One of the most significant benefits of acquiring assets out of a bankruptcy estate is the ability to obtain those assets free and clear of liens, claims, interests and encumbrances, pursuant to § 363 of the Bankruptcy Code and the terms of a bankruptcy court sale order. In certain circuits, including the Second Circuit, the term “interests” includes not only in rem interests, but in personam interests as well, such as successor liability claims. The GM case does not challenge the underlying notion in the Second Circuit that § 363 sales can be authorized free and clear of successor liability claims; rather, the GM litigation on successor liability presents the issue of the extent to which a sale order can be enforced against parties who did not receive direct “actual” notice of the sale. The appeal arises as a result of the Decision on Motion to Enforce Sale Order entered by Judge Gerber in the GM case on April 15, 2015 (the “bankruptcy court decision” or BCD). The BCD is now on appeal and has been briefed in the Second Circuit, with oral argument having been conducted on March 15, 2016.
The BCD concerns the rights of two general groups of claimants that were allegedly harmed by a failure of GM to provide them with actual notice of certain critical deadlines in the GM case, including (a) notice of the expedited § 363 sale in the GM case and (b) notice of the proof of claim bar date.
The first, and more publicized, group of plaintiffs was the so-called economic-loss plaintiffs. These claimants asserted economic-loss claims against New GM as well as claims against Old GM, based primarily on the conduct of Old GM. As the media reports made the general public aware, certain personnel at GM knew of an ignition switch defect before the company filed for bankruptcy — some as early as 2003 (a fact GM disputes on appeal). The second group of claimants was the so-called pre-closing accident plaintiffs (those plaintiffs who had actual accidents involving the ignition switch defect that took place before the § 363 sale, but that had not put GM on notice of a claim). These two groups of creditors were not provided with “actual” notice of either the § 363 sale or the proof-of-claim bar date.
The failure of these two groups of creditors to receive actual notice of these events raised a host of issues, including whether, having not received actual notice of these deadlines, (a) their claims against New GM were barred by the sale order and (b) they were entitled to file late claims and participate in a distribution of assets held by the general unsecured creditors’ trust (GUC Trust) established in the bankruptcy case of Old GM.
What makes this situation interesting is that it forces the court to balance the competing interests of two seemingly innocent groups: the class action plaintiffs that did not receive actual direct notice, and New GM, which purchased the assets free and clear of any successor liability claims and, allegedly, did not have any knowledge of the claims at issue (although questions have been raised as to when New GM actually knew about these defects and whether its conduct in reacting to what it did know creates independent liability to these plaintiffs for New GM). As between these two parties, the bankruptcy court nominally came out in favor of the class action plaintiffs, but only to the extent they could demonstrate prejudice, which, for the most part in GM, they plaintiffs did not do, except with respect to one narrow category (the scope of which is being tested in the courts). The BCD essentially concluded that, with 850 objections and opposition by the attorneys general from 44 states, virtually all of the arguments the plaintiffs would have made at the time were argued by other similarly situated parties and overruled. As to the ability of the class action plaintiffs to assert claims against the GUC Trust in the bankruptcy case of Old GM, the BCD concluded that such claims were barred by the doctrine of equitable mootness, since 89 percent of distributions had been made, the plaintiffs failed to seek a stay of further distributions, and allowing the late claims would defeat the expectations of the creditor class as the time the plan was confirmed. Thus, on the whole, it can fairly be said that the plaintiffs did not fare well in the bankruptcy court, and the Second Circuit reportedly expressed skepticism as to this result at oral argument.
The outcome in the Second Circuit is very difficult to predict because the issues presented are primarily issues of law, as to which a de novo standard of review applies. Whether a showing of prejudice is required to establish a due process violation in the sale context is a critical legal issue, as is defining the standard of what a “known” creditor entitled to actual notice is. Among other things, the appellants are asserting that the failure to receive notice and the inability to participate in the process is prejudice (essentially, prejudice per se). If the Second Circuit agrees with the appellants, it will increase the risk and consequences flowing from the lack of proper notice. Even if the decision is affirmed on appeal, the GM case highlights the importance of notice on the ability to enforce sale orders, as well as the need for purchasers from a bankruptcy estate to carefully scrutinize the process to ensure the best possible service, as such purchasers could have adverse consequences from the seller’s notice deficiencies. In the GM case, 850 objections were filed to the sale, but in most cases purchasers will not typically have that type of “safety net”; creditors who did not receive notice may often make new arguments that were not raised by any creditor at a sale hearing. As to the one argument the class action plaintiffs identified that the other objecting parties did not make – that claims against New GM based solely on conduct of New GM post-closing should not be barred – Judge Gerber found that prejudice existed, and such claims were allowed to proceed against New GM.
Regardless of the outcome in the Second Circuit, there are certainly some lessons to be learned, some teaching points resulting from the GM case, and some lingering questions (some of which may be answered by the Second Circuit):
- Notice matters, particularly to the buyer. If you are representing a purchaser of assets, you always want to make sure the debtor provides the best possible notice to all potential claimants. It is the debtor’s duty to provide proper notice, but the ramifications of defective or insufficient notice fall upon the purchaser, and the purchaser wants the best protection possible.
- The GM case was unique because there was considerable public interest, and many parties argued positions that claimants not receiving notice would have argued. As such, the “no harm/no foul” rule applied. In a smaller case, if the interests of the claimants without notice are not represented or argued, there is a greater risk of prejudice. As noted by the court in GM, concerns of due process generally trump the interest of finality in sale orders, and courts will likely try to find a remedy.
- Although the GM and Chrysler (and TWA) cases represent the liberal side of the law, not all courts allow a sale free and clear of in personam successor liability claims.
- It is important to act promptly in order to preserve rights. Plaintiffs may lose this case with respect to their right to claims against the debtor’s estate because they failed to act promptly to seek a stay of distributions.
- There are lingering questions of when it is necessary to provide actual notice and when “constructive” publication is sufficient. Who, precisely, are “known” and “unknown” creditors? It’s not always easy to distinguish between these two groups, and notice to tens of millions of creditors is not always easy to accomplish. Perhaps one safe rule of thumb, however, is that if the law requires other notices to be sent to a party regarding a specific issue or potential claim (e.g., motor vehicle recall notices), most likely these are “known” creditors who should be given actual (as opposed to constructive) notice.
- Even if prejudice is required for a due process violation, what finding is necessary to show prejudice? Delay? Lack of equal treatment with other creditors?
- Even if there is a due process violation and prejudice, it is hard to know what remedy is appropriate. Most agree that aggrieved unsecured creditors should not fare worse than other creditors, but why should they do better (and perhaps significantly better) by being able to act as if the sale order had never been entered and be permitted to go after New GM?