Bankruptcy Court rules successor ignition switch defect claims are barred against ‘New GM’

Issue November 2015 By Jonathan M. Horne

In the depths of the 2008 financial crisis, General Motors (Old GM) filed the fourth-largest bankruptcy in the history of the United States, seeking approval to sell substantially all of its assets to a newly formed entity (New GM) "free and clear" of its legacy liabilities. At the time, Old GM was bleeding cash and surviving only thanks to emergency loans from the federal government, earning it the dubious nickname "Government Motors." That sale -- totaling approximately $82 billion -- was approved within 40 days of the bankruptcy filing and allowed New GM to emerge from bankruptcy a more financially stable company.

Fast forward to March 2014, when New GM first announced to the public the presence of defects in ignition switches installed in model years prior to the bankruptcy sale. Dozens of accident deaths have reportedly been linked to the defect, which has resulted in one of the largest automobile recalls in history. Significantly, at the time of the bankruptcy sale, dozens of GM employees, including engineers, senior managers and attorneys, knew enough information about the ignition defect to trigger Old GM's obligations under the National Traffic and Motor Vehicle Safety Act to conduct a recall of the affected vehicles. Upon this revelation, vehicle owners immediately filed complaints against New GM. In response, New GM agreed to compensate victims who suffered physical injury or death as a result of the defect, but otherwise argued that the "free and clear" provision of the Bankruptcy Court's sale order insulated it from successor liability on claims for various forms of economic loss. The U.S. Bankruptcy Court for the Southern District of New York -- the same court that approved the bankruptcy sale -- recently entered an order enforcing that sale order and concluding that ignition switch defect claims were barred by the bankruptcy sale order.

The bankruptcy sale

The increasingly favored means of accomplishing a bankruptcy "reorganization" is to sell substantially all of the bankruptcy debtor's assets free and clear of all liens, claims and encumbrances under Bankruptcy Code § 363. These so-called "363 Sales" amount to an effective short sale of the going concern business, with the Bankruptcy Court sale order insulating the purchaser from claims of pre-bankruptcy creditors. Generally, the purchaser of a debtor's assets is not liable for claims asserted against the debtor unless the purchaser expressly agrees to assume such liabilities. However, in the case of future claims against a purchaser -- such as where a product sold prior to the bankruptcy sale injures someone after the sale -- the issue becomes much thornier when these future claimants lacked sufficient notice and constitutional due process that are bedrock principles on which bankruptcy sales are built.

By any standard, the GM bankruptcy and 363 Sale were remarkable. The company employed over 200,000 people and did business with approximately 11,500 vendors as part of its supply chain that employed approximately 500,000 more people. These factors alone made it a complex deal, made only more complicated by the United States and Canadian governments' involvement and a 40-day closing deadline. In total, 850 parties in interest objected to the sale in one form or another, although the majority of objections were to specific provisions of the proposed order -- including the free and clear provision -- and not to the sale as a whole. Ultimately, the court overruled objections to the free and clear provisions and concluded that New GM should be protected from successor liability claims.

The ignition switch claimants

While the ignition switch defect resulted in many accidents causing injury and death, New GM had agreed to satisfy claims for death, personal injury and property damage in accidents occurring after the 363 Sale involving vehicles manufactured by New GM and Old GM alike. Furthermore, the Sale Order did not insulate New GM from its obligations to conduct recalls and fix defects in accordance with federal and state law, even for defects in vehicles manufactured by Old GM.

Thus, the claims put at issue by the 363 Sale were limited to mostly unliquidated claims alleging an amalgam of economic loss damages estimated in the aggregate between $7 and $10 billion. These economic loss damages allegedly flowed from such things as the reduction in the resale value of affected cars, other economic loss, such as missing work when getting the ignition switch replaced, and inconvenience. Other classes of claimants included victims suing with respect to accidents occurring before the bankruptcy sale, and owners of non-defective GM vehicles claiming that the defect and recall caused damage to the GM brand and thus resulting economic loss to them.

The court's analysis

The Bankruptcy Court focused on whether the bankruptcy sale process afforded the various ignition switch claimants procedural due process, and if not, whether the court could or should do anything about it at this stage.

Generally, notice must be provided in bankruptcy cases that is reasonably calculated, under all the circumstances, to apprise people of the pendency of any proceeding that may result in their being deprived of any property, and to afford them an opportunity to present their objections. However, where the identities of creditors are known, actual notice must be given. Thus, while the court concluded that notice by publication was sufficient to all vehicle owners generally, it was not sufficient to owners whose cars had ignition switch defects, because at that time Old GM had a known recall obligation and knew the names and addresses of those owning the affected vehicles. As a result, ignition switch defect claimants had not received sufficient notice of the 363 Sale.

However, even where a claimant has not received sufficient notice, due process is not violated unless the lack of notice results in actual prejudice to the aggrieved party. Thus, the court concluded that while the claimants were prejudiced with respect to the bar date for filing claims against Old GM, only economic loss claimants were prejudiced with respect to the 363 Sale because at the time of the sale, the court considered and rejected most of the same arguments the ignition switch claimants now advanced. In one respect, however, the court held that economic loss claimants were prejudiced by their lack of notice, noting that no one had argued - as they were now - that the proposed bankruptcy sale order was overbroad in that it should not have excluded claims involving Old GM vehicles and parts, so long as the claims were based solely on New GM conduct and not successor liability.

Given that certain claimants' procedural due process rights had been violated, the court concluded that they deserved a remedy tailored to the prejudice they suffered, to the extent the law permits. However, the fact that purchasers of bankruptcy assets like New GM acquire property rights too, and that taking away purchasers' contractually bargained-for rights strikes at the heart of the bankruptcy system, was also a critical factor in the court's analysis. In light of these concerns, the court settled on a "remedy" of sorts by clarifying that under its previous sale order New GM would have liability for ignition switch defect claims only to the extent that it had engaged in its own independently wrongful conduct, and not because it assumed any Old GM liabilities. Ultimately, the court affirmed that New GM would not suffer successor liability for Old GM liabilities, and thus cautioned trial courts analyzing claims that are supposedly against New GM to be extraordinarily careful to ensure that they are not in substance successor liability claims "dressed up to look like something else."

Conclusion

While the GM bankruptcy and sale were certainly unique in scope and circumstance, the court's ruling that ignition switch claimants cannot assert successor liability claims against New GM based on Old GM conduct reaffirms that sales "free and clear" of prepetition claims mean what they say, and that buyers can generally rely on the protections provided by bankruptcy sale orders even where substantial unknown liabilities are subsequently revealed.

This article appeared in the Summer 2015 edition of the ComCom Quarterly, the newsletter of the Complex Commercial Litigation Section. For more articles like these on business litigation, bankruptcy and intellectual property topics, check out the Quarterly at http://is.gd/lFJCJw.