Restructuring

Co-authored by John J. Ramirez
Every year, the American Bankruptcy Institute teams up with Georgetown University Law Center to host bankruptcy judges, along with legal professionals from across the industry, at its Views from the Bench conference to discuss developments in the restructuring world with (as the name would suggest) a heavy emphasis on the views of bankruptcy judges.
The sales and executory contracts panel that our colleague, Gary Holtzer, moderates had a star-studded bench, with three judges from the United States Bankruptcy Court for the Southern District of New York attending: the Honorable Stuart M. Bernstein, the Honorable Robert E. Gerber, and the Honorable Sean H. Lane; along with Martin Bienenstock of Proskauer Rose LLP, who acted as facilitator.
The panel was thrown a curveball in preparing for the conference: the Views from the Bench organizers artfully persuaded Judge Thomas Ambro of the United States Court of Appeals for the Third Circuit to deliver a fascinating talk on the implications of RadLAX Gateway Hotel v. Amalgamated Bank, one of the main decisions in the sales and executory contracts arena this year.  The Weil Bankruptcy Blog covered the RadLAX decision here.
As a result, the panel focused on three decisions that presented important developments in the sales and executory contracts arena, namely Morgan Olson LLC. v. Frederico (In re Grumman Olson Indus, Inc.), a case dealing with successor liability claims; Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, a case dealing with trademark license rights; and Super Nova 330 LLC v. Gazes, a case dealing with unexpired leases.
In re Grumman Olson Industries, Inc.: Successor Liability Claims
Having delivered the decision in the case, which was subsequently affirmed by the United States District Court for the Southern District of New York, it seemed fitting that Judge Bernstein gave the conference attendees a primer on  his decision in the long-closed chapter 11 case of truck manufacturer Grumman Olson, In re Grumman Olson Indus., Inc.
The Grumman Olson decision clarified the limitations on a buyer’s ability to acquire assets free and clear of successor liability claims under section 363(f) of the Bankruptcy Code.  By holding that section 363 sale orders cannot bar successor liability claims brought against the purchaser of a debtor’s assets for prepetition acts resulting in harm that occurs only once a sale has been consummated, this case is a warning that due process rights of future claimants cannot be overlooked while debtors seek to maximize the value of their estates.
Section 363(f) authorizes the trustee or a debtor in possession to sell property of a debtor “free and clear of any interest in such property.”  An interest in property includes “claims” that arise from the assets being sold.  Purchasers of assets under section 363(f) typically enjoy in personam relief, similar to the discharge applicable to debtors under the Bankruptcy Code, exonerating a buyer from successor liability, including liability for tort claims, as a result of section 363 sale orders.  The Grumman decision, however, makes clear that section 363(f) does not absolve buyers from successor liability claims by persons who, at the time of the sale, did not have a claim against the debtor because such persons had not yet been injured and had no identifiable relationship to the debtor or its products.
The facts of the case date back to December 9, 2002, when Grumman Olson Industries filed its chapter 11 petition. The following July, Grumman completed a 363 sale of certain of its assets to Morgan Olson. The sale order purported to release Morgan Olson from liability for certain claims, stating that:

“[t]he sale…of the assets to be purchased…shall be free and clear of all…claims…and other interests…whether arising prior to or subsequent to the commencement of this Chapter 11 case.”

The sale order also provided that Morgan Olson as the purchaser would have no liability, responsibility or other obligation of the debtor arising under or related to the asset sale, “including, but not limited to, claims for successor or vicarious liability.”
The Grumman Olson chapter 11 case was closed in 2006, but Morgan Olson subsequently moved to reopen the case and sought a declaratory judgment and injunctive relief to bar a tort claim arising from an incident involving a Grumman vehicle manufactured prepetition.   The tort claimant, Denise Frederico, had been injured when the FedEx delivery vehicle she was driving hit a telephone pole.  The truck body of the FedEx delivery truck was manufactured and sold before the Grumman Olson chapter 11 case but occurred after the sale, the confirmation and the closing of such case.  Denise Frederico and her husband John Frederico then sued Morgan Olson alleging it was liable as the successor to Grumman Olson, the manufacturer of the delivery vehicle, under a product-line continuation theory.  After reopening the case, the bankruptcy court then ruled against Morgan Olson, delineating the scope of protection available under section 363(f).
While the wording of the sale order in Grumman Olson made clear that the assets were to be sold free and clear of any liability from “claims,” the question faced by the court was what constituted a “claim” within the meaning of the sale order, especially with regards to future torts.  The answer hinged on whether the claim fell within the definition of a “claim” under section 101(5) of the Bankruptcy Code.  Most courts follow the Eleventh Circuit decision in In re Piper Aircraft Corp., 58 F.3d 1573, 1577 (11th Cir. 1995), which developed a two-part test for when an individual has a “claim” against a debtor manufacturer:

1. if events occurring prepetition created a relationship; and
2. the basis for liability is the debtor’s prepetition conduct in designing, manufacturing and selling the allegedly defective or dangerous product.

