Successor Liability in Bankruptcy Asset Sales Navigating the - - PowerPoint PPT Presentation

Successor Liability in Bankruptcy Asset Sales

Navigating the Limitations on "Free and Clear" in Section 363 Sales

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Presenting a 90-Minute Encore Presentation of the Teleconference with Email Q&A George W. Shuster Jr., Partner, Wilmer Hale, Boston Meg McKenzie Feist, Associate, Choate Hall & Stewart, Boston

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Unsuccessful Successors? Limits on Bankruptcy Sales “Free and Clear”

• f Successor Liability

June 19, 2012

George W. Shuster, Jr. Meg McKenzie Feist george.shuster@wilmerhale.com mfeist@choate.com 617-526-6572 (t) 617-248-5000 (t) 212-937-7232 (t)

George Shuster is a partner in WilmerHale’s bankruptcy and financial restructuring practice group and debt finance group. Meg McKenzie Feist is an associate in Choate Hall & Stewart’s finance and restructuring group.

6

Overview

• “Free and Clear” Protections in Section 363 Sales
• Successor Liability Under Non-Bankruptcy Law
• Successor Liability & Section 363 Sales
• Recent Decisions Limiting Buyer Protections
• Beyond Bankruptcy Code Boundaries
• Practice Tips

7

“Free and Clear” Protections in Section 363 Sales

• In bankruptcy sales outside 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.”

• The level of protection that purchasers can obtain in bankruptcy “free

and clear” sales depends on the scope of the phrase “interest in property,” which is not defined by the Bankruptcy Code.

• What the phrase means, and whether it encompasses in personam claims

as well as in rem interests, has been the subject of significant debate.

• While Section 363(f) clearly provides in rem relief, cleansing transferred

assets of attendant liens, many courts, especially those in the Second and Third Circuits, have concluded that Section 363(f) also offers certain in personam relief, releasing the asset purchaser from certain claims.

8

Successor Liability Under Non-Bankruptcy Law

• General Rule: A buyer of assets does not take on liability for claims

running against the seller.

• Exception: 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.

• Required Showing: To sustain a successor liability claim, a plaintiff is

typically required to show that: (1) plaintiff has a meritorious claim against the seller; (2) defendant/purchaser bought the seller’s assets related to the claim; and (3) plaintiff has satisfied one or more additional elements rendering the purchaser’s liability appropriate.

9

Successor Liability Under Non-Bankruptcy Law

• As an example of this “additional element”, successor liability

may in some states be imposed on a purchaser “for injuries caused by defective products manufactured by a predecessor if the successor continues to manufacture the product.”  Cont’l Ins. Co. v. Schneider Inc., 582 Pa. 591 (Pa. 2005): Discusses

“product-line” exception to the general rule against successor liability.

• Because the doctrine of successor liability arguably requires

particular conduct on the part of the defendant/purchaser, successor liability claims have been characterized as in personam claims against the defendant/purchaser, rather than in rem interests in the purchased assets.

10

Successor Liability & Section 363 Sales

• As a matter of policy, consideration of whether successor liability claims

should be extinguished in a Section 363 sale involves competing goals:

• Compensating Plaintiffs’ Injuries: On one hand, parties injured by

the seller pre-sale should be able to recover damages—from the purchaser of the seller’s assets, if necessary.

• Maximizing Value for Creditors: On the other hand, a broad “free

and clear” power has been viewed by courts as:

• maximizing the value of estate assets, and the return to all

creditors, by encouraging purchasers; and

• maintaining Bankruptcy Code priorities by preventing unsecured

claimants from proceeding against a successor entity while leaving secured creditors with recourse only to the estate’s limited assets.

• These “competing” goals can sometimes overlap—sometimes potential

plaintiffs are also creditors of the bankruptcy estate.

11

Successor Liability & Section 363 Sales

• Even though successor liability claims have been characterized as in

personam, rather than in rem, many courts have placed those claims into the category of “interests in property” that can be extinguished in sales under Section 363, so long as the claims are connected to or

arise from the transferred assets.

 In re Trans World Airlines, 322 F.3d 283 (3d Cir. 2003): 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 extinguished as against the buyer in Section 363 sale of TWA’s airline assets to American Airlines because those claims would not have arisen but for TWA’s investment in airline assets and commercial aviation.

