Parties to all legal proceedings - including bankruptcy proceedings - are entitled to Constitutionally protected due process rights, including reasonable notice and an opportunity to be heard. In the bankruptcy context, the debtor must give known creditors reasonable notice of certain critical events, including the sale of the debtor’s assets and the deadline to file claims against the debtor.

Another important aspect of a bankruptcy case is a debtor-in-possession’s ability to sell its assets under section 363 of the Bankruptcy Code to a purchaser “free and clear” of claims and interests, including possible successor liability claims, shielding purchasers of a debtor’s assets from claims of the debtor’s creditors. These “free and clear” protections increase the marketability of the debtor’s assets and are an essential part of the bargained-for consideration received by most purchasers in a bankruptcy sale.

In a recent opinion issued In re Motors Liquidation Company (i.e., the GM bankruptcy case), No. 09-50026, 2015 Bankr. LEXIS 1296, the Bankruptcy Court for the Southern District of New York addressed due process and related issues in the context of a motion by GM Motors, LLC (New GM) to enforce the provisions of the court’s 2009 order (the sale order), approving the sale of substantially all of the assets of General Motors Corporation (Old GM) to New GM free and clear of, among other things, successor liability claims.

In the opinion, the court dealt primarily with tricky due process issues resulting from economic loss claims (asserted by the Economic Loss Plaintiffs) arising from ignition switch defects affecting approximately 27 million vehicles, defects GM knew about before both the 363 sale and the deadline for filing proofs of claim in the bankruptcy case. (These claims are for product recalls and related damages, and do not include personal injury or property damage claims). These ignition switch claimants, some of whom filed class action suits against New GM with claims in the $7-10 billion range after New GM’s March 2014 announcement of the defects, however, never received actual notice from Old GM of either deadline (nor did they receive recall notices that Old GM was required to, but did not, send). The decision also dealt with personal injury claimants who were allegedly injured prior to the closing of the 363 sale (Pre-sale Closing Plaintiffs) as a result of ignition switch defects – these creditors likewise were not provided with notice of the sale or claims bar date. It is important to note that the court’s decision did not deal with any accident claims involving post-sale closing deaths, personal injuries or property damages, including claims that might have resulted from the ignition switch defects, as New GM voluntarily agreed to assume responsibility for such accident claims after the sale motion was filed.

Old GM’s failure to provide actual notice to the Economic Loss Plaintiffs and the Pre-sale Closing Plaintiffs (collectively, the Plaintiffs) raised related due process questions as to whether these claimants could (1) assert claims (caused by Old GM) against New GM under a theory of successor liability, (2) file late proofs of claim in Old GM’s bankruptcy case, having missed the proof of claim filing deadline, and (3) participate in distributions being made to unsecured creditors under Old GM’s chapter 11 plan (the Plan), assuming that their claims could be allowed.

The court held that the Plaintiffs’ claims arising from the ignition switch defects are subject to the sale order’s free and clear provisions barring the assertion of successor liability claims. In other words, the plaintiffs’ claims related to the ignition defects caused by Old GM cannot now be asserted against its successor, New GM.

The court concluded that, while these claimants were denied their due process notice rights in connection with the sale, no due process violation occurred, which further requires that the claimant demonstrate that it was prejudiced as a result of the notice deficiency. According to the court, the Plaintiffs suffered no prejudice, and so no due process violation, as a result of Old GM’s failure to provide the required notices in connection with the sale.

The lack of prejudice stems from the fact that, while the Plaintiffs did not get notice of the sale, other similarly situated creditors did get notice of the sale, filed objections, raised the very same successor liability arguments that these claimants asserted, and the court overruled all of these objections and permitted the sale of Old GM’s assets to New GM free and clear of successor liability claims. In other words, the terms of sale order are enforceable to enjoin successor liability claims against New GM because, even if the Plaintiffs had had the opportunity to object to the sale, their objections likewise would have been overruled and the sale to New GM, free and clear of successor liability, still would have been approved.

The court did hold, however, that the Economic Loss Plaintiffs were prejudiced by the lack of due process: they missed an opportunity to advance one argument in opposition to the proposed sale order that had not been raised by other claimants at the sale hearing in 2009. These claimants argued, and the court agreed, that the sale order should not have barred causes of action against New GM arising out of New GM’s own, independent, post-sale acts so long as the claims are not based on acts committed by Old GM. The court allowed these types of claims to proceed even though the sale order would otherwise have enjoined the claimants from pursuing New GM for these claims. By contrast, the court held that the Pre-sale Closing Plaintiffs could not assert successor liability claims against New GM because their claims occurred while Old GM was in existence, in Old GM cars using Old GM parts “before New GM could have done anything wrong” and, thus, could not be asserted against New GM.

In addition to denying the Economic Loss Plaintiffs the right to pursue New GM on successor liability claims caused by Old GM, the court further barred these claimants from filing claims in Old GM’s bankruptcy case and obtaining distributions from the liquidating trust established for general unsecured creditors (the GUC Trust). Importantly, the court denied that relief even though it found that Old GM clearly violated the creditors’ due process rights by failing to notify them of the claims bar date, and even though they didn’t learn of the existence of these claims until almost five years after the bankruptcy claims bar date.

The court determined that the Economic Loss Plaintiffs’ claims were equitably moot. Specifically, the court found that allowing such claims would require a modification of Old GM’s Plan; and modifying Old GM’s Plan to allow the late claims would prejudice the expectations of Old GM’s other creditors regarding, among other things, the size of the claim pool and the timing of distributions on account of their claims. In addition, the plaintiffs’ intentional failure to seek a stay of a claim distribution (made after they became aware of their claims against Old GM) also made the application of equitable mootness doctrine appropriate. While the delay was not particularly long, it prevented the court from staying a large distribution to creditors.

Whether or not one agrees with the court’s ruling, the practical aspects of this decision are striking. The Economic Loss Plaintiffs were deprived of their right to assert claims and receive distributions from the GUC Trust that, but for GM’s due process violations, they would have received had their claims been filed and allowed. The decision also raises important bankruptcy policy questions including whether this outcome creates improper incentives for debtors who are subject to product liability and latent defect claims and how the rights of creditors who are affected by such lack of notice are to be dealt with in future cases.

The battle will rage on. Knowing the importance and controversial nature of its opinion, the bankruptcy court certified its judgment for review to the Second Circuit Court of Appeals. The outcome of this appeal will be of great interest to creditors, debtors, the bankruptcy community and the general public.