Overview
While many bankruptcy sale orders contain provisions purporting
to absolve the purchaser of "successor liability" claims
related to the purchased assets or business, a recent case from the
U.S. Bankruptcy Court for the Southern District of New York is a
reminder of the limits on the enforceability of these
provisions—especially against claimants who did not
receive notice of the sale order. In In re Grumman Olson
Industries, Inc., the bankruptcy court permitted a tort
claimant, injured by a product manufactured and sold by the debtor
pre-sale, to assert a successor liability claim against the
purchaser of the debtor's assets in a Section 363 sale, despite
language in the court's own sale order purporting to exonerate
the purchaser from such claims.1 The court also engaged
in a discussion regarding the nature of the successor liability
claim at issue that draws into question the level of comfort that
buyers may generally take from bankruptcy sale orders purporting to
protect them against successor liability claims.
Successor Liability Claims
As a general proposition, the buyer of assets does not take on
liability for claims running against the seller. The state law
doctrine of successor liability, however, is an exception to this
general rule. Under the doctrine of successor liability, a
plaintiff may be permitted to assert against an asset purchaser a
claim based on the seller's pre-sale actions. To sustain the
claim against the purchaser, a plaintiff is typically required to
satisfy three components of the claim: it must prove the merits of
the claim as if the claim were asserted against the seller, it must
demonstrate that the defendant/purchaser bought the seller's
assets related to the claim, plus it must prove one or
more additional elements rendering the purchaser's liability
appropriate.2 For example, successor liability may in
certain states be imposed on a purchaser "for injuries caused
by defective products manufactured by a predecessor if the
successor continues to manufacture the
product."3 Due in part to the requirement of
this additional element, which often consists of a conduct
requirement on the part of the purchaser, some courts and
commentators have characterized successor liability claims as
in personam claims against the defendant/purchaser, rather
than in rem interests in the transferred
property.4
Bankruptcy Code Section 363 Sales "Free and Clear" of
In Personam ClaimsIn bankruptcy sales of assets outside of a plan of
reorganization, purchasers rely on Bankruptcy Code Section 363(f),
which permits bankruptcy estate property to be sold "free and
clear of any interest in such property."5 In the
absence of a Bankruptcy Code definition of an "interest in
property," many courts have interpreted this statutory
language to include certain types of successor liability claims,
protecting asset purchasers against such claims where bankruptcy
sale orders so provide.
The characterization of successor liability claims as in
personam claims that follow the asset owner, and not as in
rem claims that follow the asset, does not itself defeat an
argument that a Section 363 sale may be "free and clear"
of successor liability claims. Indeed, there are many courts,
particularly those in the Second and Third Circuits, that have
placed in personam claims into the category of
"interests in property" that can be extinguished in sales
under Section 363, so long as such claims are "connected to,
or arise from" the assets sold.6 The general view
of these courts is that "in personam claims, including any
potential state successor or transferee liability claims . . . as
well as in rem interests, are encompassed by section
363(f)."7
In the Third Circuit's seminal decision in In re Trans
World Airlines ("TWA"), the court ruled
that certain discrimination claims of TWA's employees, as well
as claims related to a travel voucher program awarded to TWA's
flight attendants in settlement of a sex discrimination class
action, could be excluded in a Section 363 sale of TWA's
airline assets to American Airlines and instead left in the
bankruptcy estate of the debtor/seller because those claims would
not have arisen but for TWA's investment in airline assets and
commercial aviation.8 In other words, because the in
personam claims had a relationship to the use to which the
transferred TWA assets were put, they were "interests in
property," within the meaning of Section 363(f).
This logic tends to blur the line between in personam
claims and in rem claims for the purposes of "free
and clear" sales. And, indeed, there are bankruptcy policies
that support an expansion of the definition of "interests in
property" to include some in personam claims. Courts
that use the "free and clear" power of Section 363(f) to
exclude successor liability claims may believe that barring such
claims helps to maintain Bankruptcy Code priorities by preventing
unsecured claimants from proceeding against a successor entity
while leaving secured creditors with recourse only to the limited
assets of the estate.9 Additionally, a broader
"free and clear" power has been justified as maximizing
the value of estate assets, and the return to all creditors, by
encouraging purchasers who otherwise may be deterred by the risk of
being held liable for claims against the debtor.10
In re Grumman Olson
Industries: Purchaser Remains Subject to
Successor Liability Claims
Even against the background of decisions in the Second and Third
Circuits permitting sales "free and clear" of in
personam claims that have a connection to or arise from the
transferred assets, the bankruptcy court in Grumman
declined to bar a successor liability claim against a purchaser for
an injury related to a truck manufactured by the debtor prior to
the sale. In doing so, the Grumman decision highlights one
significant limitation to the "free and clear" power of
Section 363(f) and suggests another. First, Grumman
illustrates that successor liability claims of plaintiffs injured
post-Section 363 sale by the debtor's products manufactured or
sold pre-Section 363 sale—future claims that are
virtually unknowable at the time of the sale—likely
cannot be extinguished by a sale order. Second, Grumman
suggests a nuanced logic for considering successor liability claims
after a "free and clear" bankruptcy sale. Because
successor liability claims can be thought of as arising from the
post-sale conduct of the buyer, rather than from the transferred
assets, such claims may be outside the reach of "free and
clear" sale orders altogether.
