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Not Necessarily Free and Clear II: Successor Liability in General Motors

The scene is Detroit, and the time is early 2009. General Motors is in a pickle. Years of multi-billion dollar losses and mounting pension obligations have taken their toll on GM, and it is looking in to filing a chapter 11 bankruptcy as a means of becoming solvent once again. By June, the U.S. Government will approve bankruptcy proceedings (In re General Motors, 407 B.R. 463, 503-04), and the creation of a completely new entity, New GM. In doing so, New GM would take on the Old GM’s assets through a section 363 sale. The implication of a section 363 sale is that the assets would be free and clear of the liens, claims, encumbrances and interests that would otherwise reduce the company to naught. This principle ordinarily holds true, but as we see in the GM case, things can start to unravel if all the t’s are not crossed or all the i’s are not dotted. Like New GM, the purchaser of a debtor’s assets can suddenly find themselves having to fend off a swarm of claimants demanding that their claims should be satisfied by the purchaser, essentially asserting that the sale was not as “free and clear” as had been thought.

Enabled in part by the government’s purchase of $50 billion dollars’ worth of the company’s stock (50% of the total), the creation of the New GM would later be lauded as a success. The action preserved, by some estimates, 1.2 million jobs and $35 billion in tax revenue. See the Center for Automotive Research analysis here.  This at a time when government involvement in bailouts of the private sector was coming under fire, as critics perceived a government preference at work in favor of corporate interests at the expense of the ignored “little guy.”

Sounds like a good deal, right? Especially for the New GM? Ah, but not all that glitters is gold. GM’s apparent success may have involved some very expensive exceptions to the presumption of the assets being “free and clear,” and those exceptions would come to haunt the owners of New GM.

Generally, it is acceptable for a company in bankruptcy to sell some of its assets if it needs to raise capital to pay off certain debts and by doing so avoid default. But what if some of the assets thus sold were paid for by revenue the company made from selling defective merchandise? Would the interests of those harmed or potentially to be harmed by the defective merchandise transfer over to the new entity?

Fast forward in time as New GM discovers its unexpected predicament.  A number of ignition switch defects in “old GM” cars came to light. New GM asserted that these were not its assumed liability—and according to court documents one might come to the same conclusion. But was there a missed step here? Did the parties harmed or potentially harmed receive adequate notice regarding the impact to their rights that would take place upon the sale? If not, such parties could file suit and potentially upset the apple cart because their due process rights may have been violated. It was under these very circumstances that the claimants came calling on New GM. New GM was potentially going to get bit in the rear from this “successor liability.”

Under normal circumstances, a sales of assets through section 363 is meant to bring more cash into an estate in part because the purchaser takes the assets “free and clear,” leaving claims with the debtor’s estate.  And what does a company have to do in order to sell under section 363? Currently, courts are of the opinion that

“It is now generally accepted that section 363 allows such sales in chapter 11, as long as the sale proponent demonstrates a good, sound business justification for conducting the sale before confirmation (other than appeasement of the loudest creditor), that there has been adequate and reasonable notice of the sale, that the sale has been proposed in good faith, and that the purchase price is fair and reasonable.” (3 COLLIER ON BANKRUPTCY ¶ 363.02[3] (15th ed. rev. 2009))

To be able to file under section 363, and for assets to be unencumbered of their liens, claims, encumbrances and interests, one or more of five tests has to be met:

  1. Applicable non-bankruptcy law permits sale of such property free and clear of such interests;
  2. such entity consents;
  3. the interest is a lien and the price at which the property is to be sold is greater than the aggregate value of all liens on such property;
  4. the interest is in bona fide dispute; or
  5. such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

Given the lack of notice, however, New GM had to defend itself against the demands of these tort claimants. The Bankruptcy Court would ultimately rely on the above guidelines and rule that this pool of tests had been adequately satisfied, particularly the third test. The court held that tort claims were, in fact, interests in Old GM. They cited the Chrysler reorganization decision, which distinguished that interests included more than mere property ownership. “It is the transfer of Old Chrysler’s tangible and intellectual property to New Chrysler that could lead to successor liability (where applicable under state law) in the absence of the Sale Order’s liability provisions. Because appellants’ claims arose from Old Chrysler’s property, §363(f) permitted the bankruptcy court to authorize the Sale free and clear of appellants’ interest in the property.6”  ( In re Chrysler, 576 F.3d at 126) Thus, the Court confirmed GM’s sale has having gone forward free and clear.

This was undoubtedly the intent from the beginning; during GM’s initial proceedings, Judge Robert E. Gerber had said that he intended that the GM sale would go through as free and clear “to the fullest extent constitutionally permissible.” He expressed that he had concerns regarding due process for claimants in future cases.  While assets were transferred to New GM, existing liabilities and claims were transferred to what was being called the General Unsecured Creditors Trust.

Ultimately, any lack of notice to tort claimants was determined unfortunate, but moot. Had they received notice, their claims would have been transferred to the unsecured creditors’ trust anyway.  However, New GM would respond to the furor by making some concessions. A motion filed to enforce the “free and clear” releases granted by the sale included a major exception, as we learn in more recent court filings:

“New GM has committed to replacing the defective ignition switch as a result of the recall being conducted under the supervision of the National Highway Traffic Safety Administration (“NHTSA”), the government agency with jurisdiction over recalls. Instead, this Motion to Enforce involves only litigation in which the plaintiffs seek economic losses against New GM relating to an Old GM vehicle or part, including, for example, for the claimed diminution in the vehicle’s value, and for loss of use, alternative transportation, child care or lost wages for time spent in seeking prior repairs. Those types of claims were never assumed by New GM and are barred by the Court’s Sale Order and Injunction.” (See GM’s Motion to Enforce)

Businesses may take for granted that during bankruptcy proceedings their assets may be sold off free and clear. However, an acquiring company may face unforeseen consequences because of its lack of foresight, and tort victims may find themselves disadvantaged in favor of a court-sponsored reorganization effort intended to allow a new entity to move forward in the world. And as we see in the case of GM, major disputes can often be resolved in an objectively equitable fashion for all involved.

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Jon Peterson

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