Daniel Halperin – Section 363(f) of the bankruptcy code is an innovative tool that allows a debtor-in-possession to sell its assets free and clear of “any interests in such property.” Many companies, including General Motors (“GM”), can attribute their post-bankruptcy success to Section 363. The free and clear sale creates a shield from product liability against an asset purchaser provided there is sufficient notice and hearing of the sale. In turn, a debtor-in-possession can use the sale’s proceeds in order to maximize pro-rata distributions to unsecured creditors.
Despite these notice requirements, the question remains: what happens to a free and clear sale if a debtor-in-possession fails to provide sufficient notice? The Second Circuit recently addressed this issue in the case In re Motors Liquidation, where GM sold its assets free and clear to a newly created entity (“New GM”) without providing actual notice to known creditors. GM and its corresponding officers were aware of a widespread key ignition-defect in its product line, which resulted in substantial harm. Armed with this knowledge, GM opted not to disclose the defect in order to ensure the confirmation of the bankruptcy sale. However, following the sale’s consummation, the public became aware of the defect, and New GM issued several recalls. Dozens of class actions alleging between seven and ten billion dollars in economic losses followed.
Prior to the Second Circuit’s decision, the Bankruptcy Court believed that while GM’s actions were truly deplorable, the key-ignition claimants would not have made a material difference to the outcome of the proceeding—no harm, no foul. The bankruptcy court would still have confirmed the plan, and the sale order’s injunction would have barred the plaintiffs’ claims. Thus, GM should not be subject to successor liability.
The Second Circuit, however, ruled that the injunction was unenforceable against the plaintiff class. “[I]f [the court] cannot say, with fair assurance, after pondering all that happened without stripping the erroneous action from the whole, that the judgment was not substantially swayed by the error, then it must find a procedural due process violation.” Groman v. General Motors LLC, (In Matter of Motors Liquidation Co.), 829 F.3d 135, 163 (2d Cir. 2016) (citing Kotteakos v. United States, 328 U.S. 750, 765 (1946)). The Second Circuit was not “confident in the reliability of prior proceeding [because] there [was] . . . a procedural defect.” Motors Liquidation Co., 829 F.3d at 162 (citing Lane Hollow Coal Co. v. Dir., Office of Workers’ Comp. Programs, 137 F.3d 799, 808 (4th Cir. 1998)). The Court essentially took a firm stance with respect to notice in free and clear sales—no notice, no finality. Thus, despite that New GM negotiated and subsequently paid a premium for an injunction, the entity would still be subject to successor liability.
While New GM is now subject to billions of dollars in successor claims, the potential effect of the Second Circuit’s holding reaches far beyond the confines of GM’s bankruptcy. Purchasers may be unwilling to pay a substantial premium for assets in a free and clear sale amidst the uncertainty regarding whether a debtor-in-possession complied with the notice requirements. At a minimum, asset purchasers will likely exhaust considerable resources in order to conduct their own due diligence. In both instances, the ultimate result is a proportional reduction in pro-rata distributions by the asset-purchaser’s corresponding expenditures. Thus, the real losers are likely unsecured creditors.
