Successor Liability

Four Categories of Claimants

Courts have addressed the survival of successor liability in the context of four categories of claimants: 1) known creditors, whose claims exist at the time of the sale or plan confirmation; 2) unknown creditors who had pre-petition physical contact with or exposure to the debtor's product, but are not aware of their exposure to the debtor's product and have not yet manifested symptoms or discovered their injury; 3) unknown creditors who had, and were aware of, pre-petition physical contact with or exposure to the debtor's product, but have not yet manifested symptoms or discovered their injury; and 4) future claimants who had no pre-petition physical contact with or exposure to the debtor's product, but who, nevertheless, are injured after consummation of an asset sale or confirmation of a plan as a result of a defective product manufactured and sold by the debtor prior to bankruptcy. The application of section 363(f) to each category of claimants depends, in large part, on whether the notice given by the debtor of the bankruptcy proceeding and the sale is sufficient to protect the claimant's rights under the Due Process Clause of the Fourteenth Amendment.

Known Creditors

With respect to known creditors, the trend in recent case law is toward an expansive reading of section 363(f) that permits the transfer of estate property free and clear of any obligations that flow from the ownership of such property, including successor liability claims arising from the debtor's defective products. As an example, in In re Trans World Airlines, 322 F.3d 283 (3d Cir. 2003), the Third Circuit concluded that successor liability claims constitute “interests in property” within the meaning of section 363(f) because “they arise from the property being sold” and, therefore, the property transfers free and clear of those claims. Relying on Trans World Airlines, the Southern District of New York came to a similar conclusion with respect to known creditors in In re Chrysler, LLC, 405 B.R. 84 (Bankr. S.D.N.Y. 2009) (appeal vacated as moot), and In re General Motors Corp., 407 B.R. 463 (Bankr. S.D.N.Y. 2009). The due process rights of known creditors are protected through actual written notice of the bankruptcy proceeding. Although courts appear to be trending toward precluding known creditors from bringing successor liability claims after a 363(f) sale, previous decisions hold otherwise. See, e.g., In re Wolverine Radio Co., 930 F.2d 1132, 1147-48 (6th Cir. 1991). Consequently, buyers should not assume that assets of the estate will automatically be transferred free and clear of successor liability claims, and their sale orders should always include provisions expressly providing that they are released from successor liability.

Unknown Creditors with Pre-Petition Contact

The second category of claimants includes unknown creditors who had pre-petition physical contact with or exposure to the debtor's product, but have not yet manifested symptoms or discovered their injury. By their nature, these claimants likely will not be identifiable by the debtor during the bankruptcy case, and their due process rights must be protected before their claims are discharged. Courts have developed a special mechanism to deal with the due process concerns of this category of unknown creditors (most commonly, asbestos claimants). Their successor liability claims may be extinguished, provided that a future claims representative is appointed to protect their interests and a trust is created to pay their claims. For asbestos claimants, this mechanism is codified in section 524(g) of the Bankruptcy Code.

Unknown Creditors Without Manifested Symptoms

The third category of claimants includes unknown creditors who had, and were aware of, pre-petition physical contact with or exposure to the debtor's product, but have not yet manifested symptoms or discovered their injury. The Western District of Pennsylvania recently dealt with this category of claimant in Wright v. Owens Corning, 450 B.R. 541 (W.D. Pa. 2011). In the late 1990s, the claimant installed shingles on her roof that were manufactured and sold by Owens Corning. In 2000, Owens Corning filed for bankruptcy relief under Chapter 11 of the Bankruptcy Code, and the bankruptcy court confirmed the debtor's plan of reorganization in 2006. The plan discharged the debtor and reorganized debtor from all claims and liabilities that arose before the confirmation date. In 2009, the claimant discovered that her shingles were cracked and water was leaking into her home. Using the test enunciated by the Third Circuit in Jeld-Wen, Inc. v. Van Brunt (In re Grossman's Inc.), 607 F.3d 114 (3d Cir. 2010), the court determined that the claimant held a pre-petition claim because she was “exposed pre-petition to a product or other conduct giving rise to an injury, which underlies a 'right to payment' under the Bankruptcy Code.” Because the claim arose pre-petition, it was discharged pursuant to the confirmation order. Further, the claimant's due process rights were not violated because the debtor published notice of the bankruptcy proceedings in several national, regional, and local newspapers and trade publications. According to Wright, the successor liability claims of this category of claimants may be discharged, provided that their due process rights are satisfied through constructive notice by publication.

