The Second Circuit handed a stinging defeat to General Motors Co. (also known as New GM) in an opinion on July 13 that countenances no excuse for failing to give actual notice to creditors of an impending sale when the company in reorganization knows the claims to exist.
It is not entirely clear from the opinion whether a purely third-party purchaser of assets “free and clear” at a bankruptcy sale will be saddled with successor liability on claims of known creditors who were not given notice of an upcoming sale. In the GM case, the auto maker essentially remained in business after the assets were sold in a Section 363 sale, thus making successor liability an easier pill to swallow.
Although the Second Circuit is allowing lawsuits against New GM based on defective ignition switches, the appeals court did not decide whether New GM in fact has successor liability.
The opinion is an important pronouncement on the due process rights of known creditors and the consequences of a lack of notice. The opinion leaves open the question of whether the lack of prejudice can turn a due process violation into harmless error.
The Second Circuit’s opinion on July 13 implies that third party-purchasers are well advised to require an escrow to cover claims of creditors who were not given notice.
The GM Bankruptcy and Quick Sale
Old GM, named General Motors Corp. before bankruptcy, was in severe financial distress and likely would have liquidated absent financial assistance from the federal government before and after its chapter 11 filing in June 2009. Within 40 days of bankruptcy, the bankruptcy court in New York approved a sale of the business as a going concern to New GM, which was initially 60% owned by the government.
The sale carved out 10% of the stock and warrants that eventually ended up in the hands of unsecured creditors when Old GM later confirmed a liquidating chapter 11 plan.
In the bankruptcy court’s 2009 sale approval order, New GM agreed to assume responsibility only for specified liabilities, including warranty claims, accidents occurring after the sale, and Lemon Law claims. Otherwise, the sale was supposedly free and clear of claims, thus broadly immunizing New GM from successor liability claims.
In early 2014 – after plan confirmation in 2011 – New GM initiated recalls of millions of vehicles. It was later discovered that Old GM had known about a defect in its ignition switches for several years before bankruptcy.
The defect caused cars and their electrical systems to shut down unexpectedly, in some cases causing accidents. With the electrical system off, air bags would not inflate, resulting sometimes in death or injury.
New GM was hit with a deluge of lawsuits following disclosure of the switch defect. New GM responded with a motion asking the bankruptcy judge to enforce the “free and clear” sale order and bar claims against it based on the switch defect.
New GM also wanted the bankruptcy court to bar plaintiffs from making claims against the trust created for unsecured creditors under the confirmed plan.
Judge Gerber’s Opinion
Now-retired Bankruptcy Judge Robert E. Gerber issued his ruling in April 2015. According to the 74-page opinion by Circuit Judge Denny Chin, Judge Gerber found that the “ignition switch claims were known to or reasonably ascertainable by Old GM” and were therefore entitled to actual notice as a matter of due process.
On an issue on which the circuit court disagreed, the bankruptcy judge decided that the plaintiffs suffered no prejudice from the lack of due process because he would have approved the sale in any event.
As a result, the bankruptcy court ruled that New GM could be liable only for its “own wrongful conduct” after the sale, such as failure to disclose the defect sooner. Judge Gerber did not decide whether New GM had any liability for its own conduct. That presumably would be a question for the class action courts.
Judge Gerber also ruled that equitable mootness would bar any claims against the creditors’ trust. He certified the case for direct appeal to the Second Circuit.
Bankruptcy Sales and Successor Liability
Whether bankruptcy sales can cut off successor liability was the first issue for Circuit Judge Chin. He agreed with other courts holding that “successor liability claims can be ‘interests’” cut off by Section 363.
Although Section 363(f) does not expressly import the definition of “claims” into the concept of “interests,” successor liability qualifies as a claim, Judge Chin said.
While requirements of due process do not cover claimants who are “completely unknown or unknowable,” Judge Chin held that a Section 363 sale can cut off successorship claims arising from pre-petition conduct, so long as the claimant is “identifiable.”
The Second Circuit on Due Process
The bankruptcy court had held that pre-closing accident claims and claims for economic loss were barred by the sale order. The appeals court reversed that holding on due process grounds.
Judge Chin said that “if a debtor does not reveal claims that it is aware of, then bankruptcy law cannot protect it.” He also said that “New GM essentially asks that we reward debtors who conceal claims against potential creditors” and observed that “the need for speed did not obviate basic constitutional principles.” Those policy statements presaged the holdings to follow.
Given that ignition switch claim holders were known creditors entitled to notice, they were therefore entitled to due process protections.
Despite the failure of due process, the bankruptcy judge had decided there was no prejudice to the plaintiffs because he would have approved the sale regardless. Although he did not decide whether prejudice must be shown to prove a denial of due process, Judge Chin reversed because there was prejudice.
Judge Chin said that “we do not know what would have happened” if plaintiffs with billions in claims were opposing sale approval while negotiating with the government and Old GM. He pointed to states’ attorneys general who objected to the sale and ended up with a concession where New GM assumed liability for Lemon Law claims.
Further, he said, “New GM was not a truly private corporation.” Since plaintiffs could petition the government for an accommodation on account of their claims, Judge Chin said the plaintiffs also might have negotiated concessions given the cost of bankruptcy and the need to complete the sale quickly.
Given prejudice, the Second Circuit reversed “the bankruptcy court’s decision insofar as it enforced the sale order to enjoin claims related to the ignition switch defect.” In other words, plaintiffs are at liberty to pursue New GM on successor liability theories.
When a case arises in the future where creditors were not given notice, an innocent purchaser seeking to avoid successor liability can distinguish the GM case on the grounds that the auto maker at the time was a government-owned entity with an endlessly deep pocket. On the other hand, GM today is privately owned, suggesting that public ownership at the time of a due process violation was not the pivotal factor for the Second Circuit.
Reversal on Other Issues
Although believing the sale order even covered claims for New GM’s own conduct, the bankruptcy court allowed the plaintiffs to pursue those theories. Judge Chin went a step further and interpreted the sale order as not even barring claims based on New GM’s own conduct.
The bankruptcy court also barred purchasers of used cars from suing New GM. The Second Circuit reversed on that ground, too, because there was “no conduct or relationship” between Old GM and used car purchasers.
Equitable Mootness
While the creditors’ trust didn’t believe it had a dog in the fight, the bankruptcy court nonetheless barred the plaintiffs from pursuing claims against the trust on the grounds of equitable mootness, at New GM’s behest. The Second Circuit reversed, holding that the bankruptcy court’s decision in that respect was an advisory opinion.
Judge Chin said that there must be an Article III case or controversy “before relief may be equitably moot.” In a footnote, he said that the court was not deciding whether the bankruptcy court – as opposed to an appellate court – can invoke equitable mootness.
Since none of the plaintiffs had taken even the first step to collect from the creditors’ trust, the circuit court held that the bankruptcy court had improperly issued an advisory opinion because there was no case or controversy. The opinion, therefore, does not say one way or the other whether equitable mootness protects the trust’s assets.