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A ‘Free and Clear’ Sale Order Is Only as Good as the Notice It Is Predicated Upon

Section 363(f) of the U.S. Bankruptcy Code enables a trustee or Chapter 11 debtor to sell its assets “free and clear of any interest in such property of an entity other than the estate,” provided it meets certain conditions. 11 U.S.C. Section 363(f). As courts have explained, “allowing sales of debtor assets free and clear of liabilities of the debtor induces a higher sale price for the assets, thereby maximizing the value of the estate and maximizing potential recovery to creditors.” In re Grumman Olson Indus., 467 B.R. 694, 703 (Bankr. S.D.N.Y. 2012) (internal citations omitted).

Thus, the inclusion of standard free-and-clear language in a 363 sale order is crucial for both the debtor seeking to maximize the value of its assets in bankruptcy and also the purchaser of such assets. Purchasers rely on the release of any liens, claims, and/or interests in the assets purchased pursuant to Section 363 to the extent certain presale claims are asserted against the purchaser following the sale—particularly in the context of successor liability claims.

However, a series of recent cases makes clear that to the extent notice of a Section 363 sale order is deficient, the free-and-clear provisions of the order may be meaningless to a purchaser who subsequently seeks to rely on such language following the sale. Specifically, the Bankruptcy Code clearly provides that estate assets may only be sold pursuant to Section 363 after “notice and a hearing…” 11 U.S.C. Section 363(b) (emphasis added). Therefore, the debtor’s ability to sell its assets free and clear of liens, claims, and/or interests—and the purchaser’s ability to rely on the free-and-clear language of a Section 363 sale order—is qualified by the effectiveness of the notice provided by the debtors of the sale.

As a result, purchasers in bankruptcy must focus not only on the terms of the sale order, but also, perhaps as importantly, on the parties to which the debtors/sellers provide notice of the sale and the manner in which such notice is given.1 This is particularly true in the products liability context where the holders of such claims are known or can be “easily” identified by the debtors. Thus, publication notice is insufficient and actual notice of the proposed sale by mail is required under the due process clause of the Fifth Amendment to the U.S. Constitution.

In re Motors Liquidation Co.

In In re Motors Liquidation Co., 829 F.3d 135 (2d Cir. 2016), the 2nd U.S. Circuit Court of Appeals examined whether the free-and-clear language included in the General Motors Corporation sale order barred claims arising from an ignition switch defect in cars manufactured years before the GM bankruptcy from being brought against the successor corporation.

On June 1, 2009, General Motors Corporation (Old GM) filed for protection under Chapter 11 of the Bankruptcy Code, and only 40 days later, new General Motors (New GM) emerged from bankruptcy as the purchaser of substantially all of Old GM’s operational assets “free and clear of liens, claims, encumbrances, and other interests…including rights or claims…based on any successor or transferee liability” pursuant to a Section 363 sale order.

Beginning in February 2014, New GM began recalling cars due to a defect in their ignition switches; however, many of the affected cars were built years before the GM bankruptcy by Old GM. Thus, where individuals might have had claims against Old GM, New GM argued that the free-and-clear provisions in the Bankruptcy Court’s sale order barred those claims from being brought against New GM as the successor corporation. Nevertheless, individuals instituted class-action lawsuits against New GM under various successor liability theories, seeking damages for losses and injuries related to the ignition switch defects.

In April 2015, the Bankruptcy Court issued an opinion enforcing the sale order to enjoin many of these successor liability claims against New GM. The Bankruptcy Court found that the ignition switch claims were known to or reasonably ascertainable by Old GM before the sale, and thus the ignition switch plaintiffs were entitled to actual notice of the sale instead of the publication notice they received (i.e., they received constructive notice of the sale through publication in The Wall Street Journal and The New York Times). However, the court held that, with limited exception, the ignition switch plaintiffs had not been prejudiced by the lack of notice, because the court would have approved the sale order even if plaintiffs were provided adequate notice.

On a certified direct appeal, the 2nd Circuit reversed and remanded the Bankruptcy Court’s findings as to the ignition switch claimants. First, the appellate court agreed with sister courts that successor liability claims can be “interests” from which property may be sold free and clear pursuant to Section 363(b) when they flow from a debtor’s ownership of transferred assets. Id. at 155.

But the court went on to hold that successor liability claims must also qualify as “claims” under Chapter 11. Id. (“Though § 363(f) does not expressly invoke the Chapter 11 definition of ‘claims’, see 11 U.S.C. § 101(5), it makes sense to ‘harmonize’ Chapter 11 reorganizations and § 363 sales ‘to the extent permitted by the statutory language.’”) (internal citations omitted). Thus, to avoid constitutional and practical concerns, property can only be sold free and clear of successor liability claims if such claims “arise from a (1) right to payment (2) that arose before the filing of the petition or resulted from prepetition conduct fairly giving rise to the claim.” Id. at 156.

