In 2009, General Motors (“Old GM”) commenced an historic chapter 11 case. With federal government backing, Old GM sold the bulk of its business and assets “free and clear” of liabilities to the new entity (“New GM”) predominantly owned by the U.S. Treasury, emerging from chapter 11 in just 40 days. In the contentious aftermath, courts have continued to grapple with issues arising from the case. On July 13, 2016, a Second Circuit panel reversed in part a decision by the U.S. Bankruptcy Court for the Southern District of New York that enforced the sale order to enjoin claims against New GM over faulty ignition switches in cars manufactured by Old GM.[1]
The Second Circuit found that Old GM had knowledge of the defects prior to the bankruptcy case and could identify the claimants, and as a result, that plaintiffs (i.e., vehicle owners) were entitled, as a matter of procedural due process, to actual notice of the bankruptcy sale and an opportunity to assert their claims and participate in the sale negotiations. The Second Circuit’s decision clears the way for ignition switch defect lawsuits to proceed against New GM. In addition, it provides critical guidance for bankruptcy practitioners to understand the risks and limitations on enforceability of “free and clear” sale orders to enjoin future claims by known parties that do not receive actual notice of the sale.
Background
In June 2009, following extensive negotiations and over the objections filed by consumer organizations, state attorneys general and accident victims, the bankruptcy court approved the § 363 sale of Old GM’s assets “free and clear of all liens, claims, encumbrances, and other interests of any kind or nature whatsoever, including rights or claims based on any successor or transferee liability.”[2] Old GM noticed the proposed sale in major publications and through direct notice to “all parties … known to have asserted any lien, claim, encumbrance, or interest in or on [the assets].”[3] Old GM, as debtor-in-possession, retained most liabilities and certain assets.[4]
Ignition Switch Defect Claims
In February 2014, New GM issued recalls of cars manufactured pre-petition by Old GM due to ignition switch defects that caused some cars to suddenly shut down while in motion, and which had resulted in injuries and damage since before entry of the sale order.[5] Old GM did not provide actual notice via direct mail of the § 363 sale to any known parties in connection with the ignition switch defects.[6]
Beginning in April 2014, class action plaintiffs filed several lawsuits against New GM, seeking a total of over $10 billion for damages from ignition switch defects in cars manufactured and sold by Old GM.[7] New GM argued that the claims should be brought against Old GM because the sale order barred claims against New GM.[8]
The bankruptcy court agreed. Notwithstanding its finding that Old GM knew or should have known of the ignition switch defect claims prior to the sale because it was aware that the defects caused cars to stall as early as May 2009, and that plaintiffs were entitled to actual notice of the sale as a matter of procedural due process, the bankruptcy court held that plaintiffs were not prejudiced by the absence of actual notice because it would have approved the sale to New GM regardless of whether plaintiffs asserted claims prior to the sale.[9] The bankruptcy court certified the order, among others, for direct appeal to the Second Circuit.[10]
Second Circuit’s Decision
On appeal, the Second Circuit panel addressed, among other things, (1) whether plaintiffs asserted “claims” of the kind that could be treated in bankruptcy and enjoined in the sale order, and if so, (2) whether enforcement of the sale order to bar those claims would violate procedural due process.