• Bankruptcy sale orders typically contain robust language purporting to

extinguish successor liability claims, even though decisions (and informal guidance from bankruptcy judges) have called into question the ability to sell free and clear of all such claims.

12

Successor Liability & Section 363 Sales

Debtor/Seller Sale Order Language

[Subject to limited exceptions,] the Purchaser’s acquisition of the Purchased Assets shall be free and clear of any “successor liability” claims or theories of any nature whatsoever, whether known or unknown and whether asserted or unasserted as of the time of Closing to the extent permitted by applicable law. The Purchaser’s business and operations shall not be deemed a continuation of the Debtors’ business or operations as a result of the acquisition of the Purchased Assets or the Transactions. Order Authorizing and Approving Free and Clear Sale, In re Nortel Networks Inc., No. 09-10138 (KG) (Bankr. D. Del. July 11, 2011) (Dkt. No. 5935). [Subject to limited exceptions,] the transfer of the Assets to Purchaser under the Purchase Agreement shall not result in (i) the Purchaser or the Assets having any liability or responsibility for any Interest against the Debtors or against an insider of the Debtors, (ii) the Purchaser or the Assets having any liability whatsoever with respect to or be required to satisfy in any manner . . . any Interest or Excluded Liability, or (iii) the Purchaser or the Assets, having any liability or responsibility to the Debtors except as is expressly set forth in the Purchase Agreement. Without limiting the effect or scope of the foregoing, as a result of the closing of the Sale Transaction, the Purchaser shall have no successor, derivative or vicarious liabilities of any kind or character . . . . Order Authorizing and Approving Free and Clear Sale, In re Blockbuster Inc.,

• No. 10-14997 (BRL) (Bankr. S.D.N.Y. April 14, 2011) (Dkt. No. 1602).

13

Recent Decisions Limiting Buyer Protections

• Facts:
• 1994: Grumman Olson manufactured, designed, and/or sold the FedEx

truck that was later involved in the subject accident.

• 2002: Grumman Olson filed for Chapter 11 bankruptcy protection.
• 2003: The bankruptcy court approved a Section 363 sale to Morgan

Olson of certain truck body manufacturing assets of Grumman Olson.

• Sale order granted in rem relief, enjoining claims against the

purchased assets. 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.

• 2008: Mrs. Federico was allegedly injured in an accident involving

the FedEx truck manufactured, designed, and/or sold by Grumman Olson. In re Grumman Olson, 445 B.R 243 (Bankr. S.D.N.Y. 2011)

14

Recent Decisions Limiting Buyer Protections

In re Grumman Olson, 445 B.R 243 (Bankr. S.D.N.Y. 2011)

15

Recent Decisions Limiting Buyer Protections

• Facts (continued):
• 2009: The Fredericos commenced a personal injury action against

Morgan in state court based on Mrs. Frederico’s alleged injury in the 2008 accident involving the FedEx truck.

• The complaint alleged that Morgan was liable as a successor

under state law because it continued the product line of Grumman trucks.

• 2010: Morgan commenced an adversary proceeding in

bankruptcy court, seeking a declaration that the sale order exonerated it from successor liability for Mrs. Frederico’s injury. In re Grumman Olson, 445 B.R 243 (Bankr. S.D.N.Y. 2011)

16

Recent Decisions Limiting Buyer Protections

• Holding: Sale order did not bar successor liability claims against buyer.
• Rationale:
• The Fredericos did not hold a “claim” against Grumman Olson

within the meaning of Bankruptcy Code Section 101(5) at the time

• f the sale because, pursuant to the Eleventh Circuit’s test in In re

Piper Aircraft, 58 F.3d 1573 (11th Cir. 1995), they had no relationship or contact with Grumman prior to the Section 363 sale.

• The Fredericos’ rights could not be affected by the sale because of

lack of due process. The Fredericos, as unidentifiable potential

future creditors at the of the sale, did not—and could not have—

received adequate notice of the sale and the release of their claims.

• In 2003, the Fredericos could not have been identified as

potential creditors because their claim arose from an event that would occur five years later.

• Even if the Fredericos could have been identified in 2003 as

potential creditors and given adequate notice of the sale, they had no basis whatsoever on which to file a claim in 2003. In re Grumman Olson, 445 B.R 243 (Bankr. S.D.N.Y. 2011)

17

Recent Decisions Limiting Buyer Protections

• Rationale (continued):
• The Fredericos’ claims were different than the claims of

individuals who are exposed pre-bankruptcy to a debtors’ asbestos products but who manifest symptoms only post-bankruptcy.

