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Order of Battle: Bankruptcy Sale Orders Versus Receivership Sale Orders For Successor Liability Protection

Law360
April 07, 2010

Judicially approved asset sales have become the order of the day. They are occurring in large numbers in both bankruptcies and state court supervised receiverships. Receiverships are rapidly becoming a preferred alternative legal process for selling assets as the cost of bankruptcy continues to escalate. Moreover, decisions under the Bankruptcy Code such as Clear Channel Outdoor Inc. v. Knupfer, 391 B.R. 25 (B.A.P. 9th Cir. 2008) and the very recent decision In re Philadelphia Newspapers, LLC, et. al, No. 09-4266, No. 09-4349, 2010 U.S. App. LEXIS 5805, March 22, 2010 as amended March 26, 2010 (3rd Cir.), have given, and will give, secured creditors new anxiety regarding the utility and predictability of bankruptcy when they have a choice regarding the legal proceeding .

While the above considerations frame a creditor viewpoint, a buyer simply seeks a court sale order transferring the assets "free and clear." This order provides the buyer some assurance that it can go forward with the business without the sins of the past. It is generally uncontested that "free and clear" means free and clear of liens and mortgages. It also can mean free and clear of other claims that were or might have been asserted against the debtor.

Even when there is broad exculpatory language in a sale order, that does not mean the buyer will not and cannot be sued on some theory of successor liability. Moreover, it does not guarantee that some of the debtor's previous business problems will not follow the buyer. Specific federal and state laws that may impose liability on a buyer, and the cases interpreting those laws, are beyond the scope of this article. But by way of a limited illustration, buyers need to be concerned about issues including workers' compensation future risk assessments, environmental issues, anti-trust concerns, Equal Opportunity Employment Commission proceedings, National Labor Relations Board proceedings, ERISA issues, tax issues, and product liability. A recent case illustrating the buyer's risk is United States v. Apex Oil, 579 F.3d 734 (7th Cir. 2009), in which successor liability was imposed on a buyer for environmental claims created by the previous owners.

Regardless of the nature of the successorship risk, a question arises: Do bankruptcy court sale orders provide more protection than a state receiver court's sale order? Assuming the exculpatory language is similar and the state's law supports sales free and clear, a party that purchases assets in a receivership proceeding is generally protected from successor liability by the sale order. The type of proceeding, whether bankruptcy or state receivership, does not affect the result. Bankruptcy court sale orders and state court sale orders receive the same legal scrutiny. They are both subject to additional analysis for certain exceptions.

Bankruptcy sales are governed by 11 U.S.C. § 363, which allows for "free and clear" sales of estate property. The Bankruptcy Code does not specifically authorize an injunction to prohibit actions against asset purchasers; rather, asset purchasers look to the "free and clear" language of the bankruptcy sale order for protection from future suits. That said, a bankruptcy court often incorporates an injunction into the sale order, while bankruptcy courts in other districts may not provide this additional buyer protection.

Receiverships also rely on court orders allowing for free and clear sales of estate property. Additionally, the receivership court may enjoin successor liability suits against the buyer. Sale orders in both bankruptcy and receivership proceedings relate to the court's in rem jurisdiction over estate property. In personam jurisdiction only arises in the context of injunctive orders. Anyone doubting the vitality of the "in rem" jurisdiction analysis should review the U.S. Supreme Court's decision in Tennessee Student Assistance Corporation v. Hood, 541 U.S. 440 (2004). Additionally, depending on the specific facts of the bankruptcy or receivership, in personam jurisdiction may preclude a party from later asserting successor liability claims against a buyer based on legal concepts such as issue preclusion or waiver.

Impact of Sale Orders on Subsequent Successor Liability Lawsuits

The traditional rule of successor liability is that an entity that purchases the assets of another corporation does not inherit the liabilities. Most states recognize four general exceptions to this rule: (1) when the buyer expressly or impliedly agrees to assume liability; (2) when the transaction amounts to a consolidation or merger of the buyer and seller; (3) when the buyer is merely a continuation of the seller; or (4) when the transaction is entered into fraudulently to escape liability. While courts frequently recite these basic elements, the results are not consistent.

Bankruptcy court orders do not prevent successor liability lawsuits by themselves. Other courts independently analyze whether there was an assumption of liability in the bankruptcy asset purchase agreement. See, e.g., Wallace v. Dorsey Trailers Southeast Inc., 849 F.2d 341 (8th Cir. 1988); Bozell v. H & R 1871, Inc., 916 F. Supp. 951 (E.D. Mo. 1996).

This analysis is also applicable to receivership sale orders when subsequent courts utilize successor liability analysis. See, e.g., John T. Callahan & Sons, Inc. v. Dykeman Electric Co., Inc., 266 F. Supp. 2d 208 (D. Mass. 2003); Swayze v. A.O. Smith Corp., 694 F. Supp. 619 (E.D. Ark. 1988).