First, the Second Circuit held that the sale order covered pre-closing ignition switch and economic-loss claims. Whether “claims” are “interests” that may be sold “free and clear” of liens pursuant to § 363 of the Code is determined on a case-by-case basis.[11] A claim is (1) a right to payment (2) that arose pre-petition.[12] Rights to payment that are contingent on future events are “claims” if they “result from pre-petition conduct fairly giving rise to that contingent claim.”[13] Where pre-petition conduct has not yet resulted in detectable injury, courts require some minimum “contact” or a “relationship” between the debtor and the claimant that allows for identification of the claimant.[14] In other words, successor-liability claims, like the ignition switch and economic-loss claims, can be interests that are enjoined by a § 363 sale so long as the claimant is identifiable. That requirement was met, the Second Circuit held, because plaintiffs’ claims arose pre-petition from Old GM’s production of cars with ignition defects.[15]
Second, the Second Circuit held that enforcing the sale order to enjoin pre-closing ignition switch and economic-loss claims against New GM would deprive plaintiffs of due process because they did not receive adequate notice of the sale.[16] “Adequate notice” requires actual notice through direct mail, and not merely publication notice, if the debtor “knew about the claim or, with reasonable diligence, should have known.”[17] The Second Circuit cited extensive evidence that Old GM had institutional knowledge of ignition switch defects as early as May 2009.[18] Among other things, Old GM approved installation of the ignition switches despite their failure to comply with Old GM’s own specifications and extensive complaints upon their installation. In any event, Old GM’s “reckless disregard” of its own reports and complaints was “sufficient to satisfy the requirement of knowledge.”[19] In addition, Old GM’s federally mandated records of vehicle ownership allowed GM to identify the affected owners.[20]
Next, the Second Circuit held that the claimants were prejudiced by the absence of notice[21] because the outcome of negotiations, the § 363 sale proceedings and the provisions of the sale order could have been very different if Old GM had disclosed the ignition switch defect and claimants had been able to come forward to assert claims against Old GM:
Opportunities to negotiate are difficult if not impossible to recreate. We do not know what would have happened in 2009 if counsel representing plaintiffs with billions of dollars in claims had sat across the table from Old GM, New GM, and Treasury. Our lack of confidence, however, is not imputed on plaintiffs denied notice but instead bolsters a conclusion that enforcing the Sale Order would violate procedural due process.[22]
Thus, the court held that the sale order does not bar ignition switch defect and economic-loss claims against New GM because Old GM’s failure to provide actual notice to the claimants violated their due process rights.
Conclusion
The Second Circuit did not address the merits of the plaintiffs’ successor liability claims.[23] However, the decision provides a roadmap to overcome the liability shield of “free and clear” sale orders where a debtor knew or reasonably should have known of the existence of claims and the identity of claimants, yet failed to provide direct notice of the sale. The decision may also incentivize purchasers of assets in § 363 sales to ensure that debtors disclose all known claims and provide direct notice to claimants of the sale. Purchasers wielding § 363 sale orders as a shield from successor liability are unlikely to prevail if enforcing the order would “reward debtors who conceal defects.”[24]
[1] The Second Circuit considered distinctive claims asserted by four plaintiffs’ groups. This article discusses only the treatment of claims for pre-closing (i.e., the closing of the § 363 sale) injuries and economic losses attributable to ignition switch defects.
[2] In Matter of Motors Liquidation Co., No. 15-2844-BK(L), 2016 WL 3766237, at *3-4 (2d Cir. July 13, 2016).
[3] Id.
[4] Id. at *3.
[5] Id. at *5-6.
[6] Id. at *8.
[7] Id. at *7-8.
[8] Id. at *8.
[9] Id.
[10] Id.
[11] Id. at *12. The Second Circuit rejected New GM’s assertion that it had already resolved, in In re Chrysler LLC, 576 F.3d 108 (2d Cir. 2009), that successor liability claims are saleable “interests” for purposes of Code § 363. Id. at *11.
[12] Id. (quoting Pension Ben. Guar. Corp. v. Oneida Ltd., 562 F.3d 154, 157 (2d Cir. 2009)).
[13] Id. (quoting In re Chateaugay Corp., 944 F.2d 997, 1005 (2d Cir. 1991)).
[14] Id. at *12-13.
[15] Id. at *13. In contrast, plaintiffs’ claims related to New GM’s conduct and used car purchaser claims were not claims that could be enjoined by the bankruptcy court because they were not based on Old GM’s conduct and had no pre-closing relationship to Old GM. Id. at *14.
[16] Id. at *17.
[17] Id. at *15 (quoting DPWN Holdings (USA) Inc. v. United Air Lines Inc., 747 F.3d 145, 150 (2d Cir. 2014)).
[18] Id. at *16.
[19] Id.at *16 (quoting McGinty v. State, 193 F.3d 64, 70 (2d Cir. 1999)).
[20] Id.
[21] The Second Circuit declined to resolve the question of whether plaintiffs were required to show prejudice to establish a deprivation of due process. Id. at *18.
[22] Id. at *19.
[23] Both GM and one group of plaintiffs in the last of the Bellwether trials recently filed summary judgment briefs in the Southern District of New York on the issue of successor liability. However, pending appeals of the Second Circuit’s decision may mean prolonged litigation before New GM’s liability, if any, can be finally determined.
[24] Id. at *17.