• For asbestos claimants, courts have addressed due process

concerns at the time of the bankruptcy by appointing a future claims representative to protect their interests and by creating a trust to pay their claims.

• While not central to its holding, the court focused on the

purchaser’s post-sale conduct in evaluating the Fredericos’ successor liability claims, calling into question more generally the power of Section 363 to extinguish successor liability claims.

• Bottom Line: Sale order may not capture and exclude all future claims,

especially those based on “successor liability.” In re Grumman Olson, 445 B.R 243 (Bankr. S.D.N.Y. 2011)

18

Recent Decisions Limiting Buyer Protections

• Subsequent History: Recently, the Southern District of New York

affirmed the judgment of the bankruptcy court below, holding that enforcing the sale order to enjoin the Fredericos’ state law action against the asset purchaser would deny the Fredericos due process.

• No. 11-cv-2291 (JPO), 2012 WL 1038672 (S.D.N.Y. March 29, 2012).
• Like the bankruptcy court, the district court left open the question
• f whether appointing a future claims representative in the

bankruptcy proceedings could have addressed due process concerns with respect to unknown future claimants. In re Grumman Olson, 445 B.R 243 (Bankr. S.D.N.Y. 2011)

19

Recent Decisions Limiting Buyer Protections

• Facts:
• 2000: Homeowners constructed a residence in which defective

windows manufactured by Eagle were installed. Eagle Windows, 714 S.E.2d 322 (S.C. 2011)

20

Recent Decisions Limiting Buyer Protections

• Facts (continued):
• 2002: Bankruptcy court approved a Section 363 sale to EWD of

certain assets of Eagle, which by that time had filed for bankruptcy protection.

• Sale order clearly granted in rem relief, stating that the sale

was “free and clear of all liens, claims, encumbrances, and interests.” Sale order also granted in personam relief, stating that the “transfer of the Assets to [EWD] . . . will not subject [EWD] to any liability whatsoever with respect to the

• peration of Eagle’s business before the Effective Time

based . . . on any theory of law or equity including without limitation any theory of antitrust or successor or transferee liability.” Eagle Windows, 714 S.E.2d 322 (S.C. 2011)

21

Recent Decisions Limiting Buyer Protections

• Facts (continued):
• 2006: Homeowners settled construction claims against the

contractor who installed the defective Eagle windows in the homeowners’ residence.

• Post-2006: The contractor and its insurers, standing in shoes of

the homeowners, brought a contribution action against EWD based on the theory that EWD was the successor of Eagle, who manufactured the defective windows, and was therefore responsible for paying part of the settlement.

• Lower court granted EWD’s motion to dismiss based,

among other things, on the sale order’s exclusion of state law successor liability claims purportedly under the “free and clear” power of Section 363. Eagle Windows, 714 S.E.2d 322 (S.C. 2011)

22

Recent Decisions Limiting Buyer Protections

• Holding: South Carolina Supreme Court reversed the lower court’s

dismissal of action; the sale order did not bar successor liability claims.

• Rationale:
• The court focused its analysis on the language of the sale order,

rather than the scope of the power of Section 363 to bar claims.

• First, the court concluded that the section of the order granting in

rem relief did not bar the claims. “[Because] the homeowners dealt with the contractor, not the window manufacturer, [] there was no preexisting relationship between the manufacturer and the homeowner giving rise to a claim [against the seller/manufacturer] within the meaning of the [] sale order.”

• Second, the court concluded that the section of the sale order

granting in personam relief did not bar the claims, finding that the provision barred only successor liability based on the seller’s

• conduct. EWD was not absolved of successor liability for its
• wn conduct.

Eagle Windows, 714 S.E.2d 322 (S.C. 2011)

23

Recent Decisions Limiting Buyer Protections

• Rationale (continued):
• The court noted that the contractor’s/insurer’s claims were

predicated on EWD’s post-sale conduct, and found that EWD could be held liable if the contractor/insurer could establish that EWD’s conduct met state law requirements for successor liability.

• Notes:
• The court did not fully explain why its conclusion that the

homeowners did not hold a “claim” against the seller/manufacturer at the time of the sale did not entirely dispose of the question of whether the sale order barred the claims against the purchaser.