Impact of Injunction on Subsequent Lawsuits

Injunctions issued in bankruptcy and receivership sale orders enjoy mixed results at best. Such orders may be completely unenforceable when used by a bankruptcy court due to a lack of jurisdiction. Courts have held that, despite retention of jurisdiction to hear matters related to the sale agreement, a bankruptcy court may not be competent to hear proceedings related to enforcement of an injunction preventing suit against the asset purchaser. See, e.g., Zerand-Bernal Group, Inc. v. Cox, et al., 23 F.3d 159 (7th Cir. 1994).

State courts have demonstrated more flexibility on enforcement of injunctions related to sales. Courts have power to issue anti-suit injunctions to prevent relitigating identical issues in another state's court. See, e.g., Sanders v. Blockbuster, Inc., 127 S.W.3d 382 (Tex. App. 2004). That said, obstacles encountered in bankruptcy court sale orders may also arise with state court sale orders, namely, that the court issuing the original sale order and injunction may have had in rem jurisdiction over the assets at issue, but it did not necessarily have in personam jurisdiction over all parties who may later appear. See, Mahan v. Gunther, et al., 663 N.E.2d 1139 (Ill. App. Ct. 1996).

Lawsuit Results as Additional Protection

Res judicata and collateral estoppel effects result from a decision in any court. Further, it is likely that, due to diversity issues, any dispute on successor liability could be heard by a federal court. Accordingly, a buyer may likely rely on the successful results of one such suit as a bar to further suits. Finally, the fact that the sale was free and clear, except for expenses and liabilities expressly assumed, though not dispositive, is likely to sway the successor liability analysis in favor of the buyer. See, e.g., Wallace, 849 F.2d 341; John T. Callahan & Sons, Inc., 266 F. Supp. 2d 208.

Full Faith and Credit

Notably, the Full Faith and Credit Clause of the Constitution plays a role in enforcement of insolvency injunction orders. The Full Faith and Credit Clause directs as follows:

Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State. And the Congress may by general Laws prescribe the Manner in which such Acts, Records and Proceedings shall be proved, and the Effect thereof.

U.S. Const. Art. IV, § 1. "In order to fulfill this constitutional mandate, 'the judgment of a state court should have the same credit, validity, and effect, in every other court of the United States, which it had in the state where it was pronounced.'" Underwriters Nat'l Assurance Co. v. N.C. Life & Accident & Health Ins. Guar. Ass'n, 455 U.S. 691, 704 (U.S. 1982). There is substantial authority generally upholding a different state's liquidation and injunction orders under the Full Faith and Credit Clause. See, e.g. Argon Fin. Group v. Marro, 897 F. Supp. 568, 569 (D.D.C. 1995); Bard v. Charles R. Myers Ins. Agency, Inc., 839 S.W.2d 791, 794-95, 36 Tex. Sup. Ct. J. 72 (Tex. 1992).

The Full Faith and Credit Clause is also supported by 28 U.S.C. § 1738, which provides that the proceedings of state courts "shall have the same full faith and credit in every court within the United States and its Territories and Possessions as they have by law or usage in the courts of such State, Territory or Possession from which they are taken." These directives further support the proposition that a state court should recognize any order issued in conjunction with another state's receivership. At least one court has deferred to another state's anti-suit injunction based on comity rather than the Full Faith and Credit Clause. See Mahan at 1116. Additionally, at least one court in Texas has granted full faith and credit to a different state's receivership injunction order. Jose Freagoso, et al. v. American Optical, Cause No. 2003-05-2778-G (District Court, Cameron County, Texas 404th Judicial District, 2003). Although this order did not relate to a sale, it suggests the general willingness of state courts to recognize injunctions issued in another state's receivership proceedings.

Practical Suggestions

Regardless of which legal process is utilized, a buyer is well advised to get as much protection as possible due to the uncertainty of what a different court will do in the future when interpreting a court sale order. The order should contain specific and comprehensive findings of fact and conclusions of law. Those findings should include an explicit statement that the buyer is not a successor. While generally disfavored in insolvency proceedings, a buyer may demand an escrow fund be created to address the uncertainty of these issues. However, the most common way that a buyer deals with these uncertainties is by discounting the offered purchase price to account for the risk. It is also in a buyer's interest to ensure that there is as much notice as possible of the sale and its "free and clear" terms so that in a subsequent lawsuit, the buyer can assert that the plaintiff had or reasonably should have had notice of the sale and did not object.

Conclusion

A party that acquires assets from an insolvent entity by court order transferring the assets free and clear of encumbrances can likely work through the successor liability risk and avoid responsibility for goods produced and sold, as well as the seller's actions, prior to the buyer's acquisition. Based on the case law, bankruptcy and receivership proceedings offer at least equal protection in this respect.

Timothy F. Nixon is a shareholder and team leader of Godfrey & Kahn's Business Finance & Restructuring Practice Group. For more information, Tim can be reached at tnixon@gklaw.com or 920-436-7693. Additional information is available on our website at www.gklaw.com.

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