In Grumman, the bankruptcy court was required to determine
the effect of its own prior order approving a sale of assets under
Section 363(f) on parties to a tort action. In July 2003, the court
approved a Section 363 sale to Morgan Olson LLC
("Morgan") of certain "Lot 2" assets of
bankruptcy debtor Grumman Olson Industries, Inc., a manufacturer
and seller of products used in the truck body industry
("Grumman"). The sale order granted in rem
relief with respect to the Lot 2 assets, stating that the sale of
assets to Morgan was to be "free and clear of all . . . claims
. . . and other interests" and enjoined claimholders from
asserting their claims against the purchased assets.11
The sale order also granted in personam relief,
purportedly freeing Morgan from liability for claims against
Grumman "arising under or related to" the transferred
assets, including claims for successor liability under
non-bankruptcy law.12
In October 2009, several years after the sale order was entered,
John and Denise Frederico commenced a personal injury action
against Morgan and others in the Superior Court of New Jersey,
alleging that Ms. Frederico, a FedEx employee, was seriously
injured in an October 2008 accident involving a FedEx truck that
Grumman manufactured, designed, and/or sold in 1994, nine years
prior to the Section 363 sale, and 14 years prior to the accident.
Their complaint alleged that Morgan was liable as a successor under
New Jersey law because it "continued the product line [of
Grumman trucks] since the purchase" and held itself out to the
public as such.13 A few months later, Morgan commenced
an adversary proceeding in the bankruptcy court, seeking a
declaration that the sale order exonerated it from any successor
liability for Ms. Frederico's injury.
On cross-motions for summary judgment, the bankruptcy court held
that the sale order did not extinguish the Fredericos'
successor liability claims against Morgan, reasoning that the
Fredericos' rights against Morgan were not "claims"
that could be extinguished in the sale order. The court noted that
while the Bankruptcy Code contains the broadest possible definition
of "claim" to ensure that all obligations of the debtor
can be dealt with in the bankruptcy case,14 there are
some limits to the term. In this instance, the court found that the
Fredericos did not hold a "claim" against the Grumman
bankruptcy estate at the time of the Section 363 sale because,
pursuant to the test laid out by the Eleventh Circuit in In re
Piper Aircraft Corp.,15 they had no relationship or
contact with Grumman prior to the Section 363 sale. This was the
case even though the basis for liability was Grumman's pre-sale
conduct in manufacturing and selling the truck. Moreover, the
Fredericos' rights could not be affected by the sale because of
lack of due process. The court noted that "[a] sale order
under [Section] 363(f) that purports to free a purchaser from the
debtor's liabilities does not bind parties in interest that did
not receive appropriate notice of the sale."16 The
Fredericos, as unidentifiable potential future creditors at the
time of the sale, did not—and, indeed, could not
have—received adequate notice of the sale. Accordingly,
the sale order did not bar the Fredericos' suit against
Morgan.17
Before considering the issue of when the Fredericos' claims
arose—which was ultimately dispositive—the
court raised the more general issue of whether the sale order could
have extinguished the successor liability claim, even if it had
arisen pre-Section 363 sale, given the particular nature of the
claim. The court acknowledged the precedent interpreting the
"free and clear" power of Section 363(f) to encompass
in rem interests, as well as certain in personam
claims. But the court found that the Fredericos' in
personam claims failed the standard set out in those
cases—the claims did not arise from or relate to the
transferred assets. Instead, the court observed that the
Fredericos' claims against Morgan were based on the post-sale
conduct of Morgan in "continu[ing] the product line [of
Grumman trucks] since the purchase," "trad[ing] upon and
benefit[ting] from the goodwill of the product line," and
"[holding] itself out to potential customers as continuing to
manufacture the same product line."18 Concluding,
the court stated: "The Sale Order did not give Morgan a free
pass on future conduct, and the suggestion that it could is
doubtful."19
Analysis
In Grumman, the bankruptcy court protected the
successor liability claims of tort victims whose injury from the
debtor's defective product occurred only post-Section 363 sale
and who therefore could not have adequately asserted and protected
their rights at the time of the sale. The court did so at the
expense of an asset purchaser who likely expected, based on the
clear language of a sale order, to have a measure of protection
against successor liability claims and who could not have known at
the time of the sale that this particular liability would
eventually arise.
