In re Grumman

In applying ' 363(f), courts have differed in their approach to the interpretation of what constitutes an “interest in property.” The phrase is not defined in the Bankruptcy Code, nor does the relevant legislative history provide helpful guidance as to how broadly a court should construe the word “interest.” Given this lack of clarity, a minority of courts have declined to extend “interest in property” beyond in rem interests, such as preexisting security interests and other liens attaching to the sale property, which are then extinguished pursuant to the ' 363 sale order, with liens attaching to the proceeds of sale. A majority of courts more broadly apply “interest in property” to include in personam interests, such as certain tort claims, including product liability claims arising against a debtor that could be asserted against a purchaser under a state law successor liability doctrine.

Yet, even where courts agree that ' 363(f) should be broadly construed to include successor liability claims generally, problems arise where such claims are based upon certain tort actions that implicate an overriding federal interest (i.e., environmental claims), or where, as in Grumman, the potential successor liability arose well after the closing of the ' 363 sale, the so-called “future claim.” Indeed, these future claims challenge courts, such as the court in Grumman, to clarify whether: 1) a “future claim” constitutes an “interest in property” pursuant to ' 363(f); and 2) conventional notice provisions can satisfy the due process rights of a future claimant.

In re Grumman Olson Industries, Inc.

On Dec. 9, 2002, Grumman Olson Industries, Inc. (the Debtor) filed for Chapter 11 relief in the United States Bankruptcy Court for the Southern District of New York. The Debtor was an automotive manufacturer, specializing in the design and manufacture of truck body parts. On July 1, 2003, the bankruptcy court issued a sale order pursuant to ' 363 approving the sale of certain of the Debtor's assets to MS Truck Body Corp., a predecessor in interest of Morgan Olson, LLC (Buyer). Pursuant to the sale order, the property was purchased by the Buyer free and clear of all claims and other interests, “including but not limited to, claims for successor or vicarious liability.” Morgan Olson, LLC v. Frederico (In re Grumman Olson Indus., Inc.), 445 B.R. 243 at 246 (Bankr. S.D.N.Y. 2011).

In October 2009, several years after the sale was completed, Denise and John Frederico (the Claimants) commenced a personal injury action against the Buyer in New Jersey Superior Court. According to the Claimants, Ms. Frederico, a FedEx employee, sustained serious injuries in October 2008 when the FedEx truck she was operating hit a telephone pole. The Claimants alleged, inter alia, that the FedEx truck involved in the accident was manufactured, designed and/or sold by Grumman in 1994, and was defective, and that the Buyer was liable for the injuries sustained by Ms. Frederico under New Jersey's successor liability law.

In March 2010, the Buyer initiated an adversary proceeding in the bankruptcy court seeking declaratory and injunctive relief against the Claimants. It its brief, the Buyer argued that the bankruptcy court's sale order exonerated the Buyer from any liability, including successor liability. Both parties then moved for summary judgment.

Bankruptcy Court Decision

Judge Bernstein issued the bankruptcy court's ruling on Feb. 25, 2011. After first confirming that the court retained subject matter jurisdiction over the proceeding because the dispute turned in part on an interpretation of the court's sale order, the court then turned to the conflict over the future claim, finding that: 1) interests in property include “claims” arising from assets that were sold, and that the Claimants, having had no contact with Grumman prior to the accident, did not hold a “claim” at the time of the sale order; and 2) the sale notice procedures did not satisfy the Claimants due process rights. Accordingly the Claimants could not be enjoined from bringing the successor liability claims against the Buyer.

