In re Motors Liquidation Co: Due Process Violation by GM Prejudices Prepetition Claimants Potentially Making Successor Liable

Practical Law Legal Update w-002-8492 (Approx. 5 pages)

In re Motors Liquidation Co: Due Process Violation by GM Prejudices Prepetition Claimants Potentially Making Successor Liable

by Practical Law Bankruptcy & Restructuring

Background

As part of a federal government rescue plan for the automotive industry, General Motors Corp. (GM) filed for Chapter 11 bankruptcy protection on June 1, 2009, in the US Bankruptcy Court for the Southern District of New York (Bankruptcy Court). Immediately after the bankruptcy filing, GM requested that the Bankruptcy Court approve a sale of substantially all of its assets free and clear to General Motors LLC (New GM) under section 363 of the Bankruptcy Code.

On June 2, 2009, the bankruptcy court ordered GM to provide actual notice of the proposed section 363 sale order (Sale Order) to all known creditors of GM and publication notice (in newspapers, etc.) to all unknown creditors. In early July 2009, the bankruptcy court approved the sale and entered an order authorizing, among other things, the sale of 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." The free and clear provision was intended to protect New GM from liability relating to claims against GM (now known as Old GM), with the exception of certain liabilities that New GM had agreed to assume.

In February 2014, New GM issued dozens of recalls relating to an ignition switch defect that prevented vehicle airbags from deploying, affecting over 25 million vehicles. Following the recall, parties filed dozens of class action lawsuits asserting that the ignition switch defect caused personal injuries and economic losses both before and after the closing of the section 363 sale.

On April 21, 2014, the plaintiffs initiated an adversary proceeding against New GM and asserted claims arising from the ignition switch defect. The successor liability claims generally comprised three categories:

Claims based on pre-closing injuries and economic losses, both related to the faulty ignition switches.
Claims based on post-closing injuries related to the faulty ignition switches of individuals who purchased a GM vehicle post-closing.
Claims based on New GM’s wrongful post-closing conduct of concealing the faulty ignition switch problems.

New GM filed motions seeking to enforce the free and clear provision in the Sale Order and enjoin the claims brought in the adversary proceeding as well as in the various class actions.

The Bankruptcy Court concluded that the publication notice provided by Old GM was not consistent with procedural due process and plaintiffs were entitled to actual notice. However, the Bankruptcy Court went on to find that plaintiffs did not suffer prejudice from the lack of notice because the court would have approved the sale anyway and the liquidation plan had since been consummated (see In re Motors Liquidation Co. ("MLC II"), 529 B.R. 510 (Bankr. S.D.N.Y. 2015)). The Bankruptcy Court therefore held that:

The Sale Order protected New GM against ignition switch claims.
New GM could only be held liable for its own wrongful conduct after the sale.

The Bankruptcy Court certified its decision for direct appeal to the Second Circuit (see Legal Update, In re Motors Liquidation Co: SDNY Bankruptcy Court Denies Successor Liability Claims Against New GM for Ignition Switch Defect).

Outcome

The Second Circuit considered the scope of the Sale Order and the enforceability of the free and clear provision with respect to plaintiffs' claims, finding that pre-closing accident and economic loss claims are covered by the Sale Order. The Second Circuit then analyzed the notice received and resulting effects, concluding, among other things, that the Bankruptcy Court's decision should be:

Affirmed on the ground that due process requires that the claimants receive actual notice of the Sale Order.
Reversed on the ground that plaintiffs' were not prejudiced by the lack of procedural due process.

Scope of the Free and Clear Provision

The Second Circuit first analyzed whether the claims arising from pre-closing accidents and economic losses from the ignition switch defect were covered by the Sale Order. The Second Circuit determined that to be covered by the Sale Order, and for the successor to be free and clear of liability, claims needed to flow from a debtor's ownership of the sold assets. To establish a flow from the debtor's ownership:

Claims must arise from a right of payment.
Claims must arise before the petition date or resulted from prepetition conduct.
The debtor must be able to identify the claimant.

In this case, the Second Circuit concluded that plaintiffs' ignition switch defect claims met the required connection to debtor's ownership of assets sold.

While the economic loss claims arising from the ignition switch defect were not revealed until five years after the bankruptcy filing, the Second Circuit found that these claims also flowed from Old GM's ownership because they were contingent claims. The Court explained that they were contingent because the defects existed prepetition, however, the claimants were not aware of the defect because Old GM did not notify them. Relying on Chateaugay, the Second Circuit held that the contingent claims resulted from "prepetition conduct fairly giving rise to that contingent claim" (In re Chateaugay Corp. ("Chateaugay I"), 944 F.2d 997, 1005 (2d Cir. 1991)).

The Second Circuit then concluded that claims relating to New GM's conduct and claims arising from post-closing purchases of Old GM used cars did not meet the required connection to the debtor's ownership of the sold assets, and were outside the scope of the Sale Order's free and clear provision. The Court therefore determined not to enjoin those claims from being pursued against New GM.

Enforcing the Sale Order Violates Procedural Due Process

The Second Circuit next affirmed the Bankruptcy Court's ruling that Old GM knew or reasonably should have known about the ignition switch defect before the bankruptcy and those vehicle owners were entitled to actual notice, rather than publication notice.

However, the Second Circuit reversed the Bankruptcy Court on grounds that the vehicle owners of the ignition switch defect did not suffer a prejudice from the lack of notice. The Second Circuit held that, in fact, the plaintiffs were prejudiced by the loss of a meaningful opportunity to participate in the sale proceedings. While the Second Circuit declined to decide whether prejudice must be demonstrated to obtain relief, it found that the claimants had been prejudiced.

Based on the facts and circumstances surrounding Old GM's bankruptcy and the federal government's involvement, the Second Circuit determined that plaintiffs likely could have influenced the sale negotiations and process if Old GM acknowledged the ignition switch defect during the bankruptcy and provided plaintiffs with actual notice of the sale. Because of the lack of notice and resulting prejudice to plaintiffs, the Second Circuit held that the plaintiffs are not barred from asserting their claims against New GM.

Would-Be Claims Against GUC Trust Were Not Equitably Moot

Finally, the Second Circuit rejected the Bankruptcy Court's order that any relief against the general unsecured creditors' trust is equitably moot. The Second Circuit noted that the plaintiffs did not seek relief from Old GM or the general unsecured creditors' trust and the trust's involvement in this case was purely at the behest of New GM. Therefore, the Bankruptcy Court's ruling was an advisory opinion because there was no case or controversy as required under Article III.

Practical Implications

The free and clear provision is of significant value and importance to buyers of distressed assets in bankruptcy because it typically provides the buyer with an assurance that that it will not be liable on account of legacy liabilities. This decision signifies the potential limits of the protection afforded by the free and clear provision when proper notice is not provided.

The Second Circuit reinforces the importance of providing adequate notice to all reasonably known claimants and creditors (even if they do not yet have fixed claims), to ensure the fullest protection afforded by a free and clear provision in a sale order. This decision also highlights the extraordinary consequences of failing to give proper notice, encouraging both debtors and buyers to take extra steps to provide notice to all potentially affected parties.

However, this decision was based on a narrow set of facts, which included the involvement of the US government in a unique bankruptcy case, and may therefore be interpreted and applied narrowly by other courts.

For more information on section 363 sales, see Practice Note, Buying Assets in a Section 363 Sale: Overview.

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