Injured As a Result of a Defective Product

The fourth category of claimants includes those persons who had no pre-petition contact or relationship with the debtor or its products, but who, nevertheless, are injured after consummation of an asset sale or confirmation of a plan as a result of a defective product manufactured and sold by the debtor prior to bankruptcy. Because these future claimants do not hold claims against the estate at the time of the sale or confirmation and, therefore, cannot receive effective notice, a 363(f) sale cannot affect their right to sue a successor in interest. In In re Grumman Olson Indus., Inc., 455 B.R. 243 (Bankr. S.D.N.Y. 2011), the debtor filed a petition under Chapter 11 of the Bankruptcy Code in 2002, and sold its assets pursuant to section 363(f) in 2003. Pursuant to the sale order, the assets were purportedly transferred free and clear of successor liability claims. In 2008, a truck manufactured and sold by Grumman prior to its bankruptcy was involved in an accident and caused personal injury. Initially, the court noted that these facts represent “the extreme case of pre-petition conduct that [did] not ' result[] in any tortious consequence to the victim” until after the sale was completed. Using the two-part “Piper” test, the court determined that the claimants did not have a “ claim” (as that term is defined in section 101(5) of the Bankruptcy Code) against Grumman at the time of the sale because the claimants did not have any contact with Grumman or its products prior to the sale. As a result, the claimants did not receive proper notice of the bankruptcy case or the sale. Even if the claimants had constructive notice of the case, they could not file a claim or object to the sale because they did not have any contact or relationship with Grumman prior to the accident. In sum, Grumman stands for the proposition that “a person injured after the sale (or confirmation) by a defective product manufactured and sold prior to the bankruptcy does not hold a 'claim' in the bankruptcy case and is not affected by either the ' 363(f) sale order or the discharge under 11 U.S.C. ' 1141(d).” This conclusion was implicitly recognized in General Motor Corp. as the buyer agreed to assume all product liability claims arising from operation of GM vehicles occurring subsequent to the 363 sale, regardless of when the product was purchased.

Conclusion

Although assets sales under section 363(f) cannot automatically absolve purchasers of all potential successor liability, there are steps that a purchaser can take to insulate itself to a certain extent. Based upon the case law discussed above, the necessary ingredients to a free and clear sale appear to be effective notice and procedural fairness. To that end, purchasers should require that debtors provide constructive notice of the asset sale to unknown claimants by publication, as was done in Owens Corning. The debtors should also reserve an appropriate amount of the sale proceeds to address potential unknown claims, similar to the trusts created in asbestos cases. Taking these steps will, at a minimum, weigh in favor of the purchaser if an unknown or future claimant subsequently brings a successor liability action that is not barred by the 363(f) sale.

Amy M. Tonti, a member of this newsletter's Board of Editors, is a partner and Luke A. Sizemore is an associate in Reed Smith LLP's Commercial Restructuring and Bankruptcy Group, resident in the firm's Pittsburgh, PA, office.

An asset sale under section 363(f) of the Bankruptcy Code is becoming an increasingly popular mechanism to improve a company's financial condition as an alternative to a traditional plan of reorganization. There are substantial advantages to a 363(f) sale, the most important being that purchasers may take property of the estate “free and clear of any interest in such property.” This language unquestionably permits purchasers to take property of the estate free and clear of any liens, but whether section 363(f) contemplates other types of interests, such as successor liability claims, is more complicated. While the trend of recent case law supports an expansive reading of “interests in property,” prospective buyers at section 363(f) sales should be aware of, and protect against, the risk of potential successor liability claims.