Notably, the court likened the facts in Grumman to a hypothetical posed by the Second Circuit in United States v. LTV Corp. (In re Chateaugay Corp.), 944 F.2d 997, 1003 (2d Cir. 1991). In Chateaugay, the Second Circuit explored a fictional fact pattern in which it was a certainty that one in 10,000 bridges built by a manufacturer would fail, and that each such failure would result in 10 fatalities. Thus, although a court could find with a reasonable degree of certainty that the bridge manufacturer would be responsible for a certain number of fatalities, it would be impossible for a court to identify specific (and exceedingly unlucky) victims before they are harmed by the bridge failure. Accordingly, under the Second Circuit's test, a contingent or unmatured obligation is a “claim” if the occurrence of the contingency or future event that would trigger liability was “'within the actual or presumed contemplation of the parties at the time the original relationship between the parties was created.'” Chateaugay, 944 F.2d at 1004 (quoting In re All Media Props., Inc., 5 B.R. 126, 133 (Bankr. S.D. Tex. 1980), aff'd mem., 646 F.2d 193 (5th Cir. 1981)). In Grumman, the bankruptcy court found the “Fredericos had no 'contact' with Grumman prior to the accident. They did not deal with Grumman and Ms. Frederico's only connection was that her employer purchased the truck and she drove it. Hence, they did not hold claims against the Grumman estate at the time of the bankruptcy sale.” In re Grumman Olson Indus., Inc., 445 B.R. at 253.

In addition, the bankruptcy court found that due process had not been satisfied because the Claimants could not have been identified as future creditors at the time notice of the sale was given, and that even if they had received notice of the sale, such knowledge would be meaningless to them because no harm had yet occurred. Id. at 254. The Buyer subsequently appealed the bankruptcy court's decision to the district court.

District Court Affirms

On March 29, 2012, the district court issued its decision affirming the bankruptcy court, finding that the future claims held by the Claimants did not constitute “claims” in bankruptcy, and that the sale notice provisions did not satisfy the Claimant's due process rights, nor could they, because there was “no way for anyone to know that the Fredericos ever would have a claim.” In re Grumman Olson Indus., Inc., 2012 WL 1038672 at *11.

Relying on virtually identical reasoning to that used by the bankruptcy court, the district court affirmed that future claims such as those held by the Claimant did not constitute “claims” at the time of the sale. The court also declined to express a formal view as to whether the appointment of a future claims representative, as can be “particularly useful in mass tort cases, such as those involving asbestos or medical implants, where a discernable class of potential claimants has already been exposed to the product,” would be sufficient to satisfy the Claimants' due process rights. Id. at *12-14. In discussing the potential merits of a future claims representative, however, the court indicated its skepticism as to whether such a representative would have been effective in Grumman, noting that in the case of “unknown future claims” such as those held by the Claimants, in which there was no material exposure giving rise to a claim prior to the sale, courts often reject efforts by future claims representatives to set aside funds and otherwise act on behalf of future claimants. Id. at *13.

The court then turned to the due process component of the dispute, repeating the bankruptcy court's refrain that the Claimants could not possibly have had adequate notice, because even if they had received such notice it would have meant nothing to them because the claim had not yet arisen, nor was there a reasonable probability that such a claim would arise. The court then explored the tension between maximizing the value of the debtor's estate and the constitutional rights of prospective claimants. The court noted that it was “certainly cognizant of the inherent uncertainty that allowing successor liability claims (notwithstanding the “free and clear” provisions of the bankruptcy court's orders) imposes upon purchasers of debtor assets in bankruptcy. To whatever extent maximizing the value of the estate is an important policy under the Bankruptcy Code, it is no more fundamental than giving claimants proper notice and opportunity to be heard before their rights are affected.” Id. at *13. Thus, the court “reject[s] the premise that maximizing the value of the estate outweighs the due process rights of potential claimants.” Id. at *14.

Implications of Grumman on Section 363 Sales

Both the bankruptcy court and the district court in Grumman firmly denied that future tort claims like those of the Fredericos constitute “claims” at the time of a ' 363 sale, and that, moreover, it may be practically impossible to satisfy the due process rights of a future claimant bringing a successor liability claim that arises after the sale has taken place. Accordingly, potential purchasers of estate property pursuant to ' 363 should beware that the broad “free and clear” language that is commonplace in ' 363 sales may not protect them from potential successor liability if the traditional factors for such liability under state law are present. Such factors include, but are not limited to, continuation of a business line, use of the same
facilities, use of the same customer lists, continuation of the same employees, use of the existing name, etc. Care should be taken, particularly where certain sale property may be more prone to tort liability, to account for the attendant risk of potential successor liability exposure.

