Unsuccessful Successors? Limits On Bankruptcy Sales 'Free And Clear' Of Successor Liability

Overview

While many bankruptcy sale orders contain provisions purporting to absolve the purchaser of "successor liability" claims related to the purchased assets or business, a recent case from the U.S. Bankruptcy Court for the Southern District of New York is a reminder of the limits on the enforceability of these provisions—especially against claimants who did not receive notice of the sale order. In In re Grumman Olson Industries, Inc., the bankruptcy court permitted a tort claimant, injured by a product manufactured and sold by the debtor pre-sale, to assert a successor liability claim against the purchaser of the debtor's assets in a Section 363 sale, despite language in the court's own sale order purporting to exonerate the purchaser from such claims.1 The court also engaged in a discussion regarding the nature of the successor liability claim at issue that draws into question the level of comfort that buyers may generally take from bankruptcy sale orders purporting to protect them against successor liability claims.

Successor Liability Claims

As a general proposition, the buyer of assets does not take on liability for claims running against the seller. The state law doctrine of successor liability, however, is an exception to this general rule. Under the doctrine of successor liability, a plaintiff may be permitted to assert against an asset purchaser a claim based on the seller's pre-sale actions. To sustain the claim against the purchaser, a plaintiff is typically required to satisfy three components of the claim: it must prove the merits of the claim as if the claim were asserted against the seller, it must demonstrate that the defendant/purchaser bought the seller's assets related to the claim, plus it must prove one or more additional elements rendering the purchaser's liability appropriate.2 For example, successor liability may in certain states be imposed on a purchaser "for injuries caused by defective products manufactured by a predecessor if the successor continues to manufacture the product."3 Due in part to the requirement of this additional element, which often consists of a conduct requirement on the part of the purchaser, some courts and commentators have characterized successor liability claims as in personam claims against the defendant/purchaser, rather than in rem interests in the transferred property.4

Bankruptcy Code Section 363 Sales "Free and Clear" of

In Personam Claims In bankruptcy sales of assets outside of a plan of reorganization, purchasers rely on Bankruptcy Code Section 363(f), which permits bankruptcy estate property to be sold "free and clear of any interest in such property."5 In the absence of a Bankruptcy Code definition of an "interest in property," many courts have interpreted this statutory language to include certain types of successor liability claims, protecting asset purchasers against such claims where bankruptcy sale orders so provide. The characterization of successor liability claims as in personam claims that follow the asset owner, and not as in rem claims that follow the asset, does not itself defeat an argument that a Section 363 sale may be "free and clear" of successor liability claims. Indeed, there are many courts, particularly those in the Second and Third Circuits, that have placed in personam claims into the category of "interests in property" that can be extinguished in sales under Section 363, so long as such claims are "connected to, or arise from" the assets sold.6 The general view of these courts is that "in personam claims, including any potential state successor or transferee liability claims . . . as well as in rem interests, are encompassed by section 363(f)."7 In the Third Circuit's seminal decision in In re Trans World Airlines ("TWA"), the court ruled that certain discrimination claims of TWA's employees, as well as claims related to a travel voucher program awarded to TWA's flight attendants in settlement of a sex discrimination class action, could be excluded in a Section 363 sale of TWA's airline assets to American Airlines and instead left in the bankruptcy estate of the debtor/seller because those claims would not have arisen but for TWA's investment in airline assets and commercial aviation.8 In other words, because the in personam claims had a relationship to the use to which the transferred TWA assets were put, they were "interests in property," within the meaning of Section 363(f). This logic tends to blur the line between in personam claims and in rem claims for the purposes of "free and clear" sales. And, indeed, there are bankruptcy policies that support an expansion of the...