Reconciling Bankruptcy Law and Corporate Law Principles: Imposing Successor Liability on Gm and Similar "sleight-of-hand" 363 Sales

Publication year2016

Reconciling Bankruptcy Law and Corporate Law Principles: Imposing Successor Liability on GM and Similar "Sleight-of-Hand" 363 Sales

Brad Warner



It was only June 2009 when General Motors filed for chapter 11 bankruptcy protection after suffering through the crippling financial effects of the 2008 financial crisis. Now in 2016, General Motors has entered what some have called its renaissance period with flourishing sales and increased profitability. Meanwhile, thousands of vehicle owners who were harmed by defective General Motors vehicles have been barred by 11 U.S.C. § 363(f) of the Bankruptcy Code from seeking an equitable remedy from the now thriving company. This result is largely due to § 363(f), which allows for assets to be sold in bankruptcy free from all liabilities including the tort claims of those injured or harmed by defective vehicles.

This Comment argues that those harmed by General Motors' defective vehicles should have access to an equitable remedy via the successor liability doctrine. The successor liability doctrine allows for an asset purchaser to be accountable for the liabilities of the seller under certain circumstances. Successor liability has been scantly applied to § 363 sale purchasers. However, this Comment contends that General Motors' § 363 sale was a "sleight-of-hand' transaction which allowed the corporation to essentially sell its assets to itself and escape most of its liabilities. This Comment explains that the successor liability doctrine was intended to prohibit these "sleight-of-hand" transactions. Furthermore, this Comment discusses how to reconcile the language of § 363(f) of the Bankruptcy Code, and the objectives of the bankruptcy process in general, with the goals of the successor liability doctrine. Finally, this Comment proposes to amend the Bankruptcy Code to internalize the cost of harm of defective products and ensure due process for consumers.

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To date, General Motors ("GM") has recalled over two and a half million vehicles due to defective ignition switches that have been linked to at least twenty-nine deaths.1 Investigative reports indicate that the company was likely aware of the manufacturing defects for over a decade.2 For years, evidence connecting the defects to accidents involving GM vehicles was largely ignored.3 Given that GM was likely aware of the defective ignition switches for years, it begs multiple questions, including why did it risk incurring a mountain of tort liability by leaving millions of these dangerous, defective vehicles in the hands of consumers? And, why did no one else call attention to the matter?4

To answer these questions requires a look to the 2008 financial crisis and the integral part that the U.S. federal government had in all aspects of GM's financial rehabilitation. On December 31, 2008, the U.S. Treasury Department extended $13.4 billion to GM, making the U.S. federal government the largest stakeholder in the corporation.5 Under the terms of the government financing agreement, GM had to present a plan for long-term viability in an effort to rebuild and restructure. Unsatisfied with GM's viability plan, President Obama announced on March 30, 2009, that GM's efforts fell short of justifying the continued use of taxpayer dollars and gave the company sixty days to adopt drastic changes, or face bankruptcy.6 On June 1, 2009, GM filed for chapter 11

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bankruptcy in the Southern District of New York.7 GM's bankruptcy filing showed that its liabilities were more than double its assets, with $82.3 billion in assets and $172.8 billion in liabilities.8

Before the company had even filed for bankruptcy, GM had already entered into a proposed sale agreement under § 363(b) of the Bankruptcy Code, which allowed the company to restructure its debts by selling substantially all of its assets (the "363 Sale").9 The bankruptcy court approved GM's prepackaged 363 Sale on July 5, 2009.10 The court referred to the asset purchasing entity as "New GM," and referred to the selling entity as "Old GM."

Under § 363(f) of the Bankruptcy Code, all assets sold in a 363 Sale are "free and clear of any interest in such property. . . ."11 Thus, New GM received substantially all of the company's assets while Old GM held on to most of the company's burdensome liabilities, allowing New GM to continue operating free from past debts.12 GM's 363 Sale was a quintessential "sleight-of-hand transaction," in which a debtor is permitted to internally restructure under the guise of an asset sale. Old GM assumed all future liability claims from incidents that occurred prior to the bankruptcy filing date, and successor liability claims against New GM were barred.13 Consequently, § 363(f) has had the effect of barring the victims of GM's defective vehicles from seeking an equitable remedy.