As the courts are concerned with the due process rights of those whose claims have not arisen at the time of the sale, it may be that the best the debtor and buyer can do is to take care to satisfy the due process rights of those whose claims do exist. It is well accepted that where the debtor is aware of a specific claimant who may have a contingent or unliquidated claim, actual notice to that claimant will be required to effect a sale free and clear of that claim. A prospective claimant may have suffered an injury and may not be aware of it (e.g., exposure to a toxic substance). As the identity of that claimant is unknown, there are degrees of protection, some of which may be prohibitively expensive in light of the value of the subject property.

At a minimum, where it is suspected that injuries exist and merely have not been sued on so that the debtor and the buyer do not know the identity of the potential claimant, notice by publication may be warranted. If it is known that a significant number of injuries exist because of, for example, the presence of carcinogens associated with the assets, if the costs can justify the effort, the parties may explore appointing a future claims representative and hiring actuaries to determine the cost in dealing with the likely claims. It may then be possible to use a Chapter 11 plan to funnel those claims into a special trust funded to deal with those claims. As the court indicated in Grumman, however, in the case of unknown future claims, even the appointment of a future claims representative may not protect against the imposition of successor liability on a purchaser.

Jeff J. Friedman is a partner and James N. Truitt is an associate in the Bankruptcy and Creditors' Rights Practice Group at Katten Muchin Rosenman LLP in New York City.

A recent decision by the United States District Court for the Southern District of New York explores the tension between the duty to maximize the value of the estate in bankruptcy and the due process rights afforded to future claimants in the context of a sale under ' 363 of the Bankruptcy Code. In Morgan Olson L.L.C. v. Frederico (In re Grumman Olson Indus., Inc.), 2012 WL 1038672 (S.D.N.Y. March 29, 2012), the U.S. District Court affirmed the bankruptcy court's ruling that a ' 363 sale order purporting to extinguish all claims for successor liability could not be enforced to enjoin a state law successor liability claim brought by claimants who, at the time of the sale, had not yet been injured and who had no way of knowing that such claims would arise. By limiting the reach of the ' 363 sale order, the court held the due process rights of future claimants outweighed the benefit to the bankruptcy estate and potential increase in value that a more broadly read ' 363 sale order might confer.

Asset Sales Pursuant to Section 363

Section 363(b) of the Bankruptcy Code provides a debtor-in-possession or trustee with the power to sell property of a debtor's estate outside the ordinary course of business, and in conjunction with ' 363(f), “free and clear of any interest” in property subject to the sale. A ' 363 sale frequently plays a critical role in a liquidation or reorganization, as it provides a debtor-in-possession or trustee with the ability to dispose of property in a manner that may increase the value of such property by extending “free and clear” protections to third party purchasers. Although ' 363 sales are widely used, courts continue to struggle with the applicability of the “free and clear of any interest” language of ' 363(f), especially as it applies against future claims, including future successor liability claims against a purchaser.

In applying ' 363(f), courts have differed in their approach to the interpretation of what constitutes an “interest in property.” The phrase is not defined in the Bankruptcy Code, nor does the relevant legislative history provide helpful guidance as to how broadly a court should construe the word “interest.” Given this lack of clarity, a minority of courts have declined to extend “interest in property” beyond in rem interests, such as preexisting security interests and other liens attaching to the sale property, which are then extinguished pursuant to the ' 363 sale order, with liens attaching to the proceeds of sale. A majority of courts more broadly apply “interest in property” to include in personam interests, such as certain tort claims, including product liability claims arising against a debtor that could be asserted against a purchaser under a state law successor liability doctrine.

Yet, even where courts agree that ' 363(f) should be broadly construed to include successor liability claims generally, problems arise where such claims are based upon certain tort actions that implicate an overriding federal interest (i.e., environmental claims), or where, as in Grumman, the potential successor liability arose well after the closing of the ' 363 sale, the so-called “future claim.” Indeed, these future claims challenge courts, such as the court in Grumman, to clarify whether: 1) a “future claim” constitutes an “interest in property” pursuant to ' 363(f); and 2) conventional notice provisions can satisfy the due process rights of a future claimant.

In re Grumman Olson Industries, Inc.