Under the Piper test, there must be both a prepetition relationship between the injured party and the debtor as well as prepetition conduct by the debtor in manufacturing or distributing the product.  So how do future torts square with this test?
The Second Circuit has previously identified two main categories of future tort claimants:

1. those who were exposed to a product prior to the sale of assets but their symptoms have yet to manifest, the classic example of this sort of claim is asbestos cases; and
2. victims who are uninjured at the time of the sale but are later injured as a result of a defective product that was manufactured prior to the sale.

It is this second category that poses problems for buyers in a 363 sale and was the subject of the dispute in Grumman Olson.
Consider the hypothetical posed by the Second Circuit in In re Chateaugay Corp., 944 F.2d 997, 1003 (2nd Cir. 1991), a case involving environmental claims:

“[A] company… builds bridges around the world.  It can estimate that of 10,000 bridges it builds, one will fail, causing 10 deaths.  Having built 10,000 bridges, it becomes insolvent and files a petition in bankruptcy. Is there a “claim” on behalf of the 10 people who will be killed when they drive across the one bridge that will fail someday in the future? If the only test is whether the ultimate right to payment will arise out of the debtor’s pre-petition conduct, the future victims have a “claim.”  Yet it must be obvious that enormous practical and perhaps constitutional problems would arise from recognition of such a claim.  The potential victims are not only unidentified, but there is no way to identify them… What notice is to be given to these potential “claimants”?”

