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Public Policy Necessitates Penetration of § 363’s Liability Shield

By: Julie Lavoie

St. John’s Law Student

American Bankruptcy Institute Law Review Staffer

 

        In In re Motors Liquidation Co.,[1] the Second Circuit reversed the Bankruptcy Court of the Southern District of New York’s holding that the “free and clear” provision[2] in the sale order[3] barred plaintiff’s claims against New GM arising out of ignition switch defects.[4] The Second Circuit acknowledged that the bankruptcy court was correct in concluding that even though the cars were not recalled for ignition switch defects until 2014, five years after the § 363 sale,[5] there was ample evidence that Old GM knew or should have known about the ignition switch defect prior to bankruptcy.[6] Therefore, due process dictates that claimants were entitled to notice of the sale by direct mail or an equivalent means.[7]  Unlike the bankruptcy court, the Second Circuit found that ignition switch claimants were prejudiced by this lack of notice.[8] The Second Circuit could not confidently say that, given the circumstances,[9] the outcome of the § 363 sale motion would have been the same if the claimants were notified and thus afforded the opportunity to be heard and partake in the negotiation.[10]

        This past summer, the Second Circuit declined GM’s request for a rehearing.[11]Criticism of the court’s refusal to honor the § 363 liability shield is two-fold. First, the decision imposes “potentially massive liability” on New GM for Old GM’s decision not to notify the claimants of the sale, which is a choice New GM did not participate in making.[12] Some argue that this “contradicts the Bankruptcy Code’s position of placing liability only on the party at fault.”[13] Second, the decision calls into question the certainty and finality of bankruptcy sales.[14] This consequence is especially unfavorable in instances where the only way to prevent a “disorderly collapse” with “far-reaching consequences” is to have a rapid bankruptcy process.[15]

        From the Second Circuit’s perspective, these perceived negative implications pale in comparison to the public policy against tolerating, much less rewarding, debtors who conceal claims against potential creditors.[16]  Moreover, this approach serves to set higher due diligence standards for purchasers. Before entering a § 363 sale agreement, a potential purchaser should “scrutinize a debtor’s business” to ensure debtors are forthright about any underlying issues and to be sure all known and potential claimants are notified of the potential sale.[17]

 



[1] In re Motors Liquidation Co., 829 F.3d 135, 144 (2d Cir. 2016).

[2] This provision was intended to act as a “liability shield” and it provided that “New GM would acquire Old GM’s assets ‘free and clear of all liens, claims, encumbrances, and other interests of any kind or nature whatsoever including rights or claims based on any successor or transferee liability.’” In re Motors, 829 F.3d at 146.

[3] The sale order governed Old GM’s § 363 sale to New GM. See id. at 147.

[4]  See id. at 163. 

[5] 1 U.S.C. § 363 (2010). This section provides a less common and more rapid mechanism for accomplishing a bankruptcy. See In re Motors, 825 F.3d. at 145. Rather than a traditional Chapter 11 reorganization, the company entering bankruptcy “sells its primary assets to a successor corporation, which immediately takes over the business.” Id.

[6] See id. at 159-60.

[7] See id. at 161.

[8] See id. at 163.

[9] See id. at 166. Specific reasons the court cited in support of its conclusion that claimants would have had negotiating leverage are that the bankruptcy court was focused on consumer confidence, the Treasury was involved in GMs affairs during the bailout, and the financial stakes if the bankruptcy was delayed. See id.

[10]  See id. at 164.

[11] See Field, Emily, 2nd Circ. Won’t Rethink GM Bankruptcy Shield Ruling, Law 360, Sept. 14, 2016, http://www.law360.com/articles/840168/2nd-circ-won-t-rethink-gm-bankrupt....

[12] Id.

[13] Id.

[14] See id.

[15] In re Motors, 829 F.3d at 144.

[16] See generally id. at 160.

[17] Randles, Jonathan, 2nd Circ. Says ‘Buyer Beware in GM Ruling on Ch. 11 Sale, Law 360, July 15, 2016, http://www.law360.com/articles/817545/2nd-circ-says-buyer-beware-in-gm-r....