Successor Liability in Section 363 Sales

The bankruptcy court's power to sell assets free and clear of successor liability claims has received a major boost
from the U.S. Court of Appeals for the Third Circuit. In United States v. Knox-Schillinger (In re Trans World
Airlines Inc.),¹ the Third Circuit joined the Fourth Circuit² in holding that a debtor-in-possession (DIP) can sell its
assets free and clear of successor liability claims when selling assets as an ongoing business under Bankruptcy Code
§363(f). That section provides that the trustee can sell assets free and clear of "any interest in such property," so
long as the holder of the interest could be compelled to take a money satisfaction.³

The Third Circuit held that successor liability claims are interests in property within the meaning of §363(f) and
that the claims were of the type that can be satisfied by monetary payment. However, although the claims were of
the type that could be satisfied by monetary payment, they remained general unsecured claims with no priority
claim to the sale proceeds. The Third Circuit determined that the phrase "any interest in such property" should be
broadly construed to include interests that could otherwise travel with the property being sold even if the asserted
interest is a general unsecured claim.

Thereafter, the Seventh Circuit cited Knox-Schillinger with approval for the proposition that the term "any
interest in such property" should be given an expansive definition.⁴ Perhaps this signals that Knox-Schillinger will
overcome the Seventh Circuit's earlier doubts as to whether the term "any interest in such property" would include
unsecured claims, such as successor-liability claims.⁵ And perhaps Knox-Schillinger will be persuasive to the First
Circuit, which, noting the Seventh Circuit's earlier doubts, declined to express an opinion as to whether successor
claims would be included as "any interest in such property."⁶

Allowing sales free and clear of successor liability under §363(f) is important because that section is
resorted to by most debtors who sell their ongoing businesses. Most debtors who need to sell their businesses are
unable to keep their businesses going for the often lengthy periods required for reorganization plans or liquidation to
be developed, negotiated and confirmed. While the bankruptcy court's power to sell assets free and clear of successor
claims may be clearer when the sale is pursuant to a plan,⁷ that power is practically unavailing in most cases
because of most debtors' need to sell quickly.

Types of Successor Liability Claims

There are two major categories of claims for which successor liability can be imposed on buyers. First are
employee-related claims arising from federal statutes providing protection to employees and which are imposed on
successors pursuant to federal common law.⁸ The other category are product liability claims that generally arise
under state law and are imposed on successors pursuant to state law.⁹

There is a substantial similarity in one aspect of the tests that must be met in both categories—that the
buyer must carry on substantially the same business as the seller. There are also similarities in the policy
considerations that underlie successor liability in both categories. These similarities are that the claimant should be
neither better nor worse off by the sale of the businesses. Thus, if the seller is failing financially, caution should be
exercised in imposing successor liability against a purchaser, who may be driven away by the prospect of such
liability.¹⁰ The judicial determination to impose successor liability is to be made after considering the facts of each
case in light of the justifications for imposing successor liability.¹¹

But there is at least one substantial difference, from a bankruptcy point of view, in the two categories of
successor liability: Successor liability can be imposed with respect to federal employment claims only if the buyer
has notice of the claims.¹² Product liability claims, in contrast, can suddenly and seemingly randomly occur after
the sale of assets to the successor. Thus, bankruptcy sales under §363(f) free and clear of product-liability claims
raise issues not raised by federal employment claims regarding whether claims, arising after the bankruptcy case is
over, can be dealt with by an order selling assets free and clear of successor liability claims.

Federal Statutory Claims

In U.S. v. Knox-Schillinger (In re Trans World Airlines Inc.),¹³ the successor liability issue was with
respect to employee claims based on federal statutes. The issue arose in the context of Trans World Airlines' sale of
assets as a going business to American Airlines. A condition of the sale was that the claim would be free of the
claims of certain of Trans World Airlines' flight attendants for sex and age discrimination in violation of Title VII
of the Civil Rights Act of 1964 and of the Age Discrimination in Employment Act.

