Ability to Avoid Successor Liability Pursuant to a §363 Sale In Bankruptcy

(Excerpt) In a case filed under chapter 11 of title 11 of the United States Code (“the Bankruptcy Code”), the company entering bankruptcy, the debtor, usually files a reorganization plan that articulates how the debtor’s assets will be addressed and creditors will be treated. Once a plan is confirmed and becomes effective, the debtor “emerges from bankruptcy with its liabilities restructured along certain parameters.” This process, however, can take years. Conversely, a sale of substantially all of the debtor’s assets, pursuant to 11 U.S.C. § 363, will often “occur on a very expedited basis.” In the case of the GM bankruptcy, the § 363 sale closed in a matter of weeks. The § 363 sale procedure is expeditious because the debtor “does not truly reorganize” but rather, after obtaining the bankruptcy court’s approval, “sells its primary assets to a successor corporation,” which can immediately begin operating the business. Meanwhile, the debtor is left with any residual assets and liabilities and, as seen in Motors Liquidation, will often proceed to arrange a plan for liquidation. An additional benefit of § 363 is that the sale can be “free and clear of any interest in such property.” After the Second Circuit’s recent decision in Motors Liquidation, however, there is concern about the efficacy of § 363(f)’s “free and clear” provision. Specifically, this holding raises the issue of whether or not § 363(f) can validly prevent third parties from asserting successor liability claims against those who purchase businesses out of bankruptcy. This article explains how, going forward, courts will likely address the successor liability of purchasers of assets pursuant to § 363 sales. In essence, the outcome will be largely dependent on how a particular court interprets the meaning and scope of the term “interest” in § 363(f). Section I explains both the broad and narrow definitions that are currently in use, with an emphasis on the more widely used broad definition and the Second Circuit’s reasoning for applying it in Motors Liquidation. Section II discusses the implications of each definition, respectively, in terms of the strength of the § 363 liability shield. Section III addresses the Due Process Clause concerns raised by the prevailing broad definition, and the impact of Motors Liquidation’s outcome in relation to due diligence standards. The article concludes with an assessment of the extent to which successor liability can be avoided using a § 363 sale