Dealing with future tort claims in the bankruptcy process always
raises concerns regarding due process, but bankruptcy treatment of
the Fredericos' type of tort claims raises unique concerns. For
a different type of future tort claims—a category that
commonly includes the claims of individuals who are exposed
pre-bankruptcy to the debtor's asbestos products but who
manifest symptoms, and become identified, only
post-bankruptcy—courts have, as explained in
Grumman, been willing to address due process concerns
through "the appointment of a future claims representative to
protect their interests and the creation of a trust to pay their
claims."20
In addition, where potential plaintiffs have received adequate
notice of a sale order barring their claims and the order has
become final without the potential plaintiffs having opposed it,
those plaintiffs may be bound by the order without regard to
whether the order exceeded the boundaries of Section 363 in
providing the purchaser protections from successor liability
claims. In Travelers Indem. Co. v. Bailey, the U.S.
Supreme Court, in the context of the bankruptcy reorganization of
Johns-Manville Corporation ("Manville"), a manufacturer
and seller of asbestos products, rejected the challenge of certain
claimants to the enforceability of the bankruptcy court's 1986
orders—entered more than two decades
earlier—enjoining claims against Manville's
non-debtor insurers.21 The Supreme Court, emphasizing
the "need for finality," found that once the orders
became final and non-appealable, they were enforceable against the
parties and those in privity with them "whether or not [the
orders were] proper exercises of bankruptcy court jurisdiction and
power."22 Under the logic of Travelers, a final and
non-appealable Section 363 sale order that grants a purchaser
releases broader than what the Bankruptcy Code actually
permits—for instance, releases of
non-"claims"—may be enforceable against a
successor liability claimant that received adequate notice of the
sale.
However, for future tort claims held by claimants like the
Fredericos whose injuries have not yet occurred at the time of the
bankruptcy or Section 363 sale and who did not have a claims
representative in the bankruptcy process, there may be, as the
Piper Aircraft bankruptcy court noted, "no way to
identify [at the time of the bankruptcy] who the victims will be or
to identify any particular prepetition contact, exposure, impact,
privity or other relationship between [the debtor] and the[]
claimants that will give rise to [] future
damages."23 For these unique "practical and
constitutional" concerns,24 future tort claims in
the latter category fell outside the protective "free and
clear" power of Section 363(f) in Grumman. In
deciding whether to purchase and how much to pay for assets in a
bankruptcy "free and clear" sale, purchasers should look
past the language of the sale order and carefully consider the risk
of their successor liability for this special type of future tort
claims.
Though not central to its holding, the Grumman court's
more general discussion regarding successor liability claims should
also cause bankruptcy purchasers to question the comfort that they
can take from sale orders. Unlike the court in TWA, and
others in the Second and Third Circuits, the bankruptcy court in
Grumman declined to link the successor liability claims
with the transferred property in order to achieve the policy goals
of permitting bankruptcy sales free and clear of such
claims—i.e., maintaining Bankruptcy Code
priorities and maximizing the value of estate assets for the
benefit of creditors. Instead, the Grumman court focused
on the purchaser's post-sale conduct in evaluating the merits
of the claims—a departure from existing precedent in the
Second and Third Circuits, which focus resolutely on the
transferred assets and the sale order's protective provisions.
If successor liability claims are viewed, as they were in
Grumman, as arising from the buyer's post-sale conduct
rather than the assets transferred in the sale, the conclusion that
these in personam claims are "interests in
property" that can be extinguished under Section 363(f)
through a sale order is much more difficult. It remains to be seen
whether the Grumman court's view in this regard is
limited to tort claims for successor liability, or is the result of
the specific facts of the case or the plaintiff's artful
drafting of the claim—or if the Grumman decision
projects a broader-reaching signal that courts are re-evaluating
the nature of successor liability claims in the context of
bankruptcy "free and clear" sales.
The Bottom Line
Buyers in bankruptcy sales under Section 363(f) should be aware that there are limits to the protections that can be obtained from a "free and clear" sale order, especially in the area of state law successor liability and even more especially in the area of tort claims based on a successor liability theory. As illustrated in Grumman, a sale order may not capture and exclude all future claims. And as Grumman suggests, the specific facts or careful drafting of the claim on the plaintiff's part could convince a court to distinguish favorable precedent and limit the purchaser's protections.
Footnotes
1. Morgan Olson, LLC v. Frederico (In re Grumman
Olson Indus., Inc.), 445 B.R. 243 (Bankr. S.D.N.Y.
2011).
2. See RESTATEMENT (THIRD) OF TORTS: PRODS. LIAB. §
12 (1998).
3. Cont'l Ins. Co. v. Schneider, Inc., 582 Pa. 591,
600 (Pa. 2005) (emphasis added) (discussing the
"product-line" exception to the general rule against
successor liability).