The bankruptcy court ordered that the sale would be free and clear of successor-liability claims. The
bankruptcy court determined that Trans World Airlines's business was on the verge of collapse, that American
Airlines's offer to purchase was the only viable offer, and that American Airlines would not purchase unless the sale
was free and clear of the successor claims.¹⁴ The district court affirmed, noting that if the sale did not go forward,
TWA would be liquidated, and the flight attendants appealing the sale order, as well as a large number of other
employees, among many others, would thereby be harmed.

On appeal, the Third Circuit presumed that the claims were claims for which American Airlines would be
liable as a successor to Trans World Airlines. In determining that such claims were "interests in such property"
within the meaning of §363(f) and therefore subject to divestment in connection with a sale of assets free and clear
of liens and interests, the Third Circuit adopted the Fourth Circuit's reasoning in United Mine Workers of America
1992 Benefit Plan v. Leckie Smokeless Coal Co. (In re Leckie Smokeless Coal Co.).¹⁵ In that case, the Fourth
Circuit, affirming a sale of coal-mining assets free and clear of successor liability for premiums due by the debtor to
employee benefit plans under federal legislation, analyzed the text of §363(f)(3) and determined that all general
unsecured claims were not "interests," but that on the other hand, "interests" were not limited to in rem interests.¹⁶

Notice Requirement

There was no issue in Knox-Schillinger as to the adequacy of the notice provided to the successor liability
claimants of the proposed §363(f) sale free and clear of their successor liability claims. The claimants were
apparently identifiable, and in any event, issues as to the adequacy of notice usually arise after the sale free and clear
of successor liability claims, when the purchaser seeks to have the bankruptcy court enjoin a claimant from suing
the purchaser to establish successor liability.

The failure to provide an identifiable holder of a successor liability claim with adequate notice of the
bankruptcy in which a sale purports to be free and clear of successor liability claims renders the sale subject to that
successor liability claim. The lack of notice is a defect of constitutional dimensions.¹⁷ There is less of a bright line
with respect to what constitutes adequate notice where the claimant is unidentifiable. Where the claimant is
identified, service by mail might be required, but where the class of claimants is large or the claimants are
unknown, notice by publication in print or broadcast media might be sufficient.¹⁸

Product-liability Claims

With respect to product-liability claims, many states have adopted the product-line exception to the general
rule that a purchaser is not liable for any seller's obligations that the purchaser did not assume. This exception
allows persons injured by a product manufactured by the seller to assert the product-liability claim against the
purchaser where the purchaser acquires the seller's manufacturing assets and undertakes essentially the same
manufacturing operation as the selling corporation. The justifications offered for imposing successor liability in
such cases are (1) the virtual destruction of the claimant's remedies against the seller because of the sale, (2) the
purchaser's ability to spread the risk and (3) the fairness of requiring the successor to assume responsibility for
defective products as a quid pro quo for enjoying the predecessor's good will.¹⁹

Thus, unlike successor liability for federal employment claims, where the buyer must have notice of the
claims in order to be liable as a successor, the paradigm for successor liability for product-liability claims is when
the injury occurs after the sale and after the assets of the selling corporation have been distributed. This structure is
illustrated by the seminal case addressing a product-liability action brought against the purchaser of a business
where the purchaser continued manufacturing and selling the same product that injured the plaintiff under the same
name and where the seller has paid all known debts and distributed the remaining money to shareholders before the
plaintiff was injured by the product manufactured by the seller.²⁰

In the bankruptcy context, it may be that a sudden, unpredictable injury occurs after confirmation of a plan
or, if no plan is confirmed, after distribution of the funds of the estate. In that situation, the product-liability claim
is not a bankruptcy "claim" within the meaning of Bankruptcy Code §101(5), but rather it is what may be called a
"future claim," even if the injury is caused by a product that was manufactured pre-petition. Such future claims are
not discharged in the bankruptcy, and a sale of debtor's assets under the Bankruptcy Code, whether under §363(f)
or a plan, cannot divest the right of holders of future claims to assert their claims against purchasers of debtors'
assets.²¹ Although the U.S. Bankruptcy Court for the Western District of Texas suggested, in dicta, that the
appointment of a legal representative for "future claims" could bind them to the treatment provided for them in a
plan,²² the Eleventh Circuit undercut that suggestion by affirming the disallowance of future claims filed by such a
legal representative.²³

