Providing an important reminder about the intersection of privacy law and bankruptcy, a bankruptcy judge has ordered the appointment of a consumer privacy ombudsman in the Chapter 11 case filed by Crumbs Bake Shop.

Crumbs – a publicly held company selling cupcakes and other baked goods – filed for Chapter 11 protection in July in the face of severe liquidity problems. The company then filed a motion seeking permission from the U.S. Bankruptcy Court in New Jersey for an auction sale that would include Crumbs’ intellectual property, consisting of such data as names, phone numbers, and addresses.

The U.S. Trustee quickly responded by filing a motion requesting that the court appoint a privacy ombudsman.

Auctioning the customer lists would violate Crumbs’ privacy policy, the trustee said, which stated that the company “is highly sensitive to the privacy interests of consumers and believes that the protection of those interests is one of its most significant responsibilities.”

The policy contained just three exceptions, which stated that customer information would be shared “only if we are compelled to do so by order of a duly-empowered governmental authority, we have the express permission of the consumer, or it is necessary to process transactions or provide our services.”

None of these exceptions applied to a bankruptcy auction, the trustee argued. “Since the sale of the customer lists to a third party does not fall within one of the carved-out exceptions, the sale of the lists is prohibited,” the trustee wrote in her motion. “To read the policy differently would render the debtors’ privacy policy meaningless, leading consumers to believe their personal information is protected when in fact, it is not.”

To reconcile the inconsistency between the privacy policy and the proposed auction, the trustee advocated for the appointment of a consumer privacy ombudsman pursuant to the Bankruptcy Code, 11 U.S.C. Section 363(b)(1)(B).

Once the ombudsman has been appointed, that provision would allow the sale to go forward only with the court’s permission after a hearing “giving due consideration to the facts, circumstances, and conditions of such sale” and “finding that no showing was made that such sale…would violate applicable nonbankruptcy law.”

To help guide the court’s consideration, the ombudsman would provide information at the hearing regarding the potential losses or gains of privacy and possible costs or benefits to consumers in the event of the sale as well as alternatives that could mitigate privacy losses or costs to consumers.

Bankruptcy Court Judge Michael B. Kaplan agreed, granting the trustee’s order.

To read the U.S. Trustee’s motion for the appointment of a consumer privacy ombudsman, click here.

To read the court’s order granting the motion, click here.

Why it matters: While no company wants to plan for its own bankruptcy, the possibility should be a consideration when drafting a privacy policy. Including an exception in a privacy policy that allows for the sale or transfer of information collected in a bankruptcy or other sale or merger of the company is a must.