Products Liability Law Daily Sale order in GM bankruptcy does not enjoin independent or used car purchasers’ claims
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Thursday, July 14, 2016

Sale order in GM bankruptcy does not enjoin independent or used car purchasers’ claims

By Colleen Kave, J.D.

The "free and clear" provision contained in the sale order through which Old GM sold its assets to New GM serves to enjoin claims arising from accidents that occurred prior to the closing of the sale (pre-closing accident claims) and economic loss claims based on ignition switch defects and other defects; however, the provision does not cover claims stemming from New GM’s own wrongful conduct in concealing defects (independent claims) or the claims of used car purchasers, the U.S. Court of Appeals for the Second Circuit held. Additionally, the appellate court determined that the sale order could not be used to enjoin claims relating to the ignition switch defect because to do so would violate procedural due process, and it vacated the bankruptcy court’s holding that claims against the GUC Trust set up to compensate Old GM creditors were barred by the doctrine of equitable mootness as an advisory decision (In the Matter of: Motors Liquidation Co., July 13, 2016, en banc).

After GM filed for Chapter 11 bankruptcy in June 2009, the company used Bankruptcy Code Sec. 363 to sell its assets "free and clear" of Old GM’s liabilities to a new entity, New GM, and thereby avoid a protracted traditional bankruptcy reorganization. The "free and clear" provision contained in the bankruptcy court’s sale order barred all successor liability claims against New GM except for those liabilities the new entity contractually assumed. Prior to the bankruptcy court’s approval of the sale order, Old GM sent direct mail notice of the proposed sale order to numerous interested parties and posted publication notice in major publications. Despite more than 850 objections, the court approved the sale, and New GM began to operate the automaker business. Meanwhile, Old GM remained in bankruptcy, and as part of its plan to pay creditors, the company established a trust (GUC Trust) which would be used to satisfy claims.

After New GM announced in March 2014 that it would begin recalling vehicles due to ignition switch defects, a number of class actions were filed against it. New GM filed a motion to enforce the sale order, asserting that most of the claims in the various class actions were prohibited by the "free and clear" provision. The bankruptcy court decided to enforce the sale order in part and dismissed any would-be claims against the GUC Trust because relief would be equitably moot since the plan had long since been substantially consummated. The bankruptcy court also found that the plaintiffs lacked notice consistent with procedural due process because the ignition switch claims were either known to or reasonably ascertainable by Old GM prior to approval of the sale order and, therefore, the plaintiffs were entitled to actual notice, not merely publication notice. Nonetheless, the bankruptcy court found that plaintiffs, other than those whose claims stemmed from New GM’s own wrongful conduct in concealing defects, had not been prejudiced by the lack of notice and, consequently, New GM could not be sued for ignition switch claims that otherwise could have been brought against Old GM. After entering judgment against all plaintiffs, the bankruptcy court issued an order certifying the judgment for direct appeal (see Products Liability Daily’s April 16, 2015 analysis).

Scope of "free and clear" provision. In its analysis of whether the "free and clear" provision in the sale order could be used to bar successor liability claims against New GM, the appellate court asserted that successor liability claims can be "interests" pursuant to Sec. 363(b) when they flow from a debtor’s ownership of transferred assets, but they still must qualify as "claims" under Chapter 11. A bankruptcy court’s power to bar "claims" in a quick Sec. 363 sale, the court opined, is no broader than its power in a traditional Chapter 11 reorganization. A claim must arise from a right to payment that preceded the filing of the bankruptcy petition or resulted from prepetition conduct fairly giving rise to the claim. Moreover, there must be some contact or relationship between the debtor and the claimant such that the claimant is identifiable.

The appellate court asserted that the bankruptcy court assumed that the sale order’s broad language suggested that the "free and clear" provision covered pre-closing accident claims, economic loss claims arising from the ignition switch defect or other defects, independent claims relating only to New GM’s conduct, and used car purchasers’ claims; however, the appellate court determined that only the first two sets of claims were barred by the sale order. The pre-closing accident claims related directly to the ownership of the GM automaker’s business, since Old GM built cars with ignition switch defects, and the claims arose from accidents involving Old GM cars that occurred prior to GM’s bankruptcy filing. Likewise, the economic loss claims arising from the ignition switch defect or other defects also flowed from the operation of Old GM’s automaker business, and the claimants had contact with the debtor prior to its bankruptcy. Even though the ignition switch defect (and other defects) were revealed after the petition date, the claimants’ economic losses were nonetheless "contingent" claims: the defects were there, but the contingency standing in the way of the claims was notification by Old GM that the defects existed.

Independent claims. By contrast, the appellate court held that independent claims relating to New GM’s conduct were not barred by the sale order because, by definition, such claims were based on New GM’s postpetition actions and were thus outside the scope of the "free and clear" provision. Similarly, the used car purchasers’ claims were not covered by the sale order because those claimants purchased Old GM cars after the closing of the sale, without knowledge of the defect or a possible claim against New GM, and they had no relationship to Old GM prior to its bankruptcy. Based on these findings, the appellate court affirmed the bankruptcy court’s decision not to enjoin independent claims against New GM and reversed its decision to enjoin the used car purchasers’ claims.

Procedural due process. Responding to the argument that enforcing the sale order would violate procedural due process, the appellate court addressed the type of notice that was adequate under the circumstances and, if the notice provided were inadequate, whether the bankruptcy court erred in denying relief on the basis that most claimants were not "prejudiced." The appellate court found no clear error in the bankruptcy court’s assessment that Old GM should have provided direct mail notice to vehicle owners because it knew, or reasonably should have known, about the ignition switch defect prior to its bankruptcy. The automaker was required by federal law to keep records of the first purchasers of its vehicles, and there was plentiful evidence that GM knew, or should have known, about problems associated with its ignition switch from the time of its development.

With regard to prejudice, the appellate court declined to decide whether prejudice is an element when there is inadequate notice of a proposed Sec. 363 sale because, even assuming the claimants were required to demonstrate prejudice, the court found they had done so. The court asserted that it could not say with fair assurance that the outcome of the Sec.363 sale proceedings would have been the same had Old GM disclosed the ignition switch defect and the claimants voiced their objections to the "free and clear" provision. Based on the business circumstances at the time, the claimants could have had some negotiating leverage, and their opportunity to participate in the proceedings, the court opined, would have been meaningful. Accordingly, the appellate court reversed the bankruptcy court’s decision insofar as it enforced the sale order to enjoin claims relating to the ignition switch defect, and it vacated the lower court’s holding with regard to claims based on non-ignition switch defects and remanded those claims for further proceedings.

Equitable mootness. Finally, the appellate court held that the bankruptcy court’s determination that any claims against the GUC Trust would be equitably moot due to the substantial consummation of the plan was advisory, and it vacated the lower court’s decision on that issue. The Trust was not a litigant in the case seeking the adjudication of any adverse legal interests; rather, the Trust sought not to be involved, and the bankruptcy court ordered otherwise. In doing so, the bankruptcy court was assessing a hypothetical scenario and formulating an answer to a question not asked by the parties to the controversy.

The case is Nos. 15-2844-bk(L), 15-2847-bk(XAP), 15-2848-bk(XAP).

Attorneys: Steve W. Berman (Hagens Berman Sobol Shapiro LLP) for Ignition Switch Plaintiffs. Joshua P. Davis (Josh Davis Law Firm) for Doris Powledge Phillips.

Companies: Motors Liquidation Co.; Wilmington Trust Co.

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