However, there is precedent for holding that successor liability may be precluded with respect to a sudden
injury occurring after a sale under §363(f) but before confirmation of a plan, where the claim can be dealt with under
the plan. In such a case, even though the injury occurred post-petition, the claim may be regarded as a pre-petition
claim because it was caused by a defective product manufactured and sold pre-petition.²⁴ Furthermore, where the
claimant fails to receive timely notice of the time for filing claims and fails to assert the right to file a late claim
that if allowed would have afforded a substantial distribution, the claimant will be precluded from seeking to
enforce the claim against the successor.²⁵ Indeed, even if the plan provided no special distribution for claimants
who have notice of the bankruptcy and an opportunity to file a claim, the claimants may be prohibited from
pursuing actions against the successor by virtue of the mere opportunity to file a claim.²⁶ Thus, it has been held
that a product-liability claim that arose suddenly after a sale free and clear of successor claims pursuant to §363(f),
and before the closure of the bankruptcy estate, precludes the claimant from asserting successor liability even though
there will be no distribution from the estate to unsecured creditors, where the claimant cannot show that he was
prejudiced by lack of notice of the sale.²⁷ The prejudice must be established by showing that the bankruptcy court
would have been dissuaded from approving the sale because the sale price was not fair enough.28

Footnotes

¹ 322 F.3d 283 (3d Cir. 2003). Return to article

² United Mine Workers of America 1992 Benefit Plan v. Leckie Smokeless Coal Co. (In re Leckie Smokeless
Coal Co.), 99 F.3d 573 (4th Cir. 1996). Return to article

³ 11 U.S.C. §363(f) (2000) provides, "The trustee may sell property under subsection (b) or (c) of this
section free and clear of any interest in such property of an entity other than an estate only if...(3) such interest is a
lien and the price at which such property is to be sold is greater than the aggregate value of all such liens on such
property...or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of
such interest." Return to article

⁴ Precision Industries Inc. v. Qualitech Steel SBQ LLC, 327 F.3d. 537, 545 (7th Cir. 2003) (holding that a
sale free and clear of liens would divest the possessory interest of a real estate tenant whose lease was rejected and
who elected to remain in possession as provided in 11 U.S.C. §365(h) (2000)). Return to article

⁵ See Zerand-Bernal Group Inc., 23 F.3d 159 (7th Cir. 1996) (citing with approval, in dicta, the discussion
in Mooney Aircraft Inc. v. Foster (In re Mooney Aircraft Inc.), 730 F.2d 367 (5th Cir. 1984), to the effect that
unsecured claims were not interests in property under the Bankruptcy Act). Return to article

⁶ See Western Auto Supply Co. v. Savage Arms (In re Savage Industries Inc.), 43 F.3d 714, 723 (1st Cir.
1994) (Cyr, C.J.) (cting Zerand-Bernal as generally contrary to the notion that §363 enables the extinguishment of
state-law based successor product-line liability claims). Return to article

⁷ 11 U.S.C. §1141 (2000) (providing that property dealt with by a reorganization plan can be "free and clear
of all claims and interests of creditors); see, also, Piper Aircraft Corp. v. Calabro (In re Piper Aircraft Corp.), 169
B.R. 766, 779 (Bankr. S.D. Fla. 1994) (stating, in dicta, that a product liability claimant would be bound by a plan
treating the claim and prohibiting the claimant from asserting successor liability against a purchaser that purchased
the debtor's manufacturing assets pursuant to the plan); Volvo White Truck Corp. v. Chambersburg Beverage Inc.
(In re White Motor Credit Corp.), 75 B.R. 944, 950-51 (stating that 11 U.S.C. §1141(c) (2000) can preempt
successor liability claims against purchaser of debtor's manufacturing assets). Return to article

