An “ipso facto provision may be unenforceable under the Bankruptcy Code even if the provision does not void the entire contract,” District Judge Mark A. Goldsmith of Detroit held in a June 6 opinion.

The case entailed a confirmed chapter 11 plan creating a trust that had filed suit against former officers and directors for violating their fiduciary duties. The provider of directors and officers’ insurance had denied coverage, prompting the trust to seek a declaratory judgment in bankruptcy court.

Because the declaratory judgment action was beyond the bankruptcy court’s ability to render final judgment, the bankruptcy judge issued a report recommending that the district court grant the insurance company’s motion to dismiss.

The insurance company’s motion to dismiss was based on an endorsement to the D&O policy that the company had purchased after the chapter 11 filing. The endorsement relieved the insurer of liability for any claim that was allegedly caused by the company’s bankruptcy or insolvency or any loss based on a claim made after bankruptcy. The endorsement also absolved the insurer of liability to a creditor for an account receivable, including misrepresentations related to extensions of credit.

Judge Goldsmith interpreted the bankruptcy court’s recommendation as concluding that a provision is a prohibited ipso facto clause only if it “invalidates the entirety of the agreement.” In the opinion of the bankruptcy court, a provision is enforceable if it only had the effect of narrowing the coverage of the policy.

The case turned on Section 365(e)(1), which provides that an executory contract or lease may not be terminated “solely because of a provision in such contract” that is conditioned on “insolvency or financial condition” or the filing of a bankruptcy petition. Section 541(c) provides that property becomes property of the estate “notwithstanding any provision” that “is conditioned on the insolvency or financial condition of the debtor.”

Judge Goldsmith said that courts “broadly construe those provisions,” to the extent that some “‘courts have prohibited enforcement of ipso facto clauses on more general grounds not based on either statutory provision.’” He said there was no authority for the proposition that a clause is unenforceable only if it applies to the entire contract.

Judge Goldsmith stopped short of ruling that the endorsement was unenforceable, saying such a conclusion would be “premature” since the bankruptcy court was yet to decide whether the policy was an executory contract.

He rejected the recommendation and remanded the case to the bankruptcy judge “for further consideration of the parties’ motions, including all of the parties’ arguments.” On remand, the insurance company may still be able to argue that some aspects of the endorsement remain enforceable.

Another opinion by Judge Goldsmith was discussed in this column on June 9.