On Dec. 9, 2002, Grumman Olson Industries, Inc. (the Debtor) filed for Chapter 11 relief in the United States Bankruptcy Court for the Southern District of New York. The Debtor was an automotive manufacturer, specializing in the design and manufacture of truck body parts. On July 1, 2003, the bankruptcy court issued a sale order pursuant to ' 363 approving the sale of certain of the Debtor's assets to MS Truck Body Corp., a predecessor in interest of Morgan Olson, LLC (Buyer). Pursuant to the sale order, the property was purchased by the Buyer free and clear of all claims and other interests, “including but not limited to, claims for successor or vicarious liability.” Morgan Olson, LLC v. Frederico (In re Grumman Olson Indus., Inc.), 445 B.R. 243 at 246 (Bankr. S.D.N.Y. 2011).

In October 2009, several years after the sale was completed, Denise and John Frederico (the Claimants) commenced a personal injury action against the Buyer in New Jersey Superior Court. According to the Claimants, Ms. Frederico, a FedEx employee, sustained serious injuries in October 2008 when the FedEx truck she was operating hit a telephone pole. The Claimants alleged, inter alia, that the FedEx truck involved in the accident was manufactured, designed and/or sold by Grumman in 1994, and was defective, and that the Buyer was liable for the injuries sustained by Ms. Frederico under New Jersey's successor liability law.

In March 2010, the Buyer initiated an adversary proceeding in the bankruptcy court seeking declaratory and injunctive relief against the Claimants. It its brief, the Buyer argued that the bankruptcy court's sale order exonerated the Buyer from any liability, including successor liability. Both parties then moved for summary judgment.

Bankruptcy Court Decision

Judge Bernstein issued the bankruptcy court's ruling on Feb. 25, 2011. After first confirming that the court retained subject matter jurisdiction over the proceeding because the dispute turned in part on an interpretation of the court's sale order, the court then turned to the conflict over the future claim, finding that: 1) interests in property include “claims” arising from assets that were sold, and that the Claimants, having had no contact with Grumman prior to the accident, did not hold a “claim” at the time of the sale order; and 2) the sale notice procedures did not satisfy the Claimants due process rights. Accordingly the Claimants could not be enjoined from bringing the successor liability claims against the Buyer.

Notably, the court likened the facts in Grumman to a hypothetical posed by the Second Circuit in United States v. LTV Corp. (In re Chateaugay Corp.), 944 F.2d 997, 1003 (2d Cir. 1991). In Chateaugay, the Second Circuit explored a fictional fact pattern in which it was a certainty that one in 10,000 bridges built by a manufacturer would fail, and that each such failure would result in 10 fatalities. Thus, although a court could find with a reasonable degree of certainty that the bridge manufacturer would be responsible for a certain number of fatalities, it would be impossible for a court to identify specific (and exceedingly unlucky) victims before they are harmed by the bridge failure. Accordingly, under the Second Circuit's test, a contingent or unmatured obligation is a “claim” if the occurrence of the contingency or future event that would trigger liability was “'within the actual or presumed contemplation of the parties at the time the original relationship between the parties was created.'” Chateaugay, 944 F.2d at 1004 (quoting In re All Media Props., Inc., 5 B.R. 126, 133 (Bankr. S.D. Tex. 1980), aff'd mem., 646 F.2d 193 (5th Cir. 1981)). In Grumman, the bankruptcy court found the “Fredericos had no 'contact' with Grumman prior to the accident. They did not deal with Grumman and Ms. Frederico's only connection was that her employer purchased the truck and she drove it. Hence, they did not hold claims against the Grumman estate at the time of the bankruptcy sale.” In re Grumman Olson Indus., Inc., 445 B.R. at 253.

In addition, the bankruptcy court found that due process had not been satisfied because the Claimants could not have been identified as future creditors at the time notice of the sale was given, and that even if they had received notice of the sale, such knowledge would be meaningless to them because no harm had yet occurred. Id. at 254. The Buyer subsequently appealed the bankruptcy court's decision to the district court.

