Friday, July 15, 2016

The Cost of Due Process

By Steve Stapleton

When General Motors Corporation filed for bankruptcy protection on June 1, 2009, it had an audacious plan, file “a quick, surgical bankruptcy,” file a motion to sell its primary assets to a new company called Vehicle Acquisition Holdings LLC owned primarily by the United States government, structure the sale in such a way that few of Old GM’s liabilities would follow the new company and liquidate the remaining assets.  Those few assets that New GM would take would be subject to a “free and clear” provision that would act as a liability shield to prevent those with claims against Old GM from asserting those claims against New GM.  Once the sale closed, New GM could begin operations and old GM would go through the process of liquidation.  Actual notice was provided to all those who held then-current claims against GM; those whose claims were unknown were given notice by publication.  Forty days later, the sale was approved and a trust (the GUC Trust) was established to hold Old GM’s assets.

The assets that remained with Old GM consisted of $1.175 billion in cash, interests in the Saturn brand, certain real and personal property and significantly, New GM stock and stock warrants that could be used to purchase shares at fixed prices.  Depending on how many claims were asserted against Old GM, there was an accordion feature put in place which provided that if unsecured claims against Old GM aggregated more than $35 billion, new GM would issue an additional 10,000,000 shares of common stock to Old GM.

Two years later, on March 29, 2011, the bankruptcy court confirmed the liquidation plan and the GUC Trust began making quarterly distributions to Old GM’s creditors.  However, on February 7, 2014, New GM disclosed for the first time to the National Highway Traffic Safety Administration that it would be recalling, among others, the 2005 Chevrolet Cobalt.  A defect in the ignition switch was to blame; a defect that could prevent the car’s airbags from deploying.  The consequences of such failure of the airbags could be fatal as an October 2006 crash which killed two teenagers revealed.  Between February and October 2014, New GM recalled 60 million cars.  Later investigations revealed that engineers within GM knew of the problem with the ignition switch as early as 2002, seven years prior to the bankruptcy filing.

In April 2014, certain ignition switch claimants brought proceedings in the bankruptcy court against New GM for losses relating to the failure of the ignition switch.  New GM sought enforcement of the Sale Order to enjoin the claims and the bankruptcy court, which had approved the sale in 2009, enjoined the claims.  The bankruptcy court held that while the ignition switch claims were known to or were reasonably ascertainable by GM prior to the sale, and thus the claimants were entitled to actual notice as opposed to the mere publication notice that they received, the court held that they had not been prejudiced, which the bankruptcy court held, was an essential element of due process, by this lack of actual notice.  In other words, the court said, the Sale Order would have been entered with or without their participation.

On appeal, on July 13, 2016, the Second Circuit Court of Appeals affirmed in part and reversed in part. **1   Significantly, the Second Circuit held that while the Sale Order applied to such claims and, if enforced, would bar those claims, publication notice to those claimants who held ignition switch claims was insufficient.  Without deciding whether the ignition switch claimants had to show prejudice, the appellate court held they were prejudiced.  The Court held that they were denied the right to negotiate with either Old or New GM and with the other parties over the terms of the Sale Order and “the opportunity to participate in [such] proceedings would have been meaningful;” and given the bankruptcy court’s focus on the impact a protracted proceeding would have had on consumer confidence and the Treasury Department’s financial stake in the outcome, the appellate court concluded that their participation could have changed the terms of the Sale Order.  As a result of such prejudice, the appellate court reversed the bankruptcy court’s order enjoining the ignition switch claimants’ claims. Assuming the case is not reversed on further appeal, the possible effect the ruling may have on New GM is large:  $7 - $10 billion in claims, not including claims arising from pre-closing accidents.

The actual notice to the ignition switch claimants would have been nominal.  The failure of such notice is immense.  The takeaway is all too apparent: give every claimant the notice to which they are entitled under the due process provisions of the Constitution.  A failure to do so could be costly.

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**1   Elliott v. General Motors LLC (In Matter of Motors Liquidation Co.), 15-2844, 15-2847, 15-2848 (2d Cir., July 13, 2016).
 

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