The Chateaugay case adopted a “fair contemplation” test to distinguish between contingent and unmatured claims, which are “claims” within the meaning of section 101(5), and potential future tort claims, which are not.  Under that test, a contingent or unmatured obligation is a “claim” if the occurrence of the contingency or future event that would trigger liability could be conceivably contemplated at the time the original relationship between the parties was created.  The Grumman Olson court acknowledged that the concepts of “maturity” and “contingency” are not readily transferable to future tort claims whose victims are “totally unaware of injury and a tortfeasor.”  Additionally, the court noted that the definition of claim, and whether future claimants like the Fredericos had a claim that was barred by the sale order is informed by the practical limit of giving meaningful notice of the sale and the right to participate in the bankruptcy case and the due process concern of cutting off the Fredericos’ rights against a successor in the absence of such notice.
Grumman Olson ultimately found that the Fredericos’ “claim” failed the prepetition relationship test under Piper and fell within the Chateaugay hypothetical.  The court found that Denise Frederico had no contact with Grumman Olson prior to the accident.  She did not deal with Grumman Olson, and her only connection Grumman Olson was that her employer purchased the truck that she subsequently drove.  Thus, the court found that Fredericos did not hold a claim against the debtors at the time of the 363 sale.  In light of these facts, the Grumman Olson court concluded that the sale order did not affect the Fredericos’ rights to sue Morgan Olson on a successor liability theory.  Of course, in any lawsuit they would still have to prove facts demonstrating that they are entitled to relief against the purchaser of assets.
Following Grumman Olson, bankruptcy practitioners must be mindful that potential liability to unidentifiable future claimants may persist despite the “free and clear” language of section 363(f).  Purchasers of business assets that could give rise to product liability or other tort claims therefore must consider these potential liabilities when determining a fair price for the assets.
Following Judge Bernstein’s summary and comments, Judge Gerber noted that he had encountered similar concerns as part of the Motors Liquidation Company (“MLC”) bankruptcy cases, with respect to vehicles manufactured by General Motors Corporation (“GM”) prior to its bankruptcy filing, which may at some point have resulted in products liability claims in the future.  In MLC’s case, extensive negotiations took place between the parties that resulted in General Motors Company (which acquired substantially all of MLC’s assets, colloquially known as “New GM”) assuming responsibility, subject to certain limitations, for product liability claims for vehicles sold after the sale of Old GM’s assets to New GM.  The central point remains though: uncertainty with respect to future claims has to be balanced with due process, and there are material concerns as to how future creditors can be bound by a “free and clear” sale order, if they haven’t suffered injury at the time the sale order is entered, and as a result haven’t submitted a proof of claim into the bankruptcy case.  Parties should, therefore, be prepared to address this issue in their briefs if they are seeking this type of relief.
Martin Bienenstock noted that, in chapter 7 cases, funds are not reserved for people who are injured following the conclusion of the chapter 7 case.  One way that Bienenstock suggested to tackle post-petition injury is in the context of federal pre-emption.  If a state law imposing successor liability does not allow a debtor to separate assets from liability, then the state law should not come into play in the bankruptcy context because of federal pre-emption.  The key, therefore, is to ensure that state attorneys general are put on notice of the intention of parties to seek to have the federal courts preempt the conflicting state law.
In a spirited debate on this concept, Judge Gerber suggested that lawyers be prepared to address, in that connection, the requirement, in 28 U.S.C. § 959,   that debtors comply with applicable non-bankruptcy law.  Judge Lane, playing devil’s advocate, argued that preemption has strict requirements, and a clear conflict between federal and state laws must be shown before federal preemption can be invoked.
At Gary Holtzer’s prompting, the panel also discussed whether the answer would be different if it was addressed through the mechanism of discharge, rather than through a free and clear sale under section 363 of the bankruptcy code.  The panel’s main concern in this respect was how to obtain a discharge with respect to claims that, at the time the discharge goes into effect, aren’t in existence yet.
Concluding the panel’s discussions on Grumman, Judge Gerber explained that the issues being addressed in Grumman involved a spectrum of claims:  post-section 363 sale manufactured vehicles are at one end of the spectrum.  A vehicle that has been manufactured before the sale, which results in injury before the sale, is at the other.  The difficult cases fall in between, with vehicles manufactured pre-sale that result in post-sale injuries.  Judge Gerber noted that it would, therefore, help bankruptcy judges if advocates could focus in their briefs not only on the narrow situation applying to their case, but also to the wider spectrum of situations along the spectrum, dealing with wrongful conduct, injury, and the 363 sale, which would then make it easier to conclude what can be done constitutionally.
Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC.:  The Impact of Trademark License Rights on Sales in Bankruptcy
The panel then turned to discuss Sunbeam, with Judge Lane summarizing the facts of the case for the conference.  In this recent decision, the Seventh Circuit expanded the rights of licensees in a debtor-licensor’s bankruptcy case by providing for the right to retain a license even when a debtor rejects the underlying contract creating such license.  The Sunbeam decision directly contrasts with the bankruptcy court’s decision In re Old Carco LLC, which held that a licensee could seek only monetary damages as a result of the debtor-licensor’s breach resulting from rejection of a trademark license agreement.
In Sunbeam, Lakewood Engineering & Manufacturing Co., a maker of box fans, had an agreement with Chicago American Manufacturing (“CAM”) in which Lakewood would acquire orders for box fans and CAM would satisfy those orders by manufacturing and selling box fans with the Lakewood name.  Three months into the contract, several of Lakewood’s creditors commenced an involuntary bankruptcy against it, and the bankruptcy court subsequently appointed a trustee.  The Lakewood trustee subsequently rejected the Lakewood/CAM agreement.  When CAM continued to produce and sell Lakewood branded fans, the Lakewood trustee commenced an adversary proceeding seeking to prevent CAM from doing so.  While the adversary proceeding was pending, pursuant to a 363 sale, Sunbeam Products, doing business as Jarden Consumer Solutions, purchased Lakewood’s business.  After a trial in the bankruptcy court, the bankruptcy judge concluded that CAM was entitled to make as many box fans as Lakewood estimated it would need for the entire 2009 season and sell them bearing the Lakewood name.  Jarden appealed directly to the Seventh Circuit, which subsequently agreed with the bankruptcy court’s interpretation of the Lakewood/CAM agreement and discussed the effect of the Lakewood trustee’s rejection of the subject agreement.