There must also be some contact or relationship between the debtor and the claimant such that the claimant is identifiable. Id. Based on the foregoing, the court concluded that the free-and-clear provisions of the sale order covered preclosing accident claims and economic loss claims based on the ignition switch and other defects, and if enforced, would bar such claims against New GM. Id. at 158.


 

The court held that while the 40-day bankruptcy was extraordinary in scale and speed, that complexity and need to move quickly “did not obviate basic constitutional principles.”

 


With respect to proper notice, the 2nd Circuit agreed with the Bankruptcy Court’s conclusion that the ignition switch plaintiffs were not provided with proper notice of the sale as required by the due process clause. The appellate court cited the general rule that “notice by publication is not enough with respect to a person whose name and address are known or very easily ascertainable and whose legally protected interests are directly affected by the proceedings in question.” Id. at 159 (citing Schroeder v. City of New York, 371 U.S. 208, 212-13 (1962)).

Thus, because Old GM knew about the ignition switch defects and could have easily ascertained the ignition switch claimants, procedural due process required that Old GM provide them with actual notice of the sale to New GM. Notably, New GM argued that the ignition switch claimants were “contingent” and thus those individuals were unknown creditors as a matter of law. The 2nd Circuit, however, dismissed this argument out of hand because (1) contingent claims are still claims entitled to adequate notice if the debtor is aware of them and (2) the only contingency that remained (i.e., Old GM telling owners about the defect) was wholly in Old GM’s control. Id. at 160 (“New GM essentially asks that we reward debtors who conceal claims against potential creditors. We decline to do so.”).

The 2nd Circuit also rejected New GM’s arguments that the notice provided was sufficient under the circumstances, because the GM bankruptcy was extraordinary and a quick Section 363 sale was required to preserve the value of the company. The court held that while the 40-day bankruptcy was extraordinary in scale and speed, that complexity and need to move quickly “did not obviate basic constitutional principles.” Id. at 161.

With respect to prejudice, however, the 2nd Circuit disagreed with the Bankruptcy Court’s conclusion that prejudice is an “essential element” of procedural due process and the ignition switch plaintiffs were not prejudiced because the Bankruptcy Court would have approved the sale even if such claimants were provided with notice. The 2nd Circuit first questioned whether prejudice is in fact an “essential element” of procedural due process, but determined that it need not decide the point because, even assuming the ignition switch plaintiffs had to demonstrate prejudice, they had done so.

Specifically, the 2nd Circuit concluded that the terms of the GM Section 363 sale order were not exclusively within the Bankruptcy Court’s control and instead were the product of extensive negotiations and input from various parties. Id. at 163. As a result of this heavy negotiation, for example, the sale order included approximately 15 sets of liabilities that New GM assumed voluntarily. Thus, the 2nd Circuit concluded that it was not confident that the sale order would have been negotiated and approved exactly as it was had Old GM revealed the ignition switch defect in bankruptcy and those claimants were provided with proper notice of the sale and an opportunity to participate in negotiations regarding the terms of the sale order.

As a result, enforcing the sale order would violate due process in these circumstances, and the ignition switch claimants could not be bound by the terms of the sale order.

In re Olsen

In In re Olsen, 563 B.R. 899 (Bankr. E.D. Wis. 2017), the Bankruptcy Court for the Eastern District of Wisconsin was similarly faced with the issue of whether a free-and-clear confirmation order approving a real estate sale could extinguish a right of first refusal (ROFR) without affording the holder of the right formal notice and an opportunity to object. In Olsen, Archer Daniels Midland Company (ADM) purchased assets pursuant to a Chapter 11 plan, including certain real property. When ADM later sold the property, Country Visions Cooperative (CVC) sued ADM in state court, asserting a ROFR to purchase the property.

Significantly, CVC was not listed in the debtors’ mailing matrix and did not receive formal notice of the bankruptcy or the sale of the property pursuant to the plan. However, CVC did have informal notice regarding the sale of the property before the confirmation hearing. There were communications between CVC’s lawyer and lawyers for the secured creditor and the debtors before the confirmation hearing. Debtors’ counsel even submitted a declaration that she told CVC’s lawyer that a confirmation hearing had been scheduled for the following week and that the property was “subject to a potential sale, and that if he or his clients wished to assert any rights, under the ROFR or otherwise, they should do so prior to or at the hearing.” Id. at 904.

Despite this, CVC did not attend the confirmation hearing and the plan was confirmed, including the sale of the property to ADM, which closed shortly thereafter. Id. As a result, ADM sought to reopen the debtors’ bankruptcy and enforce the free-and-clear confirmation order to bar CVC’s state court lawsuit.

The court concluded that CVC was not given proper notice of the sale of the property during the bankruptcy proceedings to satisfy due process before extinguishing its ROFR pursuant to the confirmation order. The court cited the U.S. Supreme Court’s landmark decision in Mullane v. Central Hanover Bank & Tr. Co., 339 U.S. 306 (1950), which provides that due process requires “notice reasonably calculated, under the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.” Id. at 314. The purpose of the notice is to permit adequate preparation for the impending hearing, and the notice must convey the required information and afford a reasonable time for interested parties to make an appearance. Id.