Four Exceptions to the Rule

As a general rule, no successor liability is imposed on a purchaser of corporate assets. There are, however, four traditionally recognized exceptions to this general rule of non-liability, namely, if: 1) there is an express agreement to assume the obligations of the transferor; 2) the transaction amounts to a de facto merger or consolidation of two companies; 3) the transaction is a fraudulent attempt to escape liability; or 4) the transferee is a mere continuation of the transferor, with growing approval for additional exceptions, including the “continuity of enterprise” exception and the “product line” exception. Although the details of each exception vary from state to state, no successor liability will be imposed absent one of these exceptions regardless of whether the asset sale is conducted pursuant to section 363(f) of the Bankruptcy Code. If, on the other hand, the prospective buyer at a section 363(f) sale is aware that one of these exceptions may apply, it should consider the risk that potential successor liability claims may survive the sale.

Four Categories of Claimants

Courts have addressed the survival of successor liability in the context of four categories of claimants: 1) known creditors, whose claims exist at the time of the sale or plan confirmation; 2) unknown creditors who had pre-petition physical contact with or exposure to the debtor's product, but are not aware of their exposure to the debtor's product and have not yet manifested symptoms or discovered their injury; 3) unknown creditors who had, and were aware of, pre-petition physical contact with or exposure to the debtor's product, but have not yet manifested symptoms or discovered their injury; and 4) future claimants who had no pre-petition physical contact with or exposure to the debtor's product, but who, nevertheless, are injured after consummation of an asset sale or confirmation of a plan as a result of a defective product manufactured and sold by the debtor prior to bankruptcy. The application of section 363(f) to each category of claimants depends, in large part, on whether the notice given by the debtor of the bankruptcy proceeding and the sale is sufficient to protect the claimant's rights under the Due Process Clause of the Fourteenth Amendment.

Known Creditors

With respect to known creditors, the trend in recent case law is toward an expansive reading of section 363(f) that permits the transfer of estate property free and clear of any obligations that flow from the ownership of such property, including successor liability claims arising from the debtor's defective products. As an example, in In re Trans World Airlines, 322 F.3d 283 (3d Cir. 2003), the Third Circuit concluded that successor liability claims constitute “interests in property” within the meaning of section 363(f) because “they arise from the property being sold” and, therefore, the property transfers free and clear of those claims. Relying on Trans World Airlines, the Southern District of New York came to a similar conclusion with respect to known creditors in In re Chrysler, LLC, 405 B.R. 84 (Bankr. S.D.N.Y. 2009) (appeal vacated as moot), and In re General Motors Corp., 407 B.R. 463 (Bankr. S.D.N.Y. 2009). The due process rights of known creditors are protected through actual written notice of the bankruptcy proceeding. Although courts appear to be trending toward precluding known creditors from bringing successor liability claims after a 363(f) sale, previous decisions hold otherwise. See, e.g., In re Wolverine Radio Co., 930 F.2d 1132, 1147-48 (6th Cir. 1991). Consequently, buyers should not assume that assets of the estate will automatically be transferred free and clear of successor liability claims, and their sale orders should always include provisions expressly providing that they are released from successor liability.

Unknown Creditors with Pre-Petition Contact

The second category of claimants includes unknown creditors who had pre-petition physical contact with or exposure to the debtor's product, but have not yet manifested symptoms or discovered their injury. By their nature, these claimants likely will not be identifiable by the debtor during the bankruptcy case, and their due process rights must be protected before their claims are discharged. Courts have developed a special mechanism to deal with the due process concerns of this category of unknown creditors (most commonly, asbestos claimants). Their successor liability claims may be extinguished, provided that a future claims representative is appointed to protect their interests and a trust is created to pay their claims. For asbestos claimants, this mechanism is codified in section 524(g) of the Bankruptcy Code.

