Early Termination of Contracts / Agreements is a Tool Available to Companies in a Financial Restructuring

Early Termination of Contracts / Agreements is a Tool Available to Companies in a Financial Restructuring

Often, when a business is facing financial difficulties it is hampered by unprofitable supply agreements or expensive service contracts. Any business that is using the Bankruptcy and Insolvency Act (the “BIA”) to make a proposal to its creditors may utilize certain provisions of the BIA to allow for the termination of contracts or agreements that are not profitable , without penalty, thereby improving its chances of successfully restructuring its financial affairs.

The BIA was written in such a way as to provide company’s with the tools they need to successfully make proposals to their creditors and continue operating. The BIA provision to terminate agreements early is one of those tools afforded to businesses in financial trouble.

In order to terminate the agreement the company must send written notice to the other parties to the agreement indicating that the agreement will no longer be effective. The company must provide the other parties with at least 30 days notice of the early termination. Upon the expiry of the thirty day period the agreement will terminate. However, it should be noted that any other party to the agreement may object to the early termination and apply to the Court to prevent the early termination.

Generally, when a company terminates an agreement early the other party(ies) to the agreement will suffer a loss as a result of the early termination. Any party that suffers a loss will have a claim in the company’s proposal.

By way of a simple example, consider the following scenario. Two years ago the company entered into an agreement to lease specialized manufacturing equipment so that it could produce a new product. The company leased the equipment from ABC Leasing Co. at a cost of $15,000 per month for a contracted term of 60 months. After 24 months the company realized that it could not manufacture this product profitably and decided to discontinue its production. If the company terminates the equipment lease after 24 months as part of it BIA proposal proceedings it is likely that ABC Leasing Co. will sustain a loss as a result of the early termination. The “loss” will likely include: (a) the 36 remaining payments, as ABC will probably not be able to lease the now “old” equipment; and (b) incidental costs incurred to pick up, store and/or destroy the equipment.

Let’s assume that ABC Leasing concludes that it sustained a loss of $360,000 in unpaid lease payments plus $40,000 of other incidental costs associated with removal and storage of the machine. ABC Leasing Co. will have an unsecured claim in the company’s proposal for $400,000 and will share in any distribution to creditors on a pro-rata basis based on its $400,000 claim.

The preceding example describes the early termination of a service contract where the company is obtaining goods or services from a third party. Alternatively, the BIA also allows for the early termination of agreements where the company is supplying goods or services to third parties. For example, where a long-term supply agreement is no longer profitable because the cost to produce goods or provide services has risen above the selling price for those goods or services, that agreement can be terminated early without a penalty pursuant to the provisions of the BIA.

In summary, the insolvency system in Canada has been set up to provide businesses facing financial difficulty with every opportunity to succeed. The ability for a company to terminate an unprofitable supply agreement or costly service contract early is just one of the tools available to assist it in successfully restructuring its financial affairs.

Author: Tom McElroy, CPA, CA, CBV, CIRP, LIT

About Albert Gelman Inc.

Albert Gelman Inc.’s corporate and consumer insolvency group has over 100 year of combined experience assisting individuals and businesses who are experiencing financial difficulty. Please feel free to call us to discuss your client’s financial situation.

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