Using Sale Orders to Block Post-Sale Claims

Under § 363 of the Bankruptcy Code, a trustee or debtor in possession may sell property “free and clear of any interest in such property of an entity other than the estate” if certain conditions are met.[1] That property may be sold “free and clear of any interest” has the effect of blocking post-sale claims against the purchaser, as “principles underlying the finality of 363 sale orders” are considered “much too important” for a court to otherwise deny full enforcement.[2]

A recent decision from the U.S. Bankruptcy Court for the Southern District of New York exemplifies how the finality of sale orders can be used to block post-sale claims against a purchaser. In Motors Liquidation Company, the bankruptcy court explained the importance of affording finality to sale orders under § 363, stating that where there is no “constitutional violation, the Court suspects that the power to deny full enforcement of a sale order (assuming that such is even possible) will rarely, if ever, be invoked.”[3] Only where there is a constitutional violation may a sale order be “modified, or selectively enforced.”[4]

Under principles of finality that surround 363 sales, successor liability is generally “cut off” and post-sale claims may not be asserted against the buyer of a debtor’s assets.[5] For example, in NE Opco, the debtors entered into an asset-purchase agreement with Cenveo, providing for Cenveo to assume certain of the debtors’ liabilities.[6] The sale order specifically provided that “all persons and entities, including employee and litigation claimants, release all liens and claims, whether arising prior to or subsequent to the commencement of the Debtors’ cases.”[7] One of NE Opco’s employees asserted “two sets of claims of employment discrimination against Cenveo.”[8] The first was for claims arising before the closing date of the sale relating to the employee’s termination, and the second for claims arising after the closing date of the sale for failure to hire.[9] In this case, the U.S. Bankruptcy Court for the District of Delaware explained that although Cenveo might have committed a wrongdoing after the court approved and entered the sale order but prior to the sale closing, the sale order barred the employee from asserting his pre-closing claims.[10] The court explained that its decision supports the policies set forth in § 363(f), including that the employee should not be able to “circumvent the priority scheme of the Bankruptcy Code by asserting successor liability claims against Cenveo while other creditors satisfy their claims against the Debtors,” and that the debtors received the highest price for its assets because the buyer “was given some comfort through the injunction language contained in the Sale Order.”[11]

In the General Motors case, the court focused on the finality of sale orders in ruling that the sale order must not be made entirely void, notwithstanding the plaintiff’s constitutional claims of lack of due process. In this case, “New GM” purchased assets of “Old GM” through a 363 sale whereby New GM agreed to assume Old GM’s liabilities for post-sale deaths, injuries and property damage.[12] After the sale, New GM announced ignition switch defects to the public, and subsequently faced more than 60 class actions for economic loss.[13] The “economic loss plaintiffs” asserted claims for an alleged reduction in the resale value of the affected cars, inconvenience and other economic losses totaling between $7 billion and $10 billion.[14] Additionally, New GM faced lawsuits from actual accident victims following the announcement, but for accidents that took place before the sale.[15] New GM moved to enforce the sale order against these “pre-closing accident plaintiffs” and against the economic loss plaintiffs.[16] However, both groups of plaintiffs argued that because Old GM failed to send out recall notices, they were not aware of the ignition switch defect, and therefore the sale order could not be enforced against them.[17]

The bankruptcy court agreed that the publication notice provided to the economic loss plaintiffs and pre-closing accident plaintiffs was insufficient.[18] Publication notice was not proper here because the owners of the cars with the defects had “known” claims with Old GM.[19] Next, the court decided whether either group was prejudiced due to lack of notice. With respect to successor liability, the court found neither to be prejudiced. However, the court did agree that the economic loss plaintiffs were prejudiced with respect to the overbreadth of the sale order, “which proscribed any claims involving vehicles and parts manufactured by Old GM, even if the claims might rely solely on wrongful conduct by New GM.”[20]

Finding that the due process violations resulted in prejudice, the court explained that although “the interest of finality is an important part of ensuring participation in bankruptcy sales, this cannot trump constitutionally mandated due process requirements.”[21] In determining the appropriate remedy, the court noted that had it not been for the fact that plaintiffs brought a constitutional claim, “the Court would decline to deny enforcement of the Sale Order,” either in whole or in part.[22] The court explained that buyers of assets in a 363 sale should be able to rely on the enforceability of 363 sale orders, and that this interest is “hugely important.”[23] With respect to the economic loss plaintiffs, the court explained that the “doctrine that would bar modification of the Sale Order under less extreme circumstances” must give way here to the constitutional concerns of due process.[24] Relying on precedent set by the Second Circuit and other lower courts, the bankruptcy court concluded that it still must not void the sale order in its entirety, but instead may excuse the economic loss plaintiffs from compliance of the sale order.[25]

Affording the sale order finality, the court stated that it “will not allow either the Economic Loss Plaintiffs ... or the Pre-Closing Sale Plaintiffs to be exempted from the Sale Order’s Free and Clear Provision barring the assertion of claims for successor liability.”[26] The economic loss plaintiffs, however, were permitted to assert claims against New GM for any cause of action arising out of New GM’s post-closing acts.[27] The court made clear that but for the due process violations, complete finality would be afforded to the sale order. Here, even with the due process violation, the court was careful not to void the sale order, but excused the prejudiced plaintiffs from compliance.