by Leonard P. Goldberger, Carol Mann
(TMA International Headquarters)
This is the third of a three-part series on the problem of successor
liability in buying businesses and assets out of bankruptcy. Last month’s
article discussed the successor liability problem in the context of “free and
clear” sales under section 363 of the Bankruptcy Code. This article focuses on
how the successor liability problem is dealt with in sales under confirmed
Chapter 11 plans.
While sales of assets
under confirmed Chapter 11 plans are by no means “bulletproof,” they
often stand a better chance of precluding successor liability claims than “free
and clear” sales under section 363 of the Bankruptcy Code. This reflects a judicial
recognition that reorganizations under Chapter 11 should offer more comprehensive relief.
As such, more narrow non-bankruptcy law rights such as successor liability
must yield the broader goals of complete financial rehabilitation. At least, that’s how
it’s supposed to work.
A “Claim” Is a “Claim”
As previously discussed, acquisitions of assets out of business bankruptcy
cases are generally made either as sales out of the ordinary course of business
under section 363 of the Bankruptcy Code or under a confirmed Chapter 11 plan of
reorganization (or liquidation). One problem with “free and clear” sales under
section 363 of the Bankruptcy Code is the “claim” vs. “interest” distinction.
Some courts have held that section 363 only permits sales which are “free and
clear” of “interests” in property (liens, mortgages, judgments, etc.), but not
of “claims” for successor liability. This limitation does not, however, appear
in the sections of the Bankruptcy Code that authorize asset sales under a
confirmed Chapter 11 plan.
Section 1123(a)(5)(D) of the Bankruptcy Code
authorizes sales of assets “free and clear,” notwithstanding any otherwise
applicable non-bankruptcy law. More importantly, section 1141(c) of the
Bankruptcy Code provides that property sold under a plan is “... free and clear
of all claims and interests of creditors...” (emphasis added). Read together,
these sections provide the statutory basis for precluding subsequent assertions
of claims based on successor liability. Moreover, if there was any doubt that
such successor liability claims are “claims” for purposes of section 1141(c),
the term “claim” has been interpreted broadly enough to encompass any types of
pre-petition liability, whether contingent, non-contingent, liquidated or
unliquidated. Thus, expansively defined “claims” referred to in section 1141(c)
would almost certainly include those types of successor liability claims which
are traditionally asserted against asset buyers under state law.
Because of this language, some courts have been
willing to close the gap left by the “claim” vs. “interest” distinction in order
to give more comprehensive and preclusive effect to confirmed Chapter 11 plans.
This is especially so because the formal requirements of the Chapter 11 plan
confirmation process offer creditors a higher level of procedural and
substantive safeguards. This, in turn, provides claimants with a more meaningful
opportunity to participate in the process that might result in cutting off their
future rights. As such, asset buyers stand a better chance of precluding
successor liability by effecting the transaction through a confirmed Chapter 11
More on Federal Pre-emption
For sales under section 363 of the Bankruptcy Code, some courts are unwilling
to hold that federal bankruptcy law pre-empts successor liability claims arising
under state law. There is a much stronger policy reason for precluding successor
liability claims for sales under confirmed Chapter 11 plans. Where the
imposition of state successor liability laws creates an actual conflict with
federal law, the Supremacy Clause of the United States Constitution provides the
basis for preclusion of such state law-based successor liability claims. Courts
that have upheld federal pre-emption have identified the broad “free and clear
of claims and interests” language of section 1141(c) of the Bankruptcy Code as
the source of the conflict between state and federal law.
of state successor liability laws has been supported by findings
that they frustrate the full purpose of federal bankruptcy law. This occurs by, among
other things, chilling the prices for sales of assets out of
the bankruptcy estate, creating unequal distributions among similarly situated creditors and selectively
benefiting certain types of claimants in violation of the federal statutory
priority scheme. As with other aspects of the successor liability debate, however, this view
is not universal and not all courts have agreed that federal pre-emption
is justified. State courts, in particular, have been more willing
to reject federal pre-emption by focusing on different federal bankruptcy law
policies which are not necessarily frustrated by the subsequent imposition
of state law successor liability claims.
Limits of Plan Injunctions
Carefully drafted plans include injunctions enjoining the assertion of
successor liability claims against asset buyers after the sale has been
consummated. This can be a powerful tool in precluding subsequent successor
liability claims, if for nothing else more than the chilling effect it may have
on potential future lawsuits. Unfortunately, these types of injunctions are not
always effective as written, especially if they purport to bind claims that did
not arise during and could not have been discharged in, the bankruptcy case.
Courts are generally unwilling to enforce such post-confirmation injunctions
against certain types of product liability claims or other so-called “future
claims” where the injury occurred post-confirmation even though the product was
manufactured, or conduct giving rise to the claim occurred, pre-confirmation.
The problem is rooted in the fact that the claimant may
not know it holds a claim at the time the bankruptcy case is pending. Here
again, courts are faced with the nettlesome question of when is a “claim” a
“claim” for bankruptcy purposes. In cases where unknown future claimants are
likely to be significant (in terms of sheer numbers of claimants and/or
aggregate dollar amounts of claims), the preclusion of successor liability is more likely to be
enforced where the confirmation process includes a court-appointed legal representative for the future
claimants who participate in the bankruptcy case and where the plan provides a means
for future claimants to effectively share in distributions when such claims
eventually arise (a post-confirmation trust fund dedicated to payment of future claims).
There is little formal guidance on how to do this right; rather,
most reported cases chronicle how it was done wrong. Only for asbestos-related bankruptcy
cases, however, is there an express statutory prescription (section 524(g) of the Bankruptcy
Code) for precluding successor liability.
Regrettably, there is no uniformity in judicial thinking on the issue of
successor liability as courts continue to strain to reach results in individual
cases. This is often the case when courts must struggle to reconcile competing
policies of maximizing values for the benefit of creditors by free
transferability of assets in bankruptcy against the rights of certain types of
injured creditors to alternative remedies. As a result, uncertainty for asset
buyers continues in the face of conflicting decisions both at the federal
circuit court and state supreme court levels. It does not appear, however, that
a solution is anywhere near.
The reconciliation of the competing policies
must come from either the United States Supreme Court or from Congress. Only the
Supreme Court can clarify the constitutional question of whether the ability to
transfer assets “free and clear” under federal bankruptcy law pre-empts
otherwise applicable state law rights to enforce successor liability against
asset buyers as an alternative remedy. Alternatively, only Congress can effect a
legislative clarification that, in all instances, “free and clear” means what it
appears to say.
(Editor’s note: The author was unsuccessful
in urging the National Bankruptcy Review Commission to recommend a comprehensive
legislative solution to the successor liability problem in its Report to
Congress in October 1997, although the Commission did make certain helpful
recommendations about dealing with the problem of future claims. None of this,
however, found its way into the bankruptcy legislation that came close to being
enacted in late 1998.)
the successor liability problem is resolved in a comprehensive manner, the
lingering uncertainty will likely continue to generate litigation both in and
out of bankruptcy as both creditors and asset buyers each try to stick each
other with someone else’s unpaid bills.