New GM contends the 363 Sale created a "bankruptcy shield" from product liability claims filed against the company.14 These arguments have been largely

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successful in barring successor liability.15 However, at the time of this publication, the Second Circuit was considering whether successor liability claims should be allowed against New GM.16

The policies behind allowing companies like GM to apply § 363(f) to bar tort victims from an equitable remedy must be re-evaluated. When large corporations like GM assemble dangerous, defective products, they should not have the option to discharge future tort liability without proper notice and reasonable compensation to all affected consumers. This Comment uses the case of GM (including its bankruptcy filing, allegations of fraud against the corporation, and underlying product liability claims against the corporation) as an illustrative example of why large corporate manufacturers who engage in a "sleight-of-hand" 363 Sale should be held accountable using the doctrine of successor liability. The imposition of successor liability would force those firms to internalize the cost of harm of defective products and ensure due process for consumers

Part I of this Comment provides a brief overview of chapter 11 bankruptcy protection and the use of 363 Sales. Part II of this Comment introduces the doctrine of successor liability and argues that § 363 should be amended to allow for the imposition of successor liability against firms that enter into "sleight-of-hand" 363 sale transactions. Part III further discusses how the doctrine can be reconciled with the language of § 363(f) and the underlying purpose of the bankruptcy process.

I. Overview of Chapter 11 and 363 Sales

This Section gives a brief overview of chapter 11 bankruptcy, the use of 363 Sales in bankruptcy, and the rise of 363 Sales of substantially all of a company's assets. Finally, this Section turns to GM's path to bankruptcy, its subsequent substantial 363 Sale, and how the terms of the sale have barred

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successor liability claims against GM, thus preventing victims of GM's defective vehicles from seeking equitable relief.

A. Chapter 11 Bankruptcy Protection

Failing corporations often must decide whether to file for bankruptcy protection. Filing for chapter 11 bankruptcy allows the debtor to reorganize its debts, while continuing to operate, use, and sell its assets throughout the bankruptcy process. The debtor begins the chapter 11 process by filing a bankruptcy petition with the court. The filing triggers an automatic stay against all creditors, freezing debt collection and allowing breathing room for the debtor-in-possession ("DIP").17 A DIP must then propose a plan to its creditors outlining how it will repay them.18 Only the DIP may file a plan for reorganization during the first 120 days. If all classes of creditors do not accept the DIP's plan after 180 days from the petition date, then a creditor may propose an alternate plan.

The Bankruptcy Code sets out a priority system that dictates the order in which creditors are repaid.19 Tort victims are considered unsecured non-priority creditors, meaning they are only repaid after all other secured and priority creditors have been repaid.20 DIPs usually cannot generate enough cash to repay all creditors who file claims against the estate and so tort claimants often end up with little or no payment.21 The low priority given to

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tort victims minimizes incentive for creditors of large corporations like GM to monitor the DIP's conduct for potential violations of tort law.22

While the priority system does not favor tort claimants, the Bankruptcy Code does provide safeguards to protect the interests of all creditors. For example, a debtor must send a disclosure statement to all of its creditors.23 The disclosure statement must be executed in good faith and it must provide creditors with adequate information about the debtor's finances and proposed reorganization that will allow creditors to make an informed decision about whether they want to approve the plan.24 The disclosure and adequate information requirements protect creditors by allowing them to make an accurate valuation of the debtor and its assets and liabilities.25 The Bankruptcy Code further requires that all classes of creditors generally must accept a proposed plan before the plan can be confirmed by the bankruptcy court, though there are some exceptions.26 Once a plan is confirmed, the debtor and all creditors, including tort creditors, are bound to the plan.27

Large corporate debtors that have considered bankruptcy protection are often in desperate need of a quick solution for their increasing liabilities and low cash flows.28 Traditional reorganizations are time-intensive and not conducive to quickly increasing cash flows and repaying debts.29 Due to the

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lengthy and complicated nature of a traditional chapter 11 reorganization proceeding, debtors have increasingly...

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