P>⁸ See, generally, Steinbach v. Hubbard, 51 F.3d 843 (9th Cir. 1995) (collecting federal cases extending
successor liability to almost every federal employment law statute in order to vindicate important statutory policies
favoring employee protection). Return to article

⁹ See Ray v. Alad Corp., 560 P.2d 3 (Cal. 1977) (seminal case imposing successor liability for product
liability); see, also, generally Conway v. White Trucks, a Division of White Motor Corp., 885 F.2d 90 (3d Cir.
1989) (describing development and parameters of successor liability in product liability cases) (cited with approval
in Western Auto Supply Co. v. Savage Arms (In re Savage Industries Inc.), 43 F.3d 714, 717 n.4, 720 (1st Cir.
1994) (Cyr, C.J.)). Return to article

¹⁰ See Chicago Truck Drivers, Helpers and Warehouse Workers Union (Independent) Fund v. Tasemkin Inc.,
59 F.3d 48, 51 (7th Cir. 1995) (quoting Musikiwamba v. ESSI Inc., 760 F.2d 740 (7th Cir. 1985) and citing with approval Steinbach v. Hubbard, 51 F.3d 843 (9th Cir. 1995)). Return to article

¹¹ See Conway v. White Trucks, a Division of White Motor Corp., 885 F.2d. 90 (3d Cir. 1989)
(product-liability claim); Musikiwamba v. ESSI Inc., 760 F.2d. 740 (7th Cir. 1985) (federal employment
discrimination claim). Return to article

¹² See Tasemkin, 59 F.3d at 49 (district court erred in dismissing complaint by pension fund against
purchaser for recovery of delinquent payment and ERISA withdrawal liability). Return to article

¹³ 322 F.3d 283 (3d Cir. 2003). Return to article

¹⁴ In re Trans World Airlines, No. 01-0056 2001, 2001 WL 1820325 (Bankr. D. Del. March 27, 2001)
(Walsh, B.J.) (discussing merits in connection with denial of stay pending appeal of order for sale free and clear of
successor claims). Return to article

¹⁵ 99 F.3d 573 (4th Cir. 1996) (affirming bankruptcy court's power to sell coal-mining assets free and clear of
claims of employee benefit plans, established pursuant to the federal Coal Industry Retiree Health Benefit Act of
1992, for premiums due from debtor-seller for health and death benefits for coal miners). Return to article

¹⁶ See Id. at 582. Return to article

¹⁷ See Western Auto Supply Co. v. Savage Arms (In re Savage Industries Inc.), 43 F.3d 714 (1st Cir. 1994) (Cyr, C.J.). Return to article

¹⁸ See Western Auto Supply, 43 F.3d at 720-22. Return to article

¹⁹ See, generally, Conway v. White Trucks, a Division of White Motor Corp., 885 F.2d 90 (3d Cir. 1989)

(describing the development and parameters of successor liability in product-liability cases) (cited with approval, Western Auto Supply Co. v. Savage Arms Inc. (In re Savage Industries Inc.), 43 F.3d 714, 717 n.4, 720 (1st Cir.
1994) (Cyr. C.J.)). Return to article

