creditors so it is important to review the bankruptcy filing to see your chances for a recovery in the bankruptcy.

Collecting money owed

If you have a contract that still is in force with a defunct company and it cannot fulfill its obligations, you may have to get the rest of your contract needs filled by another company. Soon after, you may have a damages claim against the company that went under. Of course, the difficulty will again be collecting any money owed.

Was it a corporation or a business? 

If the closed business was not a corporation, you are likely to be able to bring claims against the individuals who owned the business. Remarkably, even if the closed business was a corporation, you are likely to be able to bring claims against the individual shareholders for recovery of your damages under the contract with the corporation if the shareholders dissolved the corporation and made payments to themselves.

They also could have assigned or taken out some corporate assets for themselves in dissolving the corporation. It is not uncommon for shareholders of a dissolving corporation to repay to themselves debts owed to them by the dissolved corporation for money they invested into the business. Cash businesses are particularly suspect, as are businesses that close but are re-opened under a different name by one or more of the former owners.

If you are unsure whether your legal rights are protected when your contract partner goes under, or if you would like to discuss the matter further, feel free to contact me at (201) 806-3364.

Dan Brecher came to Scarinci Hollenbeck after being the head of the Securities and Investment Banking Department of a 250 lawyer Manhattan firm and then running his own boutique securities and investment banking law firm in Manhattan. His experience ranges from general counsel of New York Stock Exchange and NASD/FINRA member brokerage firms to representation of companies in hundreds of public and private securities offerings and advising institutional and high net worth investors. He is the editor to the firm’s blog: www.scarincihollenbeck.com/firm-insights

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