Analyzing the Validity of Pre-Petition Bankruptcy Waivers in a Written Agreement
Reading Time: 5 minutes
Is a provision in a contract waiving a party’s right to file a bankruptcy action, or limiting that party’s rights in a future bankruptcy action, valid? In short, it depends. In general, contractual agreements which limit or deny a party’s ability to file a bankruptcy action have been held to be unenforceable. However, certain types of waiver provisions and the circumstances surrounding agreement to the bankruptcy waiver may create an enforceable waiver. A great deal of litigation has sprung up around this issue and the courts still seem to be split on how to approach the validity of a bankruptcy waiver provision in a written contract.
A contractual provision that provides for a total bar against filing a future bankruptcy action is void as against public policy. This has and is the general consensus among courts in the nation. “A total prohibition against filing for bankruptcy would be contrary to Constitutional authority as well as public policy.” In re Citadel Properties, Inc., 86 B.R. 275 (Bankr. M.D. Fla. 1988). Some courts have even ruled that an agreement to temporarily withhold filing a future bankruptcy action is void as well because it would create a restraint on the free ability to pursue bankruptcy protection. In In re Madison, the debtor entered into a stipulated agreement whereby she would be precluded from filing a bankruptcy action for 180 days. In re Madison, 184 B.R. 686, (Bankr. E.D. Pa. 1995). The court refused to uphold that portion of the agreement because there is a legal principle that an agreement not to file bankruptcy is unenforceable as violative of public policy. Id at 690. “Enforcement of even an agreement which only temporarily waives such rights would appear sufficient to us to undermine the Congressionally-expressed public policy underpinning the Bankruptcy Code.” Id.
It is clear from the majority of case law that a provision seeking to withhold a party’s ability to file for bankruptcy protection is void. However, what if you wanted to only restrict certain rights in bankruptcy, but not the ability to file altogether? The case law becomes a lot murkier on this topic, but the growing trend is that certain restrictions may be allowed so long as they do not affect other creditors of the debtor and/or they were not entered into in bad faith. It has become common to allow debtors to contractually waive the automatic stay portion of the bankruptcy code. More and more written agreements, especially mortgage and security documents, are including such automatic stay waiver language. This will allow the creditor to quickly obtain relief from the automatic stay and proceed with maintaining an in rem action in state court. Further, relief from the stay is not necessarily automatic for the creditor. The creditor must still go through the process of moving for relief and obtaining an order of the court. The waiver simply makes the task easier as the debtor will likely consent to the relief requested and it will give the court a greater reason for granting the relief.
It is important to note that a pre-petition bankruptcy waiver may be binding unless the agreement was obtained by coercion, fraud or mutual mistake of material fact. In re South East Financial Associates, Inc., 212 B.R. 1003, 1005 (Bankr. M.D. Fla. 1997). However, waivers are not self-executing and are not binding on third parties. Id. This means that if a bankruptcy waiver would somehow affect the rights of another creditor in the bankruptcy action, it is very unlikely that a court will uphold the waiver. The court in In re Sky Group International, Inc., 108 B.R. 86 (Bankr. W.D. Pa. 1989) set forth a list of factors to consider when determining whether a waiver may be upheld as valid and enforceable. Such factors include (1) the sophistication of the party making the waiver, (2) the consideration for the wavier, (3) whether other parties are affected, including unsecured creditors and junior lienholders, and (4) the feasibility of the debtor’s plan. Id at 848-849. This list of factors is non-exhaustive, but it gives a more defined picture of what courts are looking at when making an enforceability determination. One type of waiver that may be upheld more often than not is a waiver of the automatic stay agreed upon in a prior bankruptcy action’s plan of reorganization. In In re Excelsior Henderson Motorcycle Manufacturing Company, Inc., 273 B.R. 920, 922 (Bankr. S.D. Fla. 2002), the debtor in bankruptcy entered into a plan of reorganization that modified an existing mortgage note. One of the stipulations in the plan was that the debtor consent to stay relief should a later bankruptcy action be filed. Id. The court upheld such a waiver because, not only was the waiver not contained in the original loan agreement, but the debtor received significant benefits for consenting to the stay relief. Id at 923-924. The court distinguished the use of a stay waiver outside the bankruptcy court from one entered into in a plan of reorganization that was confirmed by the court. In the latter, all creditors had an opportunity to object to the stay relief and the bankruptcy court itself was able to weigh in on inclusion of the waiver before allowing confirmation. Id. Based on the consideration debtor received and the lack of affect the waiver would have on other creditors, the court upheld the waiver as an enforceable provision of the bankruptcy plan. Id at 925
In sum, if a party to a contract attempts to include a pre-petition bankruptcy waiver clause that eliminates the other party’s ability to file a bankruptcy action (even for a limited period of time), the waiver will be struck as void and unenforceable. If both parties agree to a waiver limited in scope and only applicable to a small set of rights in a bankruptcy action, it does not affect the rights of any third parties, and there was no coercion, there is a greater likelihood that the waiver will be enforceable.