The Seventh Circuit began its discussion of the effect of the Lakewood Trustee’s rejection of the Lakewood/CAM agreement by disagreeing with Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. a Fourth Circuit decision that had a similar holding as Old Carco but related to patent license agreements,  and addressing the text of section 365(g) (which addresses the rejection of executory contracts and unexpired leases).  The Seventh Circuit stated that while section 365(g) classifies rejection as a breach in which debtor’s unfulfilled obligations are converted into damages, nothing in the text indicates that counterparty’s rights are “vaporized.”  The Seventh Circuit pointed to instances when a lessor enters bankruptcy and rejects a lease, but, in rejecting such lease, does not end the tenant’s right to possession.  The Seventh Circuit agreed with the judgment in CAM’s favor and, thus, held that a licensee has the right to retain its license even when a debtor rejects the underlying agreement creating the license.
Aside from the issue regarding the interplay between sections 365(g) and (n), Sunbeam highlights a concern for bankruptcy sales.  The right of trademark licensees to retain their license regardless of rejection may chill sales of licensed assets in bankruptcy cases.  Taking the Sunbeam facts as an example, if Jarden knew that it would not enjoy the exclusive right to manufacture and sell Lakewood box fans, it may have paid less for the business or not purchased the business at all.  Moreover, trademark licensees may retain their licenses post-rejection to extract premium from a purchaser who desires exclusive use of a license.  Consequently, Sunbeam presents the potential for decreasing the value realized from certain sales of assets in bankruptcy cases.
Judge Lane concluded that the practical takeaway from the Sunbeam  case is that trademark licensees may continue to use trademarks even when a debtor rejects the trademark license agreement in bankruptcy.
Judge Bernstein addressed the fact that, prior to Sunbeam, there was confusion about the absence of trademarks from definition of “intellectual property” in the Bankruptcy Code.  As a result, some courts have concluded that trademarks should be treated differently. Judge Ambro, in his concurrence in In re Exide Technologies, noted that Congress didn’t want to think about the issue further and opined that trademark license rights should be encompassed in 365(n).  Notably, the decision in Sunbeam led to the same result as Judge Ambro’s concurrence in Exide Technologies but arrived at the conclusion using another provision of the Bankruptcy Code, 365(g).
Following up on a discussion of the legislative history related to the issues raised in Sunbeam, Judge Gerber concluded this section of the panel by noting that there are some members of the legal community, including members of the Supreme Court, who have a disdain for the use of legislative history. When, however, legislative history is right on point on a matter to which the Bankruptcy Code is silent, parties may need to consider whether the legislative history is of more than minimal significance.  Judge Gerber also observed that legislative history is not infrequently written by lobbyists, and that it is congressional [add italics] intent that matters, not the lobbyists’ intent.  When, however, the legislative history is prepared by parties who have less of an axe to grind, judges might be interested in a statute’s legislative history.
Super Nova 330 LLC v. Ian J. Gazes: Unexpired Leases
Judge Gerber addressed the final decision for the Sales and Executory Contracts panel by summarizing the facts from Super Nova, in which the Second Circuit held that a lease is “unexpired”  for purposes of section 365(d)(3) of the Bankruptcy Code where the tenant has the power to revive the lease under applicable state law, and thus is an executory contract, even when a warrant of eviction is issued but not executed.  In Super Nova 330 LLC v. Gazes, the United States Bankruptcy Court  for the Southern District of New York granted the motion of a landlord of a commercial building, Super Nova, to lift the automatic stay in order to execute an issued warrant of eviction.  Subsequently, Super Nova sought an administrative expense for unpaid rent from the petition date to the eviction date of the debtor.  The bankruptcy court denied Super Nova’s administrative expense motion on the grounds that the lease was not “unexpired” because it was terminated prepetition, as a matter of New York law, upon the issuance of the warrant of eviction.  The District Court for the Southern District of New York affirmed the bankruptcy court’s decision.  The Second Circuit disagreed with the lower courts’ rulings.  It recognized that until a warrant of eviction is executed, a debtor has the ability to seek relief in state court to effect a revival of the lease by a vacatur of the warrant of eviction.  This right to go back to state court to seek and obtain such relief would give the debtor a residual interest in the lease. As a result, The Second Circuit held that such was “unexpired” within the meaning of section 365(d)(3), resulting in the duty on the part of the estate to continue to perform under it, postpetition, until rejection.  Though Super Nova addressed unexpired leases as executory contracts, the panel focused on the analogue in a motion for relief from the automatic stay context.  Judge Gerber noted that courts have developed a general rule of thumb in the Southern District of New York: the possessory interest of a debtor is enough to make the automatic stay applicable in the first instance.  But where relief from the stay is then sought, judges will look at the likelihood of a state court reinstating the lease.
The panel concluded that, as a practical matter, judges look to what is available to the state court: has a lessee tendered rent, and has the landlord refused to take it? Is there a fair debate as to damages available under the lease, as a result of scaffolding for instance, or is the debtor just puffing smoke? Depending on the outcome of this investigation, bankruptcy judges will typically hold off from stay relief for a few weeks, to see if a state court will vacate the eviction warrant.  If a debtor doesn’t have a strong case in state court, relief from the stay typically will be granted; however, if the debtor is attempting to preserve its possessory interest on a good faith basis, bankruptcy judges will wait to see what action the state court will take.
So there you have it, the Sales and Executory Contracts panel in a nutshell!  If you’re interested in further information on Views from the Bench, or want more information on how to attend next year, click here! If you can’t wait until the next conference to get your fix of hot topics in the sales and executory contracts arena, stay tuned to the Bankruptcy Blog for daily updates of the latest and greatest cases hitting the restructuring world’s radar.