The Bankruptcy Court went on to observe that in recognition of a lienholder’s due process rights, both the Bankruptcy Code and Bankruptcy Rules “take very seriously the notice given when a sale adversely affects a property interest or lien.” Olsen, 563 B.R. at 905. For example, the Bankruptcy Code and Rules provide for 21 days’ notice of a proposed sale of property of the estate outside the ordinary course of business. See 11 U.S.C. Section 363; Fed. R. Bankr. P. 2002(a)(2), 6004(a).

Moreover, the Bankruptcy Rules provide that if property is to be sold free and clear under Section 363 of the Bankruptcy Code, the relevant motion must be served on “the parties who have liens or other interests in the property” in the same manner as service of a summons and complaint. Fed. R. Bankr P. 6004(c); Fed. R. Bankr. P. 7004, 9014(b). The rules also spell out the information which must be contained in the notice, including the date of the sale hearing and the time for filing objections. Fed. R. Bankr. P. 6004(c).

The court held that the governing rules must be considered in determining whether the timing and specificity of the notice satisfy due process considerations, and that neither the timing nor the specificity requirements of the Bankruptcy Rules were met in this case. Id. at 905. CVC never received written notice regarding the sale of the property free and clear of its ROFR, and “[a]mbiguous information in a telephone call about a potential sale at a confirmation hearing one week away did not provide CVC with the requisite information, time or opportunity to protect its interest.” Id.

The court went on to dismiss ADM’s arguments that CVC had stuck its head in the sand and, instead, characterized ADM as the proverbial “ostrich” in the case. CVC was not listed as a creditor, identified in the schedules, or included on the mailing matrix. Conversely, CVC’s ROFR was recorded in the land records and appeared in the title report, putting both the debtors and ADM on constructive notice of CVC’s interest in the property.

In sum, the informal notice provided to CVC was simply insufficient to comply with due process under the circumstances, and thus the terms of the plan and confirmation order were not effective to sell free and clear of CVC’s ROFR in the property.

Day One Focus

The ability to sell assets free and clear of liens, claims, and interests in bankruptcy is a powerful tool for both debtors and purchasers, and enables debtors to maximize the value of their assets through Section 363 sales and/or Chapter 11 plans. However, recent case law reinforces the notion that proper notice of free-and-clear asset sales which complies with both statutory and constitutional requirements is of paramount importance.

As an initial matter, it is the responsibility of debtors, as sellers, to provide proper notice to all parties in interests of proposed asset sales pursuant to Section 363 of the Bankruptcy Code. Given that such sales often occur early on the in the bankruptcy process, this should be a critical focus of the debtors from day one in the case.

Moreover, it would significantly benefit purchasers in bankruptcy to shadow the debtors’ noticing process to ensure that proper notice is being provided to all parties in interest. Spending the time and money upfront during the noticing process and ensuring that proper and fulsome notice of the sale is being provided will pay off down the road when the purchaser wants to enforce the critical free-and-clear language of the sale order to bar certain presale claims brought post-sale. 


  1. See generally White v. Jacobs (In re New Century TRS Holdings, Inc.), 528 B.R. 251 (D. Del. 2014), vacated, 612 Fed. App’x 147 (3d Cir. 2015) (the District Court determined that publication notice in The Wall Street Journal, a newspaper with national distribution, was not sufficient in this case but publication in USA Today would be more appropriate since it also enjoys a broad circulation among less than sophisticated, focused readers).
Mark Indelicato

Mark S. Indelicato

Hahn & Hessen LLP

Mark S. Indelicato is managing partner of Hahn & Hessen LLP. He specializes in the practice of bankruptcy and creditors’ rights. He has been counsel to official unsecured creditors’ committees in cases that include Gymboree, Vertellus Specialties Inc., Furniture Brands International Inc., Reichhold Industries, and some of the largest subprime mortgage lender bankruptcies filed, including New Centruy TRS Holdings Inc. and American Home Mortgage Corp. Indelicato is past TMA Global chair and president and past president of the New York Chapter.

Alison Ladd

Alison Ladd

Hahn & Hessen LLP

Alison Ladd is an associate with Hahn & Hessen LLP. Her practice focuses primarily on creditors’ committees, liquidating trustees, and secured and unsecured creditors in complex corporate reorganizations, restructurings, and liquidations. Ladd has extensive experience representing clients in a number of different industries, including retail, manufacturing, wholesale/distribution, and specialty chemicals. Her creditors’ committee representations include Gymboree, Hancock Fabrics Inc., Furniture Brands International Inc., Syms Corporation and Filene’s Basement, 4Kids Entertainment Inc., and Crabtree & Evelyn Ltd.

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Asset Sales
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