²⁰ Ray v. Alad Corp., 560 P.2d. 3 (Cal. 1977). Return to article

²¹ Cf. Epstein v. Official Committee of Unsecured Creditors (In re Piper Aircraft Corp.), 58 F.3d 1573
(11th Cir. 1995) (holding that the bankruptcy court properly disallowed a claim filed by court-appointed
representative of future claimants for injuries expected to the caused by future crashes of defective airplanes
manufactured pre-petition by debtor); Lemelle v. Universal Mfg. Corp., 18 F.3d 1268 (5th Cir. 1994) (holding that
the district court erred in enjoining product-liability claim against successor, notwithstanding that the product was
manufactured pre-petition, where the sudden injury occurred years after debtor sold its manufacturing assets to
successor and confirmed a plan); Zerand-Bernal Group Inc. v. Cox, 23 F.3d 159 (7th Cir. 1994) (holding
bankruptcy court lacked jurisdiction to enjoin injured party from seeking to impose successor liability on purchaser
where the injury occurred suddenly after the sale, after confirmation of the plan, and after the estate had been fully
administered); Fairchild Aircraft Inc. v. Campbell, 184 B.R. 910 (Bankr. W.D. Tex. 1995) (holding that the
executors of persons killed in airplane crash held "future claims" that did not qualify as bankruptcy claims and that
therefore were not precluded from seeking to impose successor liability on purchaser of aircraft manufacturer's
assets, where the sale was pursuant to a plan, where the crash occurred after confirmation of the plan and where no
legal representative was appointed to represent the interests of persons who would be injured in the future); Mooney
Aircraft Inc. v. Foster (In re Mooney Aircraft Inc.), 730 F.2d 367 (5th Cir. 1984) (holding under the Bankruptcy
Act that the bankruptcy court lacked ancillary jurisdiction to enjoin executors of persons killed in airplane crash
from suing purchaser of aircraft manufacturer's assets where the crash occurred years after the sale free and clear of
claims and after the estate was closed); Schweitzer v. Consolidated Rail Corp., 758 F.2d. 936 (3d Cir. 1985)

(holding under former §77(b) of Bankruptcy Act of 1898 that FELA claims against railroad by employees who
manifested asbestosis after consummation of plan were not discharged). Return to article

²² See Fairchild Aircraft Inc., 184 B.R. at 930-31. Return to article

²³ See Epstein, 58 F.3d at 1578. Return to article

²⁴ Cf. Piper Aircraft Corp. v. Calabro (In re Piper Aircraft Corp.), 169 B.R. 766 (Bankr. S.D. Fla. 1994)
(holding that product-liability claim for personal injuries caused by defective airplane that was manufactured by
debtor pre-petition and that crashed post-petition but before the anticipated confirmation of a plan selling the
manufacturing assets was a pre-petition claim stayed by the automatic stay and stating that the claim could be dealt
with by the anticipated plan so as to preclude its assertion against the prospective purchaser); Volvo White Truck
Corp. v. Chambersberg Beverage Inc. (In re Volvo White Truck Corp.), 75 B.R. 944 (Bankr. N.D. Ohio) (enjoining
product liability claimant from asserting successor liability claim against purchaser that purchased manufacturing
assets during the chapter 11 before confirmation of a plan, where the injuries occurred after the sale of assets and
before a plan had been confirmed dealing with product liability claims); Conway v. White Trucks, a Division of
White Motor Corp, 885 F.2d 90, 94 (3d Cir. 1989) (describing the plan of White Motor Corp. as providing
insurance coverage and a special fund for product-liability claimants and holding that a person who was injured
pre-petition and notified of the bankruptcy after the bankruptcy sale and after the deadline for filing claims and who
failed to file a late proof of claim and seek to participate in the plan would be precluded from seeking to impose
successor liability on the purchaser); Zerand-Bernal Group v. Cox, 23 F.3d 159, 163 (7th Cir. 1994) (stating in
dicta that the successorship doctrine does not apply where a claimant "had a chance to obtain a legal remedy against
the predecessor, even so limited a remedy as filing a proof of claim"). Return to article

²⁵ See Conway v. White Trucks, a Division of White Motor Corp., 885 F.2d 90 (3d Cir. 1989). Return to article

²⁶ See Zerand-Bernal Group v. Cox, 23 F.3d 159, 163 (7th Cir. 1994) (stating, in dicta, that the successorship
doctrine does not apply where a claimant "had a chance to obtain a legal remedy against the predecessor, even so
limited a remedy as filing a proof of claim"). Return to article

²⁷ See Paris Manufacturing Corp. v. Ace Hardware Corp. (In re Paris Industries Corp.), 132 B.R. 504 (D.
Me. 1994). Return to article

²⁸ See Id. at 509-10. Return to article