A New York Federal Court refused recently to dismiss a successor liability lawsuit brought against the purchaser of assets for a claim based on pre-bankruptcy actions of the seller of those assets. In doing so, the court reiterated a rule that, in the wake of the GM and Chrysler bankruptcies, may have been forgotten: absent appropriate notice, a creditor or potential creditor cannot be deemed to have lost or waived its claim against the debtor or its assets, even if a purchaser now owns the assets.
In re Grumman Olson Industries, Inc., the U.S. District Court for the Southern District of New York affirmed a bankruptcy court’s ruling that a bankruptcy court sale order cannot extinguish state law tort claims, based on the debtor’s prepetition conduct, if no injury was caused until after the bankruptcy closed. The district court held that enforcing the “free and clear” provisions of the sale order on claimants who did not receive, and could not have received, notice or an opportunity to participate in the bankruptcy proceedings would violate bankruptcy procedure and due process.
The facts of Grumman
In December 2002, Grumman Olson (“Grumman”) filed for chapter 11 bankruptcy protection. Grumman manufactured and sold truck chassis to various companies, including FedEx. In July 2003, Morgan Olson (“Morgan”) purchased certain of the Grumman assets through a bankruptcy court authorized sale – a so-called 363 sale. Six years after the sale, in October 2009, Denise and John Frederico (the “Fredericos”) sued Morgan for injuries that Mrs. Frederico sustained in October 2008, when the FedEx truck she was driving struck a telephone pole. Morgan filed an adversary proceeding in the bankruptcy court seeking declaratory and injunctive relief barring the Fredericos from bringing their claim. Morgan argued that the claim was barred by the language in the bankruptcy court’s sale order, which provided (as all such orders do) that Morgan acquired assets “free and clear” of all claims against Grumman. Each side moved for summary judgment. The bankruptcy court held that the Fredericos were entitled to pursue their claim, and Morgan appealed.
Narrow issues on appeal
Although the court reviewed many facets relating to the intersection of state law and bankruptcy law, it refocused the opinion on several occasions, back to the narrow issue before it: whether or not a 363 “free and clear” sale order can extinguish a claim against a purchaser, based on the debtor’s pre-bankruptcy conduct that caused no harm to an identifiable claimant until after the bankruptcy closed.1
Section 363(f) of the Bankruptcy Code
Generally, section 363(f) of the Bankruptcy Code authorizes bankruptcy courts to grant relief absolving purchasers from successor liability. The Bankruptcy Code provides, in relevant part, “[t]he trustee may sell property…free and clear of any interest in such property of an entity other than the estate….” For companies that purchase assets through 363 sales, 363(f) is vital to the sale because it provides the purchaser with the peace of mind that it cannot be sued for any of the debtor’s pre-bankruptcy actions or missteps.
Purposes of 363(f)
Section 363(f) serves two important purposes. First, it prevents unsecured tort claimants from gaining priority over other creditors. Permitting tort claimants to sue purchasers, rather than pursuing their claims against the bankrupt estate, could result in payments to those unsecured tort claimants greater than payments to other creditors in the bankruptcy. Prohibiting unsecured tort claimants from suing 363 purchasers funnels all claims toward the estate, rather than the purchaser, and ensures fair and equal distribution among all creditors. Second, section 363(f) maximizes the value of the assets sold for the benefit of the estate and its creditors. If, at the time of the 363 sale, purchasers remained vulnerable to the possibility of future lawsuits based on the debtor’s pre-bankruptcy conduct, purchasers would have less incentive to offer full value for the assets knowing they could be held liable for the debtor’s prior actions.
The Grumman decision
Confronted with the issue of whether or not a section 363 sale order could prohibit a claimant from asserting a claim against a buyer for an injury that occurred after the sale and after the bankruptcy case closed, the Grumman court looked to the definition of a “claim.” The Bankruptcy Code provides for a broad definition of a claim: a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” 11 U.S.C. 101 (5)(A). The issue for the court was whether a “future” claim – i.e., a claim that did not exist at the time of the sale – could fit within the Bankruptcy Code’s definition. The court looked to prior cases and concluded that the claimant and the debtor needed to have a “pre-confirmation relationship…before the claimant could have its claim dealt with in the bankruptcy.”
The court then tied the scope of claims that could be cut off by a section 363 sale order to the notice provided to such claimants. According to the court, a claimant cannot be bound by an order in a proceeding about which it had no notice. While courts are often willing to allow for general notice, such as newspaper notices, parties holding future claims cannot be identified and may not even know they might one day have claims. As a result, their claims cannot be cut off. Applying its reasoning to the facts before it, the Grumman court concluded that the order approving the sale of Grumman’s assets to Morgan could not have cut off the claim of the Fredericos because the Fredericos did not have notice of the bankruptcy or the sale. They did not have notice, of course, because neither they nor Grumman could have known that they would one day have a claim.
Important take aways
The court emphasized that it was not addressing the Fredericos’ ultimate success on the issue; rather, it addressed only whether or not the sale order prevents the Fredericos from bringing the lawsuit in the first place. It concluded that the sale order did not. Just as other courts have held, the Grumman court reminds us that it is paramount to preserve due process and protect the rights of future claimants who did not receive notice of the bankruptcy sale. In the wake of this decision, prospective 363 asset purchasers should be extra mindful of the results and possible repercussions of purchasing assets out of bankruptcy; doing so enables purchasers to evaluate their risks accordingly.
1 The court assumed for purposes of its analysis that the Fredericos could establish their successor liability claim under state law.
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