Bankruptcy law offers distressed businesses tremendous power to force a reduction or restructuring of debts both large and small, but it has distinct limits, which recent events have thrown into the spotlight. Potential investors in the business or assets of reorganizing retailers, such as Sears, and manufacturing companies, such as General Motors, should take particular note.
Sometimes the limits are procedural, as in the rule in U.S. chapter 11 reorganization proceedings that allows debtors to keep favorable leases and reject unfavorable ones, with limited damages. The snafu is that, for nonresidential real estate leases in particular, debtors have only a maximum of seven months to make the decision with respect to all such leases or face automatic deemed rejection. Particularly for the wave of retail store bankruptcies that have arisen over the past several months, this limitation spells potential doom for reorganizing the network of far-flung storefront leases that is vital to larger, national retail chains. Such debtors frequently cannot make effective decisions as to which of their hundreds of storefront leases to retain, and they thus face losing all of them within only a few months.
More fundamental is a limitation on the types of debts that can be affected by a bankruptcy process. This limitation was and is front and center in the gargantuan and unprecedented reorganization of General Motors. For debtors facing large personal injury and environmental burdens, it may render any attempt at a restructuring futile or undo a seemingly successful one.
Bankruptcy laws worldwide generally limit their haircutting effect only to debts existing as of the date the debtor’s bankruptcy proceedings commenced. Later debts likely qualify for payment in full as claims arising either in connection with the administration of the insolvent estate or in the operation of the restructured entity. Thus, anchoring debts to a point in time before case opening is an important and sometimes less than straightforward task.
For loans and other contractual obligations, an agreement usually defines the amount of any claim, and even a known claim that has not crystalized can be assigned to the pre-commencement period and administered in bankruptcy in most of the world. Contingent claims that depend on the occurrence of a future, post-commencement event might be discounted for the likelihood of the contingency occurring in the future, but most modern bankruptcy laws draw such contingent claims within the scope of their coverage.
A key sticking point, however, involves unliquidated claims and especially latent and undiscoverable claims. Personal injury claims and environmental liabilities are perhaps the most salient examples. If the debtor has manufactured a dangerously defective product, or emitted hazardous waste, and it has injured identifiable victims, those victims certainly have claims, but they are unliquidated; that is, the value or amount of those claims will remain unknown until both liability and damages have been adjudicated. One could estimate these claims, as sometimes is done for contingent contract claims, but in bankruptcy systems that derive from English law, the concept of “provability” might exclude unliquidated tort (delictual) claims from the bankruptcy process entirely. In Australia, for example, unliquidated damages from personal injury claims are specifically excluded from administration in bankruptcy proceedings; a judgment establishing the claim amount must be signed before the commencement of the bankruptcy case for such claims to be “provable.”
U.S. bankruptcy law, in contrast, explicitly encompasses unliquidated claims, but General Motors’ case shows that some claims nonetheless remain outside the wide embrace of bankruptcy law. GM’s restructuring occurred over a period of just over one month in mid-2009. Nearly five years later, GM launched a massive recall of cars due to a major operational problem, a defect in ignition switches that could cause its vehicles to turn off unexpectedly and become uncontrollable while traveling at high speed. When owners of cars produced prior to the restructuring sued GM for personal injuries and economic loss due to this ignition switch defect, GM asserted that it was insulated from these claims by operation of the bankruptcy case.
For victims of accidents that occurred before the restructuring, and for all then-owners of vehicles devalued by the later-revealed latent defect, the Second Circuit Court of Appeals in New York held in July 2016 that these claims could be properly impaired in GM’s bankruptcy case. Indeed, even claims from accidents that occurred after the bankruptcy case could be properly impaired in advance as contingent claims, so long as the victims of those claims had a relationship with GM and the defective vehicle before the case closed. For future purchasers of used GM cars, however, who had no pre-bankruptcy relationship with GM, their claims for injuries and economic loss could not be reached by GM’s bankruptcy case because these claimants were unknown and unknowable at the time, and they could not be deprived of their rights without some process that was simply unavailable to them.
Unfortunately for GM, another procedural snafu revived even the old-owners’ claims. While the Second Circuit acknowledged that latent, future product liability claims can be addressed under U.S. bankruptcy law as contingent, the claimants are entitled to notice of the existence of the defect and potential claim, at least if the debtor knows about it. The Second Circuit approved a lower court finding that GM knew or should have known about the ignition switch defect, it therefore could have reasonably identified the owners of the affected vehicles, so it was required to provide these potential claimants with specific notice.
GM had not done this; therefore, these claims were not cut off by the bankruptcy case for lack of due process. In April 2017, the U.S. Supreme Court refused to review this ruling, leaving the GM restructuring potentially in ruins as billions of dollars of potential tort liability is unleashed on GM anew.
In evaluating the potential for bankruptcy to right the ship of a distressed manufacturer, account must be taken of the limits of bankruptcy’s remedial power. Some modern bankruptcy laws leave all unliquidated tort/delict claims unaffected, and even in the more liberal U.S. regime, the rights of unknown and unknowable future victims may well be beyond the reach of a restructuring. Bankruptcy law is powerful, but it has limits.