Bankruptcy Court to NY Department of Labor: “Tough(er) Luck”

Contributed by Julio C. Gurdian
Is an acquirer of assets in a sale under section 363 of the Bankruptcy Code stuck with the experience rating of the predecessor debtor for purposes of calculating unemployment insurance premiums?  That was the situation facing Tougher Industries Enterprises, LLC and Tougher Mechanical Enterprises, LLC when, pursuant to section 363 of the Bankruptcy Code, they bought substantially all of the assets of debtors Tougher Industries, Inc. and Tougher Mechanical, Inc.  After the sale closed, the New York Department of Labor slapped the purchasers with an elevated experience rating for the purposes of calculating their unemployment insurance premiums based on the high experience rate of the predecessor companies.  The purchasers went back to court and argued that the assets they purchased were free and clear of any interests, including the debtors’ not-so-favorable experience rating and the Bankruptcy Court for the Northern District of New York agreed in a March 27 decision in In re Tougher Industries, Inc., No. 06-12960, 2013 Bankr. LEXIS 1228 (Bankr. N.D.N.Y. Mar. 27, 2013), relieving the purchasers of the higher experience rating.
The order authorizing the sale was entered on November 20, 2007 and included the traditional “free and clear” language tracking section 363(f) of the Bankruptcy Code and several other provisions limiting successor liability.
In addition, the court included a provision in the sale order which allowed the court to maintain jurisdiction over matters in connection with the sale order.
Following the purchase, the New York Department of Labor applied the debtors’ experience rating to the purchasers for the purposes of calculating unemployment insurance tax liability of the purchasers’ ongoing business.  The result was that the purchasers’ rating was significantly higher than what would have been assigned to a new employer, thereby, raising the purchasers’ unemployment insurance tax premiums.  Suffice it to say, the purchasers were unhappy with the situation and took the Department of Labor to court.
The court was faced with two issues in the case.  The first was whether it still had jurisdiction to interpret the sale order, which the purchasers were relying on to shield them from the raised experience rating.  The second issue faced by the court was whether an experience rating is an “interest” under the Bankruptcy Code.  If it is, then the court has the authority to strip such interest in an asset sale under section 363 of the Bankruptcy Code.
Subject Matter Jurisdiction
The court initially concluded that it had subject matter jurisdiction for three distinct reasons.  First, it reasoned that section 28 U.S.C. § 157(b)(2)(N) gave it core jurisdiction over the matter because that section provides that orders approving sales of property are core bankruptcy proceedings.  Second, the court cited federal case law that states that the court has jurisdiction to enforce and interpret its own prior orders.  Finally, it noted that the retention of jurisdiction to decide the matter was explicitly preserved in the sale order.
The court then refuted the Department of Labor’s main argument, which relied on 28 U.S.C. § 1341 to assert that the court lacked subject matter jurisdiction of the unemployment tax determination.  That section provides that the court “shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State.”  Here, the court noted that it was not being asked to “enjoin, suspend or restrain” the Department of Labor’s assessment against the Purchasers; it was simply being asked whether the experience rating was an “interest” pursuant to section 363 of the Bankruptcy Code with respect to the Debtors’ property.  Thus, the court concluded that 28 U.S.C. § 1341 did not remove the issue from its jurisdiction.
The court also distinguished In re Victory Markets, Inc., which dismissed an adversary proceeding based on lack of jurisdiction where the state transferred the experience rating of the debtor to a company that took an assignment of all of the debtors’ assets pursuant to a chapter 11 plan.  There, however, the plan did not provide for the sale of assets free and clear pursuant to section 363(f) of the Bankruptcy Code.
Successor Liability under the Sale Order
Once the court concluded that it had jurisdiction to interpret its previous order it went on to determine whether the debtors’ experience rating was an “interest” which could essentially be left behind with the debtors rather than follow the assets to the purchaser.
Section 363(f) of the Bankruptcy Code provides that “[t]he trustee may sell property under subsection (b) and (c) of this section free and clear of any interest in such property of an entity other than the estate, only if . . . (1) applicable nonbankruptcy law permits sale of such property free and clear of such interest; (2) such entity consents; (3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property; (4) such interest is in bona fide dispute; or (5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”
The issue for the court was determining how it should construe the word “interest” in section 363 – a term not defined in the Bankruptcy Code.  The court noted a split of authority, with decisions in the Sixth Circuit and the Western District of Texas holding that the term is limited to interests in real or personal property that would have the effect of clouding title (interests “in rem”), and decisions in the Second, Third, Fourth, and Seventh Circuits, along with the First Circuit Bankruptcy Appellate Panel, holding more broadly that “interests” under section 363 include any liabilities of the debtor.  The Tougher court followed this latter line of decisions and expressly adopted the reasoning of the First Circuit BAP in In re PBBC, Inc v. OPK Biotech, LLC (In re PBBPC, Inc.), 484 B.R. 860 (1st Cir. BAP 2013), which concluded that “the transfer of an employer’s contribution rate to a successor asset purchaser is really an attempt to recover the money that the predecessor employer would have paid if it had continued in business” and therefore is an “interest” from which the property can be sold free and clear under section 363.  To buttress its conclusion, the court outlined the policy reasons behind it.  The court explained that the expansive view is more consistent with the Bankruptcy Code’s policy to maximize the value of the estate.  It reasoned that the transfer of the debtors’ assets free and clear of successor liability induced the purchaser into buying the debtors’ assets, and it concluded that the purchaser would have paid less for the assets if it could not be protected against imposition of these interests after the transaction closed.