4. See, e.g., In re Trans World Airlines, Inc., 322 F.3d
283, 290 (3d Cir. 2003); Grumman, 445 B.R. at 249; In
re Chrysler LLC, 405 B.R. 84, 111 (Bankr. S.D.N.Y. 2009);
see also George W. Kuney, Misinterpreting Bankruptcy Code
Section 363(f) and Undermining the Chapter 11 Process, 76 AM.
BANKR. L.J. 235, 257-62 (2002). The remedy for successor liability
claims may also support this characterization. Liability resulting
from a successful successor liability claim is not capped at the
value of the assets sold. See Kuney, supra note
4, at 261.
5. 11 U.S.C. § 363(f).
6. TWA, 322 F.3d at 289-90 (citing Folger Adam Sec.,
Inc. v. DeMatteis/MacGregor, JV, 209 F.3d 252, 259 (3d Cir.
2000)); see Ind. State Police Pension Trust v. Chrysler LLC (In
re Chrysler LLC), 576 F.3d 108, 126 (2d Cir. 2009),
judgment vacated, 129 S.Ct. 2275 (2009); United Mine
Workers of Am. 1992 v. Leckie Smokeless Coal Co. (In re Leckie
Smokeless Coal Co.), 99 F.3d 573, 582-83 (4th Cir. 1996);
see also In re General Motors Corp., 407 B.R. 463, 499-506
(Bankr. S.D.N.Y. 2009) (following Second Circuit's analysis in
Chrysler, which had not yet been vacated), aff'd sub nom.
Campbell v. Motors Liquidation Co. (In re Motors
Liquidation Co.), 428 B.R. 43 (S.D.N.Y. 2010); Douglas v.
Stamco, 363 Fed. Appx. 100, 102-03 (2d Cir. 2010) (relying
entirely on policy considerations, rather than analysis of the term
"interests in property," in concluding that asset sale
under Section 363(f) extinguished successor liability
claims).
7. Chrysler, 405 B.R. at 111. As a point regarding
process, the guidelines for the conduct of asset sales in effect in
the U.S. Bankruptcy Court for the Southern District of New York
state that a proposed sale order generally "should not contain
voluminous findings with respect to successor liability, or
injunctive provisions" and that a sale motion seeking findings
limiting the purchaser's successor liability must
"disclose the adequacy of the debtor's proposed notice of
such requested relief and the basis for such relief."
Adoption of Amended Guidelines for the Conduct of Asset
Sales, General Order M-383 at 10-11 (Bankr. S.D.N.Y. Nov. 18,
2009).
8. TWA, 322 F.3d at 288-90.
9. See, e.g., Stamco, 363 Fed. Appx. at 102-03; TWA, 322
F.3d at 291-93.
10. See, e.g., Stamco, 363 Fed. Appx. at 102-03; TWA, 322
F.3d at 291-93.
11. Grumman, 445 B.R. at 246.
12. Id.
13. Id. at 250.
14. See 11 U.S.C. § 101(5).
15. Epstein v. Official Comm. of Unsecured Creditors (In re
Piper Aircraft Corp.), 58 F.3d 1573 (11th Cir. 1995) (in
context of debtor's sale of assets under chapter 11 plan,
holding that future tort victims did not have "claims"
within the meaning of 11 U.S.C. § 101(5) such that their
rights could be administered in the bankruptcy).
16. Grumman, 445 B.R. at 254.
17. The Grumman court rejected Morgan's argument
based on analogy to the sale order entered by the bankruptcy court
in Chrysler, which purported to extinguish the
purchaser's liability for potential future tort claims, noting
that the Second Circuit had subsequently questioned the reach of
the bankruptcy court's authority to extinguish future claims.
Id. at 255-56; see Chrysler, 576 F.3d at
127.
18. Grumman, 445 B.R. at 250.
19. Id.
20. Id. at 251. This type of arrangement is typically
facilitated by a channeling injunction issued by the court, which,
in general, directs plaintiffs' claims to a funded trust and
bars claims against the debtor and/or related entities. See,
e.g., In re Johns-Manville Corp., 68 B.R. 618, 626 (Bankr.
S.D.N.Y. 1986); see also 11 U.S.C. § 524(g)
(codifying authority of bankruptcy court to issue channeling
injunctions in asbestos-related bankruptcy cases).
21. 129 S. Ct. 2195, 2205-07 (2009). The basis of the challenge
was that the bankruptcy court exceeded its subject matter
jurisdiction in enjoining claims against the non-debtor insurers
that were not derivative of the debtor's wrongdoing.
22. Id. at 2205, 2206.
23. In re Piper Aircraft Corp., 162 B.R. 619, 627 (Bankr.
S.D. Fla. 1994).
24. Grumman, 445 B.R. at 251.
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