It is common knowledge that the Bankruptcy Code provides a debtor with a “fresh start” by allowing it to discharge prepetition claims. Similarly, section 363 of the Bankruptcy Code allows a trustee or debtor in possession to sell property of the estate “free and clear” of prior claims. These two concepts, while relatively straightforward, raise a fundamental question — when does a creditor hold a “claim” for purposes of the Bankruptcy Code? This question is particularly relevant in the case of future claims, that is, where a debtor’s pre-bankruptcy conduct results in post-bankruptcy injuries. This article discusses two recent cases that grappled with this issue and ultimately hold that certain future claims were not discharged by a bankruptcy case.
Section 101(5)(A) of the Bankruptcy Code defines a claim as a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” Congress intended this definition to be broad so that all legal obligations of a debtor — no matter how remote or contingent — would be resolved during a bankruptcy case. “Future tort claims” exist where (i) the claimant has had pre-petition contact with the debtor or its product but has not yet discovered the injury (e.g., asbestos cases); or (ii) where a product manufactured or sold by the debtor before the bankruptcy injures a claimant after the debtor has emerged from bankruptcy. See In re Chateaugay Corp., 944 F.2d 997 (2d Cir. 1991). The second category poses a number of challenges, because the claimants are typically unidentifiable at the time of the bankruptcy and cannot be given notice of the proceedings or their effect on the claimants’ rights. To address this problem, most courts hold that a claimant has a “claim,” within the meaning of the Bankruptcy Code, only if: “(i) events occurring before the confirmation create a relationship, such as contact, exposure, impact, or privity, between the claimant and the debtor’s product; and (ii) the basis for liability is the debtor’s prepetition conduct in designing, manufacturing and selling the allegedly defective or dangerous product.” In re Piper Aircraft, Corp., 58 F.3d 1573 (11th Cir. 1995). This relationship must be between an “identifiable claimant or group of claimants” and the debtor’s prepetition conduct.
In re Grumman Olson Industries
Grumman Olson Industries, Inc. was a designer and manufacturer of truck body parts that filed for bankruptcy in 2002. No. 11-2291, 2012 WL 1038672 (S.D.N.Y. 2012). Before its filing, Grumman’s products were routinely incorporated into Ford and General Motors vehicles. During its bankruptcy proceeding, Grumman sold certain of its assets to a predecessor of Morgan Olson LLC pursuant to section 363 of the Bankruptcy Code. The sale order provided, among other things, that Morgan was free of liability for claims against Grumman arising prior to the sale or related to the purchased assets. Following confirmation of Grumman’s liquidating plan in 2006, Morgan continued to produce and market the product line as that of Grumman.
In 2009, John and Denise Frederico commenced a lawsuit against Morgan in New Jersey state court, alleging that they were injured by a product manufactured, designed and/or sold by Grumman in 1994 — years before the commencement of Grumman’s bankruptcy case. In particular, Ms. Frederico alleged that she was seriously injured in 2008 when her truck hit a telephone pole, and that Morgan was responsible for her injuries under the theory of successor liability. In response, Morgan commenced an adversary proceeding against the Fredericos in bankruptcy court, arguing that the sale order absolved Morgan of any liability for Grumman products manufactured or sold prior to the sale. The bankruptcy court held that the Fredericos’ did not hold a “claim” within the meaning of section 101(5), because at the time of the sale, the Fredericos were not identifiable claimants and therefore they could not have been notified of the release of their claims as required by due process. (For a more detailed discussion of the Grumman bankruptcy court decision, see “A Sale ‘Free and Clear’ is Not Necessarily Free and Clear of All Future Tort Liability,” International Restructuring Newswire, May 2011.)
On appeal, the bankruptcy court’s decision was affirmed by the District Court for the Southern District of New York. The district court stressed that sufficient notice is the “cornerstone underpinning of Bankruptcy Code procedure,” and that for due process reasons, a party that does not receive adequate notice of a bankruptcy proceeding cannot be bound by orders issued during that proceeding. In the case of future tort claims, the claimant is, for all practical purposes, unidentifiable and cannot be provided with appropriate notice of the bankruptcy filing. The court thus held that “[e] nforcing the Sale Order against the Fredericos to take away their right to seek redress . . . when they did not have notice or an opportunity to participate in the proceedings that resulted in that order would deprive them of due process.”
Morgan’s primary argument against imposing successor liability was that allowing this type of claim to survive section 363’s “free and clear” provisions would reduce the amount that potential purchasers are willing to pay for a debtor’s assets in a bankruptcy sale. According to Morgan, this would violate the Bankruptcy Code’s policy of maximizing the value of the estate. The district court summarily dismissed this contention, explaining that “to whatever extent maximizing the value of the estate is an important policy of the Bankruptcy Code, it is no more fundamental than giving claimants proper notice and opportunity to be heard before their rights are affected, to say nothing of constitutional requirements of due process.”
