Monday, April 23, 2012

Bankruptcy Sales:
Not So Free and Clear

Denise Frederico was injured October 15, 2008, when the FedEx truck she was driving hit a telephone pole, allegedly because the truck was defective.  The truck was manufactured in 1994 by Grumman Olson Industries, Inc. (“Grumman”).  In 2009, Ms. Frederico and her husband brought suit in New Jersey Superior Court and subsequently amended the complaint to assert that Morgan Olson, LLC (“Morgan”) was liable under the doctrine of product-line successor liability because Morgan continued Grumman’s product line.

In December 2002, Grumman filed a Chapter 11 bankruptcy petition and on July 1, 2003, the Bankruptcy Court entered an order, approving the sale of certain of Grumman’s assets to Morgan’s predecessor in interest (“Sale Order”).  The Sale Order, under 11 U.S.C. §363 of the Bankruptcy Code, provided that the sale was to be free and clear of all liens, claims and other interests.  The Sale Order further provided that the purchase of the assets would not subject Morgan to any liability including, without limitation, successor liability. 

After Morgan was sued by the Fredericos in state court, it commenced an adversary proceeding in the Bankruptcy Court seeking declaratory injunctive relief that the Fredericos’ claims were barred.  The Bankruptcy Court ruled against Morgan, In re Grumman Olson Industries, 445 B.R. 243 (Bankr.S.D.N.Y. 2011), holding that successor liability could attach because it was based on the post-sale conduct of Morgan in continuing the line of business.  The appeal to the United States District Court for the Southern District of New York (“District Court”) then followed.

On March 29, 2012, the District Court affirmed the Bankruptcy Court decision.  The Court took particular care to avoid ruling on a preemption issue raised by Morgan where Morgan argued that a New Jersey State case, Lefever v. KP Huvnanian Enterprises, Inc., 160 N.J. 307, 310, 734 A.2d 290 (N.J. 1999), was preempted by the Bankruptcy Code and wrongly decided.

The District Court determined that it did not need to rule on the preemption issues raised by Morgan.   Rather the Court decided that it would rule and consider the more basic question of “whether enforcement of the Sale Order in the manner advocated by Morgan is consistent with Bankruptcy Code Procedure and due process.” 

The Court first noted that, under a broad interpretation of 11 U.S.C. §363 and the Sale Order in the instant case, it could permissibly deal with tort claims.  However, as the court noted, that simply opened the door to the issue of whether it was appropriate to extinguish claims of this type. 

The Fredericos’ claims against Grumman are commonly referred to as “future claims.”  A future claim is a situation where the act of the Debtor, here the manufacturer of the truck, occurred pre-petition but the injury had not yet arisen when the bankruptcy was filed.  Noting that the Second Circuit had not ruled on this issue, the District Court reviewed case law from other circuits including the Eleventh Circuit case of Piper Aircraft, 58 F.3d, 1573 (11th Cir. 1995).  The District Court ultimately concluded future claims cannot be dealt with in the bankruptcy proceeding because even if those claims constituted “claims” as defined in the Bankruptcy Code, the claimants were not identifiable and could not receive sufficient notice to satisfy the due process requirements.  Indeed, no notice is possible for future claimants.  Therefore, since future claimants are unknown and do not receive notice, it would violate the constitutional due process requirements to deprive them of their legal rights.

The Court noted that frequently in mass tort and asbestos cases future claims have been dealt with by the appointment of a claims representative.  The court declined to rule whether or not a future claims representative would have been permissible but noted that the absence of the future claims representative or any other provisions for unrepresented future claimants denied the Fredericos due process.  While the court noted that sales free and clear of tort claims may enable the estate to maximize the value of the assets it sells, such policy is no more important than the fundamental due process rights of claimants to proper notice and opportunity to be heard.

Successor liability for a purchaser at a bankruptcy sale could have a significant impact on the price the purchasers are willing to pay.  It should, at a minimum, change the purchaser’s financial projections and also its due diligence.  It will become more important that purchasers ascertain that the Debtor in fact had insurance coverage for its prior operations or perhaps required the Debtor to purchase a “tail” insurance policy to ensure continuing coverage in the future.  The purchaser should also seek to be named as an additional insured on any such policy.

Alternatively the purchaser may need to increase its level of insurance and make sure that its existing insurance is broad enough to cover these new successor liabilities.  While this decision is not the final word on successor liability and may not bind other courts, it does highlight successor liability as an important consideration for the parties in the sale process.

Eckert Seamans Cherin & Mellott, LLC

1 comment:

  1. If this situation exists, then a buyer should consider insisting upon the formation by the seller of a trust or some similar vehicle to which those "future claims" can be channeled.