District Court Affirms

On March 29, 2012, the district court issued its decision affirming the bankruptcy court, finding that the future claims held by the Claimants did not constitute “claims” in bankruptcy, and that the sale notice provisions did not satisfy the Claimant's due process rights, nor could they, because there was “no way for anyone to know that the Fredericos ever would have a claim.” In re Grumman Olson Indus., Inc., 2012 WL 1038672 at *11.

Relying on virtually identical reasoning to that used by the bankruptcy court, the district court affirmed that future claims such as those held by the Claimant did not constitute “claims” at the time of the sale. The court also declined to express a formal view as to whether the appointment of a future claims representative, as can be “particularly useful in mass tort cases, such as those involving asbestos or medical implants, where a discernable class of potential claimants has already been exposed to the product,” would be sufficient to satisfy the Claimants' due process rights. Id. at *12-14. In discussing the potential merits of a future claims representative, however, the court indicated its skepticism as to whether such a representative would have been effective in Grumman, noting that in the case of “unknown future claims” such as those held by the Claimants, in which there was no material exposure giving rise to a claim prior to the sale, courts often reject efforts by future claims representatives to set aside funds and otherwise act on behalf of future claimants. Id. at *13.

The court then turned to the due process component of the dispute, repeating the bankruptcy court's refrain that the Claimants could not possibly have had adequate notice, because even if they had received such notice it would have meant nothing to them because the claim had not yet arisen, nor was there a reasonable probability that such a claim would arise. The court then explored the tension between maximizing the value of the debtor's estate and the constitutional rights of prospective claimants. The court noted that it was “certainly cognizant of the inherent uncertainty that allowing successor liability claims (notwithstanding the “free and clear” provisions of the bankruptcy court's orders) imposes upon purchasers of debtor assets in bankruptcy. To whatever extent maximizing the value of the estate is an important policy under the Bankruptcy Code, it is no more fundamental than giving claimants proper notice and opportunity to be heard before their rights are affected.” Id. at *13. Thus, the court “reject[s] the premise that maximizing the value of the estate outweighs the due process rights of potential claimants.” Id. at *14.

Implications of Grumman on Section 363 Sales

Both the bankruptcy court and the district court in Grumman firmly denied that future tort claims like those of the Fredericos constitute “claims” at the time of a ' 363 sale, and that, moreover, it may be practically impossible to satisfy the due process rights of a future claimant bringing a successor liability claim that arises after the sale has taken place. Accordingly, potential purchasers of estate property pursuant to ' 363 should beware that the broad “free and clear” language that is commonplace in ' 363 sales may not protect them from potential successor liability if the traditional factors for such liability under state law are present. Such factors include, but are not limited to, continuation of a business line, use of the same
facilities, use of the same customer lists, continuation of the same employees, use of the existing name, etc. Care should be taken, particularly where certain sale property may be more prone to tort liability, to account for the attendant risk of potential successor liability exposure.

As the courts are concerned with the due process rights of those whose claims have not arisen at the time of the sale, it may be that the best the debtor and buyer can do is to take care to satisfy the due process rights of those whose claims do exist. It is well accepted that where the debtor is aware of a specific claimant who may have a contingent or unliquidated claim, actual notice to that claimant will be required to effect a sale free and clear of that claim. A prospective claimant may have suffered an injury and may not be aware of it (e.g., exposure to a toxic substance). As the identity of that claimant is unknown, there are degrees of protection, some of which may be prohibitively expensive in light of the value of the subject property.

At a minimum, where it is suspected that injuries exist and merely have not been sued on so that the debtor and the buyer do not know the identity of the potential claimant, notice by publication may be warranted. If it is known that a significant number of injuries exist because of, for example, the presence of carcinogens associated with the assets, if the costs can justify the effort, the parties may explore appointing a future claims representative and hiring actuaries to determine the cost in dealing with the likely claims. It may then be possible to use a Chapter 11 plan to funnel those claims into a special trust funded to deal with those claims. As the court indicated in Grumman, however, in the case of unknown future claims, even the appointment of a future claims representative may not protect against the imposition of successor liability on a purchaser.

Jeff J. Friedman is a partner and James N. Truitt is an associate in the Bankruptcy and Creditors' Rights Practice Group at Katten Muchin Rosenman LLP in New York City.