In re Lear Corporation
Though Grumman dealt with complicated issues of contingent liability, the facts of the case were relatively straightforward — a product created before the bankruptcy resulted in an injury occurring after the bankruptcy. In In re Lear Corp., No. 09-14326, 2012 WL 443951 (Bankr. S.D.N.Y. 2012), by contrast, the debtor’s alleged wrongful conduct and the resulting injury spanned before and after the bankruptcy. Such facts present a substantially more complex question of when claims arise for purposes of the Bankruptcy Code.
Lear Corporation was a manufacturer of auto parts that filed for chapter 11 in 2009 due to a weak automotive industry. The company underwent a relatively quick restructuring and in late 2009 it received a discharge of claims pursuant to a confirmed plan of reorganization. Two years later, Lear became the subject of several class action antitrust lawsuits alleging that it had engaged in a continuous price-fixing conspiracy since January 2000.
In response to the antitrust complaints, Lear filed a motion in the bankruptcy court to enforce the discharge and injunction provisions contained in its confirmed plan. Lear argued that the antitrust causes of action were claims that had been discharged and that the plaintiffs were therefore barred from bringing suit. The antitrust plaintiffs responded by arguing that it was post-confirmation conduct that gave rise to Lear’s liability and therefore the claims had not been discharged.
Similar to Grumman, the central question for the bankruptcy court was whether the causes of action asserted by the antitrust plaintiffs were “claims” within the meaning of the Bankruptcy Code at the time the discharge was granted. The court began its analysis with the principle that a contingent claim may be discharged if the underlying acts occurred before the bankruptcy petition. The court then examined two cases where this principle had been applied to antitrust violations. In both cases, all of the acts giving rise to liability had occurred prepetition, and thus the courts held that the antitrust claims had been discharged.
The Lear court agreed with these prior rulings and held that to the extent the causes of action asserted by the antitrust plaintiffs arose prepetition, the antitrust plaintiffs held “claims” that had been discharged. The court also held that to the extent the debtor’s conduct gave rise to antitrust liability after the bankruptcy, the plaintiffs were not enjoined from bringing suit. While bankruptcy may offer a debtor a fresh start, a “debtor is responsible for the consequences of its actions after it emerges from chapter 11.” In this instance, the plaintiffs asserted that after its bankruptcy, Lear had committed overt acts in furtherance of the antitrust conspiracy and such acts gave rise to liability for the entire life of the conspiracy. By contrast, Lear argued that only the original conspiratorial agreement should give rise to liability, since future anticompetitive sales were only a “rippling effect” of the original conspiratorial agreement.
Recognizing that application of antitrust principals will be “intensely factual,” the bankruptcy court declined to decide when the antitrust “claims” came into being, and deferred the issue to the trial court. This procedural aspect signals that in some cases bankruptcy courts may decline to rule on complex factual issues with respect to when claims arise. Interestingly, the Lear court seemed to dismiss the due process concerns raised in Grumman, holding that notice was a “separate issue” and that the plaintiffs’ due process arguments were “not ripe for decision.”
The Lear and Grumman decisions demonstrate that there is continuing uncertainly as to the effect of bankruptcy proceedings on future claims. There is at least one company, however, that has partially succeeded in avoiding this type of future liability.
In 2009, Chrysler underwent a government-back restructuring whereby the company’s assets were sold to “New Chrysler” pursuant to a section 363 sale. The sale order immunized New Chrysler from punitive damages claims resulting from manufacturing defaults in vehicles sold before the restructuring. Thus, individuals who purchased vehicles before Chrysler’s bankruptcy were precluded from bringing punitive damages claims against Chrysler if they were subsequently injured by the vehicle after Chrysler’s restructuring (the same fact scenario as Grumman). Chrysler remained liable for future lawsuits, but only with respect to compensatory (actual) damages. While punitive damages can be excessive and unpredictable, they provide a powerful incentive for recalls and subsequent safety modifications.
Following Chrysler’s bankruptcy, several individuals injured by Chrysler vehicles have been precluded from bringing punitive damage claims against Chrysler. Understandably, these individuals have been surprised to learn that their claims were essentially discharged by a bankruptcy proceeding in which they were not involved. Now retired U.S. Bankruptcy Judge Arthur Gonzalez, who approved the Chrysler sale, was recently quoted in a Wall Street Journal article observing that “[w]ithin the parameters of ‘due process,’ it appears that bankruptcy law allows for the cutting off of liability and thereby protecting the purchaser who has paid for value.” Judge Gonzalez’s comments suggest that even though these future claimants were unidentifiable at the time of the bankruptcy sale, their due process rights were not harmed.
General Motors, which also went through a governmentbacked restructuring, attempted to include similar language in its sale order, but was unsuccessful. Because General Motors is a larger company than Chrysler and has far more older cars on the roads, various states opposed GM ’s attempt to abandon future liability. Wary of a potential public backlash and hesitant to delay the sale, GM agreed to retain future liability, including punitive damages claims. In this regard, it was politics — not law — that thwarted GM ’s attempt to discharge future liability.
Chrysler offers an attractive model for debtors looking to limit future liability. The success of such efforts will depend on careful drafting of the appropriate orders and may ultimately still be called into question by the courts. For now, however, debtors and asset purchasers should continue to carefully investigate the existence and nature of potential future claims when implementing a reorganization or liquidation strategy.