Section 363(f) of the Bankruptcy Code allows a sale to be “free and clear of any interest in” the property being sold, but it does not define the term “interest in.” Courts have held that a properly conducted bankruptcy sale conveys the assets free and clear of not only property interests but also “claims.” Courts have held that section 363(f) may be used to bar a variety of successor liability claims that relate to ownership of property.
Limitations of Section 363 on Discharge of Successor Liability Claims Following In re Motors Liquidation Co., f/k/a General Motors Corp.
As stated in In re Motors Liquidation Co., 568 B.R. 217, 227–29 (Bankr. S.D.N.Y. 2017), a bankruptcy court may approve a section 363 sale “free and clear” of successor liability claims if those claims flow from the debtor’s ownership of the sold assets. To be considered a successor liability claim discharged under section 363, a claim must arise from a right to payment that arose before the filing of the petition or resulted from pre-petition conduct fairly giving rise to the claim. Id. at 227–28 (citing In re Motors Liquidation Co., 829 F.3d 135, 155 (2d Cir. 2016)). In addition, there must be some contact or relationship between the debtor and the claimant such that the claimant is identifiable. In re Motors Liquidation Co., 829 F.3d 135, 156–57 (2d Cir. 2016). The Second Circuit in In re Motors Liquidation Co. reaffirmed the notion that a “claim” cannot be extended to include personal injury claimants who were completely unknown and unidentified at the time a debtor filed its bankruptcy petition.
The General Motors (GM) bankruptcy and product liability litigation arising out of ignition switch failures also separately addressed the enforceability of a section 363(f) order that provides for a sale free and clear of successor liability claims against plaintiffs who (1) had, by the time of GM’s bankruptcy filing, asserted state court claims against GM and (2) were provided only with constructive notice, and not actual notice, of the section 363(f) sale. The decisions emanating from the bankruptcy court, the Second Circuit, and the district court handling the multidistrict litigation proceeding present the following proposition: Notwithstanding that successor liability claims are typically claims held by a debtor’s bankruptcy estate (and not individual creditors), a tort claimant/creditor that made itself known to the debtor by the time of the bankruptcy filing, and yet did not receive constitutionally adequate notice of the bankruptcy, would not be deemed as having its individual successor liability claim discharged by the bankruptcy filing.
Finally, the GM bankruptcy and product liability litigation addressed the extent to which a purchaser of assets pursuant to a section 363 sale order can shield itself from claims that allegedly arise out of the purchaser’s own conduct (i.e., conduct separate and apart from successor liability claims for pre-bankruptcy petition conduct of the debtor). The decisions emanating from the different courts coalesce to present the following proposition: Tort claims by plaintiffs based on a purchaser’s post-petition conduct are not claims that are based on a right to payment that arose before the filing of the bankruptcy petition, and as such, they fall outside the scope of a “free and clear” provision of a sale order entered pursuant to section 363 of the Bankruptcy Code.
Seven Tips for Companies Purchasing Product Lines from Bankruptcy Estates
- Ensure that any proposed purchase price of assets reflects the risk attendant of being subject to tort claims arising out of latent defects. Such an analysis would naturally include asking the seller/debtor for data regarding (1) the extent of tort claims connected with the asset or assets at issue, (2) the expected mean latency period for the tort claims connected with the asset or assets at issue, and the (3) historical costs related to the resolution of those tort claims.
- Contemplate the extent of the secondary market for the products at issue and consider discounting its purchase price accordingly. Because it is unlikely any Bankruptcy Code section 363 sale order will be interpreted or enforced as releasing claims from those injured following a sale of the product in the secondary market, given that the purchasers of those products in the secondary market are presumably unknown to the debtor, the prospective purchaser should assume that a 363 sale order will not in and of itself preclude suit against the prospective purchaser for successor liability for personal injury claims that were unknown and not identifiable at the time of the seller’s bankruptcy filing. Whether such a claim has merit or is viable will still depend on the governing state’s law concerning successor liability claims.
- Assess whether the retention of former employees of the debtor increases the risk of facing failure-to-warn claims. If the employees were in a position to have knowledge about defects concerning the product line, such knowledge could be imputed to the prospective purchaser and support failure-to-warn claims against the prospective purchaser that are independent of any successor liability claims and irrespective of “free and clear” language in the sale order.
- Consider the risk of facing failure-to-warn claims resulting from having access to documents during due diligence pertaining to successor liability claims. The prospective purchaser will want to be in a position to be able to discount its purchase price (perhaps through a contingent due diligence provision in the offer of purchase) in the scenario where the prospective purchaser, during its due diligence period and subsequent purchase of assets, has access to or takes possession of documents detailing issues with assets or products to be purchased. The prospective purchaser could face failure-to-warn claims that are independent of successor liability claims for not taking action after being informed about issues known to the debtor at the time of the bankruptcy filing, irrespective of “free and clear” language in the sale order.
- Inquire as to the type of notice provided by the seller about the bankruptcy filing to individuals who had given notice to the seller of tort claims against the seller related to the assets under consideration. Such notice could be conveyed either through filing a lawsuit or communicating with the seller informally and should, of course, pertain only to those tort claims related to the asset or assets that the prospective purchaser contemplates purchasing. To the extent the prospective purchaser is informed that a seller provided constructive notice (e.g., by publication) rather than actual notice, the prospective purchaser would be wise to discount any purchase price that contemplates the risk of having to deal (e.g., litigate) with these tort claimants who were not given adequate notice of the bankruptcy filing (as these claimants will likely not be barred by the sale order from asserting successor liability claims).
- Consider placing conditions related to the notice to claimants on any purchase offers for the sale of assets under Bankruptcy Code section 363. To the extent that the prospective purchaser proceeds with an offer of purchase under Bankruptcy Code section 363, the prospective purchaser may want to condition its offer on the debtor providing all currently known tort claimants actual notice of not only the motion for sale of the assets under section 363 but also the proposed sale order on the motion expressly containing the “free and clear” language.
- Ask the seller whether there is any government regulation that requires the debtor to keep a record of the first purchasers (i.e., consumers) of the products at issue. If so, the prospective bankruptcy asset purchaser should consider whether to discount its purchase price to the extent that these known original purchasers did not receive actual notice of the bankruptcy filing (and thus will not, as a matter of course, be receiving a copy of the motion for the sale of assets under section 363 and proposed sale order containing the express “free and clear” language).
Manish Borde is a partner with Borde Law PLLC in Seattle, Washington.
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