Now Coming to a Bankruptcy Court Near You: The Section 363 Discharge(?!)

18 Jan Now Coming to a Bankruptcy Court Near You: The Section 363 Discharge(?!)

Norton’s recently-published 2010 Annual Survey of Bankruptcy Law offers an intriguing article focusing on an often-overlooked difference between “Section 363 sales” and Chapter 11 Plans – and suggesting that, for certain liabilities, Section 363 may actually afford broader relief than a Chapter 11 discharge.

In Classic Chapter 11 Reorganizations Versus Section 363 Sales And The Effects On Environmental Cleanup Obligations: The Choice After Apex Oil Co. And General Motors, authors Joel Gross and Christopher Anderson contend:

“[U]nless the law [surrounding Section 363 sales] changes, any debtor seeking to provide maximum protection to its surviving business from broad cleanup liabilities for divested properties would be best advised to utilize a Section 363 sale.  The protection from successor liability that can be achieved through such a sale will very likely exceed the more narrow discharge from monetary claims that can be obtained if the property is transferred under a plan of reorganization.”

In support of their argument, Gross and Anderson compare the results of two recent decisions – In re Apex Oil and the 2009 In re General Motors Corp. decision.

In Apex Oil, the 7^th Circuit held that, despite its prior discharge in Chapter 11, the reorganized debtor remained liable for environmental liabilities incurred years earlier on the grounds that such liabilities were not “claims” subject to discharge under Chapter 11’s provisions.  A prior post regarding Apex is available here.

In General Motors – by contrast – the the US Government supported, and the Bankruptcy Court accepted, the transfer of GM’s business assets to a newly-formed entity (“New GM”) under a sale “free and clear of all . . . interests,” including successor liability claims.  In reaching this decision, the Bankruptcy Court relied on the reasoning set forth in In re Trans World Airlines, Inc., 322 F.3d 283 (3d Cir.2003) – i.e., that Section 363 provides a basis for selling assets free and clear of successor liability claims.

Not every circuit permits an extension of Section 363’s “free and clear” language to successor liability claims.  See Michael H. Reed, Successor Liability and Bankruptcy Sales Revisited—A New Paradigm, 61 Bus. Law. 179, 208–211 (2005) (surveying the lower courts’ application of TWA).  Though at least one District Court and the Ninth Circuit Bankruptcy Appellate Panel have followed the TWA decision, the Ninth Circuit has not explicitly ruled.

Consequently, “[i]n light of the split in circuit authority, it remains to be seen whether the view that successor liability claims can ultimately be cut off via a Section 363 sale will prevail.  For the time being, however, the majority of appellate courts (including the Second and Third Circuits where so many major Chapter 11 cases are fled) have held that they can, and there seems to be a similar trend in the lower courts.”

That said, the use of Section 363 to avoid environmental liabilities isn’t without its problems: “One potentially important limitation, which appears not to have been addressed by any court to date, is Section 363(e)’s requirement that all sales approved under Section 363 provide adequate protection for the interest of any entity in the property sold.”

Other issues present themselves as well.  For example:

– Is it possible to provide for liens against the sale proceeds for successor interests?  Gross and Anderson don’t think so – as they see it, doing so would provide otherwise-unsecured creditors with preferential treatment.

– How much are contingent successor claims truly worth?  Even if it were possible to provide “adequate protection” for successor claims, doing so raises the question of what such claims are truly worth.

– Finally, the ability to shield assets from successor liability claims frequently implicates the Court’s equitable power under Section 105, and the extent of its scope.

Problematic or not, these considerations likely won’t stop debtors from taking a shot at a sale: “[G]iven the certainty following Apex Oil that at least some injunctive claims will survive a traditional chapter 11 reorganization, it can be expected that debtors with significant environmental exposure will prefer to follow the roadmap laid out in GM.”