Second Circuit: Despite 363 Sale, GM Cannot Avoid Liability for Faulty Ignition Switches

by John Stoelker

In re Motors Liquidation Company, Case No. 15-2844 (2d Cir., July 13, 2016)

By John Stoelker, Esq.

In a decision that may threaten the reliability and enforceability of future bankruptcy sales, the U.S. Court of Appeals for the Second Circuit ruled on Wednesday that, despite the “free and clear” acquisition of substantially all assets of General Motors Corporation, the purchaser could not avoid successor liability claims relating to faulty ignition switches.  The decision dealt a major blow to the surviving entity, General Motors LLC, which may now be required to defend against the claims, with as much as $10 billion at stake.

As early as 2002, General Motors Corporation (“Old GM”) began producing vehicles with an ignition switch that was known to be faulty.  Specifically, as customer complaints would soon confirm, the application of only a minimal amount of force could cause the key in the ignition to switch from the “on” to the “off” position.  While initially categorized by Old GM as a “non-safety issue,” a series of tragic accidents attributable to a sudden loss of power was determined by Old GM to have been most likely caused by a problem with the ignition switch.

 

After suffering major losses during the financial crisis of 2007 and 2008, President Obama announced that the solution to Old GM’s financial woes would be a “quick, surgical bankruptcy.”  On June 1, 2009, Old GM filed for Chapter 11 bankruptcy protection and, on the same date, filed a motion to sell substantially all of its assets to New GM free and clear of liens, claims, encumbrances, and other interests, including any successor or transferee liability.  Shortly thereafter, the bankruptcy court approved the proposed sale through the entry of an order pursuant to Section 363 of the Bankruptcy Code (the “Sale Order”).  On July 10, 2009, the transaction officially closed and New GM began operating its business.

It was not until February 2014 that New GM began recalling cars with ignition switch defects.  This quickly resulted in various class action lawsuits claiming that the faulty ignition had caused personal injuries and economic losses, both before and after the 363 sale.  In response, New GM asked the bankruptcy court to enforce the “free and clear” provisions of the Sale Order, claiming that this language shielded it from successor liability with respect to any and all damages resulting from Old GM cars.

The bankruptcy court agreed with New GM, and held that New GM could not be sued in connection with ignition switch claims that could have been asserted against Old GM prior to the 363 sale, unless the claims resulted from New GM’s own wrongful conduct.  Notably, the bankruptcy court acknowledged that because the ignition switch claims were known or could have been known to Old GM prior to the sale, plaintiffs were entitled to actual notice (as opposed to publication notice) of the sale.  However, the bankruptcy judge ruled that this lack of procedural due process did not prejudice the plaintiffs because he would have approved the sale anyway and, as such, could not prevent enforcement of the Sale Order.

On appeal, the Second Circuit considered the application of the Sale Order to four categories of claims:  (1) claims arising from accidents involving Old GM cars that occurred prior to the closing; (2) economic loss claims (such as loss of car value) arising from the ignition switch defect or other defects; (3) independent claims relating exclusively to the conduct of New GM; and (4) the claims of used car purchasers.

With respect to the third and fourth categories of claims, the Court held that these claims are outside the scope of the Sale Order and, thus, are not subject to its “free and clear” provisions.  Claims relating exclusively to the conduct of New GM (e.g., a misrepresentation by New GM about the quality of Old GM cars) and claims of used car purchasers who bought Old GM cars after the 363 sale cannot be enjoined by the Sale Order, because the claimants could not have possibly known that their claims existed prior to the 363 sale.

With respect to the first and second categories, however, the Court found both to be precluded by the Sale Order’s “free and clear” provisions, as both types of claims arose pre-closing.  With respect to pre-closing accidents involving Old GM cars, the existence of a claim against Old GM arising from such an accident fits squarely within the language of the Sale Order.  As for the economic loss claims which may not have been revealed to the claimants until several years after the closing, the Court nonetheless concluded that they existed as “contingent” claims prior to the closing, and are enjoined by the Sale Order.

However, despite holding that the first two categories of claims were enjoined by the Sale Order, the Second Circuit dealt another blow to New GM by disagreeing with the bankruptcy court’s procedural due process ruling.  Because Old GM knew or should have known about the ignition switch defect, all individuals with potential claims arising from the defect were entitled to actual notice of the 363 sale by direct mail or otherwise and not merely by publication of notices in general circulation newspapers.  The Court disagreed with the bankruptcy court’s finding that the lack of notice was not “prejudicial,” as these claimants would have had the opportunity to oppose the entry of the Sale Order had they been afforded due process through actual notice.  This, in turn, might have enabled them to negotiate a deal, as other constituencies had managed to do during the sale approval process.

This potentially catastrophic result for New GM, which now must defend itself against claims totaling nearly $10 billion, underscores the limitations of “free and clear” sale orders and the importance of providing actual notice to all potential claimants, even those with contingent claims.

And potential purchases, fearing possible attacks based on successor liability theories, would do well to consider the implications of this decision.  Many may be well served to anticipate such attacks when negotiating the asset purchase agreement to protect themselves if such claims are later asserted.  A typical provision could include escrowing an appropriate portion of the sale price to protect the  buyer from claims of people who were not, but should have been, given notice of the 363 sale.