• Additionally, the court did not fully explain why the pre-sale

installation of Eagle’s windows in the homeowners’ residence was insufficient to give rise to a “claim” against Eagle that could be extinguished in the Section 363 sale, assuming the satisfaction of due process requirements. Eagle Windows, 714 S.E.2d 322 (S.C. 2011)

24

Recent Decisions Limiting Buyer Protections

• Bottom Line:
• Eagle Windows is another example of a purchaser being exposed

to successor liability claims notwithstanding clear releases of those claims in the sale order.

• Additionally, insofar as the court interpreted the successor

liability claims as arising from the post-sale conduct of the purchaser, Eagle Windows is precedent that may support placing successor liability claims outside the scope of the “interests in property” that are subject to the “free and clear” power of Section 363(f). Eagle Windows, 714 S.E.2d 322 (S.C. 2011)

25

Beyond Bankruptcy Code Boundaries

• Recent decisions suggest that boilerplate sale order provisions

purporting to exonerate purchasers against every conceivable claim and interest could be incongruent with the scope of the “free and clear” power of Section 363.

• But the scope of that statutory power may not always be the ultimate

test for enforceability of the sale order.

26

Beyond Bankruptcy Code Boundaries

• If potential plaintiffs have received adequate notice of a sale order

barring their claims and the order has become final without them having opposed the order, those plaintiffs could be bound by the order without regard to whether the order exceeded the boundaries of Section 363, for example, in providing the purchaser with protections against all successor liability claims. 

Travelers Indem. Co. v. Bailey, 129 S. Ct. 2195 (2009): U.S. Supreme Court, in context of bankruptcy reorganization of Johns-Manville Corporation, a manufacturer of and seller of asbestos products, rejected challenge of certain claimants to enforceability of bankruptcy court’s 1986 orders enjoining claims against Manville’s non-debtor insurers. Emphasizing “need for finality,” the Court 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.”

27

Beyond Bankruptcy Code Boundaries

• On the other hand, if potential plaintiffs do not have a chance to appeal

a final sale order barring their claims, those plaintiffs may be able to argue that they were never bound by that order. 

Putnam Funds, 126 S. Ct. 2145 (2006): District court’s decision to remand cases involving certain securities claims because those claims were not precluded under the Securities Litigation Standards Act of 1998 was effectively a decision regarding the court’s own jurisdiction, and 28 U.S.C. §1447 accordingly barred review of that decision. U.S. Supreme Court noted that the parties could re-litigate the issue of preclusion in state court on remand because they were barred from appealing the district court’s preclusion decision.

28

Beyond Bankruptcy Code Boundaries

• In light of the “transaction protection” provisions of Section 363(m),

a court could find this situation to exist where a bankruptcy sale closes immediately following entry of the sale order, effectively foreclosing a potential plaintiff’s opportunity to appeal the sale order.

• Bankruptcy Code Section 363(m) provides that the reversal or

modification on appeal of an authorization of the sale or lease

• f property does not affect the validity of that sale or lease

under such authorization to an entity that purchased the property in good faith.

29

Practice Tips

• Asset Purchasers:
• In deciding whether to purchase and how much to pay for assets in a

bankruptcy “free and clear” sale, purchasers should look beyond

the sale order and carefully consider the risk of successor liability

based on the evolving precedent.

• Purchasers should continue to negotiate for broad releases in the sale
• rder, even if those releases may seem incongruent with emerging

case law limiting buyer protections under the Bankruptcy Code.

• Potential Plaintiffs:
• Potential plaintiffs should not delay in objecting to provisions in a

bankruptcy “free and clear” sale order or in appealing the entry of the order.

• As explained, failure to timely assert those challenges could result in

third-parties with notice of the sale being bound by the order, even if the order exceeds the scope of the “free and clear” power of Section 363(f).

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George W. Shuster, Jr. Meg McKenzie Feist * WilmerHale Choate Hall & Stewart george.shuster@wilmerhale.com mfeist@choate.com 617-526-6572 (t) 617-248-5000 (t) 212-937-7232 (t)

Thank You For Attending

*At the time of the replay of this webinar (originally presented on May 15, 2012), Meg McKenzie Feist is no longer affiliated with WilmerHale and is an associate with Choate Hall & Stewart in Boston, Massachusetts.