Section 363 and the Limits of Buyer Protection

Section 363 and the Limits of Buyer Protection

Asset sales through bankruptcy are all the rage – they’re presumably [relatively] quick.  And just as importantly, they’re perceived as clean – that is, they permit assets to be sold “free and clear” of an “interest” in the property.


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The term “interest” has been construed broadly, and has been interpreted to extend to successor liability claims – including often prohibitively expensive environmental liabilities.  Indeed, one recent post on this blog (here) notes the potentially broad reach of bankruptcy court orders authorizing asset sales – and suggests the relief available in some circumstances may even be broader than the Chapter 11 discharge.

But not all courts agree with this conclusion . . . at least not entirely.

Late last month, the Southern District of New York (the same jurisdiction which authorized the “Section 363” sale of General Motors free and clear of environmental liabilities) reached a different result in the case of In re Grumman Olson Industries, Inc.

Grumman Olson, an auto-body manufacturer whose primary customers were Ford and General Motors, commenced Chapter 11 proceedings nearly nine years ago and completed a “363 sale” of its assets to Morgan Olson, LLC about 6 months after filing.  The sale order contained provisions which purported to release both Morgan Olson and the sold assets themselves from any successor liability claims which might arise.

Ms. Frederico, a FedEx employee, sustained serious injuries on October 15, 2008 when the FedEx truck she was driving hit a telephone pole.  In a New Jersey lawsuit filed after the accident, the Fredericos claimed that the FedEx truck involved in the accident was manufactured, designed and/or sold by Grumman in 1994, and was defective for several reasons.  The Fredericos claimed that Morgan Olson continued Grumman‘s product line, and was, therefore, liable to the Fredericos as a successor to Grumman under New Jersey law.  In response, Morgan Olson requested that Bankruptcy Judge Stuart Bernstein re-open the [now closed] Grumman Olson case, then filed an adversary proceeding to determine that the Federico’s claim was barred by the prior sale order.

Both sides sought Judge Bernstein’s summary judgment regarding the Morgan Olson suit.  In a 21-page decision, Judge Bernstein ruled (following a brief discussion addressing his continuing jurisdiction to interpret the prior sale order) that  Morgan Olson was, indeed, a successor for purposes of the Fredericos’ suit.  This was because the Fredericos’ claimed injuries arose not from the assets sold through bankruptcy, or from personal claims against Grumman Olson that arose prior to Grumman’s Chapter 11, but from Morgan Olson’s post-confirmation conduct:

the Fredericos are basing their claims on what Morgan [Olson] did after the sale. According to their state court Amended Complaint, Morgan [Olson] is liable as a successor under New Jersey law because it “continued the product line since the purchase,” “traded upon and benefited from the goodwill of the product line,” “held itself out to potential customers as continuing to manufacture the same product line of Grumman trucks” and “has continued to market the instant product line of trucks to Federal Express.” The Sale Order did not give Morgan [Olson] a free pass on future conduct, and the suggestion that it could is doubtful.

A good portion of Judge Bernstein’s decision is devoted to a discussion of what constitutes a “claim” for bankruptcy purposes – and the circumstances under which an anticipated “future tort claim” (i.e., claim based on a defective product manufactured by the debtor which hasn’t yet caused an injury, but which will at some point in the future) may be addressed through a “Section 363” sale.

In permitting the Fredericos to proceed with their New Jersey law suit against Morgan Olson, Judge Bernstein’s analysis focused on three areas:

– the Fredericos’ lack of any meaningful “contact” with Grumman prior to the commencement of Grumman’s case or confirmation of Grumman’s Chapter 11 plan;

– the absence of any notice by the Fredericos of the Grumman/Morgan sale; and (though less important than the lack of contact and lack of notice)

– the absence of any provision for such anticipated “future claims” in Grumman’s Chapter 11 plan.

In the end, he observed that “every case. . . addressing this issue has concluded for reasons of practicality or due process, or both, that a person injured after the sale (or confirmation) by a defective product manufactured and sold prior to the bankruptcy does not hold a ‘claim’ in the bankruptcy case and is not affected by either the § 363(f) sale order or the discharge under 11 U.S.C. § 1141(d).”

Judge Bernstein’s Grumman Olson decision serves as an important reminder that “section 363 sales” – though undoubtedly a very powerful tool for disposing of distressed assets quickly and cleanly – do not provide “bullet-proof” protection for any type of liability which might be associated with the debtor’s assets, or with its general product line.

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