Unknown Creditors Without Manifested Symptoms

The third category of claimants includes unknown creditors who had, and were aware of, pre-petition physical contact with or exposure to the debtor's product, but have not yet manifested symptoms or discovered their injury. The Western District of Pennsylvania recently dealt with this category of claimant in Wright v. Owens Corning , 450 B.R. 541 (W.D. Pa. 2011). In the late 1990s, the claimant installed shingles on her roof that were manufactured and sold by Owens Corning. In 2000, Owens Corning filed for bankruptcy relief under Chapter 11 of the Bankruptcy Code, and the bankruptcy court confirmed the debtor's plan of reorganization in 2006. The plan discharged the debtor and reorganized debtor from all claims and liabilities that arose before the confirmation date. In 2009, the claimant discovered that her shingles were cracked and water was leaking into her home. Using the test enunciated by the Third Circuit in Jeld-Wen, Inc. v. Van Brunt (In re Grossman's Inc.), 607 F.3d 114 (3d Cir. 2010), the court determined that the claimant held a pre-petition claim because she was “exposed pre-petition to a product or other conduct giving rise to an injury, which underlies a 'right to payment' under the Bankruptcy Code.” Because the claim arose pre-petition, it was discharged pursuant to the confirmation order. Further, the claimant's due process rights were not violated because the debtor published notice of the bankruptcy proceedings in several national, regional, and local newspapers and trade publications. According to Wright, the successor liability claims of this category of claimants may be discharged, provided that their due process rights are satisfied through constructive notice by publication.

Injured As a Result of a Defective Product

The fourth category of claimants includes those persons who had no pre-petition contact or relationship with the debtor or its products, but who, nevertheless, are injured after consummation of an asset sale or confirmation of a plan as a result of a defective product manufactured and sold by the debtor prior to bankruptcy. Because these future claimants do not hold claims against the estate at the time of the sale or confirmation and, therefore, cannot receive effective notice, a 363(f) sale cannot affect their right to sue a successor in interest. In In re Grumman Olson Indus., Inc., 455 B.R. 243 (Bankr. S.D.N.Y. 2011), the debtor filed a petition under Chapter 11 of the Bankruptcy Code in 2002, and sold its assets pursuant to section 363(f) in 2003. Pursuant to the sale order, the assets were purportedly transferred free and clear of successor liability claims. In 2008, a truck manufactured and sold by Grumman prior to its bankruptcy was involved in an accident and caused personal injury. Initially, the court noted that these facts represent “the extreme case of pre-petition conduct that [did] not ' result[] in any tortious consequence to the victim” until after the sale was completed. Using the two-part “Piper” test, the court determined that the claimants did not have a “ claim” (as that term is defined in section 101(5) of the Bankruptcy Code) against Grumman at the time of the sale because the claimants did not have any contact with Grumman or its products prior to the sale. As a result, the claimants did not receive proper notice of the bankruptcy case or the sale. Even if the claimants had constructive notice of the case, they could not file a claim or object to the sale because they did not have any contact or relationship with Grumman prior to the accident. In sum, Grumman stands for the proposition that “a person injured after the sale (or confirmation) by a defective product manufactured and sold prior to the bankruptcy does not hold a 'claim' in the bankruptcy case and is not affected by either the ' 363(f) sale order or the discharge under 11 U.S.C. ' 1141(d).” This conclusion was implicitly recognized in General Motor Corp. as the buyer agreed to assume all product liability claims arising from operation of GM vehicles occurring subsequent to the 363 sale, regardless of when the product was purchased.

Conclusion

Although assets sales under section 363(f) cannot automatically absolve purchasers of all potential successor liability, there are steps that a purchaser can take to insulate itself to a certain extent. Based upon the case law discussed above, the necessary ingredients to a free and clear sale appear to be effective notice and procedural fairness. To that end, purchasers should require that debtors provide constructive notice of the asset sale to unknown claimants by publication, as was done in Owens Corning. The debtors should also reserve an appropriate amount of the sale proceeds to address potential unknown claims, similar to the trusts created in asbestos cases. Taking these steps will, at a minimum, weigh in favor of the purchaser if an unknown or future claimant subsequently brings a successor liability action that is not barred by the 363(f) sale.

Amy M. Tonti, a member of this newsletter's Board of Editors, is a partner and Luke A. Sizemore is an associate in Reed Smith LLP's Commercial Restructuring and Bankruptcy Group, resident in